"Take Care in the Stock Market"


"An O.K. performance, but not a great performance." That's the forecast of the 2005 economy and market from William Wolman, author and former BusinessWeek chief economist, who says he expects about a 6% to 7% increase, uncorrected for inflation. So he suggests that "people should run fairly conservative portfolios."

The falling dollar is one big worry in Wolman's eyes, but he doubts that foreign holders of massive U.S. debt will try to collect and thus destabilize the American economy. He recalls the saying that, "if a company owes the bank $1 million, the bank has the company where it wants it. But if a company owes the bank $100 million, the company has the bank where it wants it." However, he sees that debt as a long-term threat.

One thing that could destabilize the market and the economy is President George W. Bush's plan to privatize part of Social Security, Wolman warns. He doesn't expect it to pass without a greater Republican majority in Congress than now exists, but should it eventually be enacted, he notes that most people don't realize "how unsuited the stock market is to providing retirement income for the mass of Americans."

These were a few of the points Wolman made in an investing chat presented Dec. 28 by BusinessWeek Online and Standard & Poor's, in response to questions from the audience and from Jack Dierdorff of BW Online. Following are edited excerpts from this chat. AOL subscribers can find a complete transcript at keyword: BW Talk.

Q: Bill, the so-called Santa Claus rally seems to be still going. Do you expect it to last into the new year?

A: I expect it to continue to some extent, but I wouldn't get too excited at this point. There are too many uncertainties, and the falling dollar is a problem that simply can't be ignored.

Q: Should investors be in stocks or bonds in 2005?

A: My own feeling is that people should run fairly conservative portfolios. So I would guess about a 50-50 split is about the right way to go at this point.

Q: You mentioned the weak dollar -- can growth continue under the staggering debt we're building?

A: There's a famous old saying that if a company owes the bank $1 million, the bank has the company where it wants it. But if a company owes the bank $100 million, the company has the bank where it wants it. By this I'm saying that it'll be extremely hazardous for the countries to which the U.S. owes money to destabilize the American economy by trying to collect on its debts in a sudden way. It would be very hard on the economic growth rates...and on employment and growth in those [creditor] countries.

Having said that, it's worth noting that countries sometimes behave irrationally, and the capacity of the creditors, especially Japan and China, to destabilize America is quite high. And in dealing with that issue, I subscribe to the conventional wisdom, which is that the U.S. should make a serious effort to cut the deficit in the federal budget. Whether this will actually happen is a question on which I'm somewhat skeptical.

But let me put it this way: I think the U.S. has at least another year in which to play the debtor game. And I don't expect substantial stock market destabilization because of the huge outstanding U.S. debt, but there's no question that that debt is a long-run threat.

Q: Do you think anyone in the Bush Administration shares that "conventional wisdom" on cutting the budget deficit?

A: I suspect that some of them do, and they all pay lip service to cutting that deficit. But if they made serious noise, they wouldn't be in the Bush Administration. Look what happened to [former Treasury Secretary] Paul O'Neill, who was and is a very good man. He was a great executive as well.

Q: Where do you see interest rates?

A: I share the conventional wisdom here again that rates will rise gradually in small increments.

Q: What do you think of banking stocks, both large and small?

A: I think they fall in the category of other relatively conservative stocks. I will say, however, that what might be called brilliant marketing by the Bank of America (BAC), which is turning its branches into pretty consumer-friendly places, is having a big impact on banks and will put pressure on most banks to spend a lot more money on marketing.

Playing catch-up with BofA will not be easy. And so, although I don't like to recommend stocks, I like BofA itself the best of all the big banks. I also think that regional banks are still very good acquisition prospects.

Q: What's the highest fed funds rate consistent with a stable, but not necessarily prosperous, economy?

A: That's a good question, and given our relatively low inflation rate, it's not a high number. I'd be a little bit scared of anything over, say, 4.5% very soon.

Q: Do you think President Bush's Social Security plan would have a major destabilizing effect on our economy?

A: About that there's no question whatever. The answer is yes, it would have a major destabilizing effect on the economy. I don't expect it to pass in this session of Congress. We're going to need an even bigger Republican majority to make that happen. It's kind of interesting to realize how unsuited the stock market is to providing retirement income for the mass of Americans.

In a book that I co-authored a couple of years ago called The Great 401(k) Hoax, there was a calculation about how much money would be in the average Social Security check if Social Security depended on its income from dividends to provide retirement benefits. At the time the book came out, which was about three years ago, the number was under $500 per [monthly] Social Security check.

At that time, the average check being paid out was about $800. How, then, can profits, which are what you earn a share of when you invest in stocks, possibly fund Social Security payments? The answer is that they can't, which would turn Social Security into a Ponzi scheme if you depended on profits to fund it. This is a fact that's consistently ignored in the discussion of Social Security.

My own view is that the only way to make the system workable is to have people work well beyond what's now the normal retirement age. And that, folks, is what's going to happen. I did that for almost 10 years, and believe it or not, it was fun.

Q: How do REITs look? They tend to pack high yields, but how long can the real estate boom last?

A: That's a huge question. My guide to it is Robert Shiller, the Yale economist, who's famous for inventing "irrational exuberance" as the way to describe what happened during the great stock market bubble of a few years ago.

Shiller says he knows a lot more about the housing market than about the stock market, since he has studied it all his life. He believes that there's a housing bubble somewhere out there, although he also admits that it's incredibly difficult to forecast when and where it will hit.... I would say that some diversification out of real estate is a good idea for those who are real-estate-heavy, which is many of us these days.

Q: Are there foreign stocks U.S. investors should look at? In high-growth areas such as China and India? Or elsewhere?

A: The answer is yes. And the answer is India and China, still. The facts are that these countries have great education systems, graduate far more tech and science whizzes from their universities than we do at this point, and that the competition has just begun.... And the Indians are convinced that 20 years from now their real competition will be from China and not the U.S. The threat over the long run that we will be displaced in this [tech] area is a real one.

Q: Are you comfortable in Asian investments, given the nature of instability over the last 30 to 40 years?

A: That's a good question, but as far as I can see, India is finding its way to stability as a genuinely democratic country -- surprisingly so, for a country where income is so unevenly distributed. I personally know China not nearly as well as I know India, but again I think that the benefits of a relatively free economy are so great that the outlook for both China and India is optimistic.

One further point that's important: Commercial civil law has made great strides in those countries, and nothing is more important to safeguarding the future of their industry. I'm very impressed with those guys, and we're going to see competition like we've never seen before.

Q: Do you have any prediction on stock sectors that will do best in 2005?

A: As I remember, I made about one sectoral forecast in the chats I've done with BusinessWeek over the past couple of years. And that, I'm proud to day, was a forecast that satellite radio would do very well. And, boy, was I right. XM Satellite Radio (XMSR) and Sirius (SIRI) are off today, but I still believe that this will be a hot sector in the coming year -- indeed in the coming two years. So it's a small sector, but it continues to be my favorite.

Q: Bill, can you tell us anything about the book project you and Anne Colamosca are working on now?

A: With some hesitation. I'll just tell you that the book is about a time-travel project that will bring Adam Smith and Benjamin Franklin back to life to give us their impressions of the problems that face the U.S. now and the way in which to deal with those problems.

Q: We'll look forward to that. Now, in today's news we had a 10-point rise in the consumer confidence index. What do you see ahead for consumer spending and consumer stocks?

A: The number is surprising, and I'm not sure that I fully believe it. However, insofar as it's true, it's unquestionably a big plus in the short run. The bad news, of course, is that it will keep the savings rate down at a time when we really need a higher savings rate.

Q: Where do you see the economy, such as GDP growth and the market -- Dow or S&P -- by the end of 2005?

A: I would say about 6% to 7% higher than it is now, uncorrected for inflation. So it'll be an O.K. performance, but not a great performance. It's important for people to realize that despite the yearend rally, the market has not done all that great this year.

One thing we found out, especially from the work of Yale economist Bob Shiller, whom I talked about earlier, is that the kind of stock market bubbles that we had a few years ago cast a very long shadow. I don't expect that to be very different this time. So it's important to take care in the stock market.


Steve Ballmer, Power Forward
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