What a Drag!

S.C. GWYNNESmack in the American heartland, far from both Wall Street andAsia, the 15,500 workers of Harnischfeger Industries, based inSt. Francis, Wis., got slammed from both directions. A proudworld beater that builds mining equipment and huge machines thatproduce 70% of the world's printing paper, Harnischfeger has justseen its sales to Singapore and other troubled Pacific Rimcountries drop from $600 million a year to nearly zero. Itsstock, riding high at $44 a year ago, was beaten down to $16 inlast week's market rout, gutting the 401(k) retirement plans ofmany of its employees. What I have in Harnischfeger stock isdown by two-thirds, says a glum Dave Trench, 57, a machinerystock attendant at a Harnischfeger subsidiary in Nashua, N.H.When I look at retirement, I might start to sweat. At least hestill has his job--for now. Harnischfeger announced in late Augustthat it soon will begin dismissing 3,100 employees, or a fifth ofits work force.Look at Harnischfeger, and you can see the origins of the stockmarket's grinding 1,698-point decline, a loss of 8% from the July17 peak of the Dow Jones industrial average at 9337.97. Thecompany also offers a glimpse of what might come next, asAmerican workers and investors like Dave Trench wonder whetherthe long boom is over. Should they pull their money out ofstocks? Does the market slide foretell a recession? How is any ofthis bad news possible when the U.S. economy seems so strong,with the lowest unemployment, inflation and interest rates seenin a generation?Like American business generally, Harnischfeger entered thisturmoil strong and lean. Well-managed with a skilled andproductive work force, it had prospered from the past decade'sexplosive growth in global freedom and commerce. But then camethe currency crisis that began in Thailand in July 1997 andspread like a contagion through the rest of Asia--and last monthto Russia and last week to Latin America, hammering down localcurrencies and slashing demand for U.S. exports. Cheaper Asianexports began grabbing more and more domestic business away fromU.S. companies and sliced into their earnings. That trendfinally drove down an overheated stock market, taking back, inthe past seven weeks, almost a quarter of the $9 trillion thatstocks have pumped into U.S. portfolios during the roaring '90s.When the Dow plunged 512 points last Monday, investors at firstregarded it as an irrational response to the financial andpolitical turmoil in Russia--a vast country that still bristleswith 7,000 strategic nuclear warheads but whose economy scarcelyrivals that of the Netherlands and accounts for less than 1% ofU.S. exports. Investors treated Monday's market action as anotherof those dips in which they had been taught to buy stocks onthe cheap. Heck, it wasn't even as big as the one-day dip lastOct. 27, and the market had shrugged that one off within sixweeks before powering to new highs and greater glory.With that in mind, bargain hunters on Tuesday sent the Dowrebounding 288 points, in the second-largest single-day pointgain in history. President Clinton, for whom rising stocks havecovered a multitude of sins these past six years, tracked the Dowanxiously as he traveled to beleaguered Moscow. During a dinnerwith Russian President Boris Yeltsin, Clinton stopped economicadviser Gene Sperling in the receiving line to tell him, quietlybut with palpable relief, that the market's up and flashed athumbs-up sign.But this time things were different. The Dow fell Wednesday. Andthe next day. And the next day, losing ground for the seventhtrading day out of the previous eight and posting a 411-point, or5%, setback for the week. Despite the release last week of freshreports chronicling persistent low unemployment and rising ordersfor factory goods, anxiety spread from the stock market to thereal economy of jobs and paychecks. The market drop served as areminder--one about as subtle as a poke in the eye--that in today'sglobal economy, not even a healthy U.S. can quarantine itsfactories and offices and markets from the illnesses of countrieshalfway around the world. It vividly showed Americans how theturmoil in Asia and Latin America is slashing the profits of U.S.corporations, which might be forced to respond with layoffs andcutbacks in spending.PAGE 1||||Federal Reserve Chairman Alan Greenspan, speaking after themarkets closed last Friday, revealed that Fed policymakers areworried that the threat to the U.S. economy from global financialturmoil rivals the danger of wage and price inflation. The Fed isnow as likely to cut interest rates, he hinted, as to raise them.It is just not credible that the U.S. can remain an oasis ofprosperity unaffected by a world that is experiencing greatlyincreased stress, Greenspan said in a speech at the Universityof California, Berkeley. Then he headed off to join TreasurySecretary Robert Rubin in a meeting where they urged Japan's newFinance Minister to deal with his country's insolvent banks andother financial troubles, which are dragging down not only thehuge economy and financial markets of Japan but also those ofother Asian countries--and now the U.S.Only 21 months ago, with the Dow at 6500, Greenspan was warningagainst irrational exuberance in the stock market. Severalother wise elders expressed hope that last week's correction willhave the cleansing effect of strengthening the historicrelationship between stock valuations and the earnings of theunderlying companies--a notion that had fallen out of favor afteryears of momentum investing, in which all that mattered wasthat someone would buy the hot stock that some greater fool wouldsoon bid up to an even higher price. The price-earnings ratio forthe S&P 500 has approached a record 30 this summer, twice itshistorical norm. Securities analysts, reassessing the impact ofthe turmoil in Asia and other foreign markets, last week beganchopping down their estimates for growth of U.S. corporateprofits, to as little as 3% for all of 1998, and zero growth for1999, a sharp drop from last year's robust 12%.In a bit of lucky timing, Fidelity Investments, the mutual-fundgiant, last week rolled out a promotional and educationalcampaign starring Peter Lynch, its legendary fund manager. Lynchwas troubled, he told TIME, that in the first half of this year,the S&P 500 was up 15%, but [corporate] profits were down. Healso expressed relief that the correction came now, rather thanhaving the market drop to 7500 after it's gone up to 14000.There was remarkably little evidence of panic among individualinvestors last week. One measure of that is the amount of moneythat flows in and out of equity mutual funds. In August, a monththat included several gut-wrenching weeks, there was a netoutflow of $5.4 billion, or well under 1% of the total investedin equity funds. Though this was the first such exodus since therecession and stock slump of 1990, the number is still quitemodest when compared with the 4% that fled equity funds after theOctober 1987 correction. Last week investors pulled a net $6.2billion out of stock funds Monday and Tuesday, but on Wednesday anet $6.5 billion flowed right back as the market bounced,according to Trim Tabs Financial Services. There has not beenany retail panic as far as we can see, says Scott Chaisson, abranch manager for Fidelity in midtown Manhattan. There seems tobe an awareness that there are going to be ups and downs likethis.The real test, though, won't come until later, when new investorsface the results of their first sustained market decline. Anunprecedented 43% of adult Americans are now invested in stocks,up from only 21% in 1990. (That helps explain why we are hearingless Schadenfreude over the discomfort of Wall Street yuppiesthan in past corrections.) A striking 57% of all household assetstoday are allocated to equities. Small wonder: the market hasdoubled just since 1994. But these investors are about to getaccount statements showing declines of 20% to 30%. Even if theyhave been in the black over the past 12 months, not to mentionthe past few years, it will be a shock to be reminded, for thefirst time in years, that stocks can go down as well as up.Investors large and small who had put money overseas in search ofdiversification, or simply higher returns, were sorelydisappointed last week. Day after day, one giant U.S. bank afteranother came forward, like sheepish A.A. members fallen off thewagon, to confess they had succumbed to the lure of big returnsfrom Russian investments on which--surprise!--the Yeltsingovernment has defaulted. Citicorp announced that its earningsfor the third quarter will be cut by about $200 million inRussian losses. The price tag at Bankers Trust, about $260million; at brokerage firm Salomon Smith Barney, $360 million inthe past two months.All told, U.S. financial institutions had losses mounting to $8billion by week's end, and one of the fears that drugged thestock market was that U.S. companies might face even largerlosses in Latin America, where they have much more exposure(about a third of U.S. exports) and where currencies came underfresh assault late last week. Brazil saw $11 billion in capitalfleeing the country in the past five weeks--not because itseconomy is weak but because of each investor's fear that otherinvestors might flee any economy slurred with the labelemerging. Money also fled the stocks of financial institutionswith lots of business and investment in the emerging markets.Citicorp's stock dropped to about half of its recent high, losing$40 billion of market value.|PAGE 2|||Other companies that took major hits were transportation stockswhose business involves trade and travel: the parent companies ofsuch airlines as American, United and Delta. Companies likeCoca-Cola, Procter & Gamble and Gillette, which not long ago werepraised for their successful penetration of global markets, lastweek were punished harshly through stock sell-offs. GeneralElectric, the world's most valuable public corporation and one ofthe most admired, fell 22%, losing $68 billion of its marketvalue.The near panic over emerging markets was strongest among some ofthe hedge funds, the high-risk vehicles that often deliver highreturns to wealthy investors. After famed investor George Soroslost $2 billion in Russia, John Meriwether's Long-Term CapitalManagement announced that it had lost $2.1 billion, or half itsasset value, so far this year. Russia and Asia became thetrigger for the correction in the U.S. stock market, says DavidWyss, chief economist at DRI/McGraw-Hill, a consulting firm.Although there had already been a softening in earnings over thepast few quarters, traders needed to be hit with a two-by-four tomake them realize you just can't get double-digit increases inearnings every year.Russia also became the trigger for another concern, at oncepolitical and economic: We were suddenly threatened by an oldfear--the Soviet Union and militarism, says John Silvia, chiefeconomist at Scudder Kemper Investments. If the world is not aspeaceful as we expected, then a lot of money in the U.S. thatwent into consumer spending and capital investment may now haveto go back to defense, and that's going to shock the budgethere.As the Dow ended its week at 7640.25, it was approaching one ofthe standard benchmarks for a bear market: a 20% drop from aprevious peak. Many investors, though, have been in a quiet bearmarket for several months; that's because, during the last stagesof the run-up in the Dow and the S&P 500, most of the increasewas accounted for by such large companies as Coca-Cola andMicrosoft; many smaller stocks were left behind. In the S&P 500,virtually all the gains in share prices in recent months weremade by the 50 largest. At the same time, the Russell 2000 indexof smaller stocks--traditionally favored by many individualinvestors--was off 29% from its April high. And as of Monday, theaverage stock on the New York Stock Exchange was off 38% thisyear. Even before last week, nearly half of U.S. domestic stockfunds were losing money for the year.Several economists see the current market as an untraditionalbear market or, as Harvinder Kalirai, an economist at theconsulting group I.D.E.A., sees it, what's happening on WallStreet is a cyclical bear in a secular bull market. This is acyclical fluctuation. The longer-term or secular trend in themarket, though, is still higher.Many individual investors also hold that faith. Dennis Lese, 52,an executive with Amoco Corp. in Chicago, says that he is stayingin the market but that the six-figure losses he suffered lastweek have caused him to postpone his planned early retirement. Iwas thinking about retiring and living off stocks, he says. Butnow I think I'll work a few more years.Others seemed content to ride it out, in the knowledge that thegains of the past few years will cushion the impact of a downmarket now. Anyone with brains knows the thing to do is to sitback and wait, says Stephanie Rubin, 52, an executive with asearch firm in Chicago who has about $300,000 in stocks. If it'sdown 25% on paper, it doesn't bother me because it's money tiedup in an IRA account. I'm not going to touch this money till I'm65.Some people who were actively playing the market, however, weresinging a different tune. I was panicking, said Alan Herkowitz,39, a New York systems analyst and a self-described short-termtrader who invests play money in the market.One of the biggest worries in a sustained market downturn is thatit might depress consumer confidence and spending. Contrary topopular belief, though, big stock market drops alone rarelyherald recessions. According to a study by Peter Temin, aneconomics professor at M.I.T., falling stock prices directlycaused only one minor economic downturn in this century, in 1903.But a slumping stock market can certainly add to the drag on aslowing economy, through the so-called wealth effect. In arising market, economists estimate that for every dollar ofincreased wealth, consumers spend an additional 4[cents]. Andthey often stop spending that money when their stock gainserode. If $2 trillion has been lost from investors' pockets overthe past seven weeks, then at 4[cents] on the dollar we couldexpect an $80 billion drop in annual consumer spending, or about1% of the total U.S. economy. While that alone is not enough tostop the economy from growing, economists say, it could combinewith the global currency crisis to tip the U.S. into recessionlater this year or in early 1999.A persistent stock market decline can also hurt the economy bymaking companies more cautious about expansion and hiring. Ifthe stock price isn't doing well, says John Lonski, chiefeconomist for Moody's Investors Service, shareholders will putpressure on management to cut costs to improve returns. Thatusually means layoffs and plant closings, which ripple throughthe economy as laid-off people cut spending.||PAGE 3||Pushing against these negative currents, fortunately, is thepersistent, fundamental strength of the U.S. economy. The trendin wages and employment, which wield far more influence overconsumer confidence and spending than stock prices, remainsstrong. As she placed a tortilla warmer in her shopping cart lastweek at a store in Nashville, Tenn., Sue Allison, 53, a publicrelations officer for the Tennessee supreme court, observed thatthere are a million people out tonight spending $90 on nothing,just as I am. My husband and I won't touch [our retirementstocks] for at least 15 years, so I don't worry about short-termlosses. In fact, aside from corporate profits and stock prices,most other leading indicators are pointing briskly upward. Ordersfrom American factories rose 1.2% in July, the strongestperformance since November. As investors around the globe soughta safe haven for their capital, long-term interest ratescontinued their slide to 5.3%, a silver lining for the U.S. inthe cloud over emerging markets. Those low rates in turn haveboosted the used-housing market, which recorded an all-time highof houses sold in July. Housing values, another important factorin Americans' calculation of their wealth, are rising smartly atabout 5% a year. Unemployment stands at 4.5%, nearly a 28-yearlow, and only 1.8% for those with college degrees. Thanks torising productivity, real wages have been rising for the firsttime in nearly three decades without spurring inflation. The U.S.growth rate, while down from its feverish 5.5% in the firstquarter, is still expected to register 2%-plus for the rest ofthe year. The only skunk at this picnic is the Asian, Russian andLatin financial crisis, estimated to have knocked about 2.5percentage points off second-quarter growth of 1.5%.If recession comes, economists say, the cause will be theinability of countries such as Brazil, Indonesia, Malaysia,Mexico and Venezuela to buy as many U.S. exports with theirdevalued currencies--and the hit on U.S. wages and corporateearnings as cheap imports from those countries grab a greatershare of the U.S. consumer's wallet.At Nucor Corp., a $4 billion North Carolina steelmaker, theglobal tumult has hit home in both ways. Nucor's exports aredown, falling globally from an annual rate two years ago of700,000 tons to the present 30,000 tons, much of which isaccounted for by Asian markets. But far more worrisome is thetough competition in the U.S. market from cheap steel made inJapan, Korea and Russia. Currency devaluations in those countrieshave made their products cheap for American buyers, says chairmanKen Iverson. The U.S. is the only economy left that's doingwell, so they're going to ship it all here. That makes Americathe consumer of last resort--a lifeline to many foreign economies,but at a heavy cost to many U.S. companies and workers. Again,such disruptions quickly get capitalized into stock prices: Nucorshares have fallen from $61 a year ago to $39 last week.Another North Carolina company feeling the pain is Beacon Sweets,which makes, among other products, gummi watches (gelatin candyin the shape of a watch). Although most of its business isdomestic, Beacon had begun to grow in China, Korea, Singapore,the Philippines and Japan. But over the past year, Beacon hasseen its export business evaporate. Says Stephen Berkowitz, anexecutive vice president: Our business in those countries hasabsolutely dried up as a result of currency devaluations.Perhaps the greatest risk to both the U.S. and global economiesis that today's hard times could bring a rising tide of globalprotectionism, including controls not only on trade but also onflows of capital. With the leadership in Russia and Japanvirtually paralyzed, and President Clinton distracted by hispersonal problems, there is a danger that the trend toward freermarkets could be reversed. This is already happening in placeslike Malaysia, which last week imposed foreign-exchange controlshurtful to multinational firms in the U.S. and elsewhere--not tomention to Malaysia itself, which will be hard pressed to attractinvestment. Nor is the U.S. immune. If unemployment begins torise, blame will quickly attach to the rocketing U.S. tradedeficit--one of the most immediate effects of the crisis inAsia--and will tempt members of Congress to impose new limits onimports. That, more than any other factor, could eventually leadto a significant recession in this country and others. What weneed is leadership, says Hugh Johnson, chief investmentstrategist at First Albany, a brokerage firm. Without it, wehave a vacuum, and the market always hates that.|||PAGE 4|For Clinton, much is at stake. The rising market and robusteconomy have long boosted his approval rating and made both hisallies and his adversaries loath to cross him. A significantdownturn in the economy, or a longer stock decline than expected,could make Americans feel much less patient with his foibles, andcould embolden his enemies. Studies of polling show that a soureconomy in 1973-74 contributed significantly to Americans'disgust with President Richard Nixon in the later stages of theWatergate scandal.For American investors too, much is at stake. One of the worstthings they could do is let rising volatility and uncertaintydrive them out of stock investments. Returns on stocks have faroutdistanced most other investments over time, producing anaverage annual return, after inflation, of 6.4% from 1927 through1995, which includes the period when stocks struggled to regainthe highs they reached before the 1929 crash and the GreatDepression. Investors can also take heart that the stock marketusually bounces back far more quickly than it did in the 1930s.In nine of the 11 months where the S&P 500 lost 4% or more sinceOctober 1987, returns were positive with-in two months of thedrop. In all cases, including the 1987 crash, the market returnedto positive returns within six months. As TIME's Dan Kadlecexplains in the following story, most investors should stay withstocks, except when handling money they might need within thenext three years.For all its problems, Harnischfeger offers encouragement toother Americans at this uncertain time. Folks at the Wisconsincompany have earned higher wages and have been able to educatetheir children better because of the profits they have reapedfrom the unprecedented spread of global commerce and free trade.But the price of that prosperity is a global economy sointerlinked that the troubles of America's trading partners veryquickly become its troubles too, even when America's domesticeconomy is showing remarkable resilience, as it is now.Harnischfeger's managers believe they are in for a rough ridefor several quarters, but that the company's future, like thatof the American economy, is bright over the longer term. SaysFrancis Corby Jr., the company's executive vice president forfinance and administration: We'll bounce back. They alwayshave.||||PAGE 5