What Do the Bulls Know?

The stock market put on a spectacular show of defiance in 1991. Wall Street's bulls ignored the crushing weight of debt on the economy and the signs of a protracted recession. Every major stock-market index pushed into record-high territory. The Dow Jones average leaped 535 points to an all-time peak of 3168.83, a gain of more than 20% -- and for good measure, rose nearly 33 points during the first two days of 1992. The S&P 500 gained even more than the Dow during 1991, rising 26%, and NASDAQ, the most popular measure for small stocks, surged a record 57%.

The man most responsible for fueling the rally was Alan Greenspan. The Federal Reserve chairman engineered a drastic drop in the discount rate, which is what the Fed charges banks for borrowing money, from 7% at the beginning of the year to 3.5% at the end. Besides giving the economy a nudge, the drop in rates triggered a wave of so-called asset shifting. Dismayed by low yields on CDs and Treasury securities, savers bet their money on the stock market. A record $31 billion flowed into stock mutual funds during the first 11 months of the year.

But how reliable is a rising market as a leading indicator of economic recovery? In the past, the bulls have been a good bet. The last time the Fed pushed down interest rates to end a recession was in the summer of 1982, which quickly sparked a Wall Street rally. Four months later, the economic slump was over. But bulls know when to retreat too. If investors see no recovery by summer, watch out for at least a temporary comeback of the bears.