A look ahead to the 2005 economy

By Marshall Loeb, CBS.MarketWatch.com
Last Update: 5:00 AM ET Dec. 25, 2004

NEW YORK (CBS.MW) -- If you're looking for a formula for your asset allocation as the new year begins, you probably could do worse than follow the advice of Standard & Poor's Investment Policy Committee.

For a typical balanced investor, it recommends an asset allocation of 45 percent in U.S. equities, 15 percent in foreign stocks, 25 percent short-term bonds and 15 percent cash. Previously, S&P had a somewhat more defensive allocation.

Naturally, if you're younger, more confident about the future and willing to take some chances, you would put relatively more of your assets into stocks. If you're older and more conservative, you would invest relatively more in bonds and cash.

This allocation reflects S&P's forecast for the economy and for the markets in general. It tends to be close to the standard forecast of investment professionals.

The S&P forecast is that real GDP will advance in 2005 by a healthy 3.6 percent, on top of the quite strong 4.4 percent rise in 2004. That would make 2005 a good year, though not a great one.

This forecast also calls for the Consumer Price Index to rise by a noninflationary 2.3 percent. Meanwhile, the yield on the 10-year Treasury note would go up from 4.2 percent to 5 percent, the dollar would continue sliding and oil prices would slip from $45 a barrel now to $39 at next year's end.

Global economic growth rates are projected by S&P to rise 1.8 percent in Japan and 1.9 percent in Europe, 6.2 percent in non-Japan Asia, including a 7 percent advance in China.

A number of astute financial professionals generally agree with this prognosis, or at least major parts of it.

Joe Williams, senior vice president and director of equities of Commerce Trust Co. in Kansas City, is one of those who has a slightly more bullish attitude toward stocks, though he expects the economy's growth to slow to 2.5 to 3 percent.

He notes that the consensus is that 10-year interest rates will go up. "But we've been surprised before," he says. Williams believes that those 10-year rates may remain stable.

"And it may be," says Williams, "that profits will be better than the 6 to 10 percent now forecast. They may come in closer to 10 to 16 percent." Falling oil prices and the reduction of labor costs due to outsourcing may help lift profits.

In any event, he believes that there may be a change in the leadership of the stock market. For the last three or four years, small-cap stocks have performed best, midcap stocks have been somewhere in the middle and large-cap stocks have underperformed. But now, he reckons, large-cap stocks may do remarkably well. That's because their price/earnings ratios, at 18 or 19 times earnings, are roughly equivalent to the p/e ratios of small- and midcap stocks. It is one of those rare times, say Williams, that large-cap stocks are relative bargains.

Meanwhile, Robert Hormats, vice chairman of Goldman Sachs (International), sees a fairly healthy growth rate in most parts of the world. It will be strong enough to enable the Federal Reserve Board to continue to raise interest rates. It will also contribute to modestly higher inflation.

"That means," says Hormats, "that equities are likely to do reasonably well, and bonds are likely to be under pressure in the earlier and middle part of next year."

Hormats admits that there are many risks to this forecast.

One wild card is the dollar. If the dollar declines precipitously, it would push up U.S. inflation and have a very negative effect on the bond market.

Another wild card is oil prices. The odds are that they will stabilize, but there's always the risk that they won't. An actual disruption in oil supplies could be very harmful to the economy.

Hormats believes that "there's a long-term structural bull market in oil, given that there has been an underinvestment in the infrastructure of the industry relative to the [strong] demand we're seeing now."

If he is right, then oil prices are destined to go up, if not next year then sometime in the future.

Email dynamics

Email is fast becoming an important and possibly the only universal advertisement portal except the search engine. and considering that my dad still finds using google too unweildy i think email is the only way to get him to buy a play station for example. And the readers of forbes.com being in the spedning segment the following survey clearly shows yahoo's 57% market share of it:

http://www.forbes.com/technology/2004/12/21/cx_js_1221polldujour.html

and hotmail is lost immense ground and is a distant third.

2004: China's coming out party

2004: China's coming out party
Analysis
Mary Hennock
BBC News business reporter

For years, specialist China-watchers have been predicting that the wider world would one day wake up to the country's global economic influence and superpower potential.

2004 was the year when it happened.

The world focused on China's new-found economic strength as never before.

Its thirst for oil, outpouring of cheap exports and status as the world's most energetic economy - with growth topping 9% - all grabbed attention.

China has moved into the mainstream this year, no longer seen as a remote place, but the next big thing.

A sub-titled Mandarin movie - Zhang Yimou's 'Hero' - grossed $49m (£25m) at US box offices in its opening month. And Shanghai hosted its first Grand Prix on a circuit that stunned even the glamorous world of Formula One.

Meanwhile Britain's Silverstone nearly dropped quietly out of F1, too strapped for cash to stay a contender. Events like these confirmed China's arrival on the contemporary cultural stage.

Information industry

One growth industry springing up as a result of China's rip-roaring economy is China forecasting. Economists are churning out China research as never before. Demand is overwhelming.


These days I feel I have to read the business news, and then I turn and read the Chinese business news
Justin Urquhart Stewart, Seven Investment Management

"Everywhere we went, we found that our customers had questions about China," says Carl Weinberg, chief economist at High Frequency Economics in New York.

"Some even suggested that we drop Australia from our research and substitute China."

As a result, Mr Weinberg, who has never been to China, launched into a year of hard study, and began issuing a weekly research bulletin in 2004.

"Bond traders, banks, fund-managers - all sides of the financial community are interested," he says.

His experience is not an isolated one. Justin Urquhart Stewart is a director of Seven Investment Management, a London-based firm advising wealthy private clients.

"These days I feel I have to read the business news, and then I turn and read the Chinese business news," he says.

"I would say almost every discussion I have with a client includes some discussion of China," agrees Bob Parker, vice-chairman of Credit Suisse Asset Management. CAM operates a clutch of China-related investment funds.

Exports and oil

When and how did China move from marginal to mainstream in conversations on Wall Street and in the City of London?

The US presidential election campaign got the ball rolling, as the Bush Administration launched a high-profile assault on China's fixed exchange rate, accusing Chinese factories of undercutting US manufacturing jobs.

Meetings of the IMF and G7 in late 2003 endorsed US complaints.

But perhaps the biggest contributor to pumping up China's profile has been the rising price of oil.

Crude oil prices repeatedly broke records, ending 2004 about 35% higher.

China's appetite for oil raised its imports by more than 100 million tonnes - 34% - over 2003 levels. Other factors pushed up crude prices too - instability in Iraq, hurricanes in the Caribbean and politics in Russia all played a part.

But rising oil prices struck home with Western consumers.

Prices of other raw materials also climbed, such as minerals, cement and steel.

In Mozambique, for instance, sugar farmers complained that China's demand for transport was pushing up shipping costs and hurting their exports.

There was no single moment that made China an essential topic for economists. Rather, they say awareness has snowballed over the last couple of years as China's impact keeps surfacing.

Mr Weinberg's own moment of revelation came at a conference of the North Carolina World Trade Association in 2002.

"I thought I'd find two dozen hog farmers frustrated at trying to sell pork bellies to euro land," he admits.

Instead, China's growing domination of world textile markets brought together an audience of 2000 people "all with an interest in China".

"People from the ports in Norfolk, Virginia, all the way down around the Florida panhandle...wanted to be the gateway city" for imports of Chinese textiles, he says.

Stocks Shanghai-ed

But anyone who thought the world's fastest growing economy was a good place to make a fast buck on the stock market this year was wrong.

China's financial markets have not roared ahead in tandem with its economy.

The Shanghai Composite Index dropped 12% in 2004. In a ranking of 60 stock indexes, only Thailand did worse.

Investors could have got a better return on Cairo's CASE 30, which rose 116%, or Peru's Lima General Index - up 44% - or even in Indonesia, so often viewed as an Asian giant woefully under-fulfilling its potential.

The year's solid performers were Eastern European stocks and funds, bolstered by EU enlargement. Stock markets in Prague and Budapest gained roughly 50%.

"Emerging markets have outperformed developed markets by a very large margin, but Asia has underperformed and China has underperformed," says Mr Parker.

"There's a disconnect between the hype and the reality."

Even stocks in industries stretched by China's growth did not produce gains.

Shares in the giant Baoshan Iron & Steel Co did poorly, while the Shanghai Composite's best performing stock was a liquor company, Kweichou Moutai, from the poverty-stricken Guizhou region.

China's markets have been depressed by worries about whether Beijing could engineer a soft-landing for the overheating economy, and more attractive prospects in Shanghai's property sector.

Some investment analysts argue that the smart money lies in avoiding direct investment in Chinese stocks, in favour of the commodity producers feeding China's economic juggernaut.

Others - like CAM - predict that China-linked funds will do better next year. But despite China's poor return on equity investment, plenty are watching closely, feeling they should be there.

"One feature of world capital markets is the amount of money sitting on the sidelines", says Mr Parker. Much of it, he thinks, is earmarked for China.

And that does nothing to harm the market for China research.

"The quality of research has slowly improved, which is logical because people are putting more resources in," says Mr Parker, a regular visitor to China for more than a decade.

In his view, even the disappointments of 2004 have been "a bit of a wake-up call for investors" by forcing China-watchers to be less gung-ho and more specific.

The Technological Rise Of China Was Just the Beginning

The Technological Rise Of China Was Speedy --
And Just the Beginning

--- THE WALL STREET JOURNAL
December 20, 2004; Page B1

XIAMEN, China -- At first blush, the sale of International Business Machines Corp.'s PC unit to China's biggest PC maker, Lenovo Group, this month seemed quite shocking. After all, Lenovo is a Chinese company -- majority government-owned even -- and it's gobbling up a storied asset of the bluest American blue chip.

But the deal shouldn't have come as such a surprise. Lenovo is one of a handful of Chinese companies with the size, management skills and financial strength to attempt such a coup. And the deal helps IBM in China and means it won't have to hand off its baby to a U.S. competitor.

There's good reason, though, to pay attention to the deal and what it means about China. First, China is more advanced in the use of technology than many people know. It passed Japan this year to become the second biggest consumer of PCs after the U.S. It's closing in on 100 million Internet users, placing it second in that area, though it still has only half as many users as the U.S. And 15 million Chinese subscribe to broadband DSL service. That's more than in the U.S., though many Americans get their high-speed connections from a cable company.

In cellphones, China's 250 million users far surpass those of any other country. (Official statistics claim more than 325 million subscriptions, but they overcount business travelers, who get more than one subscription to avoid high roaming fees.) What's more, those 250 million users are still only about one-fifth of China's population.

The second big reason to pay attention to China's technological rise is that it's happening faster here than it did elsewhere in Asia. The transfer of marginal businesses from the U.S. and Europe to lower-cost operators in Asia has been going on for more than a generation, starting with Japan, then South Korea and Taiwan. China's government, companies, partners and investors learned lessons from the country's neighbors. They're also all moving faster because the tools of the trade -- manufacturing equipment, logistics systems and the like -- are all better than ever.

Even the everyday use of e-mail and videoconferencing sets the Chinese apart. Earlier this year, after a rocky first three months together, product managers at Huawei-3Com Co., a data-network-equipment joint venture of China's Huawei Technologies and the U.S.'s 3Com, developed a routine of e-mail, conference calls and face-to-face meetings. "By the second quarter, we adjusted our communication mechanism and we could prioritize items," says Rose Chen, president of international sales. Last week, the venture shipped its first products.

Already in China it's possible to detect regional technology centers and competition for workers, similar to the rivalry between Silicon Valley, Boston and Seattle in the U.S.

Southern China's Guangdong province, dominated by the cities of Guangzhou and Shenzhen, is the center of most TV, stereo and computer assembly. Meanwhile, the city of Suzhou, not far from Shanghai, is home to a lot of notebook PC production, notably many of the operations of Taiwan's giant contract manufacturers.

A group of telecom-equipment makers is based in Hangzhou, which is also along the central coast near Shanghai. The country's biggest homegrown chip maker, Semiconductor Manufacturing International, is farther north in Tianjin, near Beijing, in facilities originally built by Motorola. Meanwhile, both Motorola and Intel are way out in the western city of Chengdu. They're taking advantage of access to engineering universities that for years offered support to the country's military contractors, located there by the government in the belief they would be insulated from attack.

Finally, China's size means that its technological gains could have longer-lasting consequences. For instance, China passed the U.S. in unit consumption of TV sets two years ago as household penetration of TVs passed 90%, closing in on the near ubiquity of TVs in developed countries. If population trends hold, China is unlikely to be challenged as the world's largest market for TVs until the middle of the century, when India is expected to become the most populous country.

And when final figures emerge shortly, we're likely to learn that China passed the U.S. this year as the world's top PC maker, another change unlikely to be challenged for years to come.

A recent study by University of California-Irvine researchers found that most of China's recent PC-industry growth was driven by outside companies, led by the Taiwan-based contract manufacturers. But it's not just them. This year the output from Dell's China factory here in Xiamen, from which the company supplies Japan as well as China, will match production at pre-IBM Lenovo.

Still, Lenovo is China's first company to tackle the complexity of a high-profile, international deal. In the process, it plans to move its headquarters from Beijing to a suburb of New York City and take an IBMer as its CEO. More than 70% of its sales will come from outside China, while 70% of its workers will be inside China.

And the cherry on top: Lenovo's largest shareholder will continue to be an unlisted holding company controlled by the Chinese government.