January 20, 1998
Dow Jones Average: 7873
S & P 500 Index: 979
Asia
The cascading economic crisis in Asia has stunned the public and the
investment community. Everyone is wondering what happened to the "Asian
Economic Miracle". Over the past few months we have read countless articles
about Asia and talked at length with experts on this region. We do not
pretend to be experts ourselves in Asian matters, but we do have a few
observations to share in this update.
It seems that Asia's strengths have become weaknesses or at least masked
underlying problems. People in Asia are known for saving a large portion
of their income. These savings have fueled the economic boom in Asia,
providing the capital for new factories and modern production equipment.
A high savings rate would appear to be an unmitigated positive, but
there has been a downside. The huge pool of savings overwhelmed the
viable investment options. Banks and investors became less discriminating
with their funds and started pouring money into marginal businesses
and expensive real estate. Excessive property values and over-indebted,
unprofitable companies are a big part of Asia's current malaise.
Asians are also known for their strong work ethic, discipline, respect
for authority, and individual sacrifice for the good of the group. While
such personal qualities may constitute an employer's dream, they are
also easily exploited by corrupt politicians and ruling elites such
as the Suharto family in Indonesia. Dissent may be messy, inefficient,
and expensive, but without it abuses go unchecked and are more difficult
to correct in the long run.
The social and business fabric is more tightly woven in Asia than in
Western countries. Employees and employers form bonds that often last
a lifetime. Banks and companies frequently go beyond the lender/borrower
relationship and buy large stakes in each other. Government is intimately
involved in business planning through such agencies as Japan's powerful
Ministry of Industry and Technology. While there are benefits from these
supportive relationships, the entanglements that develop can be alarming.
Financial reports from banks and industrial companies in Asia are opaque
and complicated by Western standards. In such a tightly linked system
problems spread more quickly, are harder to uncover, isolate, and cure.
The Western Nations through the IMF (International Monetary Fund) have
moved into Asia to prevent the problem from spreading further. There
is great concern about a domino effect taking down one company after
another in Asia, leading to mass layoffs, severe recession in the region,
and eventually worldwide economic decline. The current financial condition
of many Asian banks and countries is dire, and requires an immediate
cash infusion totalling tens of billions of dollars. A cash bailout
is never a pleasant choice, because it effectively papers over the past
mistakes and abuses of corrupt politicians, property speculators, and
irresponsible banks.
The IMF hopes to exact some fundamental changes in return for the
cash. The first change should be an opening of the books, an accurate
accounting of bad loans, and disentanglement of banking and corporate
relationships. Corruption and political influence is another area that
needs to be addressed. Asians are a proud people and until very recently
felt that their economy was superior to all others. We expect a lot
of negotiating, posturing, and threats over the next few months and
grudging change at best.
Current Strategy
The Asian crisis is affecting virtually every company that we follow.
All exports to Asia are now earning less in terms of U.S. dollars. The
possibility of severe recession in Asia is very real and yet to come.
Even though Europe is the largest U.S. trading partner, a sharp falloff
in demand from Asia will be noticeable. Growth rates for many U.S. companies
may slip modestly due to Asia. The problem is that the stock market
in the U.S. is priced at a level that requires decent profit growth
rather than slippage.
It is not surprising that U.S. investors have moved money into bonds
and safe, steady companies. Electric utilities have enjoyed a surge
of popularity, Bell Companies are back in vogue, and medical stocks
have soared to new heights. Worries about a tight labor market and inflation
have been replaced by fears of deflation. We have moved money out of
companies, such as Bankers Trust and Texas Industries, that may be vulnerable
to events in Asia. We have invested proceeds in bonds and stocks such
as MBIA, both beneficiaries of deflation and lower interest rates.
We are not intending to make wholesale changes in our clients' portfolios.
Our current list of key holdings includes the NY Times, Cisco, McGraw
Hill, Helmerich & Payne, Travelers, MBIA, Intuit, Carlisle, and IBM.
This premier group of companies, all purchased at low prices, continues
to perform well in a challenging market environment. We are keeping
a core group of stocks in each portfolio and building up cash reserves
by selling less important holdings. If events in Asia create buying
opportunities we will be ready to deploy the cash reserves.
