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ADAM SMITH'S MONEY GAME Missed the show? Get a phone call half way through? Fail to catch the name of a stock in "Personal Best"? In case you did, we are happy to provide you with a transcript. If you would like a transcript from a previous season, please visit 800-All-News at www.800-all-news.com or call them at (800) All-News. ANNOUNCER: [voice over] This program is made possible by a grant from MetLife, helping people become financially secure for 130 years. Funding has also been provided by the Roy R. and Marie S. Neuberger Foundation. ADAM SMITH: [voice over] In the Money Game this week, a special holiday report for the investment outlook for the rest of 1998. Vice Chairman Robert Hormats, Goldman Sachs International, what global surprises does he think could rock the markets? And, superstar strategists Mary Farrell of Paine Webber, Byron Wien of Morgan Stanley, and Ron Hill of Brown Brothers. What do they see in their crystal balls? Find out next.
Fast Forward [Back to top] ADAM SMITH: Hello, I'm Adam Smith and welcome to a special edition of The Money Game. What's the right investment mix for the second half of 1998? Has the bull market in the U.S. run out of steam? Do the storm clouds in Asia have a silver investment lining? For the next half hour, we'll be asking and answering questions like these. Come along, for a fast forward review of your personal best investing options for the rest of 1998. ADAM SMITH: What are the key global trends that could affect your investments? Robert Hormats is vice chairman of Goldman Sachs International and a former assistant secretary of state. He was on the ad hoc team assembled to advise Korea last fall. To get his latest thinking, I went to talk to him to get the Big Picture.
Big Picture [Back to top] ROBERT HORMATS, Goldman Sachs International: I think the next six months is probably the most dangerous period for the global economy since the oil crisis, particularly because of the deteriorating situation in east Asia. ADAM SMITH: [voice over] The turbulence in Asian countries like Korea, Indonesia and Malaysia has many worried about the possibility of economic collapse. But the biggest problem could come from the economic power house in the region. [on camera] Japan. Number two economy in the world. What's the problem? ROBERT HORMATS: They - first of all, don't feel the same sense of urgency about domestic reform that we think they should feel. Second, they also don't feel this responsibility for the regional leadership in the same way America does about the Western hemisphere. Third, they really don't know how to address these long standing problems at the banks without causing a lot of unemployment in the banking sector, pushing down the value of a lot of bad loans. Forcing people to fess up to the fact that these are bad loans and using public money to deal with the problem which is very unpopular. ADAM SMITH: Give me the Hormats best guess on Japan. ROBERT HORMATS: Japan will begin to tackle its banking problem in earnest for literally the first time in seven years. I think they will create a new bank which they call a ``bridge bank'' similar to our RTC. Second, I think they also will try to stimulate their economy more. They have a stimulus that they have already legislated which will kick in toward the end of the year. So I think in the medium term the environment in Japan is going to get better. ADAM SMITH: You were on the advisory team for Korea last fall. How's Korea doing? ROBERT HORMATS: I think Korea is doing very well in implementing the kinds of reforms it needs to implement to be a stronger economy. The problem is that, while they're doing that, the very process of restructuring banks and restructuring corporations, has meant more unemployment, a little more labor discontent. But the fundamentals are being put in place for a stronger economy down the road, although there will be a bumpy road between now and then. ADAM SMITH: [voice over] Another Asian country making the headlines is China. Is China a contender to stabilize the region? ROBERT HORMATS: China clearly is committed to continuing its market reforms and holding its currency stable. They realize that if the currency were to depreciate dramatically, they'd lose a lot of the stature they had gained during this period; and second, other currencies would collapse along with their currency so they would not be better off in the end of the process. ADAM SMITH: [on camera] To the average American, what harm or what good could come out of the Asian crisis? ROBERT HORMATS: If the Asian problem deteriorates dramatically for Americans it means American companies will not sell as many products to Asia which has an adverse effect on jobs. If the banking system in the Asian region, particularly in Japan, deteriorates, it will have a very bad effect on financial markets not only in Asia but around the world. And from a political point of view, Japan is our major ally in the region. If it suffers real weakness, real internal weakness, it's from a strategic point of view a big problem for the United States going down the road. ADAM SMITH: [voice over] Uncertainties in east Asia haven't touched the soaring markets in another part of the world. Europe. ROBERT HORMATS: I feel very positive about Europe. Several years ago I did not see Europe addressing the major problems it had to address, particularly industrial restructuring. Now you see a more optimistic attitude in Europe except for unemployment, which is a big problem. But the corporate sector has restructured itself, become much more productive, much more efficient. Europe is creating a single currency market which is a big plus and is going to make them more competitive and, by and large, European governments have addressed their fiscal problems which have been a big problem. Now they're reducing their budget deficits. ADAM SMITH: [on camera] So the EURO is going to work? ROBERT HORMATS: My bet is that there is enough capability among leaders in Europe and enough will power among Europeans to make the EURO work. The danger from the EURO is that it requires a great deal of adjustment. The workforce has to become more flexible. A lot of corporations that are inefficient have to become more efficient very quickly. There's going to have to be a lot more coordination among European governments about fiscal policy, welfare policy. So the pain of adjustment is going to be significant but the benefits if it succeeds are going to be enormous. ADAM SMITH: [voice over] And what about another key area region: Central and South America? ROBERT HORMATS: Latin America has done well largely because it has undertaken a lot of the reforms that Asia has yet to undertake. Latin America has strengthened its banking system. It has undergone important corporate restructuring. A lot of companies in Latin America have begun to rely more on equity as opposed to debt. So Latin America is a lot better off; not without problems, they still have problems, they still have improvements that they need to make in their banking system. In many cases, they still have large current account deficits. But they are a lot better off than we thought they would have been several years ago. ADAM SMITH: [on camera] What about Russia? ROBERT HORMATS: Russia has been adversely affected by the Asian crisis, in part because investors are taking a skeptical view toward all emerging markets, in part because the Asian crisis has caused a decline in the price of oil and raw materials which are major exports. The plus in Russia is that the private sector is beginning to take hold; private investments beginning to emerge. A number of private companies are doing quite well internally and in international markets. But the adjustment is a very painful one and I think Russia is going to be in for a period of economic difficulty for several months, if not several years. ADAM SMITH: We have a problem _ the Y2K problem _ the computer glitch that's going to happen in January 2000. We're addressing this problem, slowly. What about the rest of the world? ROBERT HORMATS: The rest of the world is not paying as much attention to this problem. I likened the Y2K crisis to the oil crisis in the following sense _ the oil crisis was really triggered by a cutback in supply of only 5 percent of Arab oil production _ only 5 percent. In the area of computers and computer software, given the interconnectiveness, a problem in 5 percent of the world's computers, even though most of them are abroad, could have enormous ramifications for the United States and for other countries. ADAM SMITH: Could this produce a recession or slowdown in the year 2000? ROBERT HORMATS: If there is real disruption in financial markets and in the supply chain, it could cause a major drop in world economic growth, along with additional inflation if goods were simply not available and not ready. There could be supply shortages as well. ADAM SMITH: All right, let's give you an unlimited airline ticket and a suitcase full of cash. Tell me your three best ideas and the three areas you would warn me away from. ROBERT HORMATS: The best investment ideas today are in corporations and countries where major economic restructuring is underway. I think there are such examples in east Asia _ Korea being one; Singapore being another _ and in China, as well. A lot of companies are becoming much more moderate. I think western Europe, having gone through a period of relative economic lethargy, is now moving ahead. And I think if you look also at some of the smaller economies, like Israel. I just visited Israel. A lot of very good high technology, knowledge-oriented companies are doing public offerings in the United States. They're very well run. They're very high tech. I think they'll be positive players in the global economy in the coming years. ADAM SMITH: And the worst? ROBERT HORMATS: Indonesia at this point is really the weak economy of Asia, not because they're not very talented people, but because a lot of the corporate restructuring that has begun in Thailand and Korea and the Philippines and China has not yet begun in Indonesia. So that's a danger point. I think the Middle East is a concern because most countries in the Middle East have really not begun the process of globalization. And sadly, Africa has just not kept up with globalization. There has not been that emphasis on education and training that there has been in much of east Asia. And a lot of investment that Africa had hoped for is simply not going there.
Global Advice [Back to top] ADAM SMITH: Where will the smart money be investing around the world in the months to come? Ron Hill of Brown Brothers Harriman came to his interest in global investing by an unusual route _ he ran an art gallery in Japan and Brown Brothers hired him for his fluency in Japanese. Ron Hill joins me now to give you his best global advice. Ron, walk me around the world a little bit. Let's start with Asia. RON HILL, Brown Brothers Harriman: Adam, mostly what we see there is debris, I'm afraid still. Not a lot of investible opportunities just yet; bottoming process. Need to see stability in the currencies. Look for Japan to set the pace, to lead us out. And I think eventually when the opportunities arise, they'll arise in the financial sector and, of course, some of the premier global exporting companies. ADAM SMITH: Okay. Walk me around the rest of the world. RON HILL: Well, the part of the world, of course, that's most exciting right now is Europe. The EURO, sort of phenomenon is beginning to really gel. You're seeing real growth. The domestic economy is coming alive now. Unemployment is starting a slow trek downward. Interest rates have come down dramatically to the lowest in recent memory. ADAM SMITH: What do you buy in Europe? RON HILL: I think you want to focus here on some of the consumer goods _ Electrolux, as the new consumer power comes along. It's a great way to play this. Obviously, the telecommunications revolution with Ericsson, Nokia continuing to be good players there. There's just a lot of excitement. And the financials _ focus on those big financials. There's going to be more consolidation in Europe. ADAM SMITH: You like financials all around the world then, don't you? RON HILL: Well, basically it's a consolidation story. So when they get cheap, there's always a buyer out there. ADAM SMITH: What are the big financials in Europe that you like? RON HILL: Well, right now in Europe, a lot of the play is with Generale, the Italian insurance company, and Allianz, the German insurance company. This is a great way to tap into the emerging private savings, private pension market that's just now developing as an equity culture grows in Europe. ADAM SMITH: You'd even buy European indexes? RON HILL: European indices are another way to go, yes. With a slightly more favorable outlook for the southern European market, Spain and Italy, than the northern European. But they're all benefiting right now from low interest rates and this better demand. ADAM SMITH: And not a cloud on the horizon? RON HILL: Well, there's always clouds on the horizon, especially the further north you go, the closer you get to Russia. A serious breakdown in that economy would obviously have implications. Generally, the pressure is felt first in Germany, that's why the southern markets_ ADAM SMITH: Excuse me. All these bad spots don't trouble you? Russia? Japan? Southeast Asia? RON HILL: At the end of the day, what we try to look at is what is the lever back into the economy? There's a Russian lever which is definitely working the German economy. But overall, it's a small part of what happens in European economies. The same is true for the United States. So the key is always what's the economic lever back into these economies that's going to drive down corporate profits or ruin the interest rate outlook? ADAM SMITH: Pretend we're clients of Brown Brothers. Do we stay fully invested? What do we do for the next six months? RON HILL: Overall, as long you're exposed primarily to the American and European markets, it's fully invested at or near your maximum equity exposure. ADAM SMITH: No cash? RON HILL: We have some cash obviously in invested portfolios just because you always look for opportunities to get more invested. But I think overall you should be close to the maximum of your comfort level. ADAM SMITH: If I am not 100 percent invested, what should I buy to bring myself up? RON HILL: In the American markets, we continue to recommend an overweight in the pharmaceutical and health care sector in general. ADAM SMITH: I didn't know they were high priced. RON HILL: Oh, but look, strong earnings growth and strong revenue growth, 9 percent sales, 15 percent earnings in the first quarter, widening profit margins. ADAM SMITH: That's Viagra and all that. RON HILL: Right. It's all in there but, you know, it's working across the board. I think that steady earnings growth, large cap stocks, that's what people want to see whether it's Europe or the United States. ADAM SMITH: Large cap? Procter & Gamble? Coca-Cola? I thought people think they're too high priced? RON HILL: But, Adam, the fact is that's where the best profit margins have been, the greatest visibility. And sitting as we are here today, most of everyone realizes we're not close to the beginning of this bull market; we're closer to the end. The liquidity in large cap stocks is a safety valve in case you need to sell. ADAM SMITH: Oh, you need to get out. Okay. When is the end? RON HILL: So far, remarkably, the end is nowhere in sight. All of our_ ADAM SMITH: How long is your horizon? RON HILL: Twelve to 18 months. No recession in the U.S. economy, six to 12 months, no major problems in the financial market. ADAM SMITH: Ron, I say to you, ``Domo arigato.'' RON HILL: Do itashima shite. [Graphic: Ron Hill's Top Global Picks
Company Symbol
American Outlook [Back to top] ADAM SMITH: The performance of the American stock market in the 1990s has set records. Since it hit a low of about 2,500 in 1990, the Dow Jones Average has been on a tear, hitting above 9,000 this year. Will the good times continue to roll? Joining me now is Mary Farrell of Paine Webber for the American outlook. Mary, what's on your clients' minds? What do they want to know and what do you tell them? MARY FARRELL, Paine Webber: Basically, clients have certainly enjoyed the bull market. But we're at the stage where it has made them a little nervous. These gyrations of the last few months have not been comfortable. So I think their key question is where are we going? ADAM SMITH: And where are we going? MARY FARRELL: Essentially up. All of the factors that have brought prices to this level _ declining long-term interest rates, increasing corporate earnings and low inflation _ do remain in place to support further increases. ADAM SMITH: So you think interest rates continue to go down and earnings continue to go up? MARY FARRELL: Yes, but a key thing is both of them more moderately than they have over the last two to three years. So I think we have to expect more moderate gains in the next 12 months than we have seen in the last_ ADAM SMITH: And that's not in the price? MARY FARRELL: I think to certain extent it is. But I also think we've built in expectations for investors. This has been unprecedented returns -- ADAM SMITH: Yes, it has. MARY FARRELL: -- and I think we do need to scale back a bit. ADAM SMITH: Mary, what about all these trouble spots everywhere? Doesn't Asia undercut the earnings story? MARY FARRELL: It does have an impact, but I would say a very muted impact. Clearly, it's a global marketplace and what happens in Asia is definitely going to influence the U.S. The question is by how much? And the fact is that in total the amount of business that U.S. companies do in Asia is not enough that those problems are going to derail this nice growth pattern. ADAM SMITH: So pretend I'm a client of yours and tell me what to do now? How much cash? How much in stocks? MARY FARRELL: Basically for a balanced account we would ordinarily have 60 percent stock or a little bit below that, a little bit below the 32 percent normal bond weighting. Cash those short-term interest rates that are abnormally high. But for long term investors, common stocks really continue to be the place to be. ADAM SMITH: But, Mary, I just did a little mental math and you have 15 percent in cash. Isn't that pretty high for somebody who's as bullish as you are? MARY FARRELL: It is, but those short-term interest rates we think are abnormally high. ADAM SMITH: Do you think your next move is to get more cash? MARY FARRELL: I would suspect the next move is to get more stocks. And that supposes that we're going to continue in this sort of up and down pattern. Basically, we think the trend of long-term interest rates continues down. We think 5 percent, certainly some time in 1999, at least by year end, would be normal for the long bond. ADAM SMITH: Then we should all buy bonds? MARY FARRELL: The capital gains off bonds, or the total return, I should say, off bonds are not likely to equal the total return off stocks. ADAM SMITH: So, Mary, what should I buy? MARY FARRELL: The best value in the market continues to be growth, and growth is not cheap. But I think it still represents value. The classic big cap. ADAM SMITH: For example? MARY FARRELL: In the technology area, that group has been bounced around a lot. But Compaq, Microsoft, Staples, which is sort of a non-technology tech play, remain very attractive. Global growth. Again with the problems in Asia it scared off some global investors, but companies like Coca-Cola, Pepsi, Procter & Gamble, should continue to do quite well. ADAM SMITH: Aren't those stocks very rich in terms of their earnings? MARY FARRELL: They are not cheap. But what I would argue here is that the last time we saw this period with low interest rates and low inflation was back in the '50s and early '60s. And certainly the price for the market or the price for those stocks today is below what it was back then. So I think we've repriced these growth stocks for the new low inflation, low interest rate environment. ADAM SMITH: Final question _ how long does all this go on? MARY FARRELL: The fundamental factors could favor this bull market continuing, not on a straight line up, but until well past the year 2010 if the savings rates of the baby boomers continue moving up. [Graphic: Mary Farrell's Top Domestic Picks ADAM SMITH: For another view of American markets, joining me now is Byron Wien of Morgan Stanley Dean Witter Discover. Byron, in your strategizing about the stock market you use a model. And roughly speaking, it's the lower interest rates go, the higher the price-earnings ratios of stocks go. Is that it? BYRON WIEN, Morgan Stanley Dean Witter: Sort of. It assumes that the proper value for the S&P 500 is the discounted present value of all the future earnings of the S&P 500. ADAM SMITH: Translate that quickly for us ignoramuses_ BYRON WIEN: It means that if you take earnings 10 years out, you discount them back at a, say, 10 percent or a 6 percent rate so that $10, 10 years out is only worth about $4. ADAM SMITH: All right, but right now it's saying the lower interest rates go, the higher price-earnings ratios can go? BYRON WIEN: Right. The way_ the end product is that at lower interest rates the price-earnings ratio would go up and the stock market would go up. ADAM SMITH: What is the model telling you now? BYRON WIEN: The market is telling me now that the stock market is about 10 percent overvalued. It was about 20 percent overvalued in April. ADAM SMITH: Your colleague, Barton Biggs, whom I read religiously, along with you, is very bearish because of what he calls the lack of pricing power. He thinks Asia is going to affect everything. That gloom doesn't seem to have spread to you. BYRON WIEN: No. Barton and I are concerned about the market but for totally different reasons. Barton thinks that companies have no pricing power; costs are increasing; margins are going to be squeezed; and earnings are going to be disappointing. I think that_ and eventually that will lead to a recession. I think that earnings are going to be okay, the economy is very strong. It would actually be overheating if it weren't for Asia. There is some pricing power in the service sector. I think there are going to be some inflationary pressures that develop later on in the year. And I think the market is going to go down because interest rates are going to move higher. ADAM SMITH: How much is the market going to go down? And when is it going to do it? BYRON WIEN: I think it will happen sometime in the fall or late summer when the inflationary pressures converge and we begin to see higher interest rates. ADAM SMITH: Tell us quickly, what do we do now? How much cash? Take some money out of the market? Put money back in the market? What? BYRON WIEN: I think we're getting great opportunity in this rally to take some money off the table. I wouldn't get entirely liquid, but I would try to have at sometime late summer, depending on your risk profile, 10 to 25 percent cash. I would have more cash than you've had anytime since 1994. ADAM SMITH: More cash than anytime since 1994. And 25 percent cash would be a lot? BYRON WIEN: Right. ADAM SMITH: It means you'd have to sell a lot of stocks. BYRON WIEN: You might. But I wouldn't sell_ if you're an individual, I wouldn't sell your low-cost holdings in companies that you still believe in. I would sell your mistakes and I would sell stocks you have modest profits in. ADAM SMITH: So you think there's going to be opportunities to buy? BYRON WIEN: Right. ADAM SMITH: Is there anything to buy now? BYRON WIEN: Yes, I like the airlines. I like some technology stocks; I still think there are opportunities there. I like economically sensitive stocks. The stocks I don't like are the large capitalization, consumer, multi-national companies. ADAM SMITH: Coca-Cola. BYRON WIEN: Procter & Gamble and so forth. ADAM SMITH: Because? BYRON WIEN: Because I think those are wonderful companies but their stocks are very poorly priced. [Graphic: Byron Wien's Top Domestic Picks ADAM SMITH: Many of you have e-mailed us or written from all over the country about some of our recent shows. [voice over] For example, my recent conversation with Warren Buffett made headlines, even the front page of the Financial Times. If you missed the program and would like a transcript, you'll find it on our web site at www.adamsmith.net. Or if you'd like a videotape of the broadcast, call 1-800-ALL-NEWS. Our chat with Julian Robertson, a top hedge fund manager, also got some notice and you will find that transcript on the web. Or you can call our 800 number for the tape. We value your e-mails and letters. Keep them coming at this e-mail address _ letters@adamsmith.net. Or drop a written line to Adam Smith's Money Game, 885 Third Avenue, Suite 2800, New York, New York 10022. We look forward to hearing from you. And if we use your letter on the air, I'll be sending you a personally signed copy of my book, The Money Game. [on camera] I'm Adam Smith. See you next week as the Money Game continues. ANNOUNCER: For more of the Money Game, visit us in cyberspace at www.adamsmith.net. ANNOUNCER: This program is made possible by a grant from MetLife with over $330 billion in assets under management. Funding has also been provided by the Roy R. and Marie S. Neuberger Foundation. CREDITS [Back to top] Editor-in-Chief ADAM SMITH Produced by ADAM SMITH EDUCATIONAL PRODUCTION Special thanks to: 3-D Models Provided in Part by 3-D CAFE For a VHS cassette send $19.95 or $5.00 for a printed transcript to: Copyright _ 1998 Adam Smith Educational Productions Ltd.
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