Jess: I have to agree with you with respect to the Japanese but I think you are taking it a bit too far with respect to the Chinese and their willingness to devalue the yuan. They have a whole different agenda and devaluation would seem to be counter to that agenda. The Japanese, on the other hand, are bordering on taking the hari-kari route to redemption for some reason which as a westerner I will never understand. Anyway, I enjoy your commentary. I like this guy Applegate's commentary on Japan:
Headline: U.S. Investment Strategy: Japan: Attempted Suicide? Author: Jeffrey M. Applegate 1(212)526-4585 Company: Country: MKT CUS Industry: NOINDU Today's Date : 06/15/98 * We are cutting our 1998 S&P 500 operating EPS forecast to $47 from $48 and 1999 EPS to $51 from $53. Expected EPS growth is 4% this year and 8% next.
* We are also modestly reducing our after-tax profit margin forecast for the S&P Industrials to 6.6% from 6.7% this year and to 6.9% from 7.0% in 1999.
* Our new year-end price target for the S&P 500 is 1200 and the Dow Jones Industrials equivalent is 9800.
* Our expected total return from the S&P 500 is now 26% for the year and 11% to year end,for the 30-year Treasury, 13% for 1998 and 6% to the end of the year, and for the shorter duration bond, 9% for the year and 5% to year end.
* Domestic asset allocation remains unchanged at 75% stocks, 25% bonds, 0% cash.
JAPAN: ATTEMPTED SUICIDE?
Nearly. The news out of Japan is getting worse rapidly. AndTokyodoesnothing. Quite astounding. The Asian recession and Japan's paralysis are worse than we'd originally forecast. Commodity prices are a good deal lower than we had thought. And the dollar is a good deal stronger. Over time, the Asian recession should help reduce the cost of goods sold for U.S. corporations along with market share gains in Asia. Near term, however, we are for the second time this year modestly reducing our expected 1998 U.S. equity return to 26% from 28%. Our new, lower year-end price target for the S&P 500 is 1200. Asset allocation remains unchanged at 75% stocks, 25% bonds, and 0% cash. As much as it pains us to be writing about Japan again probably as much as it pains you to read it Japan's current suicide attempt is the major global and U.S. equity investment issue. What's astonishing is that we're watching a destruction of wealth as epic as it is needless. Tokyo acknowledged that it has a banking problem half a year ago. As any decent shrink will tell you, when the patient goes from denial to acknowledgment, they're usually well on the road to recovery. Tokyo then put in place a rescue institution along the lines of the U.S. Resolution Trust Corporation. They said they would fund it to the tune of $240 billion. But as recently as this week, the policy chairman of the Liberal Democratic Party said there would be no bank bankruptcies in the near future. And today, when queried about the yen, Prime Minister Hashimoto complained that the United States needs to pay more attention to its current account deficit. Hello! Anybody home? So apart from $13 billion in bank rescue funds that's largely been wasted, Tokyo continues to dither. The markets, however, aren't. So the yen crashes through 140 as the Nikkei hovers barely above 15,000. Our calculus about the dynamics between Japanese policymakers and Japanese asset prices remains the same: when falling currency and stock prices are painful enough, Tokyo will respond. And we still don't think that the worst case scenario China devalues is the high probability scenario (see Asia, Act 2, U.S. Strategy, May 29, 1998). But the latest yen swoon makes the rest of Asia's recovery more problematic. It is fostering another wave of commodity price deflation. And it will likely further slow global growth. In the United States, all this remains ample reason for the Federal Reserve to stand pat as Chairman Greenspan told us this week, noting the substantial drag from Asia. Which is in the process of getting more substantial. This should also mean that the United States continues to not intervene to stabilize the yen. Treasury Secretary Rubin's intervention policy is fairly straightforward: you intervene when the fundamentals are with you; you don't when they aren't. He reiterated that sensible policy this week. Even President Clinton, probably on cue, praised the Chinese for not devaluing. Presumably, the Clinton Administration is not saying all this stuff in expectation of China devaluing. More goods deflation and slower growth prompted a big bond rally. The 10-year Treasury is now below Fed Funds and the yield curve between the two year and the 10-year is inverted, barely. To our knowledge, there's no precedent for this, absent Fed tightening. It is a measure of the market's concern about deflation, a concern that appears more acute than any we can recall. This is leading some people to worry that much slower U.S. growth lies ahead; maybe even a recession. We don't believe one should get too carried away with this kind of reasoning for several reasons. From the late 1960s through the early 1980s, a flatter yield curve was usually the harbinger of slower growth. But that hasn't been the case in the 1990s; nor was it in the 1950s and early 1960s. When inflation is this low, you usually get flattish yield curves alongside good growth. Historically, an inverted yield curve has preceded U.S. recessions. But the yield curve isn't yet inverted. Moreover, looking through our data on interest rates, when the curve inverted it was because the short end went through the long end (i.e., the Fed was tightening to create a recession to fix an inflation problem). In 1998 by contrast, we believe that the demand dampening and deflationary impact of Asia's recession on the U.S. economy will prompt the Fed to cut the Funds rate a quarter point by year end. Asia's near-term impact on U.S. stocks is largely negative, primarily raising concerns about a profits recession. Earnings preannouncements for the second quarter look only marginally worse than usual: 91% of the 69 companies that have preannounced are negative surprises. That compares with an average of 88% at a comparable time point for preannouncements during the last four quarters. However, the Asian recession is worse than we had originally forecast, the dollar a good deal stronger, and commodity prices lower. While there will ultimately be some benefits from Asia for U.S. corporate profits lower cost of goods sold and a larger Asian market share we believe it is prudent for us to modestly reduce our profits forecast and expected equity return for the second time this year (see Modestly Reducing Our Year-End S&P 500 Price Target, U.S. Strategy, May 15, 1998). We're cutting our 1998 S&P 500 operating EPS forecast to $47 from $48 and 1999 EPS to $51 from $53. Expected EPS growth is 4% this year and 8% next. Underlying that, we're also modestly reducing our after-tax profit margin forecast for the S&P Industrials to 6.6% from 6.7% this year and to 6.9% from 7.0% in 1999 (see related comments, Profit Margin Hiccup). Since there is no change in our interest rate or inflation forecasts, we're sticking with an expected forward P/E on the market at year end of 23. Bottom-up EPS expectations for 1999 are still in excess of $56 way too high, we believe. We expect that will degrade considerably to $52, as analysts adjust to the Asian recession, falling pricing power, and a stronger dollar. Accordingly, our new year-end price target for the S&P 500 is 1200 ($52 times 23 P/E). The Dow Jones Industrials equivalent is 9800. Our expected total return from the S&P 500 is now 26% for the year and 11% to year end. For the 30-year Treasury, it is 13% for 1998 and 6% to the end of the year. For the shorter duration bond we own in our portfolio, expected return is 9% for the year and 5% to year end. Accordingly, domestic asset allocation remains unchanged at 75% stocks, 25% bonds, and 0% cash. We, along with everyone else on the planet, are waiting for the light bulb to go on in Tokyo. ----------------------------------------------------------------------------- Disclosure Legend: A-Lehman Brothers Inc. managed or co-managed within the past three years a public offering of securities for this company. B-An employee of Lehman Brothers Inc. is a director of this company. C-Lehman Brothers Inc. makes a market in the securities of this company. G-The Lehman Brothers analyst who covers this company also has position in its securities. |
