Cover Story: Where To Invest '96: The Framework: Global Outlook
AROUND THE CORNER: EASY MONEY AROUND THE WORLD
Of all the years that have confounded even prescient investors, 1995 takes the cake. First came the wipeout in Mexico and other emerging markets. Next was the collapse and partial recovery of the dollar. And despite all the gloomy news, the U.S.--and the British and Swiss--stock markets climbed to record highs.
In 1996, pros say, even more surprises could be on the upside (table, page 39). And just two words account for all the optimism: easier money. After a big monetary squeeze that started in 1994, "central banks around the world are loosening their purse strings," explains Michael J. Howell, strategist for ING Baring Securities Ltd. in London. "Global liquidity is rising fast."
For investors, that could spell nirvana. Economists estimate that the Bank of Japan alone has pumped $100 billion into domestic and international markets since early 1995 in a heroic effort to pump up lagging economic growth, shore up tottering banks, and bring down the towering yen. The infusion helped fuel a rally in Japanese stocks and bonds. It even leaked into the U.S. market, where some pundits believe a sudden wave of Japanese cash is partly responsible for the long-term Treasury bond yield's fall to a hair over 6%.
GOOD OLD DAYS. Few think the Japanese central bank will stop anytime soon. And with the U.S. economy slowing, the Federal Reserve looks nowhere near ready to end the easing it began with a quarter-point rate cut in July (page 42). Lower U.S. rates would certainly give European central banks room to follow suit. In fact, more analysts now believe that Europe--where growth is flagging despite modest Bundesbank rate cuts in 1995--is headed for its sharpest rate reductions in many years.
Indeed, if central banks continue pumping away, world liquidity (chart, page 40) could eventually match its near-record levels of 1993, when double-digit returns were the norm for industrial countries' equities--and when emerging markets turned in an extraordinary average return of 64%. Now, two years later, some economists and money managers think the good old days may be about to return. "I expect a number of years of improvement for the equity market worldwide," says Norbert Walter, chief economist at Deutsche Bank Research in Frankfurt. Many money mavens think the same will hold true for bonds, especially in continental Europe, where long-term interest rates have not dropped as far as those in the U.S. or Japan and thus have farther to fall.
But waiting for the big monetary payoff may take patience. In Japan, despite some progress, the economy still faces a long recovery. The stock market, however, is looking ahead. The Nikkei stock average is up by a third from 1995's lows. Corporations are recording year-over-year profit increases of close to 30%, as cost-cutting starts to bear fruit. A stronger dollar is helping, too: From its low of 79 yen in April, the greenback's value has rebounded to around 100.
The dollar could gain an additional 10% to 15% against the yen in coming months, traders say. Why? The Bank of Japan will continue throwing cash at the currency market in a bid to "do whatever it takes to bring the yen down," predicts William P. Sterling, chief strategist at BEA Associates, a New York fund manager.
But even if the central bank gets the yen under control, the Japanese economy must absorb the immense problems of the country's banks, which are saddled with $800 billion in bad loans from the go-go 1980s. The burden is so large that Mineko Sasaki-Smith, an analyst at Morgan Stanley & Co., thinks Japan's Economic Planning Agency will soon cut its estimate of gross domestic product growth for this year to 1%, down from the rosy 2.8% it still publicly insists is in the cards.
While authorities are taking steps to begin a U.S.-style workout of Japan's loan problems, it could take five years to resolve them--and get the economy back in high gear. Some analysts think Japanese growth won't rise above 2% until 1997. For that reason alone, it's hard to see the Ministry of Finance and Bank of Japan tightening their fiscal or monetary purse strings very soon.
Continental Europe, too, faces a measure of pain before its economies return to robust growth. To make sure they comply with the terms of their deal to create a single currency by the century's end, European Union members are keeping their budgets tight. But that's creating plenty of angst. Hobbled by high interest rates and growing labor strife, France is seeing growth falter. And in Germany, says Deutsche Bank's Walter, "we're in a minirecession."
By Walter's reckoning, Europe's largest economy has been stagnant since summer. And it's unlikely to pick up before next spring. That's when a stronger dollar--perhaps worth 1.60 marks, compared with 1.45 now--should begin to revive exporters' shipments and bolster their sagging profits. What could bring the mark and other Continental currencies down, of course, is lower interest rates. And as pessimism over the European economy builds, optimism for new rate cuts by the Bundesbank and other central banks is mounting.
ONLY WEAPON. In fact, with most governments trying to rein in welfare-state spending and curb budget deficits, easier money is about the only weapon Europe has these days to combat recession. To be sure, France's markets could get a huge boost if the government of Prime Minister Alain Juppe prevails in his battle with unionized workers to get the runaway social security budget under control. A victory could push the Paris bourse up more than a third, some analysts say.
But even if the government wins, France will remain burdened by a real estate crunch and structural woes at big commercial lenders such as Banque Nationale de Paris and Credit Lyonnais. As a result, lower interest rates will still be needed to get the economy going. And what goes for France will apply to the rest of Europe as well. "The longer growth is stalled, the more the pressure will grow on governments and central banks to stimulate their economies. And interest rates will be part of the solution," says Morgan Stanley analyst Richard Davidson.
He thinks rates could "fall more than expected," perhaps by at least half a percentage point in Germany and 1 1/2 points in Denmark and Spain. Such declines, Davidson maintains, will raise expectations for growth and corporate earnings and will set Euroequities ablaze. But mounting global liquidity should lift emerging markets, too. And not a moment too soon--because 1995 has brought little but grief.
The severe recession brought on by the 55% devaluation of the peso has left the Mexican stock market down 25% in dollar terms in 1995, even after a summer rebound. Inflation jitters, political turmoil, and flight by overseas investors, meanwhile, have the Thai market languishing. And India's equities have sagged 23% as the central bank fights inflation. With a dearth of buyers, "emerging markets are the cheapest they've been since 1984," observes Baring's Howell.
To Howell and a few other intrepid stock-pickers, however, emerging markets won't stay this cheap for long. For example, Charles I. Clough Jr., Merrill Lynch & Co.'s chief investment strategist, notes that money growth is increasing in China again, after the central bank brought inflation down from 24% to 11% over the past year. This should reaffirm the country's "remarkable growth story" and stoke interest in the many China issues trading in Hong Kong, he says. Latin America, too, should start enjoying more placid times, helped by moderate U.S. interest rates and an intensifying focus on domestic economic reforms.
"REAL PRICE ACTION." Bank of America economist Guillermo Estebanez estimates that Mexico's GDP will expand by 3% in 1996 after its disastrous 7% plunge the year before. Brazilian growth may approach 4%. Even Argentina's recession-plagued economy should enjoy some relief. If these forecasts pan out, Latin stocks could rapidly reverse much of their 1995 losses. After all, points out BEA's Sterling, the region's markets are so thin--especially since the Mexican collapse--that "it doesn't take much to get some real price action."
What could go wrong with the coming year's easier-money outlook? U.S. growth could accelerate sooner than expected, putting additional Fed rate cuts on hold. Europe's currency tensions could break out anew, preventing many EU members from cutting rates nearly as aggressively as they wish. And even if the Fed stays loose, Latin America could fail to achieve the recovery it hopes to see.
But the bulls are putting long odds on such events. "There is no inflation, and interest rates will remain very subdued," says Hans Rudolf Muller, a senior asset manager at Zurich's Credit Suisse. "We'll have a very benign environment for stocks." As they watch the world's central banks step on the accelerator, the bulls are getting ready for a global race to recovery.By William Glasgall in New York