A Fearful World Hopes Americans Ignore Headlines

A lot of what the financial press has been serving up lately, most Americans understandably don’t want to deal with.

Collapsing currencies? Plummeting stock prices? Deflation? Depression?

What happened to the “best economy in 50 years,” to paraphrase Federal Reserve Chairman Alan Greenspan earlier this year?

It is, of course, a lot more fun for everyone when stocks are soaring day after day than when they’re in a free fall, which is what last week felt like worldwide.

The Dow Jones industrials lost 481.97 points last week, or 5.6%, to close Friday at 8,051.68. The blue-chip index still is up 1.8% year-to-date, but at the rate we’re going that won’t be tough to erase in a trading session or two.

Many investors probably would love to still have any profit on their stock portfolios this year. While the Dow now is off 13.8% from its July 17 peak, which in Wall Street parlance merely qualifies as a “correction” (a word loaded with hope), the damage among individual stocks ranges from bad to catastrophic.

Even within the Dow many stocks clearly are in the midst of genuine bear market declines (meaning a drop of 20% or more from peak levels). Shares of aluminum king Alcoa have tumbled 30% from their 52-week high. Banking giant J.P. Morgan is down 34% from its high, Goodyear is off 35% and Hewlett-Packard is down 37%.

Investors who own smaller shares are, for the most part, in shock. Chatsworth-based MRV Communications, which makes computer networking equipment, on Friday warned that weakening sales will cause earnings this quarter to be below expectations.

MRV’s stock collapsed 53% on Friday, from $14.38 to $6.81 a share on Nasdaq, leaving the price a stunning 83% below the $39.25 some unlucky investors paid at the stock’s peak almost one year ago.

That probably speaks volumes about how investors will treat any disappointing news from companies in coming weeks, as we head into September and the usual earnings “pre-announcement” season--when firms that aren’t likely to meet Wall Street’s third-quarter earnings estimates ‘fess up.

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On the other hand, it may become more difficult to disappoint Wall Street: Analysts have been busy slashing their earnings estimates, fearful that the weakness in corporate earnings in the first half of this year has worsened this quarter.

Earnings tracker First Call in Boston says analysts, in total, now figure that operating earnings for the blue-chip Standard & Poor’s 500 companies will rise a mere 3.7% this quarter over the third quarter of 1997.

As recently as July 1, the overall estimate had been for 10% growth this quarter.

What’s more, the current measly estimate “likely will go significantly lower as analysts return from vacation and as the pre-announcement season heats up,” says Chuck Hill, research chief at First Call.

Because even novice investors understand that earnings ultimately underpin stock prices, falling estimates for near-term profit growth just reinforce many investors’ reluctance to pay up for stocks right now. Hence, the path of least resistance for the market--given all of the financial, economic and political turmoil worldwide--has been down.

Yet some market pros insist that the decline in U.S. stocks already has been overdone.

The reigning chief of the bulls, Abby J. Cohen of brokerage Goldman, Sachs & Co., once more on Friday reiterated her stance that U.S. stocks, and the U.S. economy, have a far better outlook than what recent headlines might suggest.

Russia’s crisis, Cohen insists, has “minimal direct economic consequences for the United States,” because we export very little to Russia, and because U.S. banks’ loan exposure to Russia is tiny.

Even accounting for East Asia’s deep recession, Russia’s economic collapse and the risk that Latin America is next, Cohen refuses to budge from her view that the U.S. economy is large enough to withstand it all.

“We continue to expect the U.S. economy to grow at a moderate pace consistent with ongoing gains in profits and little change in inflation,” Cohen told Goldman’s well-heeled clients on Friday.

If you trust that view, she said, then blue-chip stocks overall now are 7% to 10% undervalued.

The problem with Cohen’s analysis, ironically, may be that she’s dealing with the fundamentals--i.e., she’s trying to rationally value stocks based on expected earnings, interest rates and inflation.

But the U.S. market may have crossed into the zone where psychology--and the potential for investors to make decisions based less on fundamentals than on what they believe other investors will do--become more important than an assessment of the facts.

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To put it another way, a market that arguably paid little attention to fundamentals on the way up, as investors pushed many stocks to absurd levels versus underlying earnings in the euphoria of spring, probably isn’t going to pay much attention to fundamentals on the way down, either.

Indeed, it’s the nature of markets to overshoot in the short run. Nobody overreacts like Wall Street, whether the news is good or bad.

Can we talk ourselves into a bear market? We know smaller stocks already are there, with the Russell 2,000 index of smaller shares now off 27% from its April peak.

The Dow, as mentioned above, now is off 13.8% from its July 17 peak, which surpasses the 13.3% August-to-October correction of last year. We’re now into the worst decline since the last bear market, which occurred in 1990 after Iraq invaded Kuwait. The Dow fell 21% from peak to trough that year.

If stocks can’t stabilize in the next couple of weeks, the issue won’t be how much corporate earnings will be hurt this year by global woes, but simply how much investors are willing to lose in the market before pulling the plug.

So, yes, we can talk ourselves into a bear market--which is exactly what happened in the crash of 1987, as pessimism and fear quickly overtook a market that had been flying high for most of that year.

Talking ourselves into a recession, or worse, is another matter.

The sad fact of life for many other nations is that this year’s giant “wealth transfer” continues: As commodity prices fall, commodity-producing nations are hammered, while commodity-consuming nations--like the United States--mostly reap the benefits.

Oil, gold, lumber, meats, grain . . . it all gets cheaper for U.S. consumers. Certainly, our Farm Belt and Oil Patch suffer, but they are very small pieces of our economy as a whole, relative to their importance to the economies of many smaller countries.

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Ditto for the interest-rate situation: Long-term Treasury bond yields are at record lows thanks to the “flight to quality” by global investors into U.S. bonds. That will keep mortgage rates down, if not push them even lower.

Even factoring in the loss of export business now hurting many U.S. companies, most economists believe that U.S. consumers can continue to keep the domestic economy in growth mode for the time being.

If global financial markets can at least stabilize soon, the American consumer may find that it’s OK to ignore the desperately bad news from overseas after all. Perhaps the best U.S. economy in 50 years can keep rolling on in the face of the horrible turn of events this year for the average Russian, the average Hong Konger, the average Mexican.

On some level, the rest of the world is, in fact, hoping that we ignore the headlines and keep spending as only we know how.

More than ever, the world needs a buyer for everything that’s for sale--including stocks.

Tom Petruno can be reached by e-mail at [email protected].