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Magical millennium tour.


IT'S BEEN A LONG, STRANGE AND PROFITABLE JOURNEY for the 10-year-old bull market, especially in the latter half of the '90s.

From 1995 through 1998, the U.S. stock market posted stratospheric returns. The Standard & Poor's 500 index rose 37.5%, 23.0%, 33.4% and 28.6% in those four years, for a 30.5% compound annual return. By contrast, the long-term return on U.S. stocks dating back to 1926 is about 11% per year.

In 1999, however, investors experienced a more "normal" year, one closer to the long-term trend. Inflation advanced a notch, and interest rates moved up 50 basis points as the Federal Reserve raised short-term interest rates twice in the year, dampening stock market returns. By the end of October, the S&P 500 was up only about 12% for the year. Although a fourth-quarter rally might lift stocks, at this writing it seems as if the broader market will wind up with a sub-par performance--at least in comparison to recent years.

What's in store for 2000? A scary beginning, most likely, as investors wait to see how successfully companies and governments, dependent on computers, coped with the Y2K bug. From that point on, though, BLACK ENTERPRISE'S annual roundup of financial professionals found plenty to cheer in the investment scene during the year to come. Returns on stocks might not climb back north of 20%, but they could well post a decent, double-digit return.


Some market experts say the economy will expand next year, but at a slower rate than in 1999. "The pace seen at the start of 1999 is too fast to be sustained," asserts David Blitzer, S&P's chief economist. He expects the economy could slow down early in 2000 but grow at a healthy 3% rate in the second half of the year.

Inflation, as expressed by the Consumer Price Index (CPI), is expected to rise about 2.2% next year, up a tad from the 1.6% rate of 1998 but still well below the level of most recent years, says Blitzer. He adds that interest rates are not expected to move much higher than current levels while corporate profits could edge up about 4%. Altogether, such a scenario would indicate a solid if unspectacular year in the financial markets.

Not every seer expects the world to move on such an even keel in 2000, however. For example, some experts say Federal Reserve Chairman Alan Greenspan could rain on the parade by raising short-term interest rates in order to contain inflation. The Fed remains committed to beating down the slightest hint of inflation, even when the evidence from economic reports like the CPI has been less than convincing.

"I'm not forecasting a recession, but I think economic growth will barely stay positive," says Don Hays of Hays Market Focus Advisory Group, Nashville, Tennessee. "The United States has held up the rest of the world for a while, but that can't go on forever. In 2000, I expect problems from other countries to spill over to the U.S., slowing down our economy."

Hays, who spent years as chief investment strategist at the firm now known as First Union Securities, based in Richmond, Virginia, says political and economic instability in parts of Asia, Latin America, Eastern Europe and Russia could derail U.S. growth. Also, growth in Western Europe, one of the U.S.'s main trading partners, has slowed down and may also put a dent in economic vitality.

Further, Hays sees little threat of inflation in an economic slowdown. "Interest rates are likely to fall," he says. "The stock market doesn't look appealing, with prices at current levels and corporate profits under pressure from a weaker economy. Therefore, I think investors' best choices for [2000] will be cash and long-term, high-quality bonds," essentially both ends of the maturity spectrum. As a result, he's shunning intermediate-term and less-than-investment-grade bonds.


The majority of the experts BE polled think that the current growth rate of the long-running Goldilocks economy--not too hot, not too cold, but just right--will continue far beyond 2000.

"The economy likely will keep growing [in 2000], and right through the year 2008," says Claud Burks, a financial counselor with FCI Financial Group in Millis, Massachusetts. That year is significant because, according to demographer Harry Dent, at that time there will be 40 million baby boomers between 45 and 54 years of age--peak earning and spending years for this significant group--and they will drive the economy.

Napoleon Rodgers, managing director of Alpha Capital Management in Detroit, sees the economy continuing to expand at a "brisk pace" in 2000, as the U.S. continues to enjoy the longest peacetime expansion in history. (The last recession occurred back in 1990.) "I think economic growth will be in the 2.5% to 3% range," Rodgers says. "The Federal Reserve Board is not likely to raise rates sharply, which could slow things down."

"Fundamentally, the economy is in good shape, "says Percy Bolton, an investment consultant and head of Percy E. Bolton Associates in Los Angeles. "I expect growth of 2.5% or more in 2000." Bolton does expect the economy to overcome some first-quarter, Y2K-related complications. Essentially, market observers think Y2K computer problems could result in some disruptions in manufacturing, distribution, and data transmission. In addition, businesses, consumers and investors may be cautious in the first quarter of the year, waiting for any Y2K problems to be resolved.

Similarly, Thomas Okomo, a financial analyst with Atlantic Capital Management in Sherborn, Massachusetts, sees the current expansion continuing, although he also sees some first-quarter problems because of Y2K glitches.

Randall R. Eley, president of the Edgar Lomax Co., an investment management firm in Springfield, Virginia, is more cautious. He sees the economy slowing down a bit in 2000, which he considers a favorable development.

But Eley warns that if the economy continues growing at a torrid pace, "corporate profits will keep growing rapidly and the trade deficit will expand. That would heighten the Fed's concerns about inflation," leading to a steep increase in rates, which would hurt the markets.

Although the above scenario is possible, Eley thinks it's more likely that the economy will cool off on its own, eventually leading to much slower growth by the third quarter of 2000, negating the need for Fed action. Further, he predicts consumers will be forced to cut back their spending, and use that money instead to reduce personal debt.


After modest increases of 1.7% and 1.6% in 1997 and 1998, the CPI edged over 2% in 1999 and further inching up is likely in 2000. "Inflation seems to be under control," says Rodgers, who sees the CPI rising about 2.4% in 2000. "That won't be enough for a major disruption in the markets." To put things into perspective, inflation rose from 2.5% in 1995 to 3.3% in 1996 and the S&P 500 posted a 23% gain in 1996.

If inflation is in the 2% to 2.5% range, it will be below the level feared by some alarmists. "Despite all the warnings about consumer spending, inflation hasn't been a problem and likely will stay near current levels," says Atlantic Capital's Okomo. He explains that technological innovations will help companies enjoy productivity gains, which, in turn, will help companies increase wages to workers, yet they'll be able to hold down prices on goods and services.

Other factors will work in the other direction, keeping upward pressure on inflation in 2000, Eley says. "The dollar has decreased, especially against the Japanese yen, and that probably will mean higher costs for foreign goods imported into the U.S. In addition, federal workers recently received a large wage increase, which may add to inflationary wage pressures throughout the economy."

The highest inflation figures are offered by Burks, who sees price levels slowly increasing over the next two to three years. "I don't think inflation will get out of hand, as it did back in the 1970s, but I think inflation could gradually increase to 4% or even 4.5% within seven to eight years as the economic expansion continues," he says.

Rising inflation generally means higher interest rates, but none of our respondents anticipates a big spike in rates. "Interest rates probably will be flat to a bit higher in 2000," Okomo says. "The Fed has increased interest rates twice [in 1999] and may act again if the job market stays tight and the dollar remains strong. Thus, short-term rates might move up. However, long rates are unlikely to move higher if there is a widespread belief that the Fed is keeping inflation under control."

A similar view is expressed by Eley, who says that further tightening by the Fed is likely to ward off rampant inflation, so short-term interest rates may edge up another 25 basis points. He thinks yields on long-term bonds will stay near current levels of 6.25% to 6.35%.

Bolton expects rates on three-month U.S. Treasury bills to inch up toward 5% in 2000, while the yield on the 30-year U.S. Treasury might top 6.5%. Burks argues that interest rates are higher now than they were a year ago and are unlikely to rise further. "Some increase in inflation has been anticipated," Burks says, "so I don't look for further increases in 2000."


The combination of economic growth and moderate inflation has powered the U.S. stock market in the 1990s, but will that hold true in 2000? In general, our experts see good if not great times ahead. "Continued consumer spending probably will mean greater corporate profits, which will be positive for stocks," says Rodgers.

Market leadership is likely to shift to large-capitalization value stocks in an economic slowdown, Eley predicts. "In a weaker economy, larger companies usually do better than small ones," he says. "In addition, value stocks are not as vulnerable to price collapses as growth-oriented issues might be."

Eley thinks the excessively strong performance of large-cap growth stocks could end in 2000, and large-cap value stocks will advance, reversing a years-long trend. Large-cap growth funds had an average total return of 34.32% in 1998, beating large-cap value funds' return of 12.38%, according to Morningstar, a mutual fund research firm in Chicago. And through the third quarter of 1999, large-cap growth funds returned 8.58%, compared with a 0.08% gain for large-cap value funds, according to Morningstar.

Investors should look for companies with strong balance sheets, low price-to-earnings and low price-to-book ratios, Eley says. Further, he recommends companies with market leadership and worldwide exposure whose stocks haven't enjoyed big advances in their prices. For example, consider stocks like Chevron (NYSE: CHV), Dow Chemical (NYSE: DOW), DuPont (NYSE: DD), General Motors (NYSE: GM), Philip Morris (NYSE: MO) and Sears, Roebuck & Co. (NYSE: S) when building a basic portfolio, he says.


Eley prefers basic industrial companies for 2000, but some technology companies that were beaten up earlier in 1999 are now more attractive. "If you have a large portfolio, you might include well-valued tech companies" such as Eastman Kodak (NYSE: EK), Harris (NYSE: HRS) and Raytheon (NYSE: RTNa).

Okomo points to three sectors of the equity market that he expects to excel in 2000. "The technology sector should continue to be a growth area, with the expansion of the Internet generating excitement," he says. His tech favorites: AT&T (NYSE: T) and EMC Corp, (NYSE: EMC).

The healthcare sector appeals to Okomo because of demographics: an aging population will need more medical care. Leading pharmaceutical companies such as Merck (NYSE: MRK) and Pfizer (NYSE: PFE) will benefit from the aging of the population, he says. Okomo also thinks 2000 will be a good year for leisure companies such as Walt Disney (NYSE: DIS) and Time Warner (NYSE: TWX). Although Disney stock has been beaten down, Okomo says the company still possesses valuable assets--its extensive film library and theme parks--that will help the shares rebound.

Bolton estimates that stocks might return 8% to 9% on investments in 2000, which would be near the long-term record. "The best buying opportunity may come after the beginning of the year," he says, "if Y2K fears temporarily depress the market." His favorite market sectors are those that have lagged: small-capitalization stocks, foreign stocks and real estate investment trusts (REITs).

He's particularly upbeat about REITs. As long as the economy keeps growing, properties will produce substantial rental income and REITs will pay high yields to investors. But for investors interested in risky sectors, Bolton advises buying mutual funds instead of individual stocks.


Burks says that investors should consider mutual funds for all types of stocks, not just volatile ones. "Even with a strong market, most individual investors lose money because they don't take the time to educate themselves. Therefore, I usually recommend investing through mutual funds," he says. Burks advises a mix of large-and small-cap funds, including value and growth styles, tailored to your goals. He says investors should look for mutual funds with good 10-year track records.

Mutual funds might be especially helpful outside the U.S., where it's difficult to research individual stocks. Okomo says that international stocks may do well, especially those in Europe and Latin America, but he would hold off until after the first quarter, when foreign countries will have had the time to iron out any Y2K problems.

Okomo likes Janus Worldwide's management style because the fund has out-performed other international funds. For example, in 1998 it returned 25.87%, far ahead of the 12.16% garnered by all funds in that category, according to Morningstar. He also is upbeat about Janus' research capabilities.

Be especially careful about selling your winning investments if the market turns down, Bolton advises. By selling stocks that have appreciated sharply, you'll incur hefty capital gains taxes. Selling them, and paying taxes, is similar to suffering a correction of up to 20% in the share price, he says.


With interest rates likely to stay flat or increase, the bond market may be treacherous in 2000--as it has been in 1999--so our panel is generally cautious. "The bond market is likely to suffer from excessive concerns about the Fed's interest rate moves," says Rodgers. "Short rates may move higher if the Fed keeps tightening while long-term bonds may stay in a trading range," with the yield on the 30-year Treasury bond likely to fluctuate between 5.5% and 6.25%. "Altogether, investors should stay in the intermediate sector of the bond market."

Eley suggests investors should buy bonds maturing in three years or fewer. "If you go longer, you won't receive enough extra yield to justify the extra risk," he says. "I'd stay with government bonds. Corporations may run into difficulties making bond interest payments if the economy slows down."

Burks, although more upbeat on bonds, also advises a conservative stance. "With rates up from a year ago, I think there are some good values now," he says, so he suggests locking in higher yields by purchasing U.S. Treasuries and investment-grade corporate bonds.

Bolton is the most aggressive on the fixed-income market, predicting that Y2K may provide buying opportunities in bonds as well as stocks. "At the end of 1999 and the beginning of 2000," he says, "there probably will be a flight to quality as investors sell junk bonds and buy Treasuries. Mutual funds might be hit with redemptions, further depressing prices. After those problems are behind us, there may be good values in the junk bond market. The same is true for emerging-markets bonds, too."

In general, junk bonds and emerging-markets bonds work best if they're held in a tax-deferred retirement account. Why? If you're stretching for yield in emerging-market and junk bonds, the interest you receive is fully taxable. By holding individual junk and overseas bonds in a tax-deferred retirement plan, that interest won't be taxed. Bolton says that investors who hold bonds in a taxable account have "no choice" but to hold municipal issues because their tax-exempt yields can be higher than the after-tax yields from taxable bonds.


Our experts are unanimous in downplaying the perils of Y2K Burks sees the "millennium bug" as being a minor inconvenience for the most part. "Moving into the new year will be a relatively seamless experience for most people," he says, with little impact on the financial markets.

Bolton thinks that Y2K might cause some paralysis in the financial markets in January and February. "You won't see many people in the financial industry taking vacations in December and January," he says, "but any disruptions may lead to buying opportunities."

Eley expects Y2K to have even less of an impact: "By the close of business on January 3, the first business day of the year, people will see that their worst fears haven't been realized, and they'll go on with their lives."

As Rodgers puts it, Y2K will be a "nonevent," with some hoarding and large amounts of cash in circulation but no significant impact on stocks or bonds.

Going into the new year and the new millennium, you shouldn't be ruled by fear or greed. Instead, a sensible approach to long-term wealth-building will pay off long after Y2K becomes a distant memory.



Economy: Slowing down on its own, especially in the third quarter, with barely a hint of inflation. Thus, no Federal Reserve action should be needed.

Stocks: Chevron (NYSE: CHV), Dow Chemical (NYSE: DOW), General Motors (NYSE: GM), Sears, Roebuck & Co. (NYSE: S), Eastman Kodak (NYSE: EK) and Raytheon (NYSE: RTNA).



Economy: Brisk pace of economic expansion, with growth in the 2.5% to 3% range. Inflation should be mild, with the Consumer Price Index rising 2.4%.

Bonds: High-quality, intermediate-term issues.


What's Hot

* Technology Companies

* Large-Cap Value Stocks

* Domestic Economy

* Investment-Grade Bonds

What's Not

* Y2K Glitch

* Large-Cap Growth Stocks

* Overseas Markets

* Junk Bonds


You're armed with our experts' prognostications on the economy, interest rates, and which stocks and bonds should do well in 2000. So, should you rush headlong into buying individual stocks and bonds? If you're the kind of person who finds market drops nerve-racking, maybe you should stick with mutual funds, instead.

Going the mutual fund route is advantageous, especially if you plan to invest in riskier shares such as small-capitalization stocks, foreign issues and real estate investment trusts (REITs), says Percy Bolton, head of Percy E. Bolton Associates in Los Angeles.

Bolton recommends the offerings of certain mutual fund companies like the Vanguard Group and T. Rowe Price Associates, as well as the mutual fund supermarket sponsored by Charles Schwab, for investors with an appetite for more volatile stocks. "These funds have low costs and they make an attempt to avoid sticking investors with taxes each year," he asserts.

Some experts, among them Claud Burks, financial counselor with FCI Financial Group in Millis, Massachusetts, think investors who want to invest in equities of any kind should stay in mutual funds, regardless of how risky or safe some stocks appear to be.

Burks likes funds that have solid 10-year performance records, such as the portfolios offered by AIM Funds, American Funds, Kemper Funds and Oppenheimer Funds.

And you can always purchase hot new funds that stand a better chance of outperforming their peers in 2000 and for years to come--portfolios recently selected by Black Enterprise (see "New Millennium, New Funds," December 1999).

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Title Annotation:investments and US economy in 2000
Publication:Black Enterprise
Geographic Code:1USA
Date:Jan 1, 2000
Previous Article:DON'T DEFER THE DREAM.
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