Heres a more optimistic viewpoint than mine, and probably more informed as well:
September 10, 1998
Fear, doubt and despair as investors eye future
Fear, uncertainty, doubt and despair. These words describe the state of many investors' minds at the end of August 1998.
There is fear of the potential for a recession and lower profits in 1999, uncertainty about how long the Asian financial malaise will last, doubt about future positive returns for stocks, and despair over how much money has been lost in global stock markets. Our forecast is that the United States and European economies will grow modestly in 1999.
Interestingly, these are precisely the conditions necessary to produce positive stock market returns.
We, too, share other investor worries about the future. But our forecast, our best guess, is that the United States and European economies will grow modestly in 1999 while other countries around the world struggle to resolve their endemic structural problems. When this growth becomes visible in several months, the U.S. and European stock markets will resume their upward direction.
The investment clock revisited
As we noted in our April '98 piece titled, "Does Anybody Know What Time It Is?," the measurement of investor confidence can produce a kind of "investment clock." Such a clock can tell us where we are in an investment cycle.
In April, investors were celebrating first-quarter S&P 500 returns of 13.8 percent. Investor confidence was high and worry was low. At the time, we estimated that it was about 10 p.m. at the investment party and suggested watching the clock closely. In July, the party ended. Money started flowing out of stock markets and stocks began a decline that we think is now much closer to an end than a beginning.
In August, like water approaching a waterfall, stocks began to decline slowly at first but then picked up speed as they headed over the precipice. This type of social behavior is common for groups or crowds. The peak of group behavior occurs when everyone (or almost everyone) panics and fear causes the crowd to disperse quickly. We believe we have reached such an inflection point. Confidence marked the top - fear marks the bottom.
What's the fuss?
Investor concerns reached a crescendo in late August. The stock market's violent reaction to the devaluation of the Russian currency and the default on the government's debt was not due to the rational economic consequences of these events (Russia represents about 1 percent of world output). Instead, these events were understood as an indication of things to come. Let's try to list investor's economic concerns and follow with our viewpoint on each issue.
1. President Clinton might be impeached for his peccadilloes.
We can't imagine this country impeaching a president for this, or that our economic policies would change. Raking him over the coals - maybe.
2. Asia's economic problems will spread to Russia, then to Latin America, Mexico and Canada, eventually bringing down the American and major European economies.
Each country's economic problems are different and will have a different significance to the world. Southeast Asia's boom was built with a dependence on foreign capital and dollar-denominated loans. Projects were often the result of "crony capitalism," not open- market decisions. The resulting withdrawal of capital from Southeast Asia will reduce industrial capacity worldwide and will be a good thing for other global manufacturers. Capital is not the issue in Japan. Its problems are related to demographics and tax rates. If Japan's leaders initiate a credible economic plan in the next few months (as we believe they will), the economies of Southeast Asia may grow in 1999.
Russia never did have the infrastructure to handle the amount of capital that was funneled into it. Russia is a non-entity in the global economic scheme of things and will remain so for years to come. The immediate problem with Russia is that its desperate position may bring it to sell weapons abroad. Canada's commodity-sensitive economy will be fine when global demand returns in 1999. Latin America is not likely to weaken much as American banks, the primary Russia is a non-entity in the global economic scheme of things.
lenders, will manage its situation.
3. U.S. profits and the economy are likely to decline in 1999.
On the contrary, we forecast that many sectors will be able to grow earnings in 1999. These sectors include retail, pharmaceuticals, health care, telecommunications, technology, financial services, and business and consumer services. Sectors such as commodities, capital goods, and possibly energy may have down earnings in 1999, but it is likely that aggregate earnings will be higher.
Stock prices for most American companies are discounting a profit environment that is much harsher than we expect. We expect to avoid a recession.
4. The millenium software "bug" will cause a recession in 1999 and 2000.
With all the attention being paid to the potential destructiveness of computer failures at midnight on Dec 31st, 1999, we suspect that most computers will be tested and many errant embedded microprocessors will be identified before such a time. Economic dislocation will occur, but "fixes" will be quickly forthcoming on an ad- hoc basis.
5. Deflation in all goods and services could set in, causing profits to decrease and consumers to postpone purchases.
While the loss of the ability to raise prices is problematic, we have been experiencing deflation in computers for well over two decades and it has yet to stop people from purchasing them. As long as sudden or dramatic deflation is avoided, preparation should allow companies to manage mild deflation (.5-2 percent).
6. Alan Greenspan will not lower interest rates soon enough.
There are several reasons to lower interest rates. One important reason is that the current negative yield curve (long rates are lower than short-term rates) is putting margin pressure on financial intermediaries such as banks. As their profit positions deteriorate, political lobbying of the Federal Reserve will increase. We suspect interest rates, based on the Federal Funds rate, will be lowered before the end of the year.
Our strategy
As we mentioned last month in our piece, "Mood Swings," we expect the United States to be able to maneuver successfully through the economic distress occurring in other countries where excess capital, in search of profit opportunities, "sloshes" between currencies.
The G-7 group of countries will meet soon to discuss global capital flows. The conclusion of such discussions could include some restrictions on currency speculation, such as increased reporting requirements, longer holding periods, and the creation of margin requirements where there are none today. It should not be the purpose of regulating bodies to prevent speculation in currencies, but rather to inhibit, or police, the "ganging up" by global hedge fund operators on currencies around world.
In addition, as global demand slows, inflation is becoming less of a worry. We believe the G-7 countries are about to examine a coordinated effort to lower central bank interest rates. We suspect interest rates, based on the Federal Funds rate, will be lowered before the end of the year.
We do not expect a quick resolution to the concerns we have stated above. These problems are real, and for some, life threatening. They have illuminated the fact that the interdependence of economies can have negative consequences. But economic crises are the breeding ground for resolution. They represent a signal to world leaders that all is not well.
Fortunately, the U.S. has an extremely robust economy and is a model for the rest of the world. We are open, complex, and large with one of the lowest corporate tax rates in the Western world. In a time of global economic distress, the U.S. dollar becomes a safe haven for others. This effect lowers our interest rates, increases our capital availability, lowers inflation here, and encourages economic growth.
The current anxiety reflected in stock prices around the world and in the U.S. will be resolved. At their current valuations, stocks represent good values for long-term investors. It is a perfect time to rebalance portfolios.
(S&P 500 - 960 September 1998)
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