Y2k and stock market - Dennis Grabow
'April 2, 1998
Expect the Unexpected: Why the
Value of the U.S. Equity Market
will Decline by 25% to 30% by
the End of 1998 due to the Year
2000 Issue
By Dennis Grabow
Introduction
Investors should expect the U.S. equity market to decline by
the end of 1998, with our forecasts indicating a 25% to 30%
decline from the end of 1997. This decline will be significantly
attributable to a condition that has been predicted for more
than 30 years - the Year 2000 computer crisis.
Year 2000 will be financially significant in 1998 because, in
the coming year, every company faces critical Year 2000
compliance deadlines. Our research indicates that most
companies will be unable to meet those compliance deadlines
and, as a result, will begin to see an impact on financial
performance.
Keeping Year 2000 in Perspective
Our predictions for a bear market come in light of recent
economic forecasts for 1998, put forth by members of the
investment community, that call for continued optimism and
investment in U.S. equities. While most advisors do not see a
gain of 20% plus for the U.S. equity market in 1998, a level
achieved in each of the last three years, they do see relatively
strong market advances. Their views are principally shaped by
the current level of economic activity, low interest rates, low
unemployment, and low inflation. Of course, these forecasts
include the prerequisite warning, "barring the unexpected."
We are saying, "expect the unexpected," and advising
investors to reassess their position in the market and their
asset allocations. Our forecast is not based on past
performance but on future events that are currently not yet
registering on the mainstream financial radar screen. In our
view, the situation is similar to the Asian monetary crisis, that
is currently a primary factor in markets around the world. In
January 1997, the Asian situation was not registering in
economic forecasts but by year end every investor, and every
analyst, was aware of how this disruption could impact the
market. For 1998, we forecast the Year 2000 issue will be the
next "unexpected" event, and by mid year the investment
community will be fully engaged in this issue.
In our view, the Year 2000 issue is the single most important
predictor of a company's future performance. Currently, there
is clear and overwhelming evidence that most companies and
municipalities are not prepared for Year 2000 and will meet
serious disruptions in their information processing systems
and process control systems. These disruptions, which will
have a ripple effect through vendor and customer chains, will
create a worldwide economic slowdown. This will impact U.S.
equity markets as well as markets around the world.
The Expected Impact of Year 2000 is Underway
Some find it difficult to envision how the Year 2000 issue will
have such a profound impact on markets. It is important to
realize the undeniable facts about Year 2000, which is the
"Millennium Investment Corporation's Condition Profile:"
Year 2000 non-compliance is not an option: every
company and municipality will be forced to confirm that
their systems are compliant.
Year 2000 affects everyone at the same time.
Year 2000 affects information and production systems.
Electronic devices may contain risk of not performing
correctly and negatively impacting dependent devices
and systems.
Year 2000 is global in scope, and an unprecedented
business challenge.
There is no "silver bullet". Each system must be tested
to determine if at-risk systems need to be
reprogrammed, repaired or replaced.
There is a worldwide shortage of resources required to
meet demand for Year 2000 remediation services, with
the result that many companies will not be able to
secure the needed resources. Others will be forced to
push back critical deadlines.
Year 2000 is a business enterprise issue, not just a
technology issue. Compliance demands leadership, a
coordinated effort and adequate resources to assure
enterprise viability.
This profile presents an unprecedented business challenge.
Never before have companies around the world faced a certain
threat to their information and production systems. While the
level of economic impact created by Year 2000 is largely
speculative, it is simply prudent to expect that there will be
disruptions in the private and public sectors. We predict the
Year 2000 issue will begin to precipitate adjustments in the
earnings projections of most companies and there will be
corrections in the market. Price earnings multiples will decline
in an environment where business enterprises are minimally
going to suffer efficiency, margin deterioration and loss of
market share.
The larger question for investors is the viability of the business
itself. This is particularly significant when considering that
companies, with multinational operations and highly
computerized manufacturing processes, and highly integrated
business relationships inherently have significant Year 2000
risk. This risk includes internal systems risk, strategic
relationships with vendors and clients, as well as dependence
on local, national and international public infrastructures.
Why Corrections Begin in 1998
We see market corrections beginning in 1998 because critical
deadlines have been established for companies working to
reach Year 2000 compliance. The Federal Reserve has
mandated that banks and financial institutions have their
systems ready for testing by December 1998. Many
companies and municipalities have also adopted this date.
With testing starting by 12/1998, organizations will have one
year to test their compliant systems and seek verification.
Discounting this event six months, investors should seriously
take note during the second quarter of 1998.
With financial analysts and investors making Year 2000
compliance a factor in their decision making they will seek to
determine a company's Year 2000 situation and their
strategies to reach compliance. Specifically, they will want to
know minimally if mission critical systems have been tested
or will be ready for testing, if the company anticipates any
disruptions due to non-compliance in their vendor or customer
chains, and how disruptions in public infrastructures can
impact operations.
Companies that are not yet developing a systems inventory,
that includes information and process control systems, and
are not preparing preliminary systems evaluations will
probably not meet critical deadlines in the compliance
process. Shareholder wealth will begin to be impacted by
inefficiencies and the accelerating cost of meeting compliance
goals, and loss of market share.
We fully expect that non-compliant companies will have
growth potential severely limited, constrained access to
capital and lower margins. Conversely, Year 2000 compliant
companies will have greater access to capital, find greater
operating efficiencies and be in the best position to gain
market share.
How and When Investors Should Respond
When investors finally realize and understand the financial
implications of Year 2000, financial assets will be revalued to
reflect the Year 2000 risk factors inherent in the business
enterprise. Will investors willingly continue to pay 20 or 30
times earnings for a company that can not ensure their
mission critical systems will be ready for testing by December
1998? We believe they won't and would advise investors to
begin developing a financial strategy that protects assets and
is responsive to opportunities in the market. Investors should
note that the Year 2000 issue will be a financial factor well into
the next millennium, so there is a need to develop both
short-term and long-term expectations.
Conclusion
Globally, we are in a period of transition that will require
several years to complete. Year 2000 will be with us well into
the next millennium, and through this period of transition,
there will be companies that use Year 2000 to their strategic
advantage while others struggle with the demands of
compliance. While important indicators on Year 2000 will
unfold in the coming months, Year 2000 is a dynamic and
rapidly evolving issue. To develop a successful Year 2000
investment strategy requires specialized research and
analysis based on an understanding of the technological,
management and economic issues surrounding Year 2000.
Our assessments of these issues lead us to conclude that
there will be a significant decline in the value of U.S. equities
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