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The top 10 investment risks -- and
surprises -- for '04
Heydon Traub, Boston Business
Journal, January 16, 2004
For the last few years, I have compiled the top 10 risks for the coming
year. Just two years ago, I jokingly noted that the No. 1 risk for the
market was the Patriots winning the Super Bowl. This was based on the myth
of the Super Bowl Theory, saying that whenever an original AFL or AFC team
won the Super Bowl that the market would decline that year. If an original
NFL or NFC team won, the market would go up.
At the time, it was not even clear the Pats would make the playoffs, but as
we all know, they went on an improbable run to win it all -- and took the
market down to its worst return in almost 30 years. And this year, an NFC
team won (Tampa Bay Bucs) and the market soared. So the Patriots could win
it all again this year. Let's hope they do, but I won't list it as a risk
this time around.
So what are the real risks for the market? Well, a quick review of last
year's picks are in order. Some of last year's picks are still a risk -- and
this review will also give the reader an assessment of my forecasting
ability last year.
For the most part, the risks did not come to fruition. Hence, the great
returns of stocks and decent returns on bonds as well for 2003. The one risk
that came through in a big way was the dollar tanking (again). The dollar
fell in 2002, but for those holding dollars versus almost any other
currency, they saw losses. The dollar has fallen about 20 percent versus its
major trading partners of Canada and Euroland. It fell about 10 percent
against the yen. And it plummeted more than 30 percent against the
Australian dollar.
Other forecasts were partly on the mark. Congress did dilute Bush's tax and
spending program. The idea of not taxing dividends didn't fly, but that
didn't stop the market from moving up. And Japan's economy didn't move into
recession as predicted, but it barely grew either, so the economy's
performance was disappointing.
I'll reel off others that either didn't happen or happened to such a lesser
degree that it did not create any problems or losses. Four of them went
together under the premise that economic growth took off. Well, the growth
was very strong, but inflation didn't rise much. And since inflation barely
budged, bond yields didn't jump. And since bond yields didn't jump, the
housing market didn't freeze up.
I thought market earnings growth would be below expectations. Well, they
usually are, but analyst forecasts were so overly optimistic in 2001-2002
that they overshot on the other side for 2003. Earnings were expected to
grow 16 percent and they will likely come in at 18 percent growth this year
(maybe even higher). The war in Iraq did not hang over the world long -- it
was resolved surprisingly well and fast for the investment markets.
Greenspan did not resign. And lastly, institutional investors didn't reduce
stock holdings. For this year, seeing limited numbers of large risks coming
true, I am going to expand the "universe" of the top 10 to allow for
surprises or major events. We'll start with those that are back from last
year.
10. Inflation rises from its currently very low levels. Not to 1970s levels,
but more like 3 percent to 4 percent. Not many people expect this, and this
will lead to a couple of other risks.
9. Bonds produce negative returns. This will only require rates to rise more
than 1 percent. If inflation moves up to the level above, count on 10-year
treasuries to jump to about 5.25 percent from their current 4.1 percent.
8. The Fed raises rates. Most expect a rate hike this year, but with the
recent bad news on employment, some are suggesting there may be no hikes
this year. Count on at least a 1 percent rise (to 2 percent) by year-end.
And now on to some new ones:
7. The dollar soars from here versus the other two major currencies, yen and
euro. At the moment, investors and speculators are selling the dollar based
on momentum and the higher rates in Europe. Once it is expected that the Fed
will raise rates, investors will lose the interest rate benefit and realize
the euro is overvalued relative to the dollar and the yen needs to fall for
Japan's economy to fully recover. This will particularly hurt investments in
non-U.S. markets.
6. Expect a terrorist attack here in the United States. This will send the
market reeling at first, but will likely recover quickly because of the
strong economic fundamentals.
5. Pharmaceutical stocks will outperform the market. Expect returns above 20
percent, after stocks lagging last year, as the political and pricing
pressures subside.
4. Tech stocks will rally early in the year. Valuations, however, will
become an issue by the second quarter (they already trade at price-earnings
ratios more than twice the overall market), leading to losses for the year
in technology.
3. More accounting scandals will come to light. They will once again send
the market down, but again only on a short-term basis.
2. Bush will win the election. This is not a surprise, but it is a key event
as many of his potential competitors plan to roll back some of the Bush tax
cuts. Obviously a tax cut rollback would hurt the market, so a Bush win will
allow for the last prediction.
1. Earnings will grow at a double-digit rate again. This will lead the
market also to double-digit returns.
So you already see the benefits of my change from top 10 risks to top 10
risks, surprises or events: I get to end on an "up" note.
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