12/28/98 A TALE OF TWO GURUS: GUARDED IN THE EAST, WARY IN THE WEST (int'l edition)

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A TALE OF TWO GURUS: GUARDED IN THE EAST, WARY IN THE WEST (int'l edition)
How two top market-watchers, one in Tokyo and one in London, view the landscape
BUSINESS WEEK correspondents asked two leading market mavens, Clifford J. Shaw and Richard G. Davidson, to reveal their 1999 investment strategies. Here's how they think stocks will fare in the coming year.
A JAPAN HAND WITH A FIRM GRIP ON REALITY
Eight years ago, money manager Clifford J. Shaw could barely get big Japanese investors to give him the time of day. Now, Japanese executives, worried about the health of their companies' pension funds, are clamoring to meet him. Not only is he known as one of the savviest market-watchers in Tokyo, but as the president of Merrill Lynch Mercury Asset Management Japan, Shaw has the clout of the firm's $500 billion in assets under management behind him.
No longer the tongue-tied Japanese-language student who arrived in Tokyo fresh from Cambridge University some two decades ago, the 48-year-old Shaw is now fluent in the local lingo--a key attribute in gauging investor sentiment. He also has a big say over how some $17 billion in funds from Japanese clients is invested. Indeed, big corporate clients such as Hitachi Ltd. and Toyota Motor Corp. are counting on Shaw's impressive track record of outperforming the Japanese for the last five years to continue.
DENIALS. In a Japan suffering its worst postwar recession, it's getting trickier to repeat that feat. Last year, fund managers earned decent returns by throwing money at auto, consumer-electronics, and other exporters--the so-called Nifty 50. No longer. Today, even big players such as Hitachi and Toshiba Corp. are experiencing their first losses since World War II. ''There is no obvious place to rush,'' says Shaw, who, unlike some of his more bullish competitors, is profoundly skeptical about the Nikkei stock average scoring major advances in the near future.
Right now, Shaw and his team of 28 fund managers are attempting to winnow out the fundamentally strong companies from those that depend on the weak yen to boost exports and profits. Given Japan's price deflation, surplus labor, and factory overcapacity, he's also searching for companies that aren't in denial about the scale of their problems. ''One of the things that's quite frustrating here is getting a straight answer,'' he says. So Shaw, a determined tennis player, has staffers hammer away at companies--much as his ''brutal'' Japanese language professor once forced his young Scottish-born student ''to repeat phrases 20 or 30 times.''
Reflecting his doubts about the economy, Shaw recommends that global investors limit their exposure to Japan. For those who must have Japanese investments, he favors recession-resistant industries such as pharmaceuticals and food. But he's wary of retailing and the crippled banking sectors, where serious overhauls are needed. He also recommends consumer-electronics companies with broad product reach such as Sony Corp. He thinks utilities, such as Tokyo Electric Power, are also safe bets, thanks to their steady stream of dividends.
Shaw believes Japan's basic problem is that bosses don't have the sense of urgency that prompted U.S. executives and, more recently, their European cousins to dramatically cut costs to generate higher returns. ''Even a very conservative German company like Siemens is looking pretty dynamic compared with its Japanese counterparts,'' Shaw says. As a result, it will take some time before Japan soaks up its excess capacity in autos, memory chips, and steel. ''This isn't going to get any better soon,'' he says.
Still, it hasn't stopped him from looking for opportunities. Despite a deteriorating economic outlook, Shaw and his team will be grilling executives again and again--just like his professor taught him--to find the likely survivors.
By Brian Bremner in Tokyo

SPOTTING STARS IN THE BRAVE OLD WORLD
Eleven stories above London's Canary Wharf, Richard G. Davidson observes the tranquillity of the Thames. It's a contrast to the turmoil that Davidson, the head of European equity strategy at Morgan Stanley Dean Witter, says will continue to rock world markets. He believes bourses will be as turbulent in 1999 as they were the previous year. ''That's no mean statement,'' he says, ''because this year there has been the highest volatility since 1987.''
Thanks to falling interest rates and rapid economic growth, Davidson thinks European markets will outperform the U.S. during the first half of 1999, with some rising as much as 15% to 20%. During the latter half of the year, however, the specter of deflation may cause some markets to stumble. Fears about the millennium bug, U.S. rate hikes, and possible currency devaluations in Brazil and China could gnaw at confidence, too. Right now, says Davidson, ''it is much more difficult to see what's going to sustain the markets with all these risks.'' Nonetheless, he predicts European markets will gain an average of 10% in 1999, about what Morgan Stanley expects for the U.S.
Judging by his record, Davidson's forecast is worth considering. Since the 31-year-old Scot began running Morgan Stanley's European model portfolio in 1994, he has outperformed the company's widely followed European index in four out of five years. Davidson stayed ahead of the crowd by anticipating investment trends and themes.
Currently, he's focused on how the Jan. 1 debut of the euro will alter the Continental investment landscape. Davidson says that once institutional investors are freed from currency concerns, they'll cast a wider net over Europe. That could mean money flowing out of Ireland, the Netherlands, and France and into Italy, Spain, and Germany, which are currently underweighted in most European portfolios. Meanwhile, the continuing convergence of European inflation and growth rates will also force investors to pay closer attention to industry sectors rather than individual countries.
Despite the new fashionability of Europewide investing, Davidson's top pick for 1999 is Italy. ''It has been our favorite for two and a half years,'' he says, ''and we still like it.'' It's the only country where growth is likely to accelerate next year. What's more, recent interest-rate cuts and consolidation in key sectors, such as banking and telecommunications, should boost profits.
Specifically, Davidson likes cellular-phone operator Telecom Italia Mobile, which posted a 25% increase in subscribers, to 12.5 million, last year. Financial institutions, especially insurer Assicurazioni Generali, offer good value as more Italians shift from fixed-income investments to higher-margin equity products. Davidson is also keen on Spain, where government reforms and falling interest rates should keep the economy solid. But as in Italy, 9% of sales of listed companies come from Latin America. That hasn't stopped him from recommending ENDESA, a utility that's cutting costs, and Argentaria, a Spanish bank. Both do have Latin American exposure, but significantly less than their competitors.
PRICING POWER. Davidson, a University of Edinburgh finance and law graduate, also is focusing on companies that can generate stable, sustainable growth. He is high on Germany's Mannesmann and Britain's Cable & Wireless PLC. Despite the recent departure of C&W's CEO Richard H. Brown, Davidson is optimistic. He thinks deregulation and the boom in data and Internet traffic will continue to power C&W's growth.
Restructuring plays such as French utilities Vivendi and Suez Lyonnaise des Eaux are also among his favorites. The former is expanding into telecommunications and media, while Suez Lyonnaise is sticking to water, energy, and waste management. Along with utilities, Davidson favors beverage and tobacco producers. In these three sectors, companies should be able to hike prices even amid low inflation. Despite the volatility Davidson sees coming in 1999, there should be no shortage of ways to invest soundly as Europe enters its new, single-currency era.
By Heidi Dawley in London

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