NEW YORK-“While there are occasional missteps-sometimes big ones as in Thailand, Indonesia, Malaysia, Korea and Japan-volatility is the price one pays for free markets,” Peter M. Donovan said in a recent presentation on the outlook for the capital markets.
Donovan, who addressed the New York Society of Security Analysts, is president and chief executive officer of Wright Investors’ Service, a Bridgeport, Conn., money management firm that conducts ongoing research into 16,000 companies worldwide. Within two years, Wright plans to expand the number of corporations under its review to 25,000.
“I do not consider myself a big bear on the [United States] stock market. But I do believe that U.S. stocks are likely to sustain a full-blooded correction or, if Asia gets much worse, an outright bear market in the coming months.”
Such a correction is overdue because none has occurred so far recently to ameliorate “excesses that have built up in stock prices.”
Donovan said the sell-off of nearly 15 percent that the Dow Jones Industrial Average underwent last summer wasn’t a true market correction, whose hallmarks are “magnitude and time.” Nor does he consider as a true correction “a market break like October’s that comes and goes in the blink of an eye-before economic fundamentals have had a chance to improve.”
Just as the difficulties facing Asian tiger countries are unusual, so too have been the last 15 years for returns on investment, which galloped along at double-digit rates.
Donovan termed the past three years, “just staggering,” with 30-percent annual profit on equities investments.
Stockholders will confront the reality that these have been an aberration, he said.
Corporate profit growth is likely to moderate in 1998. Wright anticipates earnings growth of 8 percent, “in line with their long-range potential, but perhaps not up to the expectations of investors who have accepted the profit gains of the past several years as the norm.”
The Dow is more likely to hit 7000 than 9000 in 1998, and investors hoping for it to pass the 10,000 milestone probably will have to wait until 1999 or 2000, he said.
While the stock of many big-cap companies is overpriced, “there are still relatively good values to be found among smaller issues … (but) a transition of leadership from Dow-type stocks to the broader market won’t be easy.”
Donovan said he cannot imagine that the Federal Reserve Board would impose “any large or extended tightening,” given that inflation is at a 30-year low and that Asian producers have an overcapacity of supply.
However, if the Fed tightens credit or the situation in Asia deteriorates, the negative impact on the stock prices of major corporations will reverberate among smaller publicly traded companies.
“But if such hazards can be avoided, with small stocks working their way higher while big-caps consolidate, the rotating bull market of the 1990s may find its next logical extension.”
American buyers exercising their purchasing power are the likely knights in shining armor rescuing corporate America’s damsels in distress from the impact of the economic downturn in Asia.
“Asia is, in some sense to me, an unprecedented event. I think the shock [there] will be short-lived, although it may be a bit worse than Mexico, which took two years to get out of.”
The lesson for Asia is about the need for “reform and restructuring,” which Donovan said he expects to happen and to lead to renewed growth.
The lesson for investors is that global diversification of their portfolios is important because no individual market always remains on top.
“I believe that the long-term history of the market shows that [volatility] is a price worth paying. The ascent of capitalism appears to be inexorable, which should provide opportunities for greater growth, healthy competition [resulting in] low inflation and strong securities markets into the 21st century.
“Demographic trends remain in favor of financial assets. While the single-digit returns that are in prospect for the next few years will not come close to the results of the past 15 years, stocks and bonds should keep investors well ahead of inflation.”
