Whither the market?

The last two weeks of August have been a trying time for investors. The Russian ruble was devalued by 50 percent as the country defaulted on its sovereign debt, causing markets worldwide to swoon. The Dow then suffered its single biggest drop in absolute terms on the last day of the month.

As bulls go into hiding and bears flex their muscle, the question foremost on everyone's minds is whether the longest-standing bull market in history is going to be followed by a global recession.

To be sure, there are warning signs everywhere. The pan-Asian crisis that had begun with the devaluation of the Thai baht a little over a year ago now has engulfed Korea, Malaysia, Indonesia, and Singapore--the very same tiger economies that were accustomed to sustained GDP growth rates of between 7 percent and 8 percent. In addition, the Hong Kong economy, long a beacon for free markets in Asia, is in deep recession, and that country's government has had to intervene in the nation's stock market to fight off speculators. Meanwhile, the Latin American economies in Mexico, Brazil, and Colombia are raising interest rates sky-high to protect their currencies, and the political consequences of an economic meltdown in Russia could have far-reaching ramifications.

Worst of all, though, is that Japan--the second-largest world economy--is in the midst of a deep financial crisis. Long overdue reform of its banking system continues to stall, and a combination of pan-Asian weakness, a declining stock market, and poor domestic demand all have led to economic stagnation.

In these days of globalization, economic shocks felt by one country reverberate around the globe and affect economies worldwide. But in the midst of all this global turmoil, it is useful to reflect on what drives the U.S. economy. The United States has a very large economy, and its economic fundamentals are extremely sound. Unemployment is at a 25-year low and inflation has never been lower. Consumer confidence is robust and productivity gains continue unabated. In addition, most large U.S. companies, particularly in the technology sector, get a majority of their revenues from developed economies in North America and Europe, not from Asia.

For example, Compaq derives about 87 percent of its sales from North America and Europe, and Korea, a fairly developed economy, accounts for only 2 percent of worldwide PC sales. The emerging economies in Asia are very small net purchasers of technology. It is my opinion that, because the U.S. economy remains robust and because Europe is continuing its economic recovery, global economic fundamentals do not portend a worldwide depression.

Nevertheless, ailing regional economies are having an interesting effect on Wall Street. Stock markets factor in forward-looking information and news, and conventional wisdom has it that the series of currency crises in Asia and Russia inevitably will spread to other emerging markets until they finally drag down the U.S. economy. In times like these, only the clairvoyant can accurately predict the market's direction.

That being said, it is important to look at history and extrapolate from there. My analysis of market downturns of 7 percent or greater reveals an instructive picture. When looking at the 11-year period from (and including) the 1987 crash until the end of August 1998--a period that saw the largest single decline in Nasdaq history--one notices that the average decline was 13.4 percent and lasted an average of 58 days. The average upturn, on the other hand, was 27.1 percent and lasted about 173 days. What is interesting is that there only were three declines of greater than 20 percent, and the three include the 1987 crash, the correction that we just experienced (up to August 31), and a 37-day period between July and August of 1990. The latter period coincided roughly with the onset of the U.S. recession in the third quarter of 1990, but the stock market started rallying in the first quarter of 1991, before that recession was officially over.

In fact, the largest single cumulative gain in the Nasdaq (without any 7 percent or more intervening corrections) occurred between October 1990 and February 1992, a gain of 98.2 percent! Therefore, history proves that the stock market already should have felt the brunt of any necessary corrections, and the rally that likely will follow should be especially long-lasting.

According to history, therefore, once the downturn has played its course, we should see an upturn that should last at least six months. The technology sector is especially well-placed to recover from the correction, as many of its products and services are mission-critical. I feel, therefore, that the fundamentals of the U.S. economy remain robust and that it is only a matter of time before there is significant recovery in U.S. markets.

Dan Niles is a managing director at BancBoston Robertson Stephens covering the PC and semiconductor industry.