Merrill Lynch Expects Low Inflation, Declining Interest Rates And Slower Growth Globally in 1998
PR Newswire - December 16, 1997 12:59
MER %FIN %ECO V%PRN P%PRN
Restructuring and Industry Consolidation Present
Prime Opportunities for Investors
NEW YORK, Dec. 16 /PRNewswire/ -- Merrill Lynch & Co., Inc. (NYSE: MER)
expects that low inflation, declining interest rates and slower growth will be
the environment for investors globally in 1998. Asian growth is about to slow
sharply and the Asian crises will ultimately slow the entire world economy.
For investors, the key will be to find sources of growth in a slowing economy.
Real unit growth merits a premium, but will be increasingly hard to find.
Therefore, restructuring and consolidation will prove to be major sources of
earnings growth for most companies. Industries in the throes of consolidation
include: airlines, financials, selected energy, capital goods and CATV
companies.
In the U.S., GDP growth is expected to slow to about 2.5% during 1998
after jumping nearly 4% during 1997. The Asian crises should reduce U.S.
growth by about half a percentage point next year, or more. The transmission
mechanism is the U.S. trade balance, which will deteriorate sharply as exports
slow. Asia accounts for nearly 30% of U.S. exports.
The major event in the world stock markets in 1997 was the unraveling of
the global bull market, which had made major progress in 1995 and 1996 and
then accelerated into a climactic buying phase in the first half of 1997. The
recent deterioration in the world's equity markets is likely a "warning crack"
or sign that the post-1994 global bull market is cresting and facing
additional correction in 1998.
The firm is recommending higher quality stocks and bonds for investors
around the world and believes that the two areas in the world that can accept
foreign investment and grow are Eastern Europe and Latin America. In the
U.S., financials and other bond substitutes like Real Estate Investment Trusts
are favored, as well.
The economists and strategists addressed reporters in New York at the
firm's 1998 Economic & Investment Outlook Conference. Press conferences are
also being held this week in Toronto, London, Hong Kong and Sydney to present
Merrill Lynch's outlooks for Canada, the United Kingdom, Europe, Asia Pacific
and Australia and New Zealand.
Following are summaries of remarks from the U.S. press conference:
U.S. Economy
Chief Economist Bruce Steinberg stated that the U.S. economy was beginning
to moderate even before the Asian crises could affect growth. In particular,
consumer spending appears much softer in the fourth quarter than earlier this
year. He expects that the slowdown in spending next year will be concentrated
in consumer durables, particularly vehicle buying, where pricing is likely to
weaken.
According to Mr. Steinberg, the U.S. inflation rate will continue to ease,
with CPI rising less than 2% in 1998. He believes that consumer goods prices
will decline. Mr. Steinberg's inflation view is predicated on economic growth
moderating, capacity expansion accelerating, and import prices declining. He
believes that the Fed will probably ease next year and bond yields could fall
as low as 5.5%.
U.S. Stock Market
Chief Market Analyst Richard T. McCabe said that the U.S. market has been
in a bull market cycle since the end of 1994 with the major averages having
more than doubled over the past three years. It is ending 1997 with most
momentum indicators still in a constructive position and with a favorable
interest rate and inflation background. Financials and interest rate
sensitive stocks, which usually weaken before major peaks, are continuing to
perform well. He believes that there may be further extension of the current
bull market cycle in early 1998, with the major averages possibly reaching
further new highs.
Mr. McCabe noted, however, that bull market cycles have a usual lifespan
of only three to three and a half years, and a four year cycle low is likely
to occur in 1998 following those in 1994 and 1990. He said that the market
could be vulnerable to a cyclical decline in 1998, and that could bring the
major averages down as much as 25%. Such a corrective process would likely
set the stage for the next bull market advance which could begin in late 1998
or 1999. New market leadership could emerge next year as often happens
following major market corrections.
Investment Strategy
According to Charles I. Clough, Jr., Chief Investment Strategist, the U.S.
economy enters 1998 on the heels of the strongest investment cycle and weakest
credit expansion in decades. Investment as a percentage of GDP has returned
to the heights of the late 1970s, when it reached a postwar record. Capacity
is growing at a 4% rate in manufacturing and probably much faster in services.
Both seem potential sources of slowdown in 1998.
He stated that should earnings concerns mount, he expects that bonds could
outperform stocks. Fixed investment and capacity data understate the
potential for price deflation, particularly in services. The largest
components of the U.S. services sector are financial services and retailing
areas where capacity is booming. These are transaction-based industries, Mr.
Clough noted, and the increasing commercial use of the internet will sharply
reduce costs and prices. He favors investing in industries that are
consolidating, pointing out that a long period of debt-financed expansion is
over and as consolidation emerges, and industry debt is liquidated, modest
sales growth can be translated into far more rapid earnings growth.
Fixed Income
Martin J. Mauro, Senior Economist and Fixed Income Strategist, believes
that the bond market will provide investors with relatively high inflation-
adjusted yields in the coming years and the potential for capital appreciation
in 1998. He noted that the recent swings in the stock market should remind
investors that one of the principal reasons for owning bonds is that they
provide a steady source of income that can be a buffer against possible
volatility in stocks.
Mr. Mauro pointed out that bond yields are relatively high in relation to
the present rate of inflation and where inflation is expected to be in the
coming years. For example, the yield on the 10-year Treasury was recently
3.7 percentage points above the inflation rate, compared to the historical
average of about 2.6 percentage points. He also noted that U.S. debt growth
remains modest which is another plus for bonds. The Federal deficit has
shrunk from $290 billion in 1992 to $23 billion in 1997.
For investors, Merrill Lynch is recommending higher quality issues:
Treasuries, agency securities, CDs and selected preferreds. Corporate issues
favored are in noncyclical industries such as insurance, banks without Asian
exposure and some utilities. The best values in the municipal market, in his
view, are bonds in the 10-20-year maturity range.
Quantitative Analysis
The main theme for Richard Bernstein, Director of Quantitative Analysis
and Equity Derivative Research, for 1998 is "Quality": quality stocks, quality
bonds and quality markets. He stated that higher quality stocks are already
outperforming in most equity markets around the world, and he sees no reason
why that will not continue through most of 1998.
He said: "No one really knows whether the wave of deflation emanating from
Asia will be a tsunami or a ripple." Either way he believes that investors
should structure portfolios for a slowing environment. The U.S. is his
favorite market for next year because it is the one equity market that most
investors would uniformly classify as "high quality." He also noted that the
U.S. economy is one of the few that may be strong enough to withstand the
impact of a deflationary wave.
Within the U.S., Mr. Bernstein favors large capitalization, high quality
growth stocks. He believes that the goods these companies produce are likely
to be less sensitive to the slowing economy.
Merrill Lynch has over 750 analysts in 27 countries.
SOURCE Merrill Lynch & Co., Inc.
/CONTACT: Joanne Tutschek of Merrill Lynch, 212-449-7278/
/Company News On-Call: prnewswire.com or fax, 800-758-5804,
ext. 555800/
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