Invest (in-VEST) v. To commit (money) in order to gain future profit or interest.
Despite the simplicity of that definition, anticipating profit or interest from investments in 1999 is complicated by a computing phenomenon with global implications and no historical precedence.
As the clock ticks toward the new millennium, interest in potential Year 2000 (Y2K) problems is increasing. From the complex functioning of a billion dollar multi-national corporation to routine processing of a $20 cash machine withdrawal, the immovable millennium deadline looms large for anyone attempting to gauge financial prospects.
A recent Piper Jaffray Inc. investor survey on the level of concern suggests that not just business and financial experts are paying attention. Consumers are also becoming skittish.
According to the national study, nearly 40 percent of respondents are either very concerned or somewhat concerned about the safety or performance of their investments as the new millennium draws closer.
While concern over the impact of the Y2K problem is clearly reaching individual investors, the question of what they should do appears almost as vexing as the problem itself. Despite the widespread concern, only 13 percent of survey respondents said they have made changes or plan to make changes to their investment strategies due to Y2K.
Much of the investor inactivity tied to Y2K is likely attributable to a variance in opinions on how directly the problem will impact financial markets. Without any prior cases to look to, it is virtually impossible to predict the affect on personal finances and investment holdings.
Some observers regard Y2K as a non-event that will result in nothing more than a rash of annoyances, while others preach doom and gloom. The reality will likely fall somewhere between the two views.
Media attention given to Y2K will further spur awareness of the issues and what impacts they may have on the long-term success of individual investment portfolios.
Investors large and small should take the problem seriously. It is, at least, another potential market influence, as real as any of the more conventional considerations such as strength in overseas economies or the direction of interest rates.
Despite varying opinion on how much of an impact Y2K will have on the market, taking time to evaluate likely outcomes is warranted. Regardless of where one stands on the extreme scenarios of crashing airplanes, plunging elevators and global financial gridlock, certain market factors are clear.
A key implication of Y2K is the tremendous amount of time, energy and money required to fix the problem. It is difficult to identify all of the costs likely to be incurred, but estimates for global compliance range from $600 billion to $3.6 trillion.
For investors, the enormous sums being spent on Y2K problems will affect company earnings—the fundamental measure of a stock’s investment potential. Estimated year-over-year growth in company earnings for 1998 and 1999 is expected to be noticeably less than that seen between 1996 and 1997. First Call Corporation estimates for the S&P 500 suggest annual company earnings will increase 4.2 percent in 1999, compared to a 9.3 percent increase in 1997.
Investors should also take note of the nature of certain investment sectors and their inherent dependencies on information systems. Some industries are more exposed to the problem than others, according to Dr. Edward Yardeni, chief economist at Deutsche Bank Securities and a widely regarded authority on Y2K issues. He believes utilities, phone systems, hospitals, banking and finance are the most vulnerable to the threat of Y2K.
Small U.S. firms are also at risk for adverse impact, according to Eric T. Miller, senior advisor for Donaldson, Lufkin & Jenrette. “Overall, big organizations look to be in good shape, but many small companies are probably not as prepared,” he said. Miller also believes that current world events are drawing the attention and resources of international companies away from Y2K, as Europe transfers to a common currency and Asia deals with recessionary conditions.
The impact expected in these areas and others will cause increased volatility in both equity and fixed income markets. As is the case with any potential source of market volatility, there are clear steps investors can take to protect investment holdings. The severity of those steps should match the perceived “downside” an investor attaches to Y2K and be consistent with long-term investment goals.
Prudent portfolio management involves the allocation of funds among equities, fixed income, international securities and cash based on return expectations, risk tolerance and portfolio objectives. While maintaining a positive outlook for the stock market over the long term, for example, investors can adjust their near-term investment mix to reflect higher perceived risk as a result of Y2K.
Following are specific Y2K action steps investors may want to consider based on three general levels of concern:
High concern. Take a defensive posture. Reduce equity exposure and lean toward large companies that generally deliver predictable earnings. Eliminate small-and mid-cap holdings and international exposure. Buy bonds, primarily government and municipal issues, but be selective among high-yield corporate bonds. Sell non-performing securities;
Moderate concern. Proceed with caution. Reduce equity exposure. Invest internationally, but lean toward developed versus emerging markets. Increase fixed-income exposure. Sell non-performing securities.
Low concern. Stay the course. Maintain diversification based on return expectations and portfolio objectives. Focus on large companies that are industry leaders with globally-dominant businesses and small/mid-sized companies that enjoy proprietary positions. Reduce exposure to non-performers and companies with sub-par earnings potential;
Only time will tell the true extent of the impact from Y2K related problems. For investors, it presents yet another variable in an already complex and volatile investment environment. Properly mapping out an investment strategy necessitates defining one’s level of Y2K concern and making informed decisions based on research and personal objectives.
It is, after all, the future we are talking about.
Author Rob Peterson is branch manager of the Tacoma office of Piper Jaffrey, Inc.