The Differences This Time

News bulletin: Foreign market shocks send U.S. share prices sharply lower.

Wait a minute. We’ve been here before--twice in the last eight months, in fact. And both occasions proved to be excellent buying opportunities in the U.S. market.

So what’s different this time around? Maybe nothing. With the Dow Jones industrials down 175 points early Wednesday after Tuesday’s 150-point tumble, the selling suddenly dried up, and buyers rushed back into stocks.

The Dow ended the day off just 27.16 points, at 8,936.57. The Nasdaq composite index inched up 3.01 points to 1,781.10, after trading as low as 1,742--nearly 10% below its intra-day record high reached on April 22.

The Nasdaq index has been more indicative of the broad market trend over the last month. U.S. stocks, overall, have been sliding, even before these latest explosions in emerging markets overseas.

That, in fact, is one of the big differences this time around. In October, a strong U.S. market rally was rudely interrupted by fears that Hong Kong and China would join Asia’s currency devaluation parade. (They didn’t.) In January, a New Year’s rally was temporarily dashed by Indonesia’s economic meltdown.

This time, the disturbing economic and market news from the likes of South Korea, Hong Kong and Russia is merely exacerbating U.S. investors’ already-skittish mood about stocks.

Even without prompting from foreign events, people have been increasingly reluctant to pay higher prices for U.S. shares. That’s reflected in the tally of New York Stock Exchange-listed stocks hitting new 52-week highs. The number was 506 the week ended April 17. Last week the total was just 179.

Why are investors cooling toward the U.S. market, and is this the beginning--or closer to the end--of that cooling process?

Some analysts believe that Wall Street has simply milked the last of the benefits that accrued from Asia’s economic debacle.

The main benefit has been lower interest rates. Long-term U.S. Treasury bond yields, for example, were at 6.7% last September. The yield is 5.84% now. It has been pushed lower by declining inflation (thanks in part to cheaper prices for Asian imports) and by the belief that the Federal Reserve Board, which was poised to tighten credit last fall, would remain on hold, waiting for foreign turmoil to slow the robust U.S. economy.

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But now the Fed, and the market, are facing the reality of a very tight U.S. labor market and a still-strong economy, said John R. Williams, economist at Bankers Trust New York.

In other words, the slowdown the Fed hoped would happen, didn’t. So Fed governors have been ever more vocal in recent weeks, warning of the probability of higher interest rates ahead.

“We’re in a Catch-22 situation: The equity market can’t do well if the Fed tightens. But unless the equity market sells off [hurting the economy as well] the Fed is going to tighten,” Williams said.

“Investors are thinking this is a no-win situation,” he said.

Another U.S. benefit from Asia’s economic nightmare has been the flood of low-priced imports into the United States, as Asia’s devalued currencies--and the dollar’s concurrent strength--have automatically made many items manufactured in the region cheaper for U.S. buyers.

That has been great news for American consumers with money to spend, of course. In effect, it has amounted to a giant wealth transfer from already-devastated emerging economies to the economies of the developed world, mainly the United States and Europe.

But that wealth transfer has limits, economists have warned. Cheaper imports mean more competition for American companies that compete with emerging-market exporters. (Think clothing.)

“What markets might be telling us is that what’s ahead is a real struggle for market share among emerging Asia, emerging Latin America and emerging Eastern Europe,” said Douglas Cliggott, U.S. equity strategist for J.P. Morgan Securities in New York.

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The bigger problem, however, is that the currency devaluations that have pauperized East Asia--and may do the same for Russia soon, and perhaps Latin America as well--mean fewer customers for U.S. exporters.

Prices of key commodities--oil, grains, metals, lumber, etc.--have been falling sharply over the last month, as Asian demand has waned. Stocks of U.S. companies involved in those businesses have led the market’s fall since late April. (See story, D4)

“One thing that is very clear is that industrial pricing is fading fast,” Cliggott said.

Worse, the U.S. high-tech sector--a value-added industry, rather than a commodity producer--has been among the hardest hit by Asia’s problems, as orders for computers and other equipment have fallen off.

The squeeze on U.S. corporate profits from weaker exports and the general lack of product pricing power on one side, and the tight-labor-market-induced rise in U.S. wages on the other side, is no secret: First-quarter corporate profits rose at the slowest rate since 1991.

Yet stock prices continued to advance anyway, lifting the Dow as high as 9,211.84 at its recent peak--a 16.5% gain since Jan. 1.

What the broad market’s decline of the last month is suggesting, analysts say, is that investors now are questioning what stocks really are worth, if the first-quarter profit slowdown fails to give way to faster profit growth later this year--or worse, if an even greater profit squeeze is ahead, should the U.S. economy now slow, and should sinking economies in Asia, Latin America and Russia further depress global demand.

“To me, the question is growth--where is the profit growth going to come from?” says Marshall Acuff, investment strategist at Salomon Smith Barney in New York. He believes that 1998 profit weakness will be one of the catalysts behind a decline in the Dow index to 8,000 by year-end--a 10.5% drop from current levels.

Other analysts, mindful of the strengths inherent in this bull market, wonder if this pullback, like the last two, won’t just blow over quickly. The Dow is off just 3% from its high, but many stocks have already fallen 10% or more from their peak prices. And cash still is flowing into our market in a big way, from U.S. mutual fund investors and from foreigners, buttressing stocks. (Foreigners love what a stronger dollar does to their U.S. investments.)

“I’m in the ‘just-dragging-along’ camp” in terms of U.S. market outlook, Cliggott says.

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The Federal Reserve, meanwhile, is almost certainly happy with the idea of a continuing stock market decline, many economists say. What the Fed hopes is that American investors will feel a little poorer, restrain their spending, and cause economic growth to ratchet lower in the months ahead.

Still, the risks are clearly rising: The U.S. economy must slow enough soon to wipe out worries about higher interest rates, but with stock prices still near record highs relative to underlying earnings, the economy must not slow so much that concerns about a collapse in corporate earnings become overwhelming.

Otherwise, the explosions in developing markets this week may be the least of Wall Street’s problems.

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Tom Petruno can be reached by e-mail at tom.petruno@latimes.com.

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Here We Go Again?

Wall Street and stock markets worldwide were hammered early Wednesday as economic and financial turmoil in Russia, South Korea and Hong Kong darkened investors’ collective mood. It’s the third such emerging-market-triggered stock swoon in eight months. The Dow Jones industrial average’s trend since Sept. 1, and details on the three market crises:

October: East Asia’s financial crisis explodes as currencies and stocks plunge. Rumors that Hong Kong might devaluate trigger a 554-point, 7.2% drop in Dow index on Oct. 27, to 7,161. But the Dow moves back above 8,000 by early-December, supported by falling bond yields.

January: Indonesia’s crumbling economy triggers currency meltdown, dragging other Asian markets lower again. The Dow slides 222 points, or 2.8%, to 7,580 on Jan. 9. But strong fourth-quarter profit reports quickly help lift market, as Asia appears to stabilize.

Now: Dow falls 175 points, or 1.9%, early Wednesday, responding in part to plummeting markets in Russia, Asia and Latin America on new economic worries. Dow recovers to close off just 27.16 points, at 8,936.57. But the broader U.S. market has been waning since April 22, as investors worry about corporate profit growth amid weak economies overseas and a strong dollar.

Source: Bloomberg News, Times research.