MERRILL LYNCH EXPECTS FURTHER SLOWING
IN GLOBAL GROWTH, LOWER INTEREST RATES
AND A STRONG DOLLAR IN 1999
HIGHER QUALITY INVESTMENTS AND A
BALANCED PORTFOLIO RECOMMENDED
NEW YORK, Dec. 15 -- Merrill Lynch research analysts
expect a global environment of slowing economic growth,
lower interest rates and a strong US dollar in 1999.
While global economic growth is forecast to slow to about
1.25%, lower interest rates are expected to prevent a global
recession. Widespread excess capacity suggests deflation is a
bigger risk than inflation in 1999.
The year will be punctuated by two key events that will
provide an unusual backdrop to global industries: the launch of
the Euro and the European Monetary Union (EMU) in
January and the countdown to Y2K.
Emerging markets may have passed maximum stress points
but recovery will likely be slow and a continued source of
volatility. The dollar should continue to be the world's
strongest currency.
Recommendations for investors include long-dated quality
bonds in the U.S., U.K. and Europe, as well as equity markets in countries with sizeable
current-account surpluses, especially Korea. In Japan, quality and restructuring companies are
recommended. European industries with a domestic focus and U.K. banks also look attractive.
In the U.S., industries with strong cash flow such as cable TV and gas pipelines, as well as
defensive growth such as hospital supplies, selected financials like insurance, wireless telecoms
and REITs are favored.
Merrill Lynch's top economists, strategists and market analysts addressed reporters in New
York at the firm's 1999 Economic and Investment Outlook Conference. Press conferences are
also being held this week in London, Toronto, Hong Kong and Sydney to present Merrill
Lynch's outlooks for the United Kingdom, Europe, the Middle East and Africa, Canada, Asia
Pacific and Australia and New Zealand. A conference will be held in Tokyo in January.
Following are summaries of remarks from the U.S. press conference: Economic Outlook
Chief Economist Bruce Steinberg stated that world GDP grew about 3.5% in 1997, slowed to
around 1.75% in 1998 and will slow further to 1.25 % in 1999. He expects US GDP growth to
slow to 2% in 1999, down from 3.7% in 1998. The good news is that global interest rates
should continue to move lower, he said. He expects the Fed funds rate could be down to 4% by
mid-1999 and long bond yields will fall to 4.5%. He expects just a moderate slowdown in U.S.
consumer spending. Capital spending, however, is likely to slow more sharply in reaction to an
ongoing profit squeeze.
He also expects further easing by the European Central Bank. Mr. Steinberg looks at 1999 as a
year of transition. If restructuring goes far enough, both in the US and elsewhere, the world
economy will be able to grow faster in 2000.
Senior International Economist Michael Hartnett noted that in 1998 global demand weakened
while global supply increased, thus intensifying deflationary pressures. Deflation is still a bigger
risk than inflation in 1999. He said global pricing pressure should remain intense. The Merrill
Lynch consumer price inflation forecast is 1.1% for the industrialized world, the lowest rate since
1960. Mr. Hartnett cited two conditions that would be required to stimulate "strong" output and
price recovery in 2000: 1.) European Union demand strengthens more than expected, and 2.)
substantive Japanese and Asian restructuring becalms deflation in the Far East. He said he
doubted both conditions could be met. Therefore, "soft landing" is the best the world can hope
for in 1999 to 2000, with lower-than-expected inflation leading to lower-than-expected interest
rates next year.
Investment Strategy
According to Charles Clough, Chief Investment Strategist, the forces of deflation and the
response by central banks dominated financial market behavior in 1998, with more of the same
expected in 1999. He forecasts a weakening of US corporate profits, the economic
consequences of which the Fed will try to offset by lowering interest rates. Yields on long-dated
U.S. Treasury Bonds likely will resume their down trend in 1999 as earnings weaken. Excess
investment is at the heart of the matter and deflationary patterns in 1999 are likely to migrate
from the goods sector to services activity.
Looking globally, Mr. Clough thinks emerging Asia in particular may have passed the point of
maximum stress, and year-over-year comparisons will begin to improve. Within Asia, the stock
markets of Korea and Thailand outperformed in 1998 from their lows and will likely do so again.
In Europe, evidence of manufacturing slowdown is widespread. He expects single-digit
percentage gains for most European equities, and total returns on bonds could exceed that. The
Japanese government will flood the economy with debt as it races to fund an ever-widening fiscal
deficit.
Quantitative Strategy
Richard Bernstein, Chief Quantitative Strategist, noted that he underweighted equities for the first
time in more than three years at the end of June, 1998. He said a key question is whether his
models and indicators are showing the market to be more or less attractive than they were when
he first underweighted equities. Nearly uniformly, they are suggesting that the market is less
attractive. In other words, fundamentals are deteriorating despite the market's rebound. He said
that his model suggests that overweighting the highest quality stocks within any sector during
1999 may be more important than the relative weightings between sectors. Importantly none of
his profits indicators are suggesting that the profit cycle will bottom any time soon in the U.S. or
globally.
He currently prefers high quality bonds to stocks, government-related bonds to "junk" bonds,
large cap stocks to small cap stocks, growth stocks to value stocks, the U.S. and Europe to
Japan, and developed stock markets to emerging stock markets. Market Analysis
Chief Market Analyst Richard McCabe stated that a year ago he was concerned an important
change in the financial landscape would develop in 1998. Indeed, the world markets, on
average, have suffered their deepest correction since 1992, and 1998 to date has been the most
volatile year since 1990.
Despite recent strength he does not believe the technical damage has been fully repaired. He said
markets in the U.S. and Europe could test their October lows during the first half of next year.
The second half of 1999 should be stronger. Once cyclical pressures run their course, the major
bull market trend should resume.
Beyond the U.S., markets in Europe and Latin America could come under pressure again in
early 1999. Japan may be locked in a trading range around the Nikkei 13,000 - 18,000 area,
while the rest of Asia generally appears to be in the early stages of a new bull market cycle. His
favorite markets in Asia are Hong Kong, Singapore and South Korea.
Fixed Income
Martin Mauro, Senior Economist and Fixed Income Strategist, believes the forces that shaped
bond market movements in 1998 will operate in 1999 as well. He has two investment themes for
the new year: 1.) Avoid concentrating large portions of assets in money market funds. For
investors who prefer to keep funds in short-term assets he suggests a 1-2-3 year ladder as an
alternative to money market funds. 2.) Take advantage of the unusually wide yield spreads that
are available on higher quality issues. Presently spreads generally remain near levels last seen in
the 1990-1991 recession.
He finds high quality corporate securities to offer compelling value. He favors selected issues in
non-cyclical industries such as electric utilities, insurance, pharmaceuticals, telecommunications,
and certain consumer goods. He also sees extraordinary values in the U.S. municipal market.
Municipal yields have not been this high in relation to U.S. Treasury yields since the enactment of
tax reform in 1986. Because of the exceptionally high relative yields, the U.S. municipal market
is no longer exclusively the venue of the highest income people.
Merrill Lynch is stressing to its clients the benefits of a balanced portfolio and the importance of
long term planning to overcome market volatility. This strategy may be especially helpful in a year
of modest investment returns as predicted for 1999.
Merrill Lynch Global Securities Research and Economics has over 700 analysts in 27 countries.
Merrill Lynch is the only firm to rank in the top three in all of Institutional Investor's research
surveys of the U.S., Europe, Asia, Japan and Latin America. In addition, the firm ranked first in
The Wall Street Journal 1998 All-Star Analysts Survey, and The London Financial News
"Poll of Polls," a summary of nine equity research surveys from around the world.
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