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We have a sanguine outlook for a healthy U.S. economy with both unemployment and inflation at low levels.
The Fed obviously has pulled off a soft landing in 1995-1996. The only other time the Fed has produced a soft landing, it lasted for 10 quarters. I think it's a safe bet to anticipate smooth sailing for the economy at least through 1996. We are looking for real gross domestic product growth in the 2% to 3.5% range in 1996.
P&I: What about you Rob? How do you see it?
ROBERT ARNOTT: Ours is a quantitative firm that focuses on valuation rather than on economic forecasts, so this is a personal forecast that has nothing do with the investment strategy. However, I would agree with Sarah that the outlook seems steady. There do not seem to be clouds on the horizon that could trigger a serious slowdown in the economy during 1996, nor do there appear to be inflationary pressures. So steady low inflation, steady growth over the coming 12 months seems the most likely course.
LAWRENCE SPEIDELL: I would add the same caveat. Nicholas-Applegate is a bottom-up investor, but we pay attention to what's going on. One of the things going on right now is that the dollar seems to be not going down. That's a good thing. And it bodes well for 1996.
There is a caveat in the 1996 outlook - the Fed. And Alan Greenspan is up for reappointment, which we hope will take place. Assuming all of that occurs, and we will ascribe a soft landing, a good outlook next year in the economy, 2.5% or so growth rate, stronger in the second half.
STEFAN ABRAMS: The economy has lost some momentum, but I don't think we are going to flirt with recession. Once the Fed sees some sort of budget deal - a real budget deal, not a smoke-and-mirrors deal out of the Congress and the White House - then it no longer will be hostage to that process and it will begin to bring interest rates down.
The yield curve today is inverted from federal funds out to five years, telling you that the real world interest rates structure is lower. That will be necessary to give the economy the shot in the arm that will give it the stronger second half as Christian pointed out.
P&I: You all suggest you expect reasonable inflation. Let's put some numbers on it. What rate do you expect?
MR. ABRAMS: First, let's remember the Consumer Price Index grossly overstates inflation for a whole lot of reasons. But I think next year's CPI will be in the 2% to 2.5% range, plus or minus a very minor amount. And that overstates the inflation. Ask yourself what goods or services cost more today than they did a year ago. Except maybe for a few airline fares, I have a hard time finding any.
MR. SPEIDELL: I believe the dollar is going to have some influence on it. And our guess would be that inflation will be lower than consensus which is itself pretty low. So, 1.5% to 2% is what people are expecting. And if the dollar is strong, why, it could even be coming in under that.
MS. KETTERER: We are expecting inflation to rise to about 3% next year and remain steady throughout the year. The only factor that might upset the apple cart would be the unexpected war, or price shock, or some type of weather catastrophe that would upset food prices. But we don't think those are likely.
MR. WIGNALL: I expect inflation will fade away in the sense that, yes, 1.5% inflation is possible. But more interesting will be the reaction of the financial markets to it. Inflation is ceasing to be an issue in financial markets. People are going to forget about it. The financial markets' expectation of inflation over the next five or 10 years is falling very rapidly. People really believe the Fed is on a credible path to stable prices.
P&I: Elections usually have an impact, or seem to have an impact, on the economy. We have an election next year. How do you see that playing into the economic outlook, if at all?
MR. WIGNALL: I believe the stop/go impact of an election cycle is really something of the '60s and perhaps the '70s, and really ceased to exist since the '80s. Remember, Alan Greenspan was raising interest rates in 1988 during the Republican convention. And Alan Greenspan at that time was thought to be a Republican supporter. So he was doing something against the party he seemed to favor.
The old link between the credit or fiscal policy and the election cycle will be broken. It won't have any impact.
P&I: Anybody disagree with that?
MS. KETTERER: We need to look at both ends of the spectrum. If there is a Democratic sweep, we would be a lot less optimistic about the course of the economy. It could lead to protectionism, perhaps some buckling by the government, or backlash against eroding wages. On the other hand, a Republican sweep could have more positive implications for the long-term course of the economy, especially interest rates and inflation.
MR. ARNOTT: To some extent it hinges on who the Republican candidate is. Everyone assumes that it will be (Sen. Robert) Dole. Well, Dole plays the political winds and does not have a firmly held view on an appropriate government fiscal or economic policy.
My guess is that a Dole election would lead to the kind of wishy-washy government financial and fiscal policies that we saw under (Richard) Nixon. And therefore that Republican sweep under Dole would not necessarily be a good thing.
I don't see that much difference in terms of economic conditions or in terms of market prospects between the two front runners.
MR. SPEIDELL: I would just add that there is a lot of momentum in Republican policies in the Congress, and economically, we are optimistic either way and very positive about the implications of current government policy for the markets.
MR. ABRAMS: I think Larry just put his finger on it. Here, economically the winds are blowing positively and that's much more important than anything that's going on in Washington. The country has spoken and said we can't saddle our children, grandchildren, with an ever-increasing mountain of debt and we will have to bring it under control. In exactly how many years and according to whose plan, nobody knows. But things are moving in that direction inexorably.
At the same time, you have the opening up of intense global competition with enormous capacity and resources all over the world. So you have, as Christian pointed out at the beginning, no inflation in the world. You have, in fact, a deflationary economic expansion. And nothing could be a better backdrop for financial assets than a deflationary expansion.
P&I: Let's be more specific as to the U.S. market, the U.S. equity market in particular. Last year our panel forecast returns for 1995 of 8% to 12% and we got 30% plus. What happened?
MR. ABRAMS: Well, profits surprised on the upside and interest rates surprised on the downside. So all of us experts were too conservative.
P&I: What kind of returns do you expect next year?
MR. ABRAMS: I think corporate profits will grow between 5% and 10% next year in the aggregate. That will be made up of lots of companies that have flat to lower profits and lots of companies that have outsized gains, as was the case this year, and as is virtually always the case.
Interest rates will be lower, so I think multiples will be flat to higher. If you have a 10% increase in overall corporate profits, let's say S&P 500 earnings, and lower interest rates, stocks ought to be up 10% to 15%.
MR. SPEIDELL: Well, there is something very powerful happening - something that is unique, at least in the history we have looked at - namely companies are reporting earnings ahead of estimates. And the latest data we have showed about 50% of the companies in the third quarter reported earnings numbers that were ahead of expectations.
This is slightly down from the highest levels of the mid-50% range, say six to nine months ago. But it still suggests Wall Street may be underestimating the true strength within corporations themselves. And it leads us to be optimistic for next year.
Clearly, in our view, it's earnings that are the primary reason for the upside returns in the market in 1995.
P&I: What kinds of returns are you expecting?
MR. SPEIDELL: Speaking just for myself, the long-term returns of 8% are returns that we should be pleased with in any year in the stock market. And I think there is a major problem in our industry with respect to clients' expectations. It was bad a year ago. And it's even more difficult now because if we fail to deliver another 30% year, a lot of our clients are going to feel shortchanged. In fact, 8% is a good long-term number.