While the public watches the disintegration of Mother Russia, the smart money is focusing on the real culprit for the latest market troubles: Japan.
Although most analysts blamed Thursday's global market slide on the Russian economy, the downturn can be traced to the 3 percent decline in Tokyo's Nikkei average the day before. Stock traders around the world took that dip as a sign of continuing weakness in worldwide equities.Once again, the Asian contagion is infecting us all. In a nutshell, Japan's inability to resolve internal political conflict and solve its banking crisis is keeping global markets from recovering.
Until Japan gives us a signal that it's able to correct its failing banking system, we can expect more of the same.
Two months ago, it looked like Japan might be pulling out of its funk. The global markets enjoyed a four-week rally, beginning in the middle of June when the Tokyo stock market rallied from a spring low of 14,715.38.
The ensuing rally took the Nikkei up to 16,570.78 by July 17. The Japanese market held that level for a few days before plunging anew.
U.S. stock markets also topped out around that time and have been struggling since.
The Japanese market collapsed because investors were disappointed by the new government's inability to deal with its chronic banking problems.
Foreign investors fled Japan to the safe havens of the U.S. and European markets.
What investors didn't understand was the tight relationship between European stock markets and financial stability in Russia. That relationship is very tight due to the massive amounts of money Europeans have loaned Russia. German banks alone hold over $30 billion of Russian debt.
The recent economic collapse in Russia surprised everyone. European markets were especially vulnerable. Because of Russia's collapse, the European markets lost their status as a safe haven for scared Asian money.
As a result, traders worldwide are losing confidence in equities and are running to the safety of bonds, which are guaranteed by governments.
This trend was evident Thursday. In the first hour of Tokyo trading, the Japanese stock market quickly fell through key support at 14,774 and proceeded to fall to 14,413.79. A support area, by definition, is a level where traders are likely to buy back in to the market.
The flight to quality could be seen in U.S. markets, where the yield on the U.S. 30-year treasury bond hit a 25-year low, indicating a mass influx of buyers.
What is behind this global meltdown? Simply, the supply of goods and services are exceeding the demand.
Since July 1, 1997, demand for goods and services in Asia has shrunk as those economies suffered from currency devaluations,
higher interest rates, and bank failures. And because Asian countries were unable to export due to disappearing bank liquidity, imports into Asia also fell.
What investors need to focus on is the cause for Japan's problems, the lack of demand which is causing an atmosphere of deflation. Deflation is an economic condition in which prices continue to drop. This causes consumers to delay major purchases, expecting the price reductions to continue. Of course, less purchasing is bad news for businesses and a downward spiral begins.
Deflation is one reason consumer demand is falling in Japan. Until the Japanese government implements policies that will increase consumer demand, such as permanently lowering taxes, the Japanese stock market will fall.
This deflation fear is vibrating globally. We have not experienced anything like this since the '30s. In reality, there is no real deflation in the United States. However, the markets are forward looking vehicles that attempt to anticipate future events.
The current breakdown in the Japanese stock market suggests that additional selling will occur in the South American, Mexican and Canadian stock markets. This is the real danger for the future of the American stock market.
Our greatest trading partners are Canada and Mexico. If their markets continue to plunge, a recession in those countries will soon follow, providing further distress for American exports.
U.S. markets can expect to be battered further because it is likely that corporate earnings estimates will again be lowered for the fourth quarter of 1998 and first quarter of 1999.
How low could the markets fall? First the Dow could challenge the 7,700 level and the S&P 500 could test the 965 area before a meaningful bear market rally commences. After that, who knows?
Dist. by Scripps Howard News Service
Dow still down
The Dow Jones Industrial Average struggled Friday to bounce back from Thursday's 357-point plunge. The Dow, at one point up 78.53, gave up its gains and threatened to fall below 8,000 for the first time since Jan. 30. Traders began buying at that level, and with two hours of trading remaining the Dow was down just 33.98 at 8132.01. Trading on the nation's exchanges was heavy.