There are distant but still disconcerting parallels between Russia and Wall Street, says Alexei Bayer
Why Russia? Why should an economy that accounts for around 0.5 per cent of US trade send Wall Street into a selling panic?
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FRIDAY
SEPTEMBER 4 1998ÿ
Personal Viewÿ
Futurology and risk
At first glance, it is a puzzle and has been chalked up to market over-reaction. Or to the negative impact of the Russian crisis on other emerging economies. Or to political jitters as government turmoil grips a nuclear superpower.
These forces did of course contribute to the fall in US stock prices. But there is a more direct parallel between the hapless Russian stock market - which has dropped to just 10 per cent of its peak value last October - and the mighty US one. The sad story of the rise and fall of Russian equities may teach an important lesson to US investors.
When in 1993 and 1994 Credit Suisse First Boston and other brokerage pioneers began offering Russian equities to their clients, they billed them as a highly speculative investment in an economy of the future. Russia was a great story: it had a nascent democracy, a vast underserved consumer market, a wealth of natural resources, a proven scientific and research establishment and a highly educated workforce. With market reforms under way, it was certain in time to catch up with the world's prosperous economies; investors who bought into Russian companies early on stood to reap very attractive returns along the way. Even today, all this might one day be true.
But financial markets are impatient. They factor into today's prices developments that lie far in the future. When in 1996 Boris Yeltsin, perceived in the west as the father of a democratic, capitalist Russia, moved into the lead in his re-election campaign, the path toward market reforms lay clear and the Russian stock market took off. A 100 per cent increase in 1996 was followed by an even more dramatic leap in early 1997. Share prices of natural resource, telecommunications and other blue-chip companies rocketed as a matter of course; even second and third-tier industrial companies saw intense investor interest. Never mind that the companies themselves were a mismanaged pile of rubble, or that the economy stubbornly refused to grow, or that the reform process became bogged down: investors were not buying the unappealing reality of the day but the country's bright future.
It would be considered a sacrilege in some circles to compare Russian stocks to Nasdaq shares. Nevertheless, the similarity between investors' valuations of America's high-tech shares and Russian stocks begs comparison. We have all heard how the internet, for example, will in the future be the main venue for retail sales, banking, telecommunications, information and entertainment. That is why the share prices of Yahoo!, AOL, Amazon.com and scores of other internet-related companies without dividends, profits or a proven track record have been pushed into the stratosphere during recent stock market rallies. Even now, despite this week's decline, they have stayed there, even though, without a leap of faith, their market capitalisation would be completely out of line with their size or economic significance in today's economy.
The valuation of internet stocks is an extreme case, but most high-tech, computer and related "new economy" shares are priced according to their expected future role. Even Microsoft is valued so highly by the market not for its accomplishments to date - undeniable though they are - but for its dominant position in an industry expected to be crucial for the economy of the future.
Of course, stock markets always reflect future expectations. The traditional way of looking at the price of a stock is as the discounted present value of the future dividend stream and other cashflows. But there is a difference between discounting concrete predictable events over a finite time frame - cyclical movements, demographic changes, macro or microeconomic trends - and a nebulous open-ended exercise in futurology.
As the great bull market of the 1990s gathered steam, US blue-chips have become increasingly caught up in a similar timewarp. While the European stock market rally this year has been based on tangible evidence of an accelerating economic recovery and expected medium-term benefits of monetary union, US blue chips are facing a very different set of economic fundamentals: a mature recovery, tight labour markets and a long period of historically high rates of profits growth.
As the near term became clouded, the market began to look further ahead. Long-term profit growth estimates have increased from around 12 per cent a year in the early 1990s to 14 per cent a year. Justification for such optimism, once again, is found in an economy of the future, where top US companies will be able to sell their products in a single global marketplace, benefiting from their superior market position, resources and brand names, while also using the global economy to keep down production costs.
Of course, there are huge differences between Russian companies and US high tech start-ups, to say nothing of established multinationals. A Wall Street freefall on the scale of a Russian debacle is not remotely likely: with no dividend payments and no real claim on assets by shareholders in Russia, there was no floor for Russian share prices once they started to slide. There is also the question of liquidity: at its peak, the Russian market had a total capitalisation of around $100bn, a sum that flows into equity mutual funds in the US in a few months.
Nevertheless, just as in Russia, US investors are relying on discounting developments far in the future to support very high present stock valuations. While the story that underlies both high-tech shares and blue chips may be very credible, the actual transition from the present to the future is uncertain in both cases.
In fact, as the Russian crisis rebounds back into Asia and sends shockwaves through Latin America and Eastern Europe, it becomes more and more likely that the emergence of a global economy may not be as seamless, but turn out to be an unpleasantly bumpy ride. The stock market behaviour over the past week suggests that US investors are starting to come to this conclusion.
The author is president of KAFAN FX Information Services, a consultancy. |
