Will Risk-Takers Take a Hike?
The computers may be Y2K-compliant. But how about the humans?
Even as experts are gaining confidence that the technological impact of the year 2000 computer problem will turn out to be minor, many are concluding that the biggest potential dangers to financial markets now are psychological.
Specifically, regulators and market professionals are preparing for the possibility that fears surrounding the “Y2K bug” may induce a widespread credit crunch later this year, especially in foreign markets where computer systems are thought to be far more vulnerable to disruption from the calendar rollover.
The key concern: that many investors will dump their holdings of higher-risk stocks and bonds, causing markets to swoon and cutting off credit to businesses in developing economies.
Federal Reserve Chairman Alan Greenspan, in a speech on Friday, said the Fed believes its “major challenge” related to Y2K now is dealing with the public’s fears, not with actual computer problems.
International economist Carl B. Weinberg of High Frequency Economics in Valhalla, N.Y., notes that stock market investors in India, Indonesia, Singapore and South Korea, among others, have already racked up year-to-date returns of 35% to 75% amid growing optimism about the world economy.
Given even a shadow of Y2K doubt, Weinberg says, both local and foreign investors in such markets might well decide to simply take their profits and temporarily reinvest in a safe haven such as U.S. Treasury securities.
His is a minority view, but if it happened on a wide enough scale, the result could be a financial shock similar to the one that occurred last year after Russia’s currency devaluation and bond default.
Capital starvation can ripple through many economies, dashing confidence, causing businesses and consumers to pull back on spending, threatening recession.
“I think some version of that [credit crunch] scenario is likely the biggest risk we face because it’s purely a psychological issue,” said Bruce McConnell, director of the international Y2K Cooperation Center, a United Nations-sponsored coordinating group based in Washington.
By comparison, the Y2K disaster scenarios involving technological failures--airplanes plummeting from the sky, power grids and communication systems shutting down, and so on--strike McConnell as farfetched.
The Y2K bug, of course, refers to problems large and small that could result from computers’ inability to distinguish between the years 2000 and 1900 come New Year’s Day.
Governments and businesses worldwide have spent billions of dollars trying to identify and head off any potential for system failure.
But because investors can’t be absolutely sure that catastrophes won’t arise, some are likely to play it safe, trimming back higher-risk investment holdings whose value could fall fastest in a global panic.
So far, there are some signs that such a shift is underway, but they aren’t appearing everywhere.
Overseas, many developing nations’ stock markets have pulled back in recent weeks or months, but it isn’t clear that Y2K fears are the cause.
In U.S. markets, corporate “junk” bond yields have continued to rise in recent weeks even as Treasury yields have remained flat--suggesting that a “flight to quality,” and away from risk, is in fact underway.
In theory, if such trends continue, they should also bring out bargain hunters at some point--investors eager to snap up securities with rich returns.
Indeed, junk bonds could be a great opportunity later this year, and certainly after Jan. 1, if Y2K proves to be a nonevent, argues Jeffrey A. Koch, who manages the $600-million-asset Strong High-Yield Bond Fund in Milwaukee.
“The problem is how you get from here to there,” he said, noting that the market could get worse before it gets better.
Koch and other market pros say many investors have remained wary of higher-risk securities since last fall, when markets were battered by Russia’s default. The Federal Reserve’s two interest-rate hikes in summer also have caused investors to shy away.
On Wall Street, even major bond dealers have been reluctant to hold much inventory of securities because they are afraid of taking losses in a sudden reversal. Their skittishness means less liquidity for other investors who may want to sell.
Dealers that have had a good year avoiding market disasters “don’t want any mistakes now,” said Arthur N. Calavritinos, manager of the John Hancock High Yield Bond Fund. “It’s like a football team protecting a lead--no fumbles.”
That nervousness is reflected not just in higher junk bond yields, but also in wider bond-yield “spreads” across the board in recent months--that is, a wider gulf between yields on risk-free Treasury securities and other securities of similar maturities.
Some analysts worry that those spreads could widen further soon. At a minimum, a slowdown in bond and stock trading activity and securities issuance is almost universally expected in coming months, as investors and companies grow cautious about entering into transactions that will settle around the time of the calendar rollover.
Anticipation of that slowdown is one reason credit markets have seen a flood of bond issuance this summer: Companies are trying to take care of their credit needs in advance.
“Nobody wants to come to market in size at the end of the year,” said Mary Rooney, a fixed-income strategist at Merrill Lynch.
The brokerage’s fixed-income department, under Rooney’s direction, recently polled more than 100 of its largest institutional customers--including mutual funds, pension plans and insurance companies--to find out what sort of Y2K-related precautions big investors were taking.
The respondents were active in Treasury, mortgage, municipal, investment-grade corporate and junk bond markets.
More than two-thirds of them said they expected liquidity--the ease with which buyers and sellers of bonds can find each other--to fall either “moderately” or “seriously” as Y2K approaches. Only 5% expected no impact.
And 58% of the managers said they either already had or were planning to take measures to improve liquidity in their own portfolios. Some were selling corporate bonds, for example, and buying Treasury issues.
But could such hedging moves be close to running their course?
Hancock’s Calavritinos, for one, said he has gradually accumulated cash over the summer and is now holding a few percentage points more cash than normal for his fund as a precaution.
Liquidity in emerging-markets debt is so low that for a manager who hasn’t already built the cash reserve he or she wants, it may already be too late, Calavritinos said.
Merrill strategist William H. Cunningham, noting the rise in bond yields this year, argues that corporate-bond market participants have already had a “mass anxiety attack” because of Y2K.
“The only way the markets are going to be crushed any more from here is if Y2K really is a disaster,” he contends.
Even if bonds are suitably nervous over Y2K, stock market investors worldwide haven’t yet exhibited much concern, many analysts say.
On Wall Street, the Dow Jones industrial average and the Nasdaq composite index are only modestly below their summer peaks. Nor is there any sign of heavy liquidation of higher-risk smaller stocks.
And although many foreign markets are below their 1999 peaks, few are in deep declines.
J. Mark Mobius, managing director of Templeton Asset Management and an international-investing guru, thinks the lack of anxiety is perfectly reasonable. He doesn’t consider emerging stock markets especially vulnerable to Y2K problems, he said in a telephone interview from Seoul last week.
Mobius pointed out that at the height of trading one day last month, the Chicago Board of Trade was forced to shut down for the afternoon because of a power failure. “This would never happen in emerging markets,” he said. “They’re used to power interruptions. In the Philippines, every big building has an electrical generator.”
Y2K has been thoroughly discounted and prepared for by equity markets, Mobius believes. He said he hasn’t been surprised lately to hear more foreign investors say they plan to be ready to buy on any short-term weakness in stocks.
But could a wave of selling by nervous individual investors in emerging-market mutual funds force fund managers to dump securities? Historically, relatively few mutual fund investors have joined in market panics.
What’s more, the U.S. Securities Industry Assn. recently disclosed results of a poll indicating that more than 9 out of 10 individual investors anticipate no impact on their investments because of Y2K.
Still, even though most investors did not sell securities a year ago in the post-Russian-default panic, enough did that markets plummeted, albeit briefly--and set off a global credit crunch that Greenspan said was the most abrupt in a generation.
Because access to capital is critical to keep the modern economy moving, government officials have taken steps to forestall Y2K-related financial strains, particularly in the banking system.
In addition to printing some $50 billion in extra currency to accommodate people who may withdraw more cash before New Year’s Day--just in case--U.S. authorities are relaxing the collateral requirements on banks that need short-term financing at year end.
Foreign central banks are taking similar steps to prevent a Y2K-related credit crunch.
The hope is that giving banks easier access to credit will make them less likely to tighten credit on their customers, even if markets turn wobbly. And because it is impossible to calibrate how much liquidity will be needed, governments, firms and consumers will tend to overestimate, some analysts say.
While credit-crunch fears may be real, the irony may be that cash hoarding will leave many economies awash in currency that consumers will be sorely tempted to spend once the Y2K danger is past.
The result could be “one of the more spectacular impulse-shopping booms in American history,” said Greg A. Smith, chief strategist for Prudential Securities.
His advice: Buy retail stocks.
Whatever happens in global markets over the next three months, experts say, it’s important to put Y2K in its proper perspective as a one-time event.
“It’s pretty silly to invest based on this one single element,” said Jerry Paul, manager of the $925-million Invesco High Yield Fund. In picking securities, he said, “we continue to be much more worried about execution of [a company’s] business plan, competition and the other things that aren’t going to go away Jan. 1.”
Times staff writer Thomas S. Mulligan can be reached by e-mail at thomas.mulligan@latimes.com.
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The Clock Ticks, and Wall Street Worries
Fear of potential computer glitches on Jan. 1 tied to the so-called year 2000 bug are fueling a more widespread fear on Wall Street: that many investors will dump higher-risk securities between now and Jan. 1 rather than chance market turmoil related to Y2K. Three sectors of concern:
