Why the Enron Case is negative for the US and bullish for Asia (page 1 of 2)

The TV news channels have only one story to report about, and it is how the US' seventh largest company could go bankrupt within such a short period of time while the securities regulators, Enron's auditors and its board of directors were all sleeping the slumber of confidence, complacency, and ignorance.

Of course every commentator has some kind of explanation for this financial disaster, but nobody has so far said that Enron is not really the problem, but rather a symptom of the rot and excesses, which occurred in the US bubble economy of the late 1990s and which characterize the entire US capital market.

Enron is not a unique case of accounting irregularities, false reporting and over-leverage, but is simply representative of what most companies have practiced in the last few years in order to artificially boost their earnings with the view of manipulating their share prices higher. The Enron demise will have far reaching implications not only for its dubious management, and the companies and politicians, which had a business relationship with the company, but also for the entire stock market.

The price of a stock or a market depends on fundamentals, but even more importantly on the confidence of the investing public. When investors feel confident they are willing to pay a far higher price for a stock or the entire market than when they lack confidence. Hence when investors feel good about the economy and the outlook for corporate profits they may pay 25 times earnings for the stock market.

Conversely, when their confidence level is low, they may only pay 10 times earnings or less, as was the case for most of the 1970s. Therefore, I feel that the Enron debacle combined with the recent collapse in the price of Tyco, Worldcom, Elan, and other companies such as IBM, which may have had questionable accounting practices, will lead to a lower valuation of US equities in the long run.

I maintain that it is most probable that we have already seen the high for 2002 for the US market in early January when the S&P 500 exceeded 1180. At the same time, I believe that on balance the Enron case is positive for Asian stocks as well as for gold shares. Why? Simply because over the last few years foreign investors have avoided Asian equities on the basis that Asian companies have little transparency and that in Asia corporate governance is poor. But now that it has been exposed that transparency is no better in the US than in Indonesia, money will increasingly flow to Asia where in countries like Indonesia, Thailand and the Philippines valuations are very low.

Thus I continue to recommend selling US equities in the present rally, which might extend into April. In particular we would use the current strength to sell companies, which have questionable accounting practices and which still command high P/Es, such as most high tech companies. At the same time we urge our readers to continue to buy Asian stocks, which have compared to the US a very low valuation.

So what should an investor buy who wants to have an exposure to Asia? The problem for large institutional investors is that the most attractive companies in terms of valuations tend to be small capitalization companies with market values of frequently less than $ 100 million. Still, many large market capitalization companies sell for a discount to comparable companies in the US, and institutions could always invest with a fund that specializes in small cap stocks.

Individual investors could buy a listed Asian fund, which sells at a discount to its net asset value or a basket of individual securities.