JAPAN SYNDROME REVISITED? (Thursday, March 01, 2001)
First there was the China Syndrome. The tale portrayed a problem at a nuclear power facility. If left unheeded, the core would meltdown and go all the way to China from the USA.
Then the "Japan Syndrome" emerged. It concerned the actual meltdown of financial values in Japan. For more than 10 years now, various Japanese Stock indices and real estate values have failed to surpass levels established more than a decade ago. What makes this actual case study germane is its application to the US and other markets. For a period, both the Japanese and United States economies and financial markets were viewed highly and cast as paradigms for others. Then the "unthinkable" became "uncomfortable". Falling values - both absolute and relative - occurred despite lowered interest rates. A few variables ascended to dominance during this time. One was reduced economic expectations and another was a stubborn consumption rate. Relatively high savings rates in Japan coupled with diminished optimism eroded equity values.
United States and Others
While it has been often said that there is nothing new under the sun, there are subtle variations on the theme.
There are important linkages between Main Street and Wall Street. Declining securities values undermine real physical growth. It does not happen overnight but rather on a cumulative basis. It may take months or even years to manifest itself as a new trend but financial values are very important.
The wealth effect is vital for the housing industry. When people feel "wealthy" they are apt to buy or trade up for their residences. This wealthy feeling is not so much absolute but relative. How does the individual feel today about today's conditions and tomorrow's expectations. The wealth effect influences purchases whereas income effects influence maintenances.
Moving from the individual level (micro-) to the institutional level (macro-), wealth or effectively portfolio effects influence lending practices, venture capital movements, insurance underwriting capacity and so forth. Banks and insuance companies are constrained by their portfolios and balance sheet shareholder - equity values as to size of loan, insurance underwriting or in the case of an investment bank - the extent of investment which ties to its regulatory capital structure and commitment capability.
When lowered interest rates fail to generate the bouyant movement or recovery in securities prices other factors have taken over as dominant variables. In today's markets, it seems that corporate profits are expected to continue to contract. If this was not the case, then a simple cash flow discounting model or analysis would suggest higher prices - not declining prices. Looking back, the NASDAQ peaked in March 2000. I is now the 1st of March 2001 and that index has fallen index has dropped approximately 60 percent.
Early this year, the Federal Reserve trimmed interest rates. This induced a "one-day wonder" bounce in equity values which have subsequently and swiftly retreated to levels below those before the latest rounds of interest rate cuts. Since March 2000 the blue chip indices have fared relatively better than more speculative or pioneering ones. This in part is due to credit and equity market accessability. IPO-type money has dried up for many aspirants. Second-round or subsequent fundings have also ebbed. Banks have tighten the reins on lending with only the higher rated firms maintaining relatively good terms for funding. Lesser or newer credits have been curtailed - if not barred completely. This condition is highlighted by the widening of credit spreads: AAA versus Junk, Developed Countries versus Emerging Markets.
Blue chips tend to lag on the downside because they are relatively more stable, have better balance sheets and cash positions, and continued preferred access to credit markets.
What does all this augur? With layoffs, cutbacks and outright failures even the blue chips will be tarnished. Smaller or financially crippled companies may cease or reduce payments to their (blue chip) suppliers, vendors, and creditors. This is already underway in the telecommunications and utility areas.
As a final thought, it may take 5-8 years before NASDAQ-like indices challenge their highs of a year ago. How can this be? Simple. By assuming a "return" to average equity appreciation rates of 9-14 percent per annum (depends on the length of sample period and corporate profiling), the "Rule of 72" indicates 8 years at 9 percent growth for a "DOUBLING" of prices, and just over 5 years at 14 percent per annum growth to attain the same doubling of prices.
With the NASDAQ around 2100 instead of 5100, it just might take a bit longer. Particularly when you factor in the negative reduction due to margining and margin interest payments. If you don't think so, just ask Japan. It has been more than 10 years and they are still counting, and waiting, and.......
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