In reality, when it comes to valuing equties based on current or anticipated earnings, the market is continually correcting what are perceived to be imbalances. If the Asian situation causes a distinct slowdown in business in the U.S., there is always the probability that in certain industries, sales growth will be slower than before, and profit margins may shrink due to the pressure of cheaper goods or rising costs, such as wages and benefits. One other factor is dmestic consumer spending, which accounts for approximately 2/3 of our GDP. Right now, novices and experts alike are dealing from the standpoint of ignorance under these completely new cirucmstances. This is obviously not a comfortable situation, but it is illustrative of why many company's projections of future business conditions are being given more weighting than the recently released 4th quarter earnings numbers. If one assumes that things are going to slow noticeably, then a decline in per share earnings necessitates a lowering of prices, to bring P/E ratios in line with actual growth. After all, investors may have been willing to pay 40X earnings for a growth rate of 30% per year, but if growth drops to 20%, will the same scenario apply and will a P/E of 40 be justified or accepted? Probably not. Purely domestic industries are anticipated to enjoy an advantage due to their total insulation from international factors. One might assume that sectors such as Health Care, Utilities, Retailing, Leisure, Multimedia, and Food, for example, would fall into this category, but in the end profits in any industry are not guaranteed and even this type of sector could fall if the firms within it fail to meet expectations or the bottom line suffers. It has also been assumed that the small caps would not be affected by Asia, but so far investors are not heading for these domestically based firms, but are still sticking with the more liquid, presumably safer large caps. Opinions will probably continue to shift rapidly in the months ahead, which may produce rapid and short-lived changes in sector preferences. Certainly not an easy environment to operate in, and one that should make this year very, very challenging.
Bernie Kaplan |
