Fitting your investments to the forecasts for '85
OPTIM, MINIRECESS, HARDLANDING? Those are the code names of economic scenarios that Data Resources Inc. of Lexington, Mass., feeds into a complex computer program that simulates the economy of the United States.
The names could be important for people trying to see the direction of the economy next year and invest accordingly.
The actual scenarios pretty much match up with the names. In OPTIM, falling interest rates cause continued economic growth with no real upset, and 1985 looks great. In MINIRECESS, a mild recession in early '85 is followed by a quick recovery. In HARDLANDING, strong growth rolls into next year and a big recession hits in early '86.
DRI economist David Wyss gives MINIRECESS slightly higher probablity than OPTIM or HARDLANDING. MINIRECESS is very similar to DRI's ''control,'' or consensus, program, Dr. Wyss says, which holds that economic strength will continue into the first quarter of 1985, then there will be a ''soft landing'' - a mild recession - followed by a recovery by November of '85.
With or without the benefit of such sophisticated computer simulation, many economists, brokers, money managers - and many streetwise investors as well - innately feel the same thing. Typical views: Norwest Corporation of Minneapolis sees the economy ''slowing, but expansion is not over yet.'' Fleet Financial Group of Providence, R.I., expects ''a soft landing.'' The Stein Roe & Farnham mutual fund group of Chicago forecasts ''a more moderate, sustainable rate.''
A good place to go for the consensus is Blue Chip Economic Indicators of Sedona, Ariz., which polls leading economists and then tallies their views. For '85, the average forecast is of a real (inflation-adjusted) growth rate in gross national product above 3.5 percent, year to year. Inflation, economists say, should be around 4.9 percent. Late in the year, however, says Blue Chip editor Robert J. Eggert, ''weakening leading indicators and a growing minority of our group of forecasters suggest caution.''
Economic forecasts, it should be noted, are projections based on current economic conditions. In the same way that many 1983 projections of 1984 missed the sustained boom in the first half of the year, these forecasts could be far off base by the time '85 draws to a close. Dramatic changes can be caused by miscalculations, by a less-than-omniscient grasp of the economy, by surprise news events, or by public-policy foul-ups.
If the consensus is to be believed, however, it might be time to make appropriate investment decisions.
If you are a contrarian, you probably won't believe such forecasts. Contrarians, after all, march to different drummers. But even if you are a contrarian, you'll need to know the consensus - if for no other reason than to chortle and do exactly the opposite. Stocks in '85
Corporate profits should be respectable next year. That's good news for stock-market investors. But a recession might be on the near-horizon by '85, and so a real surge on Wall Street might be short lived. Recession may just be talk, but it could have a negative effect on the stock market. Thus the investor looking for longer-term dividend growth might be disappointed toward the end of 1985 and into '86 unless he hedges against a downturn.
H. Alden Johnson, Jr., president and equity strategist at the Massachusetts Financial Services mutual fund family of Boston, thinks the downturn in the stock market that began in January of this year was, in fact, the investors' way of ''discounting'' a current economic slowdown. Mr. Johnson sees the stock market surging late this year as it anticipates a resurgence of growth in mid-' 85. In a low-inflation, steady-growth environment, Johnson's favorite investments are companies that have shown they can grow without enacting price increases.
On the other hand, Edward Guay, chief economist with Philadelphia's Cigna insurance/investment corporation, contends that ''a sustained uptrend in stock prices is not likely'' late this year and next, because ''business cycle fundamentals and credit conditions are not now supportive.'' Still, Mr. Guay notes that the ''longer-term bullish case for equities remains intact.''
Strategy: Invest for the long term in good-quality companies with growth ability. Don't expect boom or bust on Wall Street. Fixed income
Competing with stocks, as always, are the fixed-income investments. By this we mean investments that give you zero appreciation of principal but great safety and high interest rates: money-market accounts, certificates of deposit, US Treasury notes, municipal bonds.
If interest rates remain strong, then people who keep their money in fixed-income vehicles will do well. Strong interest rates, however, are a negative for the stock markets, home buyers, real estate investors, holders of adjustable-rate mortages, and borrowers of all stripes.
But even the economic forecasts that foresee higher interest rates don't see them going up by more than two or three percentage points, and usually that is followed by a late 1985 decline. Example: Economist Steven A. Wood of the Chase Econometrics service in Bala-Cynwyd, Pa., says interest rates will move up somewhat until late '85, then weaken.
As of this writing, however, economists predicting lower interest rates were making a strong case.
Orest Pokladok, a financial economist with Moody's Investors Service in New York, expects rates to decline in 1985. That, he says, ''will be good for bonds, '' referring to the secondary market. Mr. Pokladok notes that individuals are very important players in the bond market - especially in the area of municipal bonds. In the second quarter of '84, he says, individual investors were the largest buyers of municipal bonds, seeking them because of their tax-free status and relative safety.
But if interest rates decline, he says, devices such as NOW accounts and money market accounts will be less attractive. Eventually investors might take money out of these and go for stocks, if the stock market is strong. That, in turn, could help the stocks get stronger.
Strategy: You'll still be able to get good interest rates on your fixed-income investments, but, at best, don't expect more than two or three points above what you can get now. It's possible that interest rates will slip next year and you may then have to decide where to invest for better returns. Inflation and tax hedges
In a period of mild inflation and relatively high interest rates, real estate is not a very hot investment sector. But the baby-boom generation continues to prosper and will continue to need housing.
Although high interest rates and tight money can slow down the housing market overall, real estate is not quite so optional an area as stocks and bonds. People need homes, businesses need factories and offices, stores need storefronts. So it is not too risky to say that the age-old realtor's dictum will still obtain: Location will remain the three most important things to remember in real estate.
Strategy on inflation hedges (real estate, precious metals, art, antiques, etc.): These will not fare so well in a time of moderate inflation. Choose such investments with an eye to intrinsic value.
To protect your investments in 1985, you'll also have to be thinking about tax consequences and inflation. A value-added tax may be added to the landscape, especially if the Reagan administration remains in office. But realistically, no major income tax reform is likely to emerge in the near future, despite much rhetoric to the contrary.
''Tax reform is a much longer-run issue,'' Chase's Dr. Wood says. ''We won't see anything big for three or four years.''
Still, a flat tax does seem to be an idea that may emerge as law sometime in the later 1980s, given the traditional Democratic antipathy toward tax shelters, the traditional Republican desire to see the marginal tax rates lowered, and the traditional taxpayer's desire to get through April 15 more smoothly.
Consensus on taxes: Alas, they will ever be with us - at about the same level as this year.
How will 1985 be for investors?
That depends on how you invest and what you invest in. Overall, for most investors, 1985 should be somewhere between the best of times and the worst of times - put another way: somewhere between OPTIM and HARDLANDING.
