An Isle Of Prosperity - For Now

The U.S. may appear to be an island of prosperity amid Brazilian woes, sluggish Asian economies and prospects for slower growth in Europe. But don't be deceived.

As Fed Chairman Alan Greenspan often says, the U.S. is not an island, and its economic performance can't be isolated from that of the rest of the world. Analysts believe the first quarter earnings of U.S. multinationals will clearly reveal this.

"A strong dollar and weak demand, particularly in Asia, hurt sales and earnings in multinationals in the second half of 1998 and it appears that the problems of the fourth quarter will be felt to some extent in the first quarter of 1999," said Hugh Johnson, chief investment strategist at First Albany.

But, Johnson conceded, it's hard to pinpoint just how hurtful sluggish demand overseas has been to the bottom line of the big U.S. companies.

The market heard the first notes of what may soon become a familiar tune this quarter when beverage giant Coca-Cola (KO) announced global unit case volume may drop as much as 2 percent in the period due to soggy demand in Latin America and Europe, in particular. And Eastman Kodak (EK) cited recent gyrations in foreign exchange rates as one of the reasons it won't meet growth expectations for the first half of 1999.

The greenback's great performance in the past months may prove to have been a sour spot for many large companies in the first quarter, but experts say that's just part of the story.

Reflecting solid economic fundamentals in the U.S., the dollar has remained generally sturdy against the currencies of its major trading partners this year. A strong greenback renders U.S. exports expensive - suppressing foreign appetite in overseas markets for U.S. products - while rendering imports cheap.

The impact of the dollar's appreciation doesn't end there. It has the long-term beneficial effect of keeping inflation at bay because U.S. companies must keep their prices competitive as the domestic market is flooded with cheap imports.

And a perky buck pumps more foreign money into the U.S. because all dollar-denominated assets increase their attractiveness, said Peter Boockvar, equity strategist for Miller, Tabak, Hirsch & Co.

But, as strategists point out, exchange rates aren't at the root of problems on the earnings front; they're merely a reflection of a country's economic health. It's the dearth of demand in global markets that eats away at the profits of the multinationals.

Boockvar said it appears that every quarter the same companies blame a firm dollar on earnings shortfalls, referring in particular to Kodak and Minnesota Mining and Manufacturing (MMM).

"A strong dollar [always] takes a bite out of companies that haven't done a good job hedging," Boockvar said. But, he added, the IBMs and the Coca-Colas have found ways to make up for these currency losses with financial strategies involving cost cutting or stock buybacks.

The real isse that continues to plague the bottom line of U.S. companies is stagnant foreign demand.

Johnson said earnings reports from the large consumer product companies will enjoy the same attention-grabbing status of the technology complex in the next weeks because of all the uncertainty on the global front.

"They will be at the top of the list of concerns," Johnson said.

What Johnson found most troubling of the Coca-Cola announcement that weak demand had stemmed not just from Asia, but mostly from Europe and Latin America. That suggests the problem of puny demand is turning into a global concern.

Regarding the problem of dismal demand in foreign markets, Johnson said the question is whether it's a Coca-Cola problem of a general one. "The answer will be revealed when looking at the earnings of Procter & Gamble (PG), Gillette (G), Phillip Morris (MO) and Merck (MRK)."

With the brunt of their business taking place outside the U.S., analysts believe Colgate-Palmolive (CL) and Gillette could also face some disappointments.

Boockvar also points to Avon (AVP), which has tremendous exposure in Latin America and will be hit by the contraction in Brazil's gross domestic product this year, which some estimate will be by as much as 6 percent.

The recent performance of these companies' shares, analysts say, clearly shows that investors aren't confident they will be able to emerge unscathed from global distress.

The unsettling environment in overseas markets is a pressing factor that consumer companies have been wrangling with for some time. Whether those problems worsened in the first quarter compared to the fourth quarter is an open question, as is that of when the global economy will recover sufficiently to bolster company profits

The bellwether technology companies face the same sticky question regarding overseas demand. The biggest concern for Intel (INTC), Compaq (CPQ), Dell (DELL), and IBM (IBM), Johnson said, is how much demand for personal computers has slowed in the U.S. and abroad. That was certainly a fourth-quarter problem - but what about the first quarter?

U.S. companies weathered the "Asian " and "Russian" storms last year thanks to three Fed easings in the fall and continued perkiness in the U.S. economy, which has bested even the most optimistic economists' estimates. Still, though solid domestic operations have been offsetting weakness abroad, analysts warn this situation can't be sustained for long.

David Resler, chief economist at Nomura Securities, expects the trade gap, which exploded to $17 billion in January, to continue to deteriorate for the remainder of the year, as the U.S. will grow faster than its trading partners by a wide margin.

Brazil's devaluation in mid-January produced yet another shock to the system, although its impact was nowhere near that of Russia's default and devaluation last August due to the fact that the world was better prepared to face th turmoil.

Though the Brazilian currency and stock markets have stabilized, somewhat reassuring investors in the past month, Resler notes that Brazil won't escape negative growth in 1999.

The abyss may have been avoided, but the impact of the contraction in Latin American demand will certainly upset the bottom lines of U.S. corporations. "Brazil had an impact, we saw that with Coke," Johnson said.

The first stirrings of life out of Asia, with improvements in the economies of Thailand, Malaysia and Korea, will begin to show in the second and third quarters of 1999. But any rise in demand from the Asian region may not be sufficient to compensate for increased weakness in Europe.

"The vulnerability is there because (the large companies) are fetching high valuations Â… and the market isn't terribly forgiving when there's a shortfall," an analyst remarked.

David Jones, chief economist at Aubrey G. Lanston, said the market has come to a crossroads. It realizes that the first quarter won't be that good, as suggested by recent pre-announcements. But, he added, there's an implicit bet in the stock market that the global economic crisis won't pull the U.S. down from its perch. On the other hand, the U.S. will be the generator of growth overseas.

"[The market] can take a weak quarter if there's the perception that future quarters will be better," Jones concluded.

Written By Julie Rannazzisi, CBS MarketWatch