12/25/95 AN INVESTOR'S GUIDE TO THE 1996 FINANCIAL HORIZON

AN INVESTOR'S GUIDE TO THE 1996 FINANCIAL HORIZON
BUSINESS WEEK's experts offer the lowdown on everything from inflation to merger mania
For this annual double issue, BUSINESS WEEK asked its economic and market experts to come up with their best bets for 1996. How should investors play the election-year gamesmanship in Washington? Which technology stock will fare the best after the great boom of 1995? What is the most attractive investment opportunity overseas? And what's the most likely company to be swept up in merger mania over the next year? This is what our reporters came up with:

THE ECONOMY
The odds-on best economic bet for 1996 is continued low inflation, despite an unemployment rate of only 5.6%. The reasons are structural rather than cyclical. First, investment in new technology is enhancing productivity growth and holding down costs, enabling companies to keep prices low.
At the same time, corporations face increasingly intense competition. Cheap imports continue to grab a record share of domestic demand. And the competition from overseas is spilling over into other markets. The best example: the proliferation of warehouse stores and other retail discounters, which has made consumers newly hawkish about higher prices. Finally, the Federal Reserve under Chairman Alan Greenspan has made clear that it will not allow a reacceleration of inflation, and Greenspan looks like a shoo-in for reappointment.
In this environment, inflation cannot and will not accelerate from 1995's pace of about 2.8%. As a result, another best bet for 1996 is low interest rates, led by Fed rate cuts of between a half-point and a full point. This will assure that 1996 will be another good year for Wall Street and that the U.S. will stay recession-free.
By James C. Cooper and Kathleen Madigan

WASHINGTON
For investors, 1996 is shaping up to be the year of the Great Tax Debate. Washington will be consumed with talk about overhauling the U.S. tax code. But with real change not likely in the coming year, market players would be wise to resist the temptation to start fiddling with their portfolios until the fine print becomes clear. The best bet is not to bet on the passage of any specific piece of tax legislation.
Republicans will be promoting a bevy of competing tax-reform plans during the '96 campaign, including some form of a flat tax. Hoping to exploit voters' disgust with the current system and the Internal Revenue Service, the GOP hopes to put President Clinton on the defensive--so far, he has been lukewarm to the idea of overhauling the tax code.
But there will be no serious effort to pass a tax-reform bill until 1997 or 1998. With all the political fuss, it may be hard for investors to stay on the sidelines, but there's no need to react to proposals which may never see the light of day. ''Individuals shouldn't worry too much,'' says Clint Stretch, director of tax legislation at accountants Deloitte & Touche. ''The details of the bills they are looking at now just don't resemble what will come out in the end.''
By Howard Gleckman

BONDS
Bond investors shouldn't expect an exciting year. With rates at a two-year low and inflation stable, most economists and fixed-income strategists aren't forecasting much movement in yields anytime soon. Their advice: Get used to single-digit coupons.
The best buy of the year could turn out to be mortgage-backed securities, including Ginnie Maes, which now yield about 7%, predicts William H. Gross, managing director of Pacific Investment Management Co. But he advises waiting until the Federal Reserve has cut short-term rates before buying.
Investors wanting safety and liquidity should think about notes in the intermediate, five- to seven-year range. Because of the relatively flat yield curve, investors don't gain much by going to 10 years or even 30 years. For highly taxed individuals, the top pick is clearly municipal bonds. Of the tax-free closed-end funds, Thomas J. Herzfeld, head of Miami's Thomas J. Herzfeld Advisors Inc., likes Dreyfus California Municipal Income Fund and the Municipal Premium Income Trust.
By Phillip L. Zweig

MUNICIPALS
Selectivity should be the watchword for muni investors in 1996. High yields and scant new supply should help, but federal budget cuts and a weaker national economy may hurt state and local finances. Plus, fears that tax reform could eliminate their tax-exempt status could depress muni prices.
How to cope? Stick to bonds issued for projects that taxpayers will finance no matter what, such as revenue bonds issued for water and sewer projects. But avoid bonds issued for projects, such as convention centers, that could be vulnerable to an economic slowdown.
If you're looking for bargains, consider munis insured by MBIA Inc. or another insurer. Today, AAA-rated insured bonds offer higher yields than some bonds rated AA without insurance. But be careful--insured bonds may not be as easy to sell, says Richard J. Moynihan, who oversees $27 billion in muni funds at Dreyfus Corp. That risk and others will make muni investing tricky in 1996. For the intrepid, though, there are some good buys.
By Kelley Holland

LARGE-CAP STOCKS
Wal-Mart was never Wall Street's favorite place to shop, but it sure was the favorite retailer in which to invest. But nearly three years ago, Wal-Mart Stores Inc. fell from favor as its growth rate slowed, and the company pursued a costly expansion. The stock, at 23 5/8, is 26% below its all-time 1993 high, even though earnings are 50% higher. In 1995's red-hot market, the stock gained only 11%.
Now, Wal-Mart deserves another look, say its fans in the investment community. It's overpowering the competition. Several discount chains in the Northeast are in bankruptcy, and rival Kmart Corp. is on the ropes. At the same time, Wal-Mart has continued to invest in productivity-enhancing technology. More important, Wal-Mart is still growing at a steady 15%, more than twice the average company's annual growth rate, yet it sells at 16 times next year's expected earnings. ''You're getting a superior company at an average p-e ratio,'' says Ronald C. Steele, portfolio manager of the UST Master Productivity Enhancers Fund. In a slow-growth environment, Wal-Mart's superior growth rate should command a premium price-earnings ratio, and the stock could easily double in the next year.
By Jeffrey M. Laderman

SMALL-CAP STOCKS
The magic of the telecommunications revolution seems to have missed Century Telephone Enterprises. Offering local-exchange and cellular telephone service throughout 14 Midwestern states, the stock of the Louisiana-based concern has languished over the past year while the overall market has soared.
But Century is worth watching in 1996. For one, its revenues and profits have been averaging double-digit percentage increases for several years. Moreover, a third of its profits now comes from cellular operations, a positive development. At a recent p-e of 14 1/2 times estimated 1996 earnings, the stock is trading at a substantially lower multiple than larger telephone companies such as BellSouth Corp. and GTE Corp., giving it room to rise. And once telecom reform comes through, Century could turn out to be an attractive buyout target: The stock, now $31, could be worth $45 per share.
By Geoffrey Smith

TECHNOLOGY STOCKS
Investors may be wary of technology stocks after their runup in 1995. But here's one that's a genuine value: Platinum Technology Inc. The Oakbrook Terrace (Ill.) software developer trades at 15 13/16, about 14 times 1996's expected earnings.
Why so cheap? Platinum is undergoing a makeover, branching out from developing mainframe database utilities to programs for managing client-server networks, making databases more accessible and developing applications. And it's getting into the new businesses by acquiring smaller software companies.
''That's always risky,'' admits Frank Michnoff, software analyst at Donaldson, Lufkin & Jenrette Securities Corp. But if it works, Michnoff believes Wall Street will recognize the company's growth potential. By Michnoff's estimation, the stock could double in the next 12 months.
By Jeffrey M. Laderman

GLOBAL MARKETS
Money gurus who scour the globe for high potential returns largely agree: Interest rates will fall further in Europe than the U.S. over the next year. With inflation contained and growth still sluggish across the Continent, central bankers are likely to treat their economies to a healthy shot of monetary stimulus. As a result, key short-term rates in Europe could ease by as much as three percentage points, compared with an expected quarter-point in the U.S.
That prospect spells opportunity in the bond markets of Europe. ''Yield spreads are pretty wide between European bonds and their U.S. equivalents,'' says Robert J. Haddick, manager of the $488 million Fremont Global Fund, which invests in a mix of U.S. and international securities. Besides higher income now, such bonds could offer hefty capital gains as yields fall.
One downside: A significant rise in the greenback could offset gains in non-U.S. bonds and stocks alike. That means dollar-based investors should be careful to hedge any foreign holdings against dollar appreciation in 1996. One way to protect yourself against such an event is to buy shares in a global fixed-income mutual fund that hedges, such as Franklin Templeton Hard Currency Fund.
By Joan Warner

MERGER TARGETS
Last year's best takeover bet, Pet Inc., was acquired before the first half of 1995. From this year's batch of potential targets, some savvy pros are betting on Washington National Corp., which provides individual and group health insurance, disability insurance for teachers, and individual life insurance and annuities. Currently trading at $25 a share, it could be worth at least $35 in a buyout, figures investment strategist Michael E. Metz of Oppenheimer & Co. The company posted revenues of $657 million last year and has a book value of $33 a share.
The stock has been dormant for some time now, trading at a low valuation of about eight times earnings. But the insurance business has become so competitive, several big money managers note, that Washington National needs to either merge or sell itself to a larger insurer. Moreover, says Metz, management realizes that it needs to do something to enhance the stock's value. ''It's a sleeper among the takeover candidates, and I won't be surprised at all if it gets acquired in mid-1996,'' he says.
By Gene G. Marcial

SHORT SALES
Of all the Internet stocks, NETCOM On-Line Communications offers the best opportunity for aggressive short-sellers. The San Jose (Calif.) company, which went public a year ago at $13 a share, now trades at $52--a three-bagger, as Peter Lynch would say. NETCOM provides Internet services to those who want it. Dial into NETCOM, and for $30 a month you get unlimited connect time. A good deal, compared with the major online services, such as America Online Inc. and Prodigy Services Co.
NETCOM is in the red this year, but its fundamental difficulty is competition--and not just with the big boys. NETCOM competes with dozens of smaller Internet providers throughout the country, which can offer the same service for much less. The large services will eventually cut prices as well, creating enormous problems for NETCOM. But be warned: If you're thinking of shorting NETCOM and other Internet stocks, remember that these companies have a way of defying gravity--and can squeeze shorts like an overripe lemon.
By Gary Weiss