Brazil's Economic Turmoil Might Pass Unnoticed by U.S. Stocks
By Justin Lahart
Senior Writer (TheStreet.com)
1/13/99 6:23 PM ET
This morning, a doomsday scenario was not hard to construct.
Not with the news that Brazil had, in effect, devalued its currency. Not with word that its central banker, Gustavo Franco -- the guy the International Monetary Fund loved -- quit. Contagion effects. Currencies falling like dominoes. Capital flight. The same old drill.
It looked awfully grim as the opening bell approached. Brazil's real was down 9%. Sao Paulo's stock market had halted after the Bovespa dropped more than 10% at the open. With money running into the Treasury market for cover, the S&P 500 futures were down the limit. When the opening bell rang at the New York Stock Exchange, stocks fell off a cliff.
And climbed right back. After being down as much as 34.05 to 1205.46 in the early going, the S&P ended the day down just 5.11 to 1234.40. The Nasdaq, down 115.06 to 2205.69 in the morning, closed down a scant 3.94 to 2316.81. As if the world economy were pretty much the same today as it was yesterday, which it is not.
Goldman Sachs economist Gavyn Davies estimates that even if Brazilian authorities get their act together and climb back on the economic-reform wagon, the real nevertheless will devalue by about 25%. This would knock 0.2 of a percentage point off world economic growth for this year. If they don't get their act together, the real could fall by as much as 50%, shaving world GDP growth by 0.5 of a percentage point.
On top of this, there are the worries about contagion. Capital is leaving not just Brazil but all of Latin America today, and that puts pressure on other currencies in the region, most notably the Argentine peso. At the same time, there are renewed concerns in the Far East. Already troubled by the failure of mainland-based Guangdong International Trust & Investment, traders in Hong Kong today were faced with the news that Guangdong Enterprises and its Hong Kong affiliate may be unable to make forthcoming debt payments. Guangdong province is supposed to be the hotspot in China, and news of difficulties there is disconcerting. And while China continues to publish good growth figures, other figures (like electricity consumption) suggest that its economy is reeling.
Institutions Now Look to Buy the Dips
But there is a sense that none of this matters all that much. If the U.S. stock market has proven anything since the Asian economic crisis first broke in 1997, it is that foreign shocks are not enough to derail it. And if the U.S. stock market has proven anything since the troubles first arose, it is to buy on dips. Selling on something like today could be a mistake.
"You have to be careful," said Seth Tobias, general partner at Circle T Partners. "A lot of people have been caught in the past selling into these emotional blowoffs and think, 'Geez, I should have been buying.'"
What's amazing is that it's come to the point where this is more than just a retail-investor or hot-money phenomenon. "There's a big mindset on the Street to buy on the dips, and it's transferred from the retail investor to institutions," said Richard Bernstein, chief quantitative strategist at Merrill Lynch. "I got several questions [from institutions] this morning asking, 'Is it a buying opportunity if stocks go down?'"
Meanwhile, other factors are helping buoy the market. This January, cash is coming in like never before -- $2.74 billion came into equity funds in the first week of the month, according to AMG Data Services. Meanwhile, it still looks like fund managers still have above-average cash positions, according to research by J.P. Morgan, and, with new money coming in, they will be anxious to lower them. Asia, Russia, Long Term Capital Management, Brazil -- in the face of this powerful dynamic, liquidity trumps all. Or so it seems.
Then there is the sense that if anything untoward happens, the Fed will fix things. "People think the cavalry will come riding in," said Bernstein. "They view the U.S. stock market as a call option -- no matter what goes on, the Fed will save the day."
And there is the U.S. economy -- it is not just stocks that have weathered global turmoil well. Despite frequent calls for a slowdown ever since the Asian economic crisis broke, GDP continues to show healthy growth -- for 1998 it should have added about 3.5%. If Asia could not hurt it very badly, Brazil will not either. "If total U.S. exports went to zero, it would take about 0.2% out of [U.S.] GDP," said Josh Feinman, global markets economist at Bankers Trust.
It's brought us to a point where it is hard to figure out what it would take to really hurt U.S. stocks. Shocks abroad have not done the trick. Nor have slowing earnings. Which leaves people like Bernstein deeply troubled.
"It is virtually impossible to say the stock market is undervalued or fairly valued," he said. "Especially when the group that is leading the market is the Internet sector. How can you argue it's a rational market when that's happening?"
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