Has to time come to pass out the life jackets?

Kiplinger's Personal Finance Magazine, Nov, 1998

When you're on top of the world, the only direction is down. So it shouldn't be a surprise that when the world started shaking in August and September, the U.S. stock market got weak in the knees. What put us on top of the world and sparked all the talk about a new era was earnings growth so strong that it acted like a mainline shot of steroids to stock prices. Consider that between 1992 and 1997 earnings for Standard & Poor's 500-stock index grew by an annualized 12.5%, versus the historical norm of 6% to 7%. No wonder we felt like Jack hanging over the bow of the Titanic, shouting, "I'm king of the world!"

THE CAUSES. We were cocky even though we knew that since this time last year the water was mined with icebergs. For reasons of overcapacity, overlending and a dash too much corruption, capitalism just didn't take in promising apprentices to the new world order such as Malaysia, Thailand and Indonesia. Their currencies now rest at the bottom of the Pacific, and many in their nouveau middle classes have been pushed back to subsistence living. That caused a hiccup last fall in our own stock market, but onward and upward we went.

Then in August some big icebergs in the form of troubles with the second-biggest nuclear power and the second-biggest economy started to rub against our hull. The bottom fell out of the Russian ruble as it became clear that Russia was the first country to fail at both communism and capitalism. But Russia buys a tiny fraction of U.S. exports. The real problem is Asia's economic anchor, Japan, which has sunk deeper into recession and is in denial over a massive banking crisis. Add to that sympathetic dives in Latin American currencies and stocks, and the same problems starting to plague our largest trading partner, Canada.

The news seems grim. The most optimistic spin is that the heavily "at-risk" areas of the world represent only 14% of U.S. profits. The pessimistic take is that when you include Latin America and Canada as endangered, 80% of the world market for U.S. exports is either in recession or slowing sharply.

Our stock market understandably retrenched as earnings forecasts for the S&P 500 were methodically pared back this year. A consensus of analysts polled by First Call now sees earnings increasing 5% in 1998, down from a forecast of 14% in January. By September, stocks on the New York Stock Exchange and Nasdaq were down an average of 40% from their 52-week highs, a casualty count disguised by the strength of the S&P 500 and the Dow Jones industrials.

THE FUTURE. Psychologically, the low point may have come in late September, when Wall Street's biggest firms chipped in $3.5 billion to rescue an aggressive hedge fund, Long-Term Capital Management, whose imminent failure could have rocked stock and bond markets anew. Meanwhile, the good news is that, according to the calculations of Lehman Brothers' Jeffrey Applegate, 60% of the world gross domestic product rests in the relatively prosperous U.S. and Western Europe. And, he says, almost nine-tenths of U.S. corporate profits come from those two areas.

Looking forward, the keys to resuming the bull market are accelerating earnings and stanching the wounds of our big trading partners. If our trading partners can learn to stay afloat and earnings stabilize by the end of the year, look for markets to set new highs by early 1999.

But if key players such as Japan can't get their act together, the global recession deepens and deflation takes hold, reserve yourself a seat in the nearest lifeboat.