I'll take any money that my bank will credit to my account.
Here's a piece to think about:
John Dorfman
Tue, 9 Jun 1998, 3:22pm EDT
BN 6/9 'You Ain't Seen Nothin' Yet,' an Economist Warns: John Dorfman
'You Ain't Seen Nothin' Yet,' an Economist Warns: John Dorfman
(John Dorfman is a Boston-based money manager with Dreman
Value Management LLC in Red Bank, New Jersey. The opinions
expressed are his and don't represent those of Bloomberg LP or
Bloomberg News. His firm or its clients may own or trade
investments discussed in this column.
Boston, June 9 (Bloomberg) -- Corporate profits have risen
eight years in a row. What would happen to the stock market if
they fell?
That's a question investors ought to be asking. Profit
growth has been slowing for three years, and now is almost at a
standstill.
This earnings slowdown occurred while the U.S. economy was
growing fairly fast. But some economists predict a U.S. economic
slowdown in the second half. One who makes a strong case is
Stephen Slifer of Lehman Brothers Inc.
The trade deficit is ballooning, Slifer says, and
inventories are building up fast. Put those two things together,
and it makes a second-half slowdown likely. His fears make sense
to me.
''You Ain't Seen Nothin' Yet'' is the title of a May 22
report by Slifer and his colleagues Ethan S. Harris, Joseph T.
Abate and Joel S. Kent. The title refers to the impact of the
Asian economic crisis on the U.S. economy.
Tiger Slump
It was last October, about seven months ago, that Americans
first heard of an economic crisis in the emerging economies of
Asia, the so-called ''Tiger'' countries such as Thailand,
Indonesia and South Korea. Their currencies plunged, and their
stock markets cratered.
U.S. investors immediately became alarmed, and sent the Dow
Jones Industrial Average reeling for its first 10 percent tumble
since the Saddam Hussein bear market of 1990. But when nothing
immediately happened to the U.S. economy, investors breathed a
sigh of relief and bid stocks up to records.
They may have relaxed too soon. In March, the Lehman
economists wrote that ''it will take several more months for the
shock from Asia to work its way from the traded goods sector, to
manufacturing output, income and employment.''
In congressional testimony last month, Federal Reserve
Chairman Alan Greenspan said ''the effects of the Asian crisis on
the real economies of the immediately affected countries, as well
as our own economy, are only now just being felt.''
How are they being felt? Slifer spells out some of the ways.
''Already at a record size, the (trade) deficit set a new record,
widening from $12.2 billion in February to $13 billion in
March,'' he wrote. ''Since the Hong Kong stock market crash in
October, the trade deficit has widened every month for a
cumulative increase of almost 50 percent.''
Feeling strapped for cash, Asian consumers and companies are
cutting back on their purchases of American computer equipment,
cars, food, and almost everything else. At the same time, the
Asian countries are desperate to export. And their fallen
currencies make their exports very cheap in the U.S.
Trade Balance
Asia accounts for virtually all of the $4 billion worsening
of the trade balance since October, Slifer says. He warns,
though, that ''this is only the beginning of the shock from Asia
.... We believe that more than half the adjustment is still to
come.''
The buildup of inventories in the U.S. is a second brake on
the economy, the Lehman crew says. The domestic U.S. economy
looked very strong in this year's first quarter, up about 4.8
percent from the first quarter of 1997. However, much of the gain
was due to companies building up their inventories.
''The surge in inventory investment virtually assures slower
GDP growth in the second quarter,'' the Lehman economists wrote.
''At $95 billion, first-quarter inventories are piling up at a
record rate and are growing at more than three times their long-
term trend.''
It doesn't take a genius to see that if cars are piling up
on dealers' lots, car sales will slow within months. The same
applies to the economy as a whole.
Implications
Let's think about the implications for the stock market if
Slifer and his colleagues are right. There are only two ways
stocks can go up -- if corporations earn higher profits, or if
investors are willing to pay a higher multiple (price/earnings
ratio) for those profits.
Most of Wall Street expects corporate profits to rise in the
second half. If they fall instead, it will come as a rude shock.
Investors are already paying the highest multiple on record,
as judged by the P/E on the stocks in the Standard & Poor's 500
Index, which is trackable back to 1926. Could the multiple go
still higher? Conceivably, although that would probably require a
decline in interest rates. In their March meeting, the Federal
Reserve governors said they were leaning toward raising rates,
zot lowering them.
Slifer avoids spelling out what his concerns mean for
corporate profits, perhaps because he doesn't want to clash with
Lehman's strategist Jeffrey Applegate. Applegate is predicting
more stock market gains ahead, partly because he sees ''steadily
rising profit margins and profit growth.''
Applegate may be right. But I don't think so. When imports
are flooding into the U.S. and exports are trickling out, to me
it stands to reason that it's going to be tough for businesses to
show glowing profits. With inventories high, it's even tougher.
Three-Year Slowdown
Anyway, the fact is that profit growth has been slowing for
three years now. From the first quarter of 1994 to the first
quarter of 1995, profits for all U.S. corporations, public and
private, rose 28.5 percent, according to the U.S. Commerce
Department. The following 12-month period they rose 9.4 percent,
the one after that 6.5 percent. The latest quarter showed only an
estimated 1 percent profit gain.
To me, what it all adds up to is that corporate profits,
after rising every year for the past eight years, could fall in
either 1998 or 1999. I can't escape the conclusion that this puts
the ebullient stock market in peril.
If the U.S. market should get crunched, stocks with high
price/earnings ratios will probably suffer the most damage; they
usually do. These days, that includes not only the speculative
technology and biotech names, but also such well-known stocks as
Gillette Co. (trading at 47 times earnings in the past 12
months), Coca-Cola Co. (50) and Lucent Technologies Inc. (205).
Traditionally, stocks with high dividend yields hold up best
during market declines. I'd pay extra attention now to such
groups as the oil stocks, real estate investment trusts -- and
even stodgy old utilities.
--John Dorfman (617) 964-2026 through the New York newsroom.ltk
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