Mary Farrell: Here and Abroad
11/01/2002 12:00 am EST
With so many investors focused on short-term performance, it is refreshing to see a leading market analyst place the current markets into a longer-term historical perspective. One advisor who offers this sense of balance is Mary Farrell, senior investment strategist for UBS PaineWebber. Here, she covers the return to more normal historical market returns, adds historical perspective to the tech bubble, and discusses the emerging investment appeal of Europe.
"We think we have now seen the worst of the earnings picture and we think we are now seeing a slow recovery. We’re not part of the crowd that foresees a double dip. We think we’ll see the recovery continue at a very modest pace. But more importantly, we think earnings next year can rise 8% to 9%. We think a slow recovery is actually a much healthier situation for business than a boom and bust scenario. We’re looking over the next decade for the return to more normal annual market gains.
On Corporate Scandals
"We also expect volatility to remain a painful part of the investment process. It’s not going to go away. And short term we are dealing with a lot of issues. We think the corporate scandals are behind us. You will still be reading about them, but what we have seen is the market doing some self-policing. I think we’ve probably seen the worst of it regarding corporate governance issues and accounting issues. And regulations are coming into place to see that these abuses are something of the past. If you remember the early 1990s, there were huge abuses in the S&L industry and a lot of them went out of business. Many went bankrupt, wrote off the bad assets, and moved on, and the industry became strong again. Here again, we are in the process of dealing with painful realities, but we will deal with that and move on.
On the Technology Bust
"I’d like to put the technology bust into some perspective. If you go back over the past 30 years, we have had a lot of booms and busts. Financial services had a big decline in the late 80s. Real estate, also back in the 70s. Gold has had its ups and downs. Relatively speaking, information technology has followed in parallel. We’re pretty confident that, like financial services, information technology will come back, and we will survive this boom and bust cycle as well.
"Certainly the big uncertainty that remains out there is terrorism. It’s a risk that is very difficult to measure. And there is the possibility of war with Iraq. I think we will see the market responding on a daily basis to whatever the news of the day is. But ultimately, the market does get priced on its fundamentals, and we think the fundamentals do look very good from the standpoint of earnings, interest rates, and inflation. We’ve been through a very tough time, but we think the worst is behind us. So overall, we believe the direction of the market will be up going forward. Just expect that we will have a lot of volatility on the way there. Despite the nice recovery in the market in recent weeks, we still think the market is selling somewhere about 10-12% below what we would call fair value, which suggests a good opportunity in the short term.
"Europe is becoming increasingly interesting as an investment arena. In fact, with slowing growth in the US, one means of diversification is looking overseas for more investment opportunities. Europe experienced the same thing we did, the recession last year and recovering earnings, moderately this year and moderately next year. Their markets appear to be more underpriced, given the level of their markets relative to inflation and interest rates and earnings. The move toward the European Union has also made things more interesting. The Euro has led to more pricing transparency and efficiency. And something we never thought we would see happening is a trend toward lower marginal tax rates. In the past, the high tax rates in Europe heavily discouraged entrepreneurship. Here, if you are a Bill Gates, you could take on high risk and have the potential for high rewards if successful. In Europe it has been high risk with low rewards. You would be taxed heavily on any gains. That is starting to change.
"The reason we focus on Europe is that it is the second most important market for S&P earnings. About 35% of S&P 500 earnings come from overseas. We had focused on Asia for a long time because it was the engine of world economic growth for so long, but in fact, in absolute terms, the European market is much larger regarding US earnings. The US has long been the largest stock market and attracted the most foreign investment because we were seen as a safe harbor – a free open market. Europe was never particularly focused on attracting that foreign investment. But that’s now changing. We are seeing a lot of financial market reform over there.
"I’m a believer in stocks right now. I think from here, stocks will be the best performing asset. Our quantitative work is showing that the chance of stocks outperforming bonds over the next year is 90%, which is extremely high. But going forward, I don't think that indexing is going to work anymore. Nor can you just pick favorable sectors. You have to pick the companies that are delivering favorable earnings. I’d mention Procter & Gamble (