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in addition to competition by way of price.
But being ferociously resistant to structural change, I think, is the biggest negative to Japan. I think it is overwhelmed by the valuation argument.
P&I: Christian, do you have any further thoughts?
MR. WIGNALL: I think there is a value argument in Japan that probably has been overlooked, and that is in the real estate market. We have had declines of 80% or more in some real estate prices. We have rents falling by over two-thirds. And recently one of the major corporations in Japan, Marubeni Corp., bought their own headquarters from Mitsubishi Estate, from which they formerly were renting it.
This is an arm's-length transaction between two companies, so it is a commercial transaction, commercial price. And we know the rent they paid Mitsubishi. We know the price they paid Mitsubishi. And the yield is 7.5%. That compares with a bond yield of 3%.
So I think that although momentum and sentiment are still unquestionably against real estate, those numbers are beginning to be attractive.
P&I: I think we need to revisit just one other question here in the foreign markets. Which of the emerging markets have the best prospects in 1996 and why?
MS. KETTERER: We would point to China, India and Taiwan. If we are advocates of Hong Kong by definition, we have to be advocates of China, where we see rapid economic growth, moderate inflation and valuations that have been looking very attractive.
India has an opportunity for some economic revival and relatively sophisticated capital markets.
In Taiwan, the economy looks very strong. There has been turbulence in the market, it's off 39% year to date. It's just been awful in dollar terms. And it has to recover with some of the Chinese saber rattling and missile testing put aside, so it looks much better for 1996.
MR. SPEIDELL: Well, it's more a question of what don't we like, but at the top of the list of what we like I would put the Philippines.
Basically what I am saying is we like them all. We were very enthusiastic about emerging markets. I mentioned the Philippines because it's suffered one of the worst storms of the century and there was a lot of damage to the infrastructure. But as we saw in Japan, rebuilding can boost the economy, and we think it will take place there as well.
I was recently in India and that market is in the midst of a crisis period in advance of the elections. And now there are finally some excellent bargains. We recently did some additional buying in India, where we like the market.
Russia may be a surprise
MR. ABRAMS: I like Mexico and all of Latin America as the best of the emerging markets for next year.
And I don't know whether '96 will be Russia's year or not, but it's coming. The trade picture is improving, the inflation picture is improving. They seem to be able to hold the ruble in that band of 4500 to 4900 to the dollar. And I think if some of the political chips fall into place, Russia could be a real surprise in '96. Maybe I am going to have to wait another year or so, but that one's coming.
P&I: Everybody has indicated clearly, I think, they expect interest rates to decline more next year. How far do you expect long-term rates to go. Stefan?
MR. ABRAMS: If you get a real, no smoke-and-mirrors credible plan - and the arbiter of that plan will be the bond market - for reducing the federal deficit over the next seven years, give or take, then I think the whole real interest rate premium in the U.S. rate structure is going to come down a lot.
The federal budget is in surplus, excluding the interest payments. So, if you meaningfully attack the structural deficit, you are going to give the Fed the leeway to help out. And I think you could see long Treasuries by the end of next year approaching 5.25%.
MR. SPEIDELL: We are almost as bullish as Stefan.
With respect to the spreads, there could be some widening in spreads based on concerns over some credit qualities. But by and large, we are quite optimistic about the fixed income markets.
Neutral on bonds
MR. ARNOTT: First Quadrant would be the outlier here. We would expect interest rates to be flat in the coming 12 months - at the long end unaltered. And the reason for that is partly that the bond markets have rallied so very far so very fast, and partly because of the current inversion of the yield curve.
Now, that latter issue would disappear if, as Stefan suggests, a credible budget resolution were to occur. Our view on bonds would become modestly more favorable if that were to occur. We are pretty neutral.
MS. KETTERER: Assuming the economy stays at its trend growth rate, say 2% to 3%, we don't think the Fed feels any pressure to lower the interest rates. And the bond market seems to have discounted zero chance of the tightening, so it's vulnerable to any kind of disappointment.
We are looking for a renormalization of the yield curve next year, leading to a temporary selloff in bonds. And we expect the long bond to move up - this is a 30-year - to 63/4% to 7% by year end.
MR. WIGNALL: I think the outlook is probably for broadly unchanged interest rates on average. If the economy is soft in the first half, I think you might get the long bond dipping down to a 5.8% yield, but then selling off later. So overall, a very dull place to be.
I think an interesting observation is the relationship between interest rates in the United States and overseas. Because by the end of 1996, we might be in the rather extraordinary situation of the United States having among the highest short-term interest rates of the major countries.
Japan's interest rates already are substantially lower. Germany's are below. The British and French economies are very weak. I think one of the supports of the dollar is improving the trade balance in the United States and also the U.S. having relatively high short-term interest rates compared with overseas.
P&I: What are you hearing from your clients about next year? Is there any nervousness from clients about the domestic markets or international markets? In what direction do they want to go?
MR. WIGNALL: I think they are very frustrated with emerging markets, which have given very poor relative performance over the past two years. And I think the best favor we can do for our clients is hold their hands firmly in the next 12 months to say that this too will pass.
MR. ABRAMS: I agree with you completely. The clients are always fighting the last war. They all wish they had 100% of their assets in U.S. midcap companies for the last 12 months; perhaps so do I. But we really do have to hold their hands through this period.
MS. KETTERER: My clients are beginning to worry a bit about dollar strength and how it will affect their portfolios. And we try to reassure them that dollar strength, or conversely, the weakness of foreign currencies, has very positive implications for earnings, particularly the exporters and the multinationals that are in our portfolios. These companies do much better in that type of environment.
MR. ARNOTT: I think it matters less what clients are saying than what they are doing. We have seen clients with an uneasy view on market valuation and with hedges in place to protect themselves, lifting those hedges to some extent. We have seen in our long-short or market-neutral strategies increasing consideration from clients of the idea of equitizing those long-short strategies through futures, so you have the S&P plus