Here, in a nutshell, is our interpretation of what happened
in the financial markets in 1999. As the global profits
cycle re-accelerated, deflation gave way to reflation,
which led to worries about inflation. Accordingly, yield curves
steepened. Emerging markets rebounded, but the performances
of various investment styles were surprisingly mixed.
What guideposts should investors use in 2000? We offer
several.
- Continue to focus on value, lower-quality, and smaller-capitalization
stocks in most regions of the world. The more optimistic
an investor is about the outlook for the global economy
and the global profits cycle, the more he or she should overweight
value, small-cap, and lower-quality stocks. - Underweight the US market. We were quite bullish about
the US market for several years because we viewed it as the
world’s “large-cap, high-quality” market, the survivor in a
“Darwinistic” environment. Conversely, if we are now optimistic
about global growth and profitability, it makes sense to moderately
underweight the US in favor of regions that are more sensitive
to the global economic upturn. - Equal-weight Europe. Profit cycles appear to be set to
rebound in Europe, but not across the board. Those in France,
Spain, and the Netherlands are accelerating; consequently, we
favor value styles of investing in those markets. We are more
cautious about Germany, Italy, and the UK. The risk in Europe,
in our view, is that the European Central Bank and the Bank of
England will raise interest rates prematurely, curtailing the
nascent recovery in profits. - Moderately overweight Japan. The Japanese yield curve is still steep, and we expect the cyclical influences on the Japanese
economy to remain strong. The profits cycle in Japan appears to
have finally bottomed, and our profit indicators remain bullish.
The secular story of rising unemployment and rising interest rates
in Japan still looks unappealing to us, but positive cyclical factors
appear to be swamping less-favorable secular ones. - Overweight emerging markets. Our biggest overweight is
in the emerging markets. In our view, they are “small-cap, lower-quality”
issues that tend to outperform when profit cycles
accelerate. Our preference has been in Asia for some time, but
estimate revisions in Latin America have recently begun to significantly
improve. - Overweight resource markets. We continue to like “commodity-
related” investments. Pricing power is making a comeback,
according to most of our inflation indicators, albeit not to
the levels it reached before the global deflation. The resource
markets, in our judgment, are essentially the “cyclical stocks”
of the world.
A key risk is that central bankers will tighten too much, too
quickly during 2000. That would probably send the global
economy back into a deflationary spiral. Meanwhile, investors
need to keep a close eye on profits and beware of any signs of
a slowdown.
Investors also might want to note that the peak in the dollar in
1999 coincided with the trough in the global profits cycle. History
shows that, as the profits cycle accelerates, investors generally
become more willing to take risks, and they sell US
assets and dollars to purchase non-US assets. Clearly, stronger
global growth points to a weaker dollar. That’s another reason
we underweight the US market.
