Mr. Paulsen: I guess what I think on rates is if you look just at long rates for a minute, how they have been dealing with disinflation, is we've typically had big downward drafts and then we have a prolonged period of two or three or four years where they mark time, and then we have another big downdraft.
We've just had a big downdraft. Long-term rates are going to go lower, particularly if you believe that we have largely zero inflation. But I think in the next couple of years we have a trading range for the 10-year yield, let's say a mean average of 4 1/2 % goes to 5% or goes to 4%, depending on how anxious people are vs. not, but long rates kind of stay in that range.
I think all the action, however, is going to occur on the short end of the curve for the next couple of years and these easings will probably continue on, particularly if we don't have commodity prices recover. The Feds are just going to keep easing.
I think a couple of years out from now we'll probably have a 4.1/2% 10-year and a 3% short-bond bill, something like that where we're just going to have a positive yield curve in there. I think the duration bet on bonds, which has been great for a long time, is probably over except for timing and leaning, depending on whether you're closer to five or closer to four.
P&I: Lou?
Mr. Holland: My view is the secular bull market for bonds is generally over. I think over the next 12 months maybe the long bond trades will be between 41/2% and maybe 51/4% or thereabouts, but I don't see it breaking out of that range.
I would agree also that it's going to be much more difficult going forward for people who make duration bets, so I think that sector selection will be very, very important. The one area that actually at the moment is quite attractive is the high-yield area. I think that the spreads, while, in fact, they have improved by about 120 basis points since before they started cutting interest rates, clearly they are above historical norms - maybe 120 basis points above historical - and so to that extent I think the high-yield sector of the market is very attractive.
P&I: Gene?
Mr. Sit: I think we're going to be somewhere below 5% and somewhere around 51/2%, so I think I agree with everybody here. One comment is that the spread relationship between the treasury and everything else is quite wide today; therefore, this would suggest more opportunities in the non-Treasury market. However, we think that there may be a change in that spread relationship. Just as an example, historically, double-As are 50 over treasury and today are 75 to 100. I think the norm may be closer to 60 or 65. I think there will continue to be a preference for liquidity and quality and marketability, so I think you are going to see a minor change in that spread relationship, but right now it is too wide.
Mr. Hansen: We're in the 43/4, 51/4 trading range. I would only toss onto the table, when we get down to these levels of absolute yields, things do change a little bit. Keep in mind that we've kind of gotten this relative yield gain, we're now getting down to levels of where absolute levels make a difference, and that will probably cause some spreads and things to act a little bit differently, but I think that at low or absolute yields, things are going to operate just a little differently than they have.
P&I: Alan, how do you see interest rates?
Mr. Bond: I think that we continue to see the very supportive monetary kind of policy in that rates maybe trend down a little bit lower, back below 5%, but finish the year higher than they are in the first six months. It certainly doesn't seem to pay to go out more than five, 10 years.
I think the love affair with international bonds has really come to an abrupt halt and so you have investors looking towards the high-yield area and other areas because they have become much more adverse to international bonds, and I think that feeling, that sentiment, will probably persist, certainly into the first half of 1999.
Mr. Holland: Another comment about sectors - I think also the municipal market is quite attractive also, on a relative basis. You get about 97% or thereabouts of the yield you do with taxable bonds, so I think clearly municipals and high yield are the places if you're going to play around in the bond market.
P&I: Let's turn to comparing U.S. equity returns with what you would expect from other markets. Are there any markets that would likely outperform?
Mr. Sit: Let me take a crack at that. Japan is on the mend; however, it is going to be a U recovery rather than a V. Japan has two near-term problems and a couple of longer-term problems. The near-term problem is that the earnings are not going to be coming back that rapidly so therefore valuations are high, and the other near-term problem is that they need a Ronald Reagan in that place, what I mean is optimism.
You can't get going until you get some optimism in the damn place. Their economy is not in tune with the 1990s. They're being attacked on the low end by the Chinese and the Koreans, and for whatever reason, despite their high level of education, and maybe because of their taxes, they have not really been able to develop the intellectual economy that we have here. And I'm talking about Silicon Valley and Redmond, Wash., and so on so that their economy is really out of sync with what's necessary to be successful in the 21st century.
Secondly, the demographic numbers are frightening in terms of their social costs, so I think Japan is going to be OK, but not an exciting place.
I think Hong Kong is bottoming even though the latest quarter GDP is down 7% and as the financial structure is very sound, the fiscal structure is very much in place. And China has been the big surprise. As long as the Chinese can sell to us and accumulate a $60 billion trade surplus, they have the wherewithal to develop the economy. And then Taiwan is the most interesting place in Asia, and that's because of the intellectual level, the education level, and the financial resources.
Increasingly as we look down the road, a country cannot just say I'm going to produce Nike shoes and Gap sweaters and be competitive because you have got the Sri Lankans and the lower-cost producers attacking you, and having a natural resource is not that much of an advantage anymore, so to be competitive in the global economy you have got to be at the high end of the food chain, and that's what we are today. To be at the high end of the food chain, you need capital, you need a high level of education, and, of course, you have got to benefit from a free-trade economy. So Hong Kong and Taiwan are probably the most interesting places in Asia.
Europe is quite exciting and we think it is going to work. We think that the low-cost producers within the Euro will be the most successful places to be, Italy, Spain, Portugal. If there is a damper in Europe, it is, what if those Russians growl again. So our bottom line is that Euro will slightly outperform the U.S., but your performance is going to be importantly dependent upon an ability to pick the stocks.
Mr. Bond: As Gene was saying, I think there are a lot of opportunities in Europe. I guess Lou said it as well, I see a lot more restructuring taking place over there, and I just think that this restructuring is going to lead to revaluation within the marketplace and is going to lead to higher share prices.
Mr. Hansen: We think Euro will do better than the U.S. market and are especially impressed with the M&A activity in Europe. Probably the northern part of Europe is not as volatile as the southern part.
We probably like Latin America second. You really have to watch Japan closely, as was mentioned earlier. We think the Pacific markets probably did bottom in September but it is going to be a long ride for them to get back to where they need to go. As Gene pointed out, we aren't that optimistic in Japan in 1999 but it is something that merits some consideration because when Ronald Reagan takes over there, those markets are going to move a long ways in a hurry so you've got to kind of watch that one pretty closely.
So all in all I would say that we've been premature on this one but we do think that international markets will do slightly better than U.S. markets.
Mr. Paulsen: I think that the dollar is going to continue to weaken in the next few years. I think the world can't handle a strong dollar. That's what got us kind of into this mess anyway because it kept collapsing prices around the globe, particularly oil prices.
I think also it has to because of our trade flow, and I think the most important delineation between domestic and international investments is going to be the currency impact, which strongly favors the international side in the next few years.
As far as individual markets, to take a little different tilt, I guess I like Asia. One of the big things that held Japan back most of the decade and that has changed of late for the first time, is the fact that nobody in the world gave a darn about Japan and their problem because, in fact, it was helping the rest of the world. Japan exported deflationary pressure and kept everything calm and cool and it was a good thing, not to mention we were already mad at them anyway because they ate our lunch for 10 years in the '80s. I think that was a really bad thing for Japan because they were suffering in a recession-depression with no one else experiencing it so no one else was easing to help them. Now that has changed for the first time. The world is now easing and helping, and I think that's going to do more good for Asia. What Asia needed was an around-the-globe easing and helping and lifting of global growth again and I think we're doing that and I think Asia is going to be the surprise.
I don't think Europe does a lot different than the United States, and, in fact, I guess it bothers me a little bit because I see a lot of positive sentiment about Europe, and I think it's maybe overdone and the stories are out and the bets have already been made so I guess I would be more inclined to the Asian market financials closure although I think Europe might win on the currency, with the currency.
Mr. Holland: I think that stock markets go through three phases: love, hate and indifference. We probably were in the love stage back in '89 in Japan and, of course, it's been a disaster. Now we're probably going to be in the indifference stage there, and my guess is we are pretty much the same in Asia and Latin America, so I think that basically on a shorter-term period that this uncertainty will last for a year or more with regard to these markets.
I think longer term from an investment perspective, Europe will be very attractive. I say that because in this country one of the real drivers of our earnings growth and the great bull market that we have had has been this whole move toward productivity, restructuring, downsizing, rightsizing, what-have-you.
My view is we're in the seventh or eighth inning of that. I think Europe's in the third inning and so I think we have that yet to look forward to with regard to Europe. In terms of longer-term demographics, I think the key is the demographics are bad in the U.S. and most of Europe and also in Japan - meaning that those economies are probably going to grow 2% or 3%. Most of Asia is going to grow at two or three times that. Most of Latin America is going to grow at two or three times that so obviously that will be important with regard to earnings so we should expect a higher rate of return and so ergo I'm very bullish on international over the next five or 10 years but more in the emerging part of it, as contrasted to the developed part of it even though I do believe that there is some money to be made in Europe over the next couple of years.
