Stock investors from London to Frankfurt to Tokyo to Singapore just can't seem to get a rally going. The Tokyo Stock Exchange has lost 52% of its value since it peaked last March. Morgan Stanley Dean Witter's index of European stocks is down 18% since its September high. Those bourses outside the U.S. that have rallied in recent months still look vulnerable for a tumble sometime later this year.
Ask traders what the problem is and they'll tell you straight out: fears of an American bear market. Just as supercharged growth in the U.S. underpinned soaring equity markets in many countries in the late 1990s, so the sudden stateside downturn is now driving most exchanges lower around the globe. "The U.S. economy has hit the brakes, and the rest of the world has to slow as a result," says Jon F. Chait, chairman and CEO of Spring Group PLC, a London-based company specializing in recruitment for the information-technology sector. "The markets are telling you that the U.S. slowdown is going to ripple round the world." The question is how scary will the undertow from the U.S. be and how long will it last.
The giant exchanges of London, Frankfurt, and Tokyo are feeling that undertow the worst. Odds are these big, developed markets will fall further--particularly if the U.S. tumbles into recession. Despite the Federal Reserve Board's recent brace of interest-rate cuts, that's still a real possibility. "The ice is very thin, and we could easily go through it," says Johannes Reich, head of equity research and strategy at Germany's private Bank Metzler. "There's little I can see to be positive about."
AMERICAN FLU? The tight correlation that now prevails among the major bourses just increases the damage. A change of sentiment on the New York Stock Exchange, with its market cap of $11 trillion, generally leads to a change of sentiment on the $2.4 trillion London Stock Exchange and most other leading exchanges around the world. Adding to the effect is the fact that big-cap European stocks such as BP Amoco, Unilever Group, or DaimlerChrysler depend heavily on U.S. earnings. The same holds true with Japan. There, exporters like Toyota Motor Corp. and Sony Corp. closely link profits to American consumers, while high-tech operations such as NEC Corp. and Softbank Corp. closely follow the Nasdaq.
Banks in Europe, which account for a large part of many continental bourses' market caps, are especially vulnerable. Schroder Salomon Smith Barney calculates that these banks are owed almost $13 billion--some 3% of their total equity--by U.S. companies that are at risk of default.
The American effect is not all-powerful. Although the U.S. stock swoon is a good predictor of what might happen to London's Financial Times-Stock Exchange 100 index, it's not as reliable an indicator of Europe's economic health. The European blue chips get 20% of their sales from the U.S., but in the euro zone, consumer and business confidence is still buoyant and growth is expected to top 2.5% this year. That's partly because there are thousands of midsize European companies that have little exposure to the vagaries of the U.S. economy. And many consumers in Europe, Asia, and Latin America don't get as scared by market jitters as they do in the U.S. because equities are a much smaller proportion of household savings.
An optimist might also point out that some stock market indexes--especially those that fell most dramatically in 2000 --have rallied since the beginning of the year. Hong Kong's "red chip" index of China-oriented stocks has surged 20% because investors reckon the companies it tracks will benefit from Beijing's forthcoming entry into the World Trade Organization. South Korea's technology-laden Kospi index has been driven 14% higher by an influx of foreign capital. Taiwan's equivalent Taiex, which lost half its value between April and December last year, is up 24% in the face of growing Chinese demand for the PCs and other tech goods that are Taiwanese mainstays. "China will be one of our most important markets," says Ted Lee, vice-president of Taiwanese chipmaker Via Technologies Inc.
PROFIT WARNINGS. The hit to stocks of exporters to the U.S., though, is quite severe. Because some 30% of Japanese exports go stateside, the downturn will knock 0.5% off Japanese gross domestic product, calculates Peter Morgan, an economist at HSBC Securities Inc. in Tokyo. Toshiba, Matsushita Communications, and NEC are just three Japanese companies that have issued profit warnings recently as U.S. demand for their goods has weakened and inventories have swollen. "There's a lot of talk about economic decoupling," says Chait. "But the truth is the opposite. Economies and stock markets are becoming more and more integrated."
Slumping equity markets are making it difficult and costly for companies to raise fresh capital. The global contagion effect on telecom stocks is especially prevalent in Europe, where big telcos have seen 50% drops in their share prices. France Telecom Chief Executive Michel Bon discovered that in early February, when he floated shares in his mobile-phone subsidiary Orange PLC. The long-awaited initial public offering brought in less than half the money initially projected. That prompted another round of telecom stock pummeling in Europe and the U.S.
Seems pretty bearish. A U.S. recovery in the second half would certainly lift the stocks of European blue chips and Japanese high-tech houses. But that hope is being eroded by the fear that the current situation--a U.S. bear market and slowdown, investor jitters everywhere--could spiral out of control. The Fed has led the world in a round of interest-rate cuts, but it will take at least six months before the cuts have a positive impact on the economy. In that scenario, Japan's problems would deepen and the European strength would run out of steam. Then global equities would probably show next to no strength until next year.
One sign that investors fear the global stock crisis could become a global economic crisis is the continued weakness of the euro. "Considering all the bad news coming out of the U.S. and the fact that the next couple of months will be bad, it is strange that the strength of the euro is not spectacular," says Jean-Pierre Hellebuyck, who manages $235 billion for France's AXA Investment Managers Ltd. Lingering fears about Europe may be one reason there is no sign of European money managers massively selling off their U.S. positions.
The next quarter will be the crunch period that determines whether the worst-case scenario materializes. "I'm relatively positive and think there is just a 20% to 30% chance that we get two or three years of nasty markets," says Klaus Martini, head of European equities for DWS Investment, a big German money manager. But with the relentless bad news about corporate earnings and stock prices grabbing the headlines, that probability seems to be rising with each passing day.
By David Fairlamb in Frankfurt and Brian Bremner in Tokyo, with John Rossant in Paris and bureau reports