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A GLOBAL REALITY CHECKWhere is the market headed? How worried should you be?From New York to Hong Kong, from Frankfurt to Sao Paulo, from Moscow to Kuala Lampur, the message of the decade was simple: The road to riches is paved with stocks. Indeed, most world equity markets have thrived as nations opened their economies, bolstered exports, and invested in productivity enhancing technology. But for a few days in late October, that belief was sorely challenged by a meltdown in Hong Kong that left no nation's equity market undamaged. That included the U.S., where the Dow Jones industrial average suffered its largest one-day point decline in history. But investors seem to be reaffirming their faith in stocks. Individual investors, through mutual funds and brokers, responded to the Dow's 554-point plunge on Oct. 27 with a torrent of buy orders. ''I'm buying,'' said 70-year-old Rita Kane as she shuffled her walker into a brokerage office in Boca Raton, Fla., to purchase mutual funds for her grandchildren. WOUNDED. Individual investors couldn't repair all the damage. After all, the Dow shrunk by nearly 900 points in just three trading days. On Oct. 28, the Dow shot up 337 points; the NASDAQ Composite index also took back more than half its loss; and battered technology stocks returned even more forcefully. Buoyed by Wall Street's rebound, prices around the globe strengthened. In the U.S, the sharp pullback may not be over. There's plenty of skittishness in the market, which even favorable comments from Federal Reserve Chairman Alan Greenspan on Oct. 29 couldn't dispel. Still, this downdraft is more likely to be a correction than the start of a bear market. Corporate earnings are still growing, inflation is low, and investor appetite for stocks remains healthy. That said, it could take a year for the Dow to breach the all-time high of 8259, reached less than three months ago. The reason: The market has lost its momentum. ''We will not be cured from Monday's wound in one day,'' says Frank E. Baxter, chief executive of Jefferies Group, an institutional brokerage firm. The momentum began to slow last summer. Stocks had reached valuations that were difficult for even the most bullish of strategists to rationalize. The stocks in the Standard & Poor's 500-stock index were selling at 20 times next year's earnings, with giants like Coca-Cola, Gillette, and Microsoft at least double that. But, the argument went, in a world of low inflation, steady economic growth, and increasing productivity, U.S. stocks were worth it. But maintaining the lofty valuations required that nothing go wrong. ''The market had been priced to perfection,'' says David H. Thompson, director of funds management at BankBoston. In early October, Greenspan raised the possibility that he would hike interest rates. Then, market-leading tech stocks began to sputter as questions arose about slowing demand for chips and personal computers. With the Dow north of 8,000, the U.S. market was dry tinder, the Asian crisis, merely the match. ''SCREAMING BUYS.'' Still, it surprised many that a problem on the other side of the globe could have such a profound effect in the U.S. ''The Tiger countries are a relatively small piece of the global economy,'' says Gail M. Dudack, chief equity strategist for UBS Securities. ''But when you add in Hong Kong, Japan, and China, they have a much bigger global impact.'' Indeed, the U.S. and European stock markets largely ignored Asia's woes until the thought-to-be invincible Hong Kong market cracked, too. Even if the Asian stock markets stabilize, it will take several years at least for their underlying economies to regain strength. Corporate earnings will fall, bankruptcies will rise, and economic growth will slow significantly. The plunge in Latin markets also had its origins in the Far East. Fund managers, fearful of massive redemptions, were unable or unwilling to sell depressed Asian shares, so they cashed in Latin American and even Russian blue chips that had not yet been hit. In fact, the sell-off in Latin America has created ''screaming buys'' in Mexico, Brazil, and Venezuela, says Walter Molano, director of economic and financial research at SBC Warburg Dillon Read. Latin stocks trade at less than 13 times 1998 earnings--attractive share prices in a region with 5% average annual growth in gross domestic product. Even though only 7% of Europe's exports go to the Far East, the Continental stock markets also suffered from the Asian contagion. Europe's economic fundamentals are improving, though concerns about the German elections and the move toward a single currency make recoveries in Germany and France a bit iffy. Still, with a major restructuring of European companies under way, many strategists say there's a lot of value in European stocks. In the end, however, what happens in the U.S. market will set the tone for the rest of the world. And the fundamentals for the U.S. remain strong. Blue Chip Economic Indicators' survey of 50 economists projects U.S. GDP growth next year at 2.5%. That's down from about 3.6% this year. But it should allow earnings to rise by 8% compared with 12% in 1997. Despite slower earnings growth, low inflation and stable--or even falling--interest rates should push stock prices higher. How high? Abby Joseph Cohen, the Goldman, Sachs & Co. investment strategist with a sterling record on this bull market, estimates that the S&P 500 should hit 1050 in 12 months for a gain of 14%. It's now 919, down from a 983 high. PaineWebber Inc. strategist Edward M. Kerschner looks for a 10% rise in the S&P by late 1998. Both strategists see an 8% increase in corporate operating earnings for 1998. Cohen assumes an S&P price-earnings ratio of 20.5, which she maintains is well within the historical parameters for periods of low inflation. True, Cohen's assumptions on p-e ratios and earnings may seem high in the light of the recent shakeup. But the deflationary fallout from Asia could well dampen inflation more than expected and further reduce interest rates. As rates go down, p-e ratios go up. Nor are the earnings forecasts extraordinary. In fact, when forecasts are collected from analysts who follow companies, the projected gain is more than 14%, according to First Call Corp. Where the cooling market will have an immediate effect is on takeovers. Many deals, such as WorldCom Inc.'s bid for MCI Communications Corp., were to be financed with stock that has lost some purchasing power. Some 73% of takeovers in the first nine months of 1997 relied on stock for more than half of their financing, according to Securities Data Co. IPOs ON ICE. Initial public offerings could feel the chill, too. October was a record-setting month for initial public offerings--IPOs raised about $5.5 billion. But there's reasons to believe coming months will be slower. Shares of recent IPOs dropped twice as much as the Dow on Oct. 27. And even on the 28th, as stock were recovering, 13 of 20 scheduled IPOs were put on ice. The market's chill hasn't done much to cool the ardor of individual investors. Buying stocks in near-panic situations is becoming almost second nature. Certainly, it's been a profitable strategy since the October, 1987, stock market crash. ''The one thing I've learned is that when the market goes down, you don't pull your money out,'' says Adolph Reed, a 34-year-old telecommunications operations technician from Mesquite, Tex., and an investor for the past six years. ''You put money in.'' He's adding $500 to a $12,000 mutual-fund account. Reed's response is exactly what managers in the $4 trillion mutual-fund industry want to hear. There's been much concern about how investors in the 20 million additional households that have purchased funds in the past 10 years would react if the market turned ugly. Through media campaigns and investment missives, fund companies have been toughening up their shareholders for pullbacks and warning that the 20%-to-30% gains of the past few years are good fortune and not entitlements. While calls to fund companies surged, redemptions did not. ''Investors had been expecting some pullback,'' says Jeffrey S. Molitor, head of portfolio review at the Vanguard Group. ''This doesn't come as a great surprise.'' What remains to be seen is the impact of the sell-off on future fund flows, one of the market's key sources of liquidity. It's not just the $500 fund investors who are looking to buy. Peter LaMaster, 42, of Indialantic, Fla., a Cadence Design Systems Inc. exec with a near-$1 million portfolio, says he has amassed a $100,000 pile of cash, just waiting for a drop that would create new bargains. On his buy list are tech stocks he never considered cheap enough before: Intel, Hewlett-Packard, and Microsoft. LaMaster says he will take his time getting the money to work. But Peggy Ruhlin, a Columbus (Ohio) financial planner, says a client expecting a $100,000 payment in two months borrowed that much on margin to invest in an index fund now. Many value-oriented pros also jumped at the opportunity. Edwin Walczak, who runs some $300 million in large-cap value stocks for Vontobel USA, had let cash build to $90 million because he thought stocks were too high. But on Oct. 27 and 28, he opened his checkbook. He added to holdings in Wells Fargo, Disney, and Gannett, and even reestablished holdings in Coca-Cola Co., which he had sold earlier this year when he thought the price got too high. ''There's no great change in the fundamentals of my stocks,'' says Walczak. ''It's just the valuations.'' Perhaps investors are still looking to bargain hunt because they're feeling good even though their portfolios took a trip to the markdown counter. Says LaMaster: ''I just got a raise and a promotion. My company sees tremendous opportunity. Things are looking good.'' And even after the recent slide, the S&P 500 is still up 24% for the year--and more than double where it was less than three years ago. With returns as strong as they have been, it will take more than a correction to turn investors away from equities.
By Jeffrey M. Laderman, Suzanne Woolley, and Kerry Capell in New York, with bureau reports RELATED ITEMS
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Updated Oct. 30, 1997 by bwwebmaster
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