Gregg, excellent post. Helpful.
I guess I share with Ramsey the view of being bullish on Q longer term but bearish on the market, intermediate term. For the same reasons as he, basically. I started moving from worry to action 2-3 weeks ago. Did a lot of private e-mailing. Didn't want to p**s everyone off.
There are of course tradable rallies, such as the one we are currently in.
Basically I think there are now three Asian contagion scenarios.
1) East Asian economies are in a deep and painful recession. While there are frights, the really large Asian nations, Japan and China, avoid financial calamities. Fears are raised in the U.S. but generally the reduced demand from Asia provides our economy with a soft landing and escape from overheating. Profits are somewhat restrained generally, and certainly hurt in companies that export to or compete with East Asia. Commodity producers, chip and chip equipment makers. The known suspects. Asia starts recovering by 4th quarter 98. Korea and Thailand first.
2) East Asia recession, financial crises and currency devaluations have spreading effects through out most of the developing word. Commodity producers generally go through recessions. Deep scares of financial collapse in many parts of the world shock financial markets, but the U.S., Europe and Japan hold firm. The cumulative effects of recession in much of the world, and slowdowns elsewhere creates a profits recession of some depth throughout most of U.S. industry through 1999.
3) Add to 2 a Japanese banking collapse, which cause sharp and deep financial panics in the U.S. and Europe. Much unwinding of leverage. Contraction of credit due to both a loss of financial liquidity and pronounced uncertainty. World recession, including the U.S. and Western Europe. Stocks keep going down for a year at least, in legs. Then the sky brightens, birds chirp again, etc.
My bet is scenario 2. Wall Street is moving my way. Certainly a risk of scenario 2 is being priced in, as is some risk of scenario 3. Especially on panic days. Whether we have scenario 3 depends mostly upon the Japanese, really. I think Greenspan and Rubin are repeatedly telling them that. And will again Friday in San Francisco.
While I think scenario 3 is possible, I think there is very, very little chance of it developing into anything near the severity or length of the 30's debacle. Largely for the reasons you mentioned, as well as because of much better knowledge at the Federal Reserve and the Treasury as to how to manage the overall economy.
I think the growing odds of a longer and deeper profits recession, i.e. scenario 2, together with the frightening unknowns of widespread overseas financial meltdowns, is what is responsible for this sharp correction.
Specifically, I think the likelihood that corp. profits will improve generally in 1999 is being seriously rethought. More like 2000, at best. So we will have two whammies to valuations. Estimates for next year, generally, go way down. And any honest assessment of 3-5 year growth rates (multiples) must also go down. (This honesty will be slow to be articulated by the sell side analysts, probably very slow, but the markets will be getting the idea.) And the risk premium, due to a very much shakier international situation and hobbled US leadership goes up. A lot of this last has already occurred.
It seems possible to me that the Q stands against this storm. Due to the operating leverage effects of its improving margins, etc., as you have ably explained. Specifically, the large earnings surprise which Greg expects in the coming quarter will be rewarded. But the degree and location of its overseas exposure has got to cut the other way. Forward looking guidance will be carefully attended.
Unlike Ramsey, I do not think that a Hong Kong or even a Chinese devaluation will have horrible consequences for the US. Would be shocks, to be sure. And probably would cause some deepening of the profits recession. I doubt it would precipitate any real recession. I also think there is a better than even chance that China proper toughs it out and doesn't devalue. For prestige and confidence reasons, as well as because devaluation would only confer mixed blessings to their import/export situation.
What I do fear is a collapse of the Japanese banking system. Given its extremely precarious financial situation. And given the stalemates, confusion, and lack of vision in Japanese government leaders. Unfortunately I think there are some very uncomfortable parallels with Hoover in his dealings with our 1930's banking crisis. From denial, to rigid thinking, to confusion and a loss of confidence.
I imagine that very many US banks wish mightily that they could eliminate exposure to Japanese banks these days. But know that to start to do so would precipitate the very crisis they are afraid of.
Despite the risk, I suspect that a Japanese banking collapse will not happen. If it does, its the one thing that could throw the US and Europe into a real and deep recession.
Net net, a rally is on. This bear has somewhat more down to go. How long it will take for an enduring bull to re-emerge is hard to say. It will certainly be way before Asia is really out of the woods. It will not be in a few weeks. Meanwhile there is money to be made in trading and in individual very good long stock selections, decently timed. As well as puts and shorts, I suppose.
My best guesses, anyway.
Your inputs and judgments are invaluable.
Thoughts and/or critiques from all appreciated.
Regards, Doug |
