Latin American Meltdown?
By Stacey L. Bradford
Will Latin America be the Asia of 1999? That was the question on everyone's mind Wednesday as Wall Street came to grips with the Brazilian government's decision to effectively devalue its currency, the real. Although Brazil's economic situation has been sketchy for many months, many had hoped an International Monetary Fund bailout package would help keep the real afloat. But when Brazil's central bank chief quit Wednesday morning sparking the devaluation, markets worldwide plunged on fears that the turmoil would spread across the South American continent and ultimately ripple through the U.S. economy.
The markets recovered from their worst declines by the end of the day Wednesday, but investors were left with that queasy feeling so reminiscent of last summer's hand wringing over Asia. Will the crisis in Brazil indeed spread throughout Latin America and ultimately reach U.S. shores? Two of our ranked pundits, David Jones and Ed Kerschner, Face-Off on the issue.
YES!
"The one dangerous feature is that it is impossible to discount the effect of this crisis. The problem has lasted longer and is more widespread than Asia in the summer of 1997."
-- David Jones,
Aubrey G. Lanston
NO!
"Investors need to realize that neither Asia nor Latin America is enough to offset the strength in the U.S. economy."
-- Edward Kerschner,
PaineWebber
U.S. investors should not ignore the trouble in Brazil. The country's economy represents almost half of Latin America's total gross domestic product. Consequently, the devaluation of the real will push all of Latin America into recession. The recovery we were hoping to see in emerging markets in 1999 has just been delayed.
I don't think Brazil alone is a major market event. There is nothing happening in Brazil that was not already anticipated by the markets. Even if the problem spreads throughout Latin America, it is still not an event for the U.S. What happened in Brazil was a change in sentiment not in fundamentals.
The U.S. stock market will suffer a severe hit. What we are seeing is that although weakness in the Brazilian economy is not new, it has not already been priced into the market. The region will have a depressing effect on global growth as well as on U.S. corporate profits. Maybe we'll start the year at 3% GDP growth and end it at 0%.
The devaluation of the real was expected. Brazil's market had already priced it in and multinational companies have been positioning for it. Investors should focus on the fact that 80% of S&P 500 earnings come from the U.S. and Europe. And as long as these two regions remain stable, U.S. corporate profits should continue to grow at a moderate and steady pace.
The bottom line for U.S. banks is that they are at risk of being left with bad debt. Financial institutions have lent some $19 billion to Brazil and now that the currency is devalued, the borrowers will have trouble repaying the money. This will hurt the banks' profitability. We have already seen this happen in Russia. It could have a negative effect on the stock market and indirectly cause consumers to spend less.
The reason the stock market reacted to this news is not because it represents a disaster for the U.S. economy, but because U.S. markets are overvalued. At current prices, the stock market is no longer that attractive and is therefore vulnerable to any precipitous change in sentiment. It's possible that this news could even spark a 5% to 10% correction. According to my models, the S&P 500 should end 1999 at 1250, a level I consider to be fairly valued.
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