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MORGAN STANLEY DEAN WITTER
U.S. Strategy:The Ten Surprises of 1998
By: Byron R. Wien
This year marks the thirteenth list of the Ten Surprises, and I hope it will prove to be a lucky one. When I started doing this in the mid-1980s, I believed that it was useful for portfolio managers to step back from the deluge of research reports, faxes, and voice mails to reflect on the unexpected events that could move the financial markets over the coming year.
The big profits I had made as an investor came from having non-consensus ideas that turned out to be right, so I thought I would make a list of ten of them for the coming year realizing that I would probably be close to the mark with some and way off on others.
I defined a surprise as an event that a typical portfolio manager would give only a one-in-three chance of taking place but to which I ascribed a better-than-50% probability.
Over the years I have generally gotten the basic concept correct for more than half of the surprises. During 1993 through 1995 I got about 70% right, and Barron's wrote a cover story on them in August 1996. The cover-story curse proved to be intact, and that year was a rough one, but 1997 worked out pretty well, I think.
My view has always been that the surprises are a useful exercise regardless of the score, but that may be too idealistic a view in the current culture. Here is a review of last year's surprises:
[review of 1997 predictions omitted] . . . . Here is the list for 1998:
1. Bond bulls reach a state of euphoria early in the year as the Asian crisis drives long U.S. Treasury rates to 5.0%, but bond bears have a period of vindication in the second half when a stronger economy pushes long rates up to 7%.
2. Stock market bulls become euphoric as Asia stabilizes and the Dow Jones roars to 9000 in the spring, but bears have their day when the index drops to 7000 later in the year on inflation fears, Fed tightening, and rising long-term interest rates.
3. Investor uncertainty increases in the second half as 1998 becomes the year of international leadership change. Kohl loses the German elections. Israel moves to the left and Netanyahu resigns. Yeltsin says he is too ill to continue. Hashimoto steps down in Japan, and most Southeast Asian countries get new governments. Nationalism gains strength, and international cooperatives like the International Monetary Fund become less effective. Protectionism develops into a critical foreign policy issue, especially in the United States.
4. Rumors that security has broken down in the nuclear arsenal of the former Soviet Union turn out to be true. Both Iran and Pakistan are buyers. The Middle East, India, and other parts of Asia are unsettled by the prospect of renewed international hostility. Oil and oil service stocks shake off the effect of increased OPEC production and resume their uptrend.
5. Investor attention returns to Asia and Latin America as the 1997 financial crisis brings on major economic reforms. Brazil and Korea become the outstanding performers among emerging markets. Portfolio managers kick themselves for not having realized how cheap stocks in these countries became during the crisis, when both the markets and the currencies had declined.
6. Amid further campaign finance controversy, Albert Gore announces he will withdraw his name from consideration as a presidential candidate in 2000 to enable other Democratic hopefuls to solicit political and financial support. Renewed focus on American competitiveness pushes Dick Gephardt into prominence, and Newt Gingrich stages a comeback. Bill Clinton agrees to become honorary chairman of the Professional Golfers' Association upon leaving office.
7. Increased competitiveness across Asia reduces the outlook for profit growth in Japan. Structural pressures continue to build and further fiscal stimulus is announced, but the Nikkei 225 still drops below 10,000, and the Dow and the Nikkei threaten to cross.
8. A number of technology stocks, including Intel ($70), Cisco ($56), Oracle ($22), Applied Materials ($30), and Compaq ($56) become market leaders again as Asian revenues improve, components made there are transferred at lower costs, and second quarter earnings exceed expectations.
9. United States corporate profits surprise investors favorably once again. Companies prove to have some pricing power as well as an ability to expand margins through further cost reduction. Year-over-year operating earnings for the Dow Jones and S&P 500 increase more than 10%.
10. The colossal flow of money into equity mutual funds subsides. Merger and acquisition activity is brisk, but stock-for-stock, rather than cash, transactions predominate. New equity issuance continues at about a $10 billion monthly rate, and supply/demand becomes unfavorable as fund sales drop below that level. The stock market comes under pressure later in the year when portfolio managers liquidate holdings to buy new issues. . . . [remaining comments omitted] |
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