Bull’s-Eye View of ’95 Rests on Power of the Megatrends
After such a wretched year as this one for stocks and bonds, the only consolation for most investors is to take a long-term view. After all, the market and economy “megatrends” that were so positive a year ago are still in place, aren’t they?
Wall Street has been mulling that question in recent weeks, as investment pros fashion their 1995 forecasts for stock prices and interest rates. For the bullish camp, maintaining optimism is largely a function of belief in the power of certain megatrends to provide a mostly favorable environment for stocks and bonds in the ‘90s.
To the bulls, 1994 will wind up looking like a hiccup if the megatrends are still valid. But are they? Here’s an update on some of the most important trends that Wall Street touted so vociferously a year ago, before the markets went into their slump:
* Main Street loves Wall Street. Individual investors’ appetite for stock and bond mutual funds was viewed as almost insatiable a year ago, as short-term interest rates hit 30-year lows and as “long-term investing” became the mantra of the masses. As long as the public pumped billions monthly into the funds, the bull markets in stocks and bonds always had a ready source of new fuel.
But the public pump broke down for bond funds last
spring, as rising market interest rates pummeled bond values and fund investors’ losses mounted. Result: Bond funds have been drained by net shareholder redemptions since last March. In November alone, bond funds’ net new cash flow was a negative $10.9 billion, according to figures reported Thursday by the Investment Company Institute, the funds’ trade group.
Now stock funds appear to be suffering a crisis of confidence. Stock funds’ net new cash inflow in November was $3 billion, the smallest monthly inflow since August, 1991, the ICI says. And this month, many mutual fund companies say stock fund purchases have continued to wane, as high short-term interest rates lure investors back to bank CDs, Treasury bills and money market funds.
Because mutual funds have been such an important source of demand for stocks in particular, Wall Street’s fear is that a sustained drop-off in stock fund purchases--or worse, a surge in redemptions--could spell another tumble for the market. January will be a key month to watch, because many investors will be making decisions about where to put 1995 retirement savings. If they shun stocks, this megatrend could be headed for an interruption.
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Barton Biggs, investment strategist at Morgan Stanley & Co., is bullish on stocks for 1995 as a whole, with one caveat: He expects a selloff early on. And he warns, “If the public aggressively redeems equity mutual funds next year in the same way it redeemed bond funds this year,” any market decline “might last longer than I now think likely.”
* Capitalism is spreading worldwide. No doubt about it, this megatrend remains in place. But as investors learned in 1994, that isn’t necessarily immediately positive for financial markets. Surprising economic strength worldwide this year, as demand for goods and services boomed, helped send interest rates rocketing. And as capitalists everywhere clamored for capital, some economists began to contend that long-term interest rates were bound to stay higher than expected in the 1990s, reflecting a “shortage” of money. That could botch any hopes for a continuing bond rally.
For Third World capitalist economies like Mexico, meanwhile, concern about a still-wide gap between rich and poor--and the potential for social unrest--detracted this year from an otherwise generally bullish long-term outlook for “emerging” stock markets.
Even so, Dean Witter investment strategist William Dodge argues that the capitalism wave “can’t be bad in the long run” for investors, especially considering the alternative. And he sees the major industrial companies of the world’s developed economies, like the United States, as the real near-term winners. “The developed nations will provide the tools (machinery, technology, etc.) to the developing nations” to make their economies grow, Dodge says.
* Inflation will stay low. It did in the United States, Europe and Japan in 1994. U.S. consumer inflation is expected to total a mere 2.7% for the year, despite the economy’s boom. Wall Street credits the highly competitive U.S. economy and increasing competition worldwide, as falling trade barriers favor low-cost producers.
Yet low inflation didn’t stop long-term bond yields from surging in the United States or Europe--to the shock of most investment pros. Now most economists expect a slight pickup in inflation in 1995, in part because a tight U.S. labor market will help workers negotiate higher wages. The newsletter Blue Chip Economic Indicators says economists’ consensus estimate for U.S. consumer price inflation in 1995 is 3.4%.
In theory, at least, financial markets are already prepared for such an uptick. Then again, last February many pros figured that the markets were prepared for the Federal Reserve’s initial credit-tightening move. In retrospect, they weren’t. In the long run, there’s still every reason to bet on low inflation, experts say. The question near-term is how low is low to Wall Street.
* Small stocks will outperform big stocks. As small-stock indexes beat blue chip indexes for three straight years from 1991-93, analysts credited smaller companies’ nimbleness and ability to cash in on profitable “niche” demand in the global economy. Many experts predicted that small stocks’ bull run would last five to eight years--a typical cycle for them.
But the streak has ended. The Russell 2,000 index of smaller stocks is down 4.5% for the year, while the blue-chip Standard & Poor’s 500 index is off just 1.1%. Prudential Securities analyst Claudia Mott says odds are small stocks’ suffering will last: In 68 years, she says, “There hasn’t been a cycle in which small stocks outperformed for three years, lagged for a year, and then resumed their leadership position for another year or two.”
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Losing Faith
Net new cash flow into stock mutual funds plunged in November a the outflow from bond funds ballooned. Figures in billions of dollars:
Stock funds
Nov. 1994: 3.0
Bond funds
Nov. 1994: -10.9
Source: Investment Company Institute
