Stein Roe's Senior Investment Strategist's Thoughts on Y2K - projected overall impact on US economy - Industry Trend or Event

Edge: Work-Group Computing Report, Sept 13, 1999

As January 1, 2000 edges closer, Al Kugel, a 45-year veteran of Stein Roe & Farnham and a member of the firm's senior investment committee, issued the following comments assessing the "Year 2000" situation and its possible overall impact on financial markets.

THE Y2K PUZZLE

"As nearly everyone now knows, there are potential problems in many computer systems related to the rolling over of the century next January 1. This is because early programmers used only two digits to designate the year. The concern is that when we hit 01/01/00, the computers will think that the year is 1900 and cease to perform necessary functions.

"We have not formally addressed this subject before, in part because there seemed to be as much misinformation available as information. Thus, it seemed prudent to let some of the smoke clear, to collect more information from companies as to how they were coping with the problem and to see how testing programs fared in several key industries.

"As one would have expected, people in the Information Technology business have been aware of this problem for some years now, so that the bulk of the huge recent investment in new hardware and software is already Y2K compatible. Nevertheless, there is still a good deal of older equipment and a lot of old imbedded chips in place around the world. (However, to put this into better perspective, the Gartner Group, a consulting firm that has studied the problem intensively, believes that only one in 100,000 imbedded chips is likely to fail and that only 10% of the failures will last as long as three days.)

"The existence of the Y2K problem has become more widely known to investors and the general public since early 1998, which has brought additional pressure on businesses from shareholders, regulators and others to 'fix' their systems before trouble hits. As it has turned out, a good deal of time, effort and money went into remedial and replacement activity in the IT field during recent years. As a result, most of the larger companies believe that their systems will be able to perform all of the critical functions next January. One recent study indicated that over 90% of the companies in the Standard & Poor's 500 Stock Composite expect to have their computer systems compliant by the end of this September. Extensive testing has now been carried out in many key technology-dependent industries, including communications, energy, transportation and finance, with very positive results.

"At a level that should be very understandable to readers, I would note that most of them and their spouses merrily have been using credit cards with expiration dates in 2000 without any problems. Moreover, many of the state governments began their 2000 fiscal years on July 1 without any glitches being reported. (We will get another test on October 1 when the federal government rolls over to its fiscal 2000.)

NOT A SIGNIFICANT IMPACT

"As a result of all the factors noted above, our expectation is that there will not be a significant adverse impact on the U.S. economy as a whole due to the Y2K factor. However, this is not to imply that there won't be specific individual glitches, many of which can't be predicted beforehand. These will then have to be addressed and corrected once they occur. However, we do anticipate a shift in technology spending from activities related to the remediation of Y2K problems, which are now starting to wind down, back to a greater concentration on cost reduction activity.

"Although the technical aspects of the 'millennium bug' may well prove not to be very troublesome, it is necessary to take into account possible psychological aspects. If the news media start to really play up the story and this frightens the public, their actions could compound the problems. Even businesses that feel that they are in good shape for Y2K might well plan to increase inventories in case some of their suppliers have problems. As to consumers, one could imagine people stocking up on food and water, buying generators for fear of power outages and taking other precautionary actions. These could accelerate some activity into the fourth quarter of 1999, which would be offset by lesser buying in early 2000.

"It is possible that concerns could affect investor psychology and cause prospective buyers to postpone purchases of stocks later this year. If so, of course, it could mean that a lot of extra cash that had been set aside temporarily would come flooding into the market in the new year when it became clear that the world hadn't come to an end. However, this is pure conjecture, and we shall have to wait and see what actually happens. The good news is that in just four months, we will have the answer.

"Lastly, even if the American economy proves resilient to the Y2K virus, it is probable that some other countries will not be. Thus, there is the risk that more severe problems elsewhere in the world will have some ricochet impact on us. Interestingly, the more dependent an economy is on IT, the more work that has been done in that society to deal with the problem. On the other hand, countries that are lagging in remedial efforts are probably less vulnerable to technology problems generally.