Let’s Do the Time Warp Again

Story Highlights:

• Current market conditions make 2008 look similar to 1998, a year that was perfectly fine for stocks.
• The "American Contagion" and Financials troubles are currently driving fear, but similar fears in the past haven't sunk stocks.
• This present correction is a product of fear, but psychological factors don't influence long-term market returns.

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Bets on risky debt have gone awry, spooking investors about a world-wide credit infection that could tank global markets. Many fear a weak currency threatening global economic health. Jitters sent global stocks reeling to start the year. Stocks are increasingly volatile! Hedge funds are imploding! Signs of the apocalypse!

Sounds like last night's newscast, right?! It shouldn't—we're not talking about today, we're talking about 1998. To us, 2008 looks increasingly like 1998. Some might point out some differences between 1998 and 2008. The US dollar was strong in 1998; today, foreign currencies lead. In 1998, US stocks led the world; now foreign stocks dominate. But these shouldn't be surprising given the America-centric nature of this narrative. And the good news is 1998, though volatile and featuring a big market correction, was a great year for stocks overall.

In 1997, bad Asian debt roiled Asian markets and as 1998 began many feared the "Asian Contagion" would seep to the rest of the world, taking down markets. Today, it's the "American Contagion"—the US subprime mortgage "crisis" in 2007 which increased risk aversion for riskier debt. In 2008 worry has seeped abroad and folks everywhere fret troubled US Financials will poison global institutions, tanking the global economy and stocks. But just as the Asian Contagion turned out to be too small to matter much for global stocks long term, the American Contagion should have a similarly fleeting impact. Note: Though folks everywhere fear subprime woes have caused a global credit crisis, corporate lending continues to grow as borrowing rates remain benign or are even falling for all but junk-rated firms.

There are more parallels. Tech was the "must have" hot sector in 1998. Today, emerging markets have shown dominance, and like tech, may lead through the rest of this bull market cycle. Long Term Capital Management infamously collapsed in 1998, fueling fears of imploding hedge funds destroying financial markets. Today, many banks are writing down assets in an effort to deal with hard-to-value debt securities, making many fear for Financials' long-term health. Yet, despite all the fears in 1998 and a gut-wrenching market correction, global stocks ended the year up a big 25%. Though they made big headlines, the Asian Contagion and Long Term Capital Management's demise didn't matter as much for stocks as folks feared.

In 1998 market volatility had everyone scared witless—seem familiar? We view this as a good sign. Historically, you don't see this much fear at a bull market top. In contrast, corrections are short, sharp shocks fueled by fear and psychology, not fundamentals—and they are inherently short-lived. We believe the eerily similar conditions today simply won't have the lasting impact many fear—especially since so few see the parallels.

Remember, 1998 wasn't the smoothest ride. Expect more fear and volatility, but know psychology doesn't drive long-term returns—fundamentals do. And with sentiment so dour, we can see even mildly positive news on growth, earnings, etc., surpassing folks' too-meager expectations. So get ready for 1998 all over again—a perfectly fine year for stocks.