Wall Street Merry-Go-Round

By John Greenwald

A nerve-jangling week spins investors around in circles

Normally, summer on Wall Street brings a rise in the price of stocks and bonds. But this year has been different, leaving brokers and analysts totally befuddled as to whether the stock market might at any minute begin climbing to new highs or slumping to new lows. Last week the rattled and schizoid market seemed to be trying to do both. It was a nerve-testing five days of reversals and price swings that first stirred and then frustrated investor hopes for the market's much anticipated summertime rebound.

For months, market analysts have been insisting that a convincing break on interest rates is all that investors need to begin snapping up stock at the virtual fire-sale prices that have prevailed since last winter. Thus, when easier money from the Federal Reserve allowed big commercial banks to begin cutting their prime lending rate to a flat 15% the previous Friday, brokers came to work on Monday expecting buy orders aplenty. They were not disappointed. By day's end, the widely watched Dow Jones industrial average of 30 of the nation's leading corporations had racked up a 13.51 gain, to 822, its biggest one-day rise since June 23.

But jubilation did not last long. Though interest rates continued to ease fractionally lower, the short-lived rally fizzled, and by Wednesday the Dow industrials had sagged back nearly to their Monday-morning starting point. The U-turn decline of 12.94 marked the steepest drop since Feb. 22. Worse still, by week's end the drooping 30-stock average had declined even further, plunging another 11 1/2 points on Friday to close at 784.34, the lowest since April 1980.

On one point nearly everyone agreed: the chaotic trading and uncertainty were directly traceable to Washington's ongoing failure to slash the runaway federal deficits that triggered crippling interest rates in the first place. Administration officials conceded last week that next year's budget shortfall will be closer to $140 billion than to the $115 billion gap they foresaw just two weeks ago. The Government will have to borrow at least $100 billion in fresh cash during the rest of 1982, and must raise $35 billion of that by the end of September. Says Irwin Kellner, chief economist of Manufacturers Hanover Trust Co. in New York City: "If you want higher interest rates, just wait a few days. They'll come along very soon."

Wall Street's gloomiest forecasters argue that sky-high borrowing costs are literally ruining the business environment for American industry. Says Raymond Dalio of Bridgewater Associates, a Wilton, Conn., economic forecasting firm: "I think we'll see a repeat of the Crash of 1929. The only way we can avoid a further acceleration of failures is to get a substantial break in interest rates accompanied by a sharp increase in economic activity. That has not happened, and that is why I believe we are already in the early stages of a depression." Dalio expects the Dow to drop to around 600 before the end of the year.

In spite of tentative signs that the recession is beginning to bottom out, the climate for business continues to deteriorate. Last week, for example, the Labor Department reported that the unemployment rate had reached 9.8% of the labor force in July, the highest level since 1941. Nearly 500 enterprises now shut their doors every week, the heaviest corporate failure toll since the early '30s

Even the most conservative forecasters are clearly rattled by the grim climate for investors. They are particularly worried by the stubborn refusal of borrowing costs to drop more than a few percentage points. Although a 15% prime is the lowest since November 1980, it is still extremely high by traditional standards and far above the single-digit rates that prevailed into the late 1970s. Says Economist Paul Wexler of the Bank of New York: "The financial underpinnings of American industry have weakened to the point where a major unexpected bankruptcy is now a real risk."

Towering interest rates also worry Robert Farrell, the highly regarded chief market analyst for Merrill Lynch, Pierce, Fenner & Smith Co., the nation's largest investment and brokerage concern. Farrell stresses technical analysis of market trends in his forecasts and is currently warning clients that stock prices may continue sliding until at least autumn. Says he: "The U.S. economy is weaker than it's been in any cycle of the postwar period."

By contrast, Wall Street's optimists continue to stress the positive influence that easing interest rates are bound eventually to have on the economy and thus on stock prices. They look for lower rates to draw some of the approximately $215 billion now in money-market mutual funds back into the stock market. Jack Leylegian, who operates his own San Francisco-based money-management firm, expects that cash to "explode like a dynamite keg" into higher stock prices.

Other bullish forecasters agree. Says Susan Berge of the Rhode Island forecasting firm of Anthony Tucker & R.L. Day Inc.: "Our market-trend indicators say that a rally should get under way soon and take the Dow to a new alltime high above the 1,051 it reached in 1973." Barton Biggs, chief market strategist for the New York City firm of Morgan Stanley & Co., offers an equally enthusiastic forecast. Says he: "There's a good chance that by the end of the year the Dow will be selling at its book value, which is well above the 1,000 threshold."

A minority of experts offers yet a third and even more surprising view of the impact that falling interest rates could have on the stock market. One such is Howard Stein, chairman of the giant Dreyfus Corp., which manages more than $12 billion in investment funds. Stein takes the view that lower borrowing costs may actually hurt stocks because investors will dump them to switch into bonds, which have been selling at enormous discounts in recent years and stand to rise dramatically in value as interest rates decline.

Many well-heeled investors are already moving in that direction. Institutions pumped $13 billion into the bond market during the first quarter of 1982, or more than $1 billion beyond their investment during all of 1978.

Any triumph of bonds over stocks, however, would be only temporary. Leading analysts warn that it is never wise to write off stocks, because they always seem to have a way of bouncing back. Merrill Lynch's Farrell, for one, believes that the Dow may rise to around 1,200 by 1984, and that stocks could become attractive to a wide range of investors once again later in the decade. Many people may understandably find that a little long to wait, but the message of 1982's sputtering summer stock market is that only a steady and sustained decline in interest rates will rekindle investor enthusiasm. The key to that, alas, lies not on Wall Street but in Washington. --By John Greenwald. Reported by Frederick Ungeheuer/New York

With reporting by Frederick Ungeheuer/New York

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