WHY THE ASIAN CRASH MATTERS TO YOU

By Daniel Kadlec

Southeast Asia's troubles may seem safely distant to armchair investors half a world away. After all, economies and markets there historically have had low correlation with those in the U.S., meaning that if theirs tumbles, ours doesn't necessarily follow. Take Japan. Its stock market has been in decline most of the past eight years, a period in which U.S. stocks have risen 240%. Since August, the U.S. market has seemed equally impervious to the pain of 20% to 40% market plunges in Thailand, Indonesia, Malaysia, the Philippines and finally Hong Kong.

But last week something gave. Led by Hong Kong, stocks in Asia careened lower, and the U.S. market decided to join the act. The Dow Jones industrial average skidded 319 points Thursday and Friday. Without warning, U.S. investors collectively asserted that problems in Asia are tolerable up to a point--but maybe that point has been reached. If so, any further carnage in Asia's tigers, or a spillover to Japan and China, could lay waste our roaring bull market.

Global dominos is what the 1990s are all about. We live in an unusual period of low inflation, achieved in a big way by companies cutting costs to the bone to keep prices down. Executives have scanned the world in search of low-cost production and added sales, and the result is an intricately connected business world. You can bet that every big American company is doing a chunk of business in the hot Asia market.

Now Asia is experiencing severe growing pains. Banks have loaned too much money, using inflated property values as collateral. In Thailand many banks have loaned more money than they have on deposit, and some 20% of the nation's lending has been done by especially aggressive, largely unregulated nonbank financial companies. Most of these "fin-cos" are headed for extinction. It's a recipe for a flood of bad loans and higher interest rates. The economy there is headed for a slowdown, possibly a recession, in short order.

Clearly, American companies and global powerhouses elsewhere won't be doing as much business in Asia in coming quarters. And that is precisely why Asia's problems are a world event. It means big companies won't make as much money as their sky-high stock prices demand. And that gets to the heart of the problem. It's not so much that companies can't thrive without exports to Asia; it's that ebullient investors have put such absurdly high prices on stocks that even a minor disappointment in earnings will let out a lot of air. Consider Citicorp, which gets about 20% of its profit from Asia. Cut the Asian profit in half, and the bank's overall earnings would decline from an estimated $9.54 a share next year to $8.57. Even if Citi's stock sells at 15 times earnings, the same lofty valuation (for banks) it commanded before the crisis, the price would fall from its recent $144 to $129. Indeed, Citi got halfway there last week, tumbling 5%, to $136.

That kind of math suggests that U.S. stocks deserve a trim in light of Asia's weakened economies. The big risk is that the selling gets overdone. Now that investors have seen a connection they were blind to a few months ago, they might panic, fearing the kind of rout in U.S. stocks that Asian markets experienced. There were moments last week when you could feel that sort of tension.

A huge sell-off in the U.S. because of the Asian problems probably is not justified. The region isn't that vital to overall corporate earnings. But this is the way panics start: denial turns into confusion, and everyone rushes to be first out. If you're nervous, consider playing it safe for a while, especially if you can shift assets without tax consequences, as in a 401(k) plan. If you're a risk taker, look for a spot to start buying in battered Asia. There are plenty of stock mutual funds that target the Pacific Rim. Asia has become the No. 1 destination of traveling Wall Streeters the past few weeks, all of them hoping to find the bottom. We've got to be getting close.

Daniel Kadlec is TIME's Wall Street columnist. Reach him at kadlec@time.com