cbs.marketwatch.com
BankBoston's Riley looks to 1999
How high is Alan Greenspan's 'threshold of pain'?
By Tiare Rath, CBS MarketWatch
Last Update: 9:59 PM ET Oct 14, 1998
BOSTON (CBS.MW) -- BankBoston's chief investment officer, Ned Riley, isn't known as Mr. Predictor. Yet.
In early August, Riley looked into his crystal ball and declared that
long-term rates on Treasurys would plunge at least to 5 percent by the
end of this year. And he foresaw the Federal Reserve cutting short-term rates. He also anticipated the slide of stocks. (See related story.)
His views weren't exactly mainstream at that point, and they drew gasps from financial planners attending a conference in San Francisco. But many economists and analysts quickly jumped on board by September, as stocks turned more volatile.
Fast forward to today. CBS.MarketWatch.com talked with Riley about his outlook for 1999. Here are excerpts of the conversation, in which, for one thing, Riley said it's important to gauge Alan Greenspan's "threshold of pain."
The last time we talked was in early August, and at that point you thought investors were in their fear stage but needed to hit the capitulation stage where there was a mass selloff and everyone thought the world was ending. Are we there yet?
Riley: I think we are, at least as far as the professional capitulation's concerned. Clearly, the action in the markets over the last month or so has truly indicated that the professionals have really given up, and they've reached that definition of capitulation anyway, and that is basically when they see no floor for stock prices. ... And some of the stock action that we've seen over, as I've said, the last few days, particularly in those industries and companies that have been very healthy, such as drug stocks, software and defensive issues, it is usually a sign of at least professional capitulation. So I would suggest that, yes, the professionals have capitulated, but the retail investor's a whole other story right at the moment.
So do you see the Dow going any lower at this point because of the retail investors?
Riley: Well, I think the risk in the market is still another 5 percent, if not another 10 percent. And a lot of it does hinge on that retail investor. ... 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 the magnitude of any future movements in stocks as well as [in] the economy.
Speaking of the economy, some people on Wall Street are talking about a U.S. recession by next year. What do you think about that?
Riley: Well, unfortunately, I think some of them have already missed the signs out there. As far as we're concerned, we're in a profits recession already. That will probably continue at least through the second quarter of 1999. That is possibly spilling over into the traditional definition of an economic recession, which is two consecutive quarters of declining [gross domestic product]. The real issue still hinges on this baby boomer and 401(k) participant, because clearly they are the major spending force in our economy as well as the supporter of the equity market. ... Recently, the market correction has obviously decreased that net worth a bit and probably made them feel a little bit uncomfortable about spending.
Where do you see bond yields going in 1999?
Riley: On the 30-year, about 4.5 percent or better, i.e. lower. And
short-term interest rates actually matching that level, or lower. Which would bring us to the question of the Fed. Up to this point, the Fed has been maintaining a relatively restrictive monetary policy vis-a-vis the countries which we are competing against. The 25 basis-point move was too little, too late, and I would suggest that the Fed needs to take a much more aggressive action in the next six months or so in order to align our interest-rate structure with those in the euro group, particularly Germany.
So you think that [the Fed governors] need to be more aggressive. But will they be more aggressive?
Riley: I think they will be more aggressive. I think the pain of the
economic environment will become a lot more evident and a lot more
widespread as we get into the first quarter of 1999. The weaker
corporate profits that we have forecast will force a lot of recessionlike tactics [to be pursued by businesses], such as layoffs and restructurings, and those will become more common to relieve profit-margin pressures.
So the Fed, in order to combat the negative impacts of layoffs and
restructuring, needs to produce an easier monetary policy.
Where do you see the Dow and S&P next year?
Riley: After a rough fourth quarter for both the Dow and S&P, where
the old lows will be tested and probably exceeded on the downside, we
see a market that by the second half of next year should probably be
selling anywhere from 10 to 15 percent higher than the levels we've
achieved today. The Dow would then be selling closer to 9,000 by the
middle of next year, while the S&P would probably be selling closer to 1,100 [compared with] the 996 3/4 today.
Are there any areas that look good to you right now?
Riley: From an investments perspective, there are actually three areas
that I would consider in the category of, regardless of recession,
regardless of boom, these particular sectors will flourish and will do well.
The first being health care. This group is still going to remain relatively immune to an economic cycle and continue to produce profit growth on a steady and consistent nonvolatile basis of between 12 and 16 percent, depending on the company. ...
[The] second group would be technology. ... We look at a couple of
stocks, maybe like, longer term, a Microsoft (MSFT), a Cisco (CSCO)
still, a Lucent (LU), among those, to be carrying the forefront of a
longer-term focus in terms of technology.
The third area which is a turnaround area would be banking and the
money-center banks, and regional banks in particular. There, I think
stocks like Bank of America (BAC), Citigroup (CCI), along with maybe
First Union (FTU), are all providing some pretty good opportunities now, considering the correction in the market. ...
Because of the historical correlation of the small-cap group to the market overall, I think that the most money will be made after the market bottom in a smaller-cap universe. Even though [the small-cap-stock group] has been the worst performer up to this point, history has shown that six months after a market bottom small-cap stocks outperform big-cap stocks by about 50 to 75 percent, and this has been proven in the last four bear-market bottoms.
Is there anything else we should look for going into next year?
Riley: Well, that's a good question. I think the critical elements focus around the monetary and fiscal leadership. Any increasing talk that an Alan Greenspan might retire early or that a Rubin may be quitting his post would, I think, have a very detrimental and traumatic impact on the markets. That's one area that you could put into the "x" factors that we don't know will happen but, if they did happen, wouldn't be very pleasant for the markets themselves.
The other is to basically look toward the Asian situation in a more sober light. Clearly the improving in demand and consumer confidence in Japan will go a long way to lifting the spirits of other emerging-markets countries as well as even the mature economies. So all ears and eyes should be actually focused on Japan to really give us the indication and sign that things are turning around.
Have you heard anything about Greenspan wanting to retire? I mean, I haven't heard anything about that for a while.
Riley: No, I haven't either, and I do believe his normal retirement date is the year 2000, if I'm not mistaken. But I would suggest that -- you know, this is not an imminent thing -- but of course ... everybody has a certain threshold of pain. And, you know, at some point he may feel that that stress and frustration is not balancing with the quality of life. Then he might decide he wants to do something different.
Other issues which have taken a backseat, which might actually influence [the markets] somewhat are Y2K problems and the compliance with the regulation for the year 2000 conversion. If there are a lot of government agencies that are noncompliant, and they may include some portions of Treasury as well as Social Security and the like, this may be enough ammunition to force the Fed chairman to really conclude he can't control that which is not compliant and therefore may have a problem. It seems like a stretch, but we're going to hear a lot more about Y2K, particularly if the euro conversion doesn't go smoothly.
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