As a sea change brews this year for economies around the world, many investors are . . . Hanging Tense
Investors searching for a successful investment strategy for 1998 may want to head down to the beach and study the ways of the lonely surfer.
To stay on your board--and stay alive--you must be nimble, focused and well-balanced. And have plenty of courage.
There may be no better advice on Wall Street this year than that, because what investors face is a potential tsunami of change in the global economy and in financial markets:
* The crisis in East Asia, where economies, currencies and stock markets are a shambles, still is far from resolved, and its far-reaching ramifications are only beginning to be understood.
* In the United States, pessimism is mounting over the ability of blue-chip multinational companies to sustain their phenomenal earnings growth of recent years in the wake of weakened Asian demand for goods and services, an inevitable flood of cheap exports from desperate Asian competitors, and rising wage pressures at home.
* In Europe, the decades-old dream of monetary union among major nations now is just one year from reality--but the risk that the agreement could unravel in advance remains high.
* And in stock markets worldwide, volatility has become extreme in recent months. On Wall Street, 100-point moves in the Dow Jones industrial average have become far too routine for some investors’ comfort, encouraging a march into “safer” securities such as Treasury bonds.
What’s more, the message of the record 555-point Dow dive of Oct. 27 still isn’t quite clear: Was it a warning that the 7-year-old bull market is breathing its last, after an unprecedented run that has lifted the U.S. market’s value by a stunning $6.2 trillion just since 1990 and doubled the number of Americans in the market to more than four in 10?
Precisely because the world has become so interdependent in this decade in terms of trade and investment, waves of change emanating from one region now can quickly produce dangerous riptides elsewhere.
Yet if the risk of wipeout in many markets is far greater in 1998, so too is the potential for savvy investors--the nimble, focused, balanced and courageous--to have a great ride, some Wall Street pros insist.
“I think there are many more opportunities than pitfalls” ahead, says economist Allen Sinai at Primark Decision Economics in Boston.
Is that too Pollyannaish? Maybe. Some economists, after all, are warning that the odds of outright world depression have increased substantially because of Asia’s downfall.
While Merrill Lynch & Co.’s chief market analyst, Richard McCabe, isn’t in the depression camp, he is telling his clients that the U.S. stock market could fall as much as 25% this year--which would be the worst decline since 1987--as the global economy slows because of Asia’s turmoil and as more investors opt to cash out some of their huge gains from the 1990s bull market.
Certainly, under that scenario some stocks would fare better than others. But by definition a bear market is a time when many investors choose to seek cover rather than aggressively chase new investment opportunities.
And if a bear market is in fact upon us, meaning that stocks are poised to fall at least 20% from their 1997 highs, the resolve of millions of small investors in mutual funds will be tested as never before--because so many of those investors have entered the market just since 1990 and thus have no experience with nerve-racking share price declines.
As a story on D6 in today’s section details, bear markets tend to be over quickly, but it still can take years to recover just to the break-even point if you buy stocks at peak prices before a bear cycle begins.
The math works out this way: If something falls 25% in price, it then must rise 33% to get back to where it was; a 40% price decline requires a 66% rebound just to return to break-even.
Those figures are no longer hypothetical in East Asia, where markets in countries such as Thailand and Malaysia lost more than 50% of their value last year.
For now, however, most investors in U.S. stocks are still counting their winnings from a third straight year of big gains:
* The Dow Jones average, at 7,965.04 as of Friday, is down 3.6% from its record high of 8,259.31 reached Aug. 6. But it still was up 22.6% for calendar 1997, after surging 33.5% in 1995 and 26% in ’96.
* The average general U.S. stock mutual fund gained 24.4% in 1997, following a 31% rise in 1995 and a 19.5% return in ’96.
* Even the Nasdaq composite index of mostly smaller stocks, although down 9.5% from its October peak, was up 21.6% for calendar 1997.
All of which means that if investors feel the need to shift their portfolios because of fear of what may transpire in the global economy and in markets in 1998, there is still time to do so. Damage to the U.S. market overall has been limited thus far, the last few months’ wild swings notwithstanding.
But many Wall Street pros advise against a wholesale abandonment of the stock market. Many, like Sinai, see opportunities for more gains in 1998 despite the seemingly monumental challenges facing the global economy.
Abby Joseph Cohen, the oft-quoted investment strategist at Goldman, Sachs & Co., is sticking to the basically sunny outlook that has kept her on top of the market forecasting game for much of this decade.
She doesn’t believe that the global economy or U.S. stocks are courting disaster. On the contrary, Cohen expects blue-chip stocks to rise about 10% this year, on average. That would be far below the gains of recent years, of course, but just about on par with stocks’ long-term average return.
Whether you trust any particular forecast or none at all, most investment pros counsel that you at least realize the potential for both positive and negative fallout from the great wave of change expected to hit the world economy and markets this year.
Here, a look at four key elements of that expected wave:
* The Asian crisis. Including Japan and China, East Asia accounts for about one-third of global economic activity. Thus, the Asian economic debacle poses a far greater risk to world economic growth overall than perhaps any other crisis since the quadrupling of oil prices in the mid-1970s.
The great fear is that Asia’s weakness in 1998, as economies from Japan to South Korea to Malaysia contend with a full-blown banking crisis brought on by years of over-lending and overexpansion, could drag the rest of the world into depression.
The last time depression talk made the rounds was in 1987, after the global stock market crash. Before that, depression worries surged in 1982, when Mexico was in a debt crisis.
A depression never arrived, of course. And it is still a minority forecast among economists.
One reason: The economies of North America, Europe and Latin America remain healthy overall.
“It’s ironic that the fundamentals of the global economy are in much better shape than the currency [devaluation] contagion in Asia might suggest,” says Stephen Roach, economist at Morgan Stanley, Dean Witter, Discover & Co. in New York.
He still expects real global economic growth to fall to 3.5% in 1998 from about 4% in 1997. Yet many Wall Street pros believe that the growth slowdown ultimately will be beneficial--especially in the United States--by relieving potential economic bottlenecks and by allowing long-term interest rates to decline.
What about the much-ballyhooed deflation threat? No question, Asian goods substantially cheapened by the region’s currency devaluations will swamp U.S. shores. That will hurt some U.S. companies that compete in those markets.
But tradable goods account for only one-fifth of U.S. gross domestic product. The rest of the economy is service-based--and Asia cannot export much in services to America.
Edward Yardeni, economist at Deutsche Morgan Grenfell in New York, notes that the main U.S. benefit stemming from Asia’s deflation is further downward pressure on the already-low U.S. inflation rate.
“The consumer should benefit from lots of cheap imports,” Yardeni notes. And if interest rates continue to slide, “lower mortgage rates should stimulate housing activity and provide a nice windfall for homeowners who refinance,” he says.
For investors looking for opportunities amid chaos, bonds and other income-oriented securities may continue to shine in 1998 if interest rates keep falling, Yardeni says.
* Slower U.S. corporate earnings growth. Even before the Asian crisis hit, the terrific earnings growth achieved by U.S. companies in recent years was expected to slow in 1998, in part because of waning benefits from previous corporate restructurings and rising wage rates in a tight labor market.
Now there is the threat of a deeper growth slowdown. As Merrill Lynch notes, foreign-derived earnings are expected to account for about 30% of U.S. blue-chip companies’ total earnings in 1998.
If the global economy slows much more than expected--and if the dollar strengthens further--foreign earnings could be far more disappointing.
For now, Merrill Lynch still expects earnings growth for the blue-chip Standard & Poor’s 500 companies this year to reach 7.5%. That would be down from an estimated 13% in 1997.
But as many Wall Street bulls point out, the expectation still is for overall growth in profits--not a decline.
“Margins will be under pressure, but I don’t think profits are going to collapse,” says William Miller, veteran portfolio manager at Legg Mason in Baltimore.
Within the huge U.S. economy, Miller points out, there will be many companies whose earnings gains will remain healthy, so long as the economy continues to grow.
Which is why, even as many investment pros suggest that Treasury bonds yielding 5% to 6% make good sense now, Miller is more inclined to shop for beaten-down stocks.
“I can find a lot of things that should be up more than 15% to 20% over the next three years,” he says. “And that’s all you have to earn to beat bonds” at current yields, he adds.
* The approach of European Monetary Union (EMU). If all goes as planned, 11 major economies of continental Europe will launch a common currency as of Jan. 1, 1999.
“The scope of the monetary union proposal is unprecedented in
both European and world economic history,” says David Hale, economist at Zurich Insurance Group.
But what will it mean for the European and global economies in 1998? Economist Sinai sees great benefits: a convergence of interest rates across Europe, the anticipation of more corporate transactions (such as mergers) across borders, and a growing confidence in Europe that union will allow the Continent’s economy to blossom long-term.
Thus, he believes that European stock markets, which were among the world’s strongest in 1997, will continue to surge, regardless of Asia’s woes. “I see Europe as the best of the industrialized markets in 1998,” he says.
The risk? That something happens to halt EMU--causing interest rates among countries to diverge again, and shattering investor confidence.
* Rising market volatility. For many U.S. investors, stocks’ gyrations were disturbing in 1997. But many analysts say the market merely returned to normal volatility, after years of steadily rising share prices. And few analysts believe volatility will decrease any time soon.
The U.S. market experienced one significant pullback in 1996. Last year saw two. Could 1998 bring three or four such pullbacks--only to be followed by fast recoveries, and still no true bear market decline for the market overall?
It’s an idea worth considering, many Wall Streeters say. Despite the seeming elderliness of this bull market--it just finished its seventh year--up-market cycles don’t simply die of old age when their fundamental underpinnings still are in place, says veteran money manager Gary Pilgrim at the PBHG mutual funds group.
“The chronic calling for an end to the bull market because of its age is nonsense,” he says.
Moreover, it is precisely market declines that provide the best long-term buying opportunities, Pilgrim notes. That truth never changes on Wall Street.
In short, however the market plays out, an investor who maintains the surfer’s mind-set--nimble, focused, well-balanced and courageous--will always have an advantage over investors who are merely reactive.
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INVESTING IN THE NEW YEAR
Picks: Catching the stock market’s next wave. D3
Primer: Getting started with mutual funds. D10
Ratings: Ranking the top mutual funds. D12-15
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Blue Chips’ Overseas Exposure
Foreign-derived profits--either from exports or from foreign-based divisions--will account for nearly 30% of total earnings of the blue-chip Standard & Poor’s 500 companies in 1998, versus 26% in 1994, Merrill Lynch & Co. estimates.
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1994 1995 1996 1997 1998 Foreign-derived earnings per share $8.25 10.25 11.36 13.55 14.90 Domestic-derived earnings per share $23.85 27.06 29.78 32.95 35.10 Total Domestic Foreign $32.10 37.31 41.14 46.50 50.00
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*Estimates
Source: Merrill Lynch & Co.
