Ned Riley is chief investment officer at BankBoston. This week,
Ned's market outlook includes the following key points:
The global crisis has induced a credit crunch which could become very severe if monetary authorities don't orchestrate a massive coordinated easing. G7 meetings plus conciliatory remarks by Hans Tietmeyer, president of Bundesbank, help, but actions speak louder than words. Because the ''epicenter'' of this crunch is Japan, a strategy to address capital adequacy issues, bad loans, etc., would go a long way. Bank stock prices must stabilize before a solid floor for stocks is established -- they are already discounting a fairly dire picture. Look for this group to be the first to bottom, and the first to outperform on the upside.
The recent correction in several companies and industries has purged many of the excesses from the overvalued market we witnessed last spring. A substantial slide in fundamentally healthy areas, such as health care, software and various defensive issues, is usually a sign of market capitulation. Yesterday's market showed some signs that this was developing.
Unfortunately, the third quarter companies' earnings confessional period met and exceeded our expectations. More importantly, company expectations for the fourth quarter have been scaled back considerably. However, there is still a major disconnect between Wall Street analysts' forecasts for earnings next year and our own expectations. As a matter of fact, the top-down investment strategists estimate calls for a 10 to 12 percent advance in profits, while the bottom-up approach calls for a more lofty 17 to 19 percent increase. We need to close this gap so that we don't have unachievable targets next year as well. We are in a profits recession and the sooner it's recognized the better off we'll be.
At the beginning of August, I pointed out that the ''anatomy of a market correction'' spans four phases which are: irrational exuberance, indifference, fear and capitulation. At the time, we had, in my judgement reached the third phase of the unnerving environment of fear. In the last few weeks, we entered the fourth stage -- capitulation. Remember, if exuberance is when investors perceive no ceiling, capitulation is when they see no floor to stock prices. You have to look no further than the headlines in the local media. Historically, these media feature stories have been great contrary indicators.
I have been extremely pleased and somewhat surprised that the 401(k)/equity mutual fund holder has remained quiescent so far. As far as I'm concerned, this group of investors is critical to the direction and magnitude of any future movements in stocks. Should redemptions be kept to a minimum (as they have been throughout this period), further downside risk can be confined to 5 to 10 percent. However, any significant redemptions will have a profound impact, as equity mutual fund managers still have less than five percent of their assets in cash. Obviously, they are lacking the liquidity to meet a heavy stream of redemptions. We are hopeful that these investors maintain their long-term resolve and orientation, and avoid the pitfalls of ad hoc decisions on asset allocation.
There has been a huge build-up of liquidity in small CDs and money market funds. As a matter of fact, inflows of $400 billion over the past twelve months have exceeded equity fund inflows by approximately $150 billion. A steady draw-down of cash would indicate that investors feel more comfortable about a higher asset allocation toward equities.
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