Things investors need to know

Friday 3rd March 2000

PETER V O'BRIEN looks at 10 not-so-easy questions on where the markets are heading and warns to watch out for the 'red queen' effect

International broker Credit Suisse First Boston's The New Millennium Project - abbreviated from a 700-page document - asked and answered 10 questions on the markets in 2000:

Are today's changes unprecedented? No, endogenous [growing from within] technological growth is a long-standing phenomenon.
Is the knowledge economy really different? Yes, the IT revolution enhances every other technology invented, changes the price mechanism and, not least, tends to be associated with increasing rather than decreasing returns.
Is US productivity growth peaking? No, the US is close to an acceleration point in the benefits from its technology investments.
Is the US stockmarket overvalued? Yes, on conventional measures, but the market is probably discounting the acceleration point in US productivity, the full benefits of which have yet to be seen in today's cashflows.
How is industrial structure changing? Into an odd combination of mega and micro firms: mega firms that can truly exploit scale economies and "capital-light" micro firms. One risk is increasing anti-trust actions against "winner-take-all" results in the New Economy."
Will Japan recover? Yes, enough has been done to restructure/recapitalise the banks and limit systematic risk. There is increasing focus on profit and return on capital - but the immediate restructuring costs will hold back final demand growth.
Can Europe prosper? Yes, the euro is just one building block in a broader reconstruction that should allow Europe to prosper. Europe has so far lacked the "super return" US PC-oriented stocks, but there are signs of a "fat tail" emerging in telecom equipment and mobile telephone companies.
What are the prospects for emerging markets? Deflationary pressures are depressing the prices for manufactured goods and commodities. But the potential for reallocation of underused agriculture workers still remains huge and emerging country economies may remain volatile even as volatility declines in the developed world.
Fewer emerging market crises? Yes, there have been structural improvements in banking and corporate governance and future capital allocation could be more risk-aware and efficient.
Is an era of super-prosperity possible? Not only possible but plausible, particularly if Europe and Japan can adopt the US "S" curve. Risks are future major wars and the continued success of the US Federal Reserve Board and other monetary authorities, particularly in response to recurring financial asset volatility.

Some of those answers could be overoptimistic, given the point that any international broking firm has an interest in nurturing a buoyant outlook on the part of investors, but they were interesting and relevant in the context of the trend in international markets during 2000.

CSFB also provided for reminders for investors:

Be aware of accounting-based distortions and focus valuation on cash-based measures.
Do not ignore technology. Technology stocks account for 22% of the Standard & Poor's 500 index. The New Economy will affect all the stocks we invest in as strategic phenomena, such as network effects, increasing returns to scale and the high upfront costs of these new businesses, become common.
Beware of the "red queen" effect. Much of the value generated by IT-driven efficiencies will be appropriated by customers rather than shareholders.
Three clear industry winners are global, "on-trend demographically" and knowledge-based - technology (including telecoms), healthcare and financial services.

Table I shows the weekly movements in three US markets indices since the end of 1999. New Zealand media tend to concentrate on the daily level of the Dow Jones average index of 30 industrial stocks when reporting on US stock price variations but that can produce a false picture.

The Dow Jones has been narrowly-based for years - although some technology stocks were added in a recent revamp - and has disguised the extraordinary rise of technology stocks, which include those involved in the internet, e-commerce and other high-tech businesses.

The Dow Jones and S&P 500 indices had good gains last year on the back of an excellent 1998 but the Nasdaq index's increase of 85.4% could be described as phenomenal. The situation this year carried on the 1999 trend. Falls in the Dow Jones and the S&P 500 showed US concern about the possibility of an over-heated economy and rising interest as Federal Reserve chairman Alan Greenspan warned about inflationary pressures.

Rising interest rates in the US, with more likely to come this year, affected the performance of the Dow Jones and S&P 500 indices but had little impact on the technology-driven Nasdaq composite index. The same phenomenon has been seen in Australia and in New Zealand where ex-salmon farmers, ex-mineral exploration and ex-timber companies have enjoyed soaring share prices.

CSFB discussed several industries and their growth prospects globally and in the US. The firm was generally optimistic about the industries on its list while expressing caution in some cases and recommending a cyclical approach in others, energy being an example of the latter.

Industries discussed were banking, broadcasting, cable TV, global electric utilities, feature films, film distribution, food stocks (most fully valued to overvalued), insurance, metals (cyclical), photography in 2010 (digital cameras), newspaper companies, technological (computer) services providers, communications integrated-circuits companies and telecommunications.

Most of the industries and the recommended stocks within them were expected to develop through the use of high-level technology in various forms.

Equity indices suggest investors have become cautious about stock prices, apart from the technology sectors. There could be more easing, a movement that might attract buyers, but the biggest danger for the US equity market seems to be a shakeout of technology stocks, particularly among the fringe organisations, many of which have minimal cashflow but sell on extraordinarily high multiples.

That has happened in every market fad since Dutch tulip mania and the South Sea bubble.

Private New Zealand investors looking for some US action should follow the standard rule applicable at home: keep to quality and use advisers with the ability to sort out the quality from the dross.

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