Call it the market equivalent of
foot-and-mouth disease.
The bearish pox that has afflicted tech and telecom is spreading rapidly to other sectors, laying low indices like the
Dow and the
S&P 500, both of which are laden with the sort of Old Economy companies that were never part of the
Nasdaq mania. The Dow has sunk 8% in five days and the S&P is now 25% below its 52-week high. Is the selling of fuddy-duddy companies just blind panic that will reverse itself, or are investors deciding that all sectors' earnings are going to get hit hard in an economic slowdown that is fast becoming global in nature?
Detox takes the latter view.
Mostly Noise
Wednesday's slippage was sparked by rumors of bank collapses in Japan. Sure, any possibility of a financial system meltdown in a $4 trillion economy like Japan's is going to spread its fair share of fear through markets. But worries about Japanese banks have been around for a decade now. Old fear is nowhere near as potent as new fear. Maybe the old fears have simply intensified. Let's suppose the financial system there does implode under a weight of bad debts and leads to an Asia-wide depression and competitive devaluations across the region. That eventuality would certainly hurt U.S. firms and justify Wednesday's grim action.
A crisis that deepens but stays localized would still hurt America, but only temporarily. U.S. firms are hardly dependent on Japan for revenue: The country has recently accounted for only 8% of U.S. exports, compared with 23% and 21% for Canada and the European Union, respectively.
Of course, Japanese firms may repatriate some of the huge sums they have recently invested in U.S. corporate and agency bonds to shore up their balance sheets before their financial year ends on March 31. But buoyant bond prices and a remarkably resilient dollar suggest that this selling so far hasn't been large enough to rock the bond markets. In fact, after March 31, the country's economic political instability, along with increased money creation, could push more Japanese cash to the U.S. in search of shelter.
It makes sense, therefore, to look for a culprit closer to home. Rumors of forced stock sales by a troubled hedge fund are bouncing around, but people aren't convinced. The rationale for the selloff, then, could be a lot more prosaic, but all the more ugly: a broad-based profits slump.
We all know tech and telecom earnings are falling apart. But an inadequately publicized decline in earnings power has taken place in other areas, as the Bubble Economy unwinds in much the same way as the Nasdaq. In July last year, analysts expected S&P 500 earnings to grow 15.5% in 2001, according to
First Call/Thomson Financial. They're now expected to edge up 2.3%. Strip out tech and the forecast 2001 growth rate still declines, from 14% in July to 6% now.
Real Illness
In fact, some Old Economy sectors are looking rather ill, particularly consumer cyclical companies, whose earnings are now forecast to slide 3% in 2001, way below the 14% increase expected seven months ago.
The market melt implies that other sectors' analyst-projected earnings increases won't occur. The sell side is still expecting financials, for example, to post 12% earnings growth in 2001. The buy side, judging by the 5.4% decline in the
KBW Banks Index Wednesday, and that index's 16% drop from its peak, isn't so sure. The optimistic estimates for financials are probably based on the support that could come from lower rates. But easier money doesn't help, especially if banks have to charge off against profits billions of dollars of bad loans.
At its Wednesday close of 1166, the S&P 500 trades at around 20 times expected 2001 earnings. That means companies in the index should produce around $58 of earnings this year, if estimates are to be believed. But if earnings estimates come down by 20% to around $46, that P/E ratio goes up to 25 times, a generous multiple in any era, let alone one of near panic.
If the S&P were to trade at a more reasonable, considering investor expectations, 15 times those lowered earnings estimates, it would be at 690. Make no mistake: Now that
Nasdaq 1500 is in sight, Detox's new prediction is the S&P at 700. That's 40% downside from here. You heard that right.
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Peter Eavis
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