Kiplinger: The Y2K Itch (long)

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Kiplinger.com

November 1999

Fear of the computer bug will harm stocks more than the bite of the bug itself.

Let's start with the $64-trillion question: Will the Y2K bug eat the U.S. stock market, or be eaten by it? The answer is: yes. Yes, stock prices will fall -- and prices of some stocks will fall more than others -- because of people like Maurice Recame.

The 51-year-old San Diegan is like a lot of us: He's built up a handsome retirement account invested in stock funds and doesn't want to kiss this money goodbye. By the end of September he planned to convert $700,000 in funds to cash investments and wait out the trouble everyone is forecasting.

Recame is a communications technician, not a stock-market expert or a computer wizard. He isn't sure what will happen once all those computers have to figure out that the onset of a new year has taken us forward to 2000 and not backward to 1900. But he is really worried about what others will do over the next few months.

"I don't have faith that my fellow investors are going to stick it out," he says, "and I think they're going to think the same way that I do. I'm willing to give up a few months' earnings for the safety of a money-market account." If the stock market does go down, says Recame, "I'll be able to get back in at a discount."

Replicate the Maurice Recames of this world tens of thousands of times and you can sense the impact that the Y2K phenomenon will have on stocks before the year 2000 even starts.

A survey conducted by DeRemer+Associates and Prince & Associates found that 14% of mutual fund investors planned, like Recame, to sell some or all of their stock and bond funds by the end of the year. With nearly $3 trillion in stock funds, redemptions of that magnitude could bludgeon the stock market.

And "yes" again. An anticipatory sell-off this autumn will probably set the stage for a massive rally as investors' worst fears are seen as unfounded. A rally could even precede the start of the new year. Result: Stock prices will fully recover and may end up higher than before.

So buy, sell, hold -- what's a person to do? Most long-term investors should do nothing. This is a tiny bump on a long journey, so let events run their course. But if you're particularly cautious, or you plan to spend some of your investments within the next year, there are ways to protect yourself short of emulating Maurice Recame's headlong flight to cash.

The two Y2K problems

There are really two Y2K problems, as Merrill Lynch analyst Jeanne Terrile recently told clients. The first -- the obvious one -- concerns fixing all the old computer code that could cause machines to malfunction once the last two digits of the calendar strike "00." The second problem involves how people will react emotionally to an event that no one has ever confronted before (and may never again).

Wrote Terrile: "As the inevitability of 1 January 2000 draws closer and as media scrutiny focuses on that date, the trajectories of these two problems are likely to diverge further: More actual fixing gets done but more stories are written and more anxieties arise."

No one can be certain what will happen to the world's electronic infrastructure once the calendar turns over. Every analysis of the problem ends up in the same garden of guesswork. The lack of conviction stems from the unique nature of the Y2K problem: While it's conceivable, even likely, that the vast majority of large, publicly traded companies in the U.S. will have their computer and related systems debugged in time, there's no telling what kind of chain reaction might follow if, say, their parts suppliers in Malaysia and Taiwan implode.

"Even the best-prepared American firms," says Charles Gabriel Jr., a Washington analyst for Prudential Securities, "are only as strong as their suppliers and customers, both domestic and international, and their servicers and subcontractors."

On Wall Street, the loudest alarm is being sounded by Edward Yardeni, chief economist for the Deutsche Bank Alex. Brown brokerage. Yardeni, who was remarkably prescient in forecasting the sharp decline in interest rates and rise in stock prices during the 1990s, believes there's a 70% chance of a recession because of Y2K-related disruptions.

The likeliest cause of this economic downturn, says Yardeni, is a breakdown in the global "just in time" manufacturing system. Adopted by many companies, just-in-time manufacturing requires that all components arrive at precisely scheduled times for assembling into finished products, eliminating expensive inventory stockpiling.

"Even if most domestic supply chains are fixed, it is very likely that breaks in the global supply chain will occur," says Yardeni. Depending on the severity of the Y2K-induced recession, U.S. stock prices could fall as much as 30%, he predicts. Such a decline would be slightly greater than the average post-World War II bear market.

Some newsletter writers share Yardeni's concerns, but his is a lonely voice among mainstream investors. Consider the words of Bill Nygren, manager of Oakmark Select fund: "Y2K is a bunch of hooey created by the Y2K consultants to maximize their incomes."

Nygren hasn't rejected a single investment idea because of Y2K issues. Adds Bill Keithler, manager of Invesco Technology fund: "Most of the developed world has got this problem nailed."

Reverse economic effect It's quite possible that a mild slowdown in economic activity will occur in the first half of next year. Ironically, it would stem from a microburst of business near the end of 1999 as companies stockpile supplies and components to ameliorate any temporary shortages caused by Y2K snafus.

As for individual publicly traded companies in the U.S., a Morgan Stanley Dean Witter survey of 611 concerns released in late May found that two-thirds had either completed their Y2K fixes or were well along with repairs. Merrill Lynch said in its summer report that most of the companies it follows have squashed the millennium bug.

Of greater concern to investors is the progress, or lack thereof, in making Y2K repairs overseas, particularly in developing economies. Even in Britain, which is considered a leader in bug extermination, the government's Y2K task force reported that as of midsummer, seven big financial-services firms faced significant risk of material disruption because of the calendar changeover.

The U.S. State Department's inspector general told Congress over the summer that in some foreign countries "there is a clear risk that electricity, telecommunications and other key systems will fail, perhaps creating economic havoc and social unrest." Severe Y2K disruptions are considered especially likely in Russia and China.

But even in third world countries, Y2K fears are exaggerated, say some observers. Jennifer Moran, emerging-markets strategist at the Donaldson Lufkin & Jenrette brokerage, says developing nations will be less affected by Y2K disruptions than developed ones because they have so much less high-tech machinery to start with.

Mark Madden, who runs Pioneer Emerging Markets fund, says that such nations as Argentina, Israel, Singapore, South Korea and Taiwan are doing reasonably well in stamping out Y2K bugs. Other emerging markets, such as India, Indonesia and the Philippines, are lagging. But Madden contends it won't matter that much to their economies because "they're used to disruptions in banking, utilities and so forth." Many companies, for instance, have backup power-generating facilities, he says.

A Y2K investor guide Whatever you do, don't blithely sell all your stocks and bonds and assume a fetal position around your cash, in anticipation of reinvesting it after calamity strikes the global economy. Remember, Y2K is one of the most widely anticipated events ever. To a great extent, any Y2K-related disruptions may already be factored into stock prices.

And for a go-to-cash maneuver to succeed, you'd have to be right twice -- once in foreseeing a significant decline in stock prices, and again in knowing when to reinvest your money. If you wait to reinvest until after New Year's Day, you may miss the boat.

A widely held belief on Wall Street is that should Y2K disruptions prove relatively benign the first few days of 2000, stocks could experience one of their greatest advances ever on January 3 -- a "melt-up." Prudential's Gabriel suggests that some investors may anticipate just that and could ignite a rally before the New Year.

Still, given all the uncertainties, now is the time to reexamine your tolerance for risk and the way you spread your money among stocks, bonds and cash. Consider economist Yardeni's worst-case prediction of a possible 30% decline in share prices.

If your stock investments were to drop by that much, would your life be significantly affected? Would you be worried sleepless? Were you tempted in previous downturns to sell your stock holdings after a sickening slide? Will you need the money next year?

If you answer yes to any of these questions, trim your sails a bit. Consider selling the portion of your investments you'll want to spend in 2000. Assuming that you're sitting on gains, try to confine your selling to IRAs and other tax-deferred investments. Outside of tax-deferred accounts, sell stocks or funds on which you have sustained losses.

High-quality stocks and bonds boast an added level of safety as we approach Y2K Day because it's safe to assume that investors will lean in their direction, providing a cushion of demand that will benefit prices.

For instance, DLJ strategist Moran, while not overly pessimistic about the prospect for developing economies, is concerned that anxious investors will pull money out of these locales as year-end approaches. Any such selling, Moran says, could create terrific opportunities early next year. But she adds: "If you don't have to be in emerging markets in the fourth quarter, don't be there."

High-yield bonds, including U.S. junk bonds and debt issued by governments and corporations in developing nations, could also suffer from a migration to higher-quality investments. In a survey of bond-fund managers, Merrill Lynch found that 58% plan to buy more-liquid, easy-to-trade bonds by the end of the year.

Already, Y2K fears have been blamed for an increase in the yield gap between lower-rated bonds and supersafe, easily traded U.S. Treasury bonds. Cautious investors might want to lighten up on their junk-bond holdings for the rest of the year and move money into long-term government bonds (see Any bounce left in bonds?)

As if stocks of small companies haven't suffered enough in recent years, fears of Y2K may also hit them hard. To the extent that professional investors want to approach the unknown holding more easily traded stocks, they will probably load up on large, blue-chip names.

This would come at the expense of smaller stocks and would likely serve to depress their prices even further. On the other hand, if the markets do rally early in 2000, artificially devalued small stocks could be major beneficiaries. So whether to lighten up or fatten up on small-company stocks hinges on whether you want to sidestep short-term risk or try to profit from it.

Stocks to avoid Some industries go into the last months of this millennium under special clouds of uncertainty. One vulnerable area: computer services and software. Price declines have already struck shares of companies, such as Keane and Viasoft, that help businesses fix their Y2K bugs.

At one point more than one-third of Keane's revenues were Y2K-related. "Keane continues to struggle with managing a decline in its Y2K business," says Prudential Securities analyst Thomas Browne Jr. Other computer-services firms are almost certain to be hurt as clients cut back or freeze new computer or software installations until sometime in 2000, says Invesco's Keithler.

One polar opposite of the high-tech sector is also under a Y2K cloud. Property-and-casualty insurance companies may pay billions of dollars in claims if the millennium bug causes computer failures that disrupt business operations. One actuarial firm predicts that Y2K could cost the industry between $15 billion and $35 billion in losses.

"We will have quite a few lawsuits to the extent we have crashes related to machinery," says Jeffrey Thompson, an analyst for Advest brokerage. "If you have a baby on a heart monitor and it fails and the baby dies, that's a legitimate issue." Potential Y2K exposure is one reason Thompson is negative on property-and-casualty stocks for at least the next six months.

If that were not enough of a headache for the property-and-casualty insurers, several companies, among them GTE and Xerox, have filed suits seeking reimbursement for their Y2K repair costs, which could easily run into the hundreds of millions.

"Regardless of the financial outcome for the industry, the cloud of this issue is likely to hang over these stocks between now and year-end," says Salomon Smith Barney analyst Ronald Frank.

For most companies, figure on business as usual, if not throughout this brief period of uncertainty then within a short time. Stock prices may fall some in the next few months as the Maurice Recames sell shares and stash the cash.

But you'll do better abiding by the words of Pittsburgh money manager Tom Bellhy: "What matters longer term is the fundamentals of companies. If earnings are coming through, then investors will place the appropriate values on stocks and they will come back."

Reporter: Sean O'Neill

-- Ken Decker (kcdecker@worldnet.att.net), October 25, 1999

Answers

Hi Ken,

Thanks for this informative post. It's the most level-headed advice about investing that I've seen so far.

-- (KenFan@Doomerville.com), October 25, 1999.


Mr. Decker. Your are finally starting to see a problem. Welcome home son.

"No one can be certain what will happen to the world's electronic infrastructure once the calendar turns over. Every analysis of the problem ends up in the same garden of guesswork. The lack of conviction stems from the unique nature of the Y2K problem: While it's conceivable, even likely, that the vast majority of large, publicly traded companies in the U.S. will have their computer and related systems debugged in time, there's no telling what kind of chain reaction might follow if, say, their parts suppliers in Malaysia and Taiwan implode.

"Even the best-prepared American firms," says Charles Gabriel Jr., a Washington analyst for Prudential Securities, "are only as strong as their suppliers and customers, both domestic and international, and their servicers and subcontractors." "

-- MS in IS (MSIS@cyberdude.com), October 25, 1999.


garden of guesswork.......what a piece of work!!!!

-- Jay Urban (JAYHO99@AOL.COM), October 25, 1999.

Ken, let me get this straight. You bail out of the stock marketlast April, now you come in here and post some diatribe from a business pub that laments doomers by claiming

Fear of the computer bug will harm stocks more than the bite of the bug itself.

What a Grade-A asshole you are.

-- a (a@a.a), October 25, 1999.


"a,"

Ah, always the rhetorical genius. Let me see if I can dodge your rapier wit long enough to explain a few simple points.

First, the Kiplinger's view reflects mainstream America. I don't necessarily agree with it whole cloth, but it IS Y2K-related news reporting.

Second, I withdraw from the market because of my analysis of market fundamentals. Perhaps you have heard of "buy low, sell high?" I may take a few positions in late December... and sell after the "relief rally."

Third, unlike you, I am able to read (and post) information I may or may not entirely agree with. I do not hold Kiplinger's in overly high regard... but I consider them far superior to Y2Knewswire. This forum is about the exchange of information, not the conversion of "heretics."

Normally, "a," I might not take this much time with you, however, you are obviously in late stages of Milne's Syndrome. Lacking the ability to make a reasonable counter argument, you engage in profane diatribes. Try to get a grip... before are looking at Post-Y2K Stress Disorder.

-- Ken Decker (kcdecker@worldnet.att.net), October 25, 1999.



This forum is about the exchange of information, not the conversion of "heretics."

Mr. Decker,

To you and I (and all level-headed individuals), this forum is about the exchange of information. To most doomers, the meme has successfully become their religion. Your assessment of a's response therefore, is totally accurate when you smack at this point.

Nice rapier work; and kudos.

Regards,
Andy Ray



-- Andy Ray (andyman633@hotmail.com), October 25, 1999.

I apologize for calling you an ass Ken. I meant to call you a butthead, and say that concerning computer problems you don't know COBOL from a golf ball.

But do continue to brag about bailing from the market whilst complaining loudly of the doomer meme. It will make the next few months that much more interesting.

"Don't criticize a man until you've walked a mile in his shoes. That way, you're a mile away and you've got his shoes."

-- a (a@a.a), October 25, 1999.


Apology accepted, "a." I meant to say you have a mattock wit and could not tell the difference between a marginal utility and a water utility. I promise not to write in COBOL, if you promise not to engage in economic forecasting. Deal?

-- Ken Decker (kcdecker@worldnet.att.net), October 25, 1999.

Andy Ray

While I don't agree with Ken Decker sometimes, at least he provides information. What the hell have you ever done? Ask stupid questions with no answers. Any idiot can do that, it just so happens that you are the idiot.

I think Ken should be insulted by your comparison to him.

Ken

""And "yes" again. An anticipatory sell-off this autumn will probably set the stage for a massive rally as investors' worst fears are seen as unfounded.""

Well this is just a guess. His crystal ball must be Y2K compliant eh?

Information from a survey in May, fund managers guessing about Y2K remediation, this is not information but further speculation.

We already have enough of that. But this effects personal investments, often needed for retirement. Security is the focus and security is "money in the bank".

Everything else is gambling.

-- Brian (imager@home.com), October 25, 1999.


Ken: Here's the difference.

Computer skills require logic and intelligence.

On the other hand, any fool can be an economist (in fact one could make the argument that most are anyway). Likewise, any moron, or chimpanzee for that matter, could have played this bull market for a handsome profit. Predicting the economy is like predicting the weather - "luck" has a lot to do with success.

-- a (a@a.a), October 25, 1999.



"a,"

(laughter) Since when has COBOL become a litmus test for intelligence? Here's the hubris of the computer wonk in full flower. "Because I can program a computer, I'm so smart I know how the rest of the world works." How many computer geeks rail on about "management." Of course, Wall Street is littered with IT guys who thought they were WAY smarter than all of those management types.

It does take a modest amount of intelligence to become a computer programmer... though there is a huge difference between a good programmer and a bad one. Contrary to your opinion, "a," it takes a modest amount of intelligence to become an economist.

The difference, "a," is that I am not looking over your shoulder make comments about your coding. I don't bother the appliance repair guy either. It's best not to disturb technicians at work. Ultimately, the programmer is a technician. You can build a subsystem without ever going into the meta-issue of design. Coding is the brick-laying of the modern world... certainly an honorable trade.

Now, when you tell me you "know" about the economic impacts of Y2K, it's like a brick-layer who's worked on a cathedral telling me he can teach theology.

-- Ken Decker (kcdecker@worldnet.att.net), October 25, 1999.


Definitions of an economist:

Someone who can predict the past with 50 percent accuracy.

Someone who's good with figures, but doesn't have enough personality to become an accountant.

A person who explains what will happen with the economy, and then explains why it didn't.

Someone who doesn't know what s/he is talking about, but makes you feel that it is your fault/

Someone who knows the price of everything and the value of nothing;

Someone who is too smart for his/her good, but is not smart enough for anyone else's;

Someone who will know tomorrow why the things that s/he predicted yesterday did not happen today;

Someone who sees something working in practice, and asks whether it will work in principle.

A sure fire way to determine if someone is an economist: Ask the suspect "what's the difference between ignorance and indifference?" If the reply is "I don't know and I don't care" you can be pretty sure its an economist. Now the only question is what to do with him.

If an economist and an IRS agent were both drowning and you could only save one of them, would you go to lunch or read the paper?

-- Igotta (million@of.em), October 25, 1999.


OK Ken, fair enough. I can proudly say that I've never made the mistake of asking you to comment on a computer technology issue, but why do you avoid me like the plague when I quiz you on economics related topics?

Cases in point:

Milne: Explain this one, Ken

Y2K Economics 101 for Decker

For Decker: Another reason the Y2K economic downturn will be worse than the 30's

How about it assh, ah, butthead? (you'll have to excuse my language. After all, I've only got a "modest amount of intelligence", being one of them there programmer guys, you know)

-- a (a@a.a), October 25, 1999.


"a,"

You ask very silly questions about economics... probably just as I would ask you about programming in COBOL. I generally decline trying to answer your questions because I sense no real desire on your part for answers. Your unabashed hero worship of Paul Milne leaves little room for honest inquiry. Do I think you really want to learn about economics? No. You just want a chance to prove me wrong.

Let's put my thesis to the test:

Milne is wrong about the national debt. I have posted the link to a primer on Federal Reserve myths. The second link explains some of the misconceptions behind debt and the sale of Federal Reserve notes.

http://www.cofc.edu/~flaherty/conspire.html#14

http://www.cofc.edu/~flaherty/virus.pdf

Please feel free to debunk these short essays. In short, Milne is expressing some of the ideas in "The Debt Virus" and Flaherty does a fine job (saving me some work.)

As to your second post, you divide the economic world into "real" assets and everything else. Pretty silly. For example, an equity is not an "electronic promise to pay." It is a share of ownership in an enterprise like the deed on a tract of land. If you like, you can still find "paper" stock certificates. When you own a company, through direct investment or through a mutual fund, you own a share of its assets AND earnings.

The value of this share depends (indirectly) on many variables. Directly, it is the result of supply and demand. In a free market, price is ALWAYS determined by the interaction of supply and demand.

Let's take your "hard" examples: gold coins and heating oil. There are markets for both these commodities. How much your gold or oil is worth depends entirely on the marketplace. In this respect, they are no different than corporate stock. Unlike a raw commodity, a company can develop new products, improve efficiencies and increase earnings. Commodities just sit there.

Unless you have a gold mine (and refinery) or an oil well (and refinery), someone else produces these commodities for you. The economic system you criticize manages to move these raw commodities from the ground to your doorstep. As a process, this is a minor miracle.

You would not have these commodities without a viable economic system. The "wealth" of the economy is not within the factors of production like iron or oil... it is in the productive capacity of the participants. When you buy a company, it is not just binary digits... it is the cumulative effort, creativity and assets of the firm.

Your second point, success does not depend on growth. Growth often happens because we improve technology, develop new processes, reduce inefficiencies, etc. If you found a way to halt the growth process, you can still have a viable economy.

Your third point, the boom-and-bust cycle. What you see as a weakness, I see as a self-correcting system. Some investors learn (the hard way) when they overextend themselves. Capitalism is the economic jungle. Those who make bad decisions ought not to survive. Taking risks is part of the strength of our system. Not every risk pans out, but it can create tremendous results. Because of the risk- reward nature of investing, there are incentives to produce a new technology or expand into a new market.

To the Great Depression... again a silly observation. If one person with marketable skills cannot find a job... why should a second person be more successful. Let's say a fellow goes to a restaurant and says, "Can I have a job." The manager says, "No, don't need anyone." The guy responds, "Then can my wife have a job?"

Given our higher level of government employment, there is a greater safety net for many workers. (It is as if we never ended the WPA.) With two skilled workers there is a better chance of preserving at least one income. Given the international wage pressure on unskilled laborers, we are far better off with more skilled workers, a point Flint has already made.

Flint also pointed out the obvious... we undercount domestic labor. A stay-at-home spouse produces a great deal of work. (Ask one.) We just don't count this in our GDP. There are cost-savings with one spouse staying at home.

In truth, "a," it is hard to respond to your questions. Read the links, and my comments, and let's see if you really want to learn something.

-- Ken Decker (kcdecker@worldnet.att.net), October 25, 1999.


Lian,

Nothing happened, and nothing will happen. No catastrophy, no disastrous new year, no evidence. Zip. Nada. You need to find some other means of dealing with reality than blaming the messenger.

Regards,
Andy Ray



-- Andy Ray (andyman633@hotmail.com), October 26, 1999.


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