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A Global Crisis of Confidence?


These days global markets are playing follow the leader, with foreign bourses tracking the U.S. in an almost uncanny way. There's just one problem: The U.S. may be headed for rockier times, taking the rest of the world with it. "Overseas and U.S. markets have risen high enough in tandem that's there almost no chance they won't be dragged down together further," says Jeremy Grantham, chairman and chief strategist at Grantham, Mayo, Van Otterloo in Boston.

No wonder investors around the globe have a bad case of the jitters. The Standard & Poor's 500-stock index is down 28% so far this year and is experiencing the longest bear market in 60 years. And there's little sign of any relief. Indeed, the three months through Sept. 30 was the worst quarter in 15 years for U.S. stocks, with the S&P down 17.6%. Markets in Germany and France have fallen more. And while those in Japan, still mired in a long recession, performed a little better, the Nikkei 225 is still down 13% for the year in yen terms and 6.8% in dollars.

The funk is by no means over. In the two weeks ended Sept. 25, U.S. investors yanked another $6 billion out of domestic equity funds and $4 billion out of global and foreign funds.

This growing buyers' strike by investors is a nagging worry to policymakers. They fear that plummeting stock markets could pull economies down in their wake. At the late-September International Monetary Fund meeting in Washington, D.C., world finance ministers called on the U.S., Europe, and Japan to rebuild investor confidence. Private economists are starting to push the panic button, too. Stephen Roach, chief economist at Morgan Stanley, says he fears a double-dip recession in both Europe and Japan. On Sept. 30, he slashed his estimates for Europe's gross domestic product growth next year to 1.5% from 2.7%.

Not much help from the U.S. is in sight. Investor confidence remains at a very low ebb. Every day brings more headlines about fat-cat corporate crooks and truth-impaired Wall Street analysts. There's been a steady barrage of earnings warnings since mid-September across a broad spectrum of companies: McDonald's (MCD), J.P. Morgan Chase (JPM), and Electronic Data Systems (EDS). And, even when good profits are reported, investors are skeptical because of the recent accounting scandals.

Furthermore, corporate profits are losing momentum because of the sluggish economy. At the start of the year, analysts figured third-quarter earnings of S&P 500 companies would rise 23.9% from a year earlier, according to Thomson Financial/First Call. By July 1, they had cut their estimates to 16.6%. Now they expect just 7.3% growth. They still estimate fourth-quarter growth of 20.6%, but First Call expects those will be nearly halved by mid-January.

Some analysts argue valuations are still high, meaning the market could take another year to find a bottom. "Considering the magnitude of the bubble and the riskier world we live in, that wouldn't be unusual," says Charles Pradilla, chief investment strategist at SG Cowen Securities Corp.

The potential of war with Iraq has hurt markets all over. That's especially true in Europe, which is far more dependent on Mideast oil than the U.S.

Foreign markets have their homegrown demons, too. In Europe, unemployment remains high and consumer spending is growing at only about 1% a year, one-third the U.S. rate. Structural change is slow to come because stiff labor laws make it difficult to idle plants and lay off workers. "You don't see European businesses making major adjustments," says Nick Sargen, who is chief global strategist at J.P. Morgan Chase & Co.

Given the meltdown in once-sizzling industries, there's plenty of gloom. On Sept. 26, Germany announced it was closing down its high-tech stock market, the Neuer Markt, after it lost almost all of its value in a two-and-a-half year slide. Meantime, telecom companies have lost about half their market capitalization this year. European telecoms are staggering under huge debts--France T?l?com alone has $70 billion worth--and seem unlikely to grow much.

For insurers, another large sector in Europe, falling equity prices have become a critical problem. They invest more of their portfolios in stocks than their U.S. counterparts--about 25% on average vs. 4%. A slump in equity prices cuts their profits; even worse it erodes their solvency ratios.

Many strategists say that an interest rate cut from the European Central bank would help the stock markets and the economy. But inflation, as well as wages, has ticked up. "The ECB has a singular focus: keep inflation low. But they may be faced with a deflationary liquidity trap," says Richard Pell, chief investment officer at Julius Baer Investment Management in New York.

In Japan, the outlook is even worse. Economic and financial trends continue to be grim. Prime Minister Junichiro Koizumi's government, in power for more than 18 months, hasn't delivered on promises to fix the bank crisis.

Is there any glimmer of good news? Despite the 1987 crash, October is sometimes a turning point in the U.S. stock market, according to the Stock Trader's Almanac. Once the crop of profit warnings is out of the way, some companies at least may start reporting stronger earnings growth. And for the struggling markets and economies of the world, that would be a big relief--provided it happens. By Marcia Vickers in New York, with David Fairlamb in Frankfurt and bureau reports


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