How Long Will the Bull Run?

By John Greenwald

The warning signs are everywhere. Share prices in the relentlessly upbeat stock market now stand at sky-high levels by historical standards, and dividend yields have fallen to near record lows -- classic signals that the bull market that began 2 1/2 years ago has got dangerously long in the tooth. At the same time, companies continue to flood Wall Street with new issues to cash in on the bull's run before it can stumble -- another omen that the market may be overheated and headed for a fall. Even the current rush of little-guy buyers is usually a harbinger of a bear market.

Much of the money propping up share prices comes from small savers who have put their money into mutual funds simply because returns on alternative investments have got so low. With money-market deposits and CDs barely eking out 2% in interest, individuals poured a record $11.3 billion into stock mutual funds in March, snapping up shares so fast that managers barely had time to invest all the cash. Buyers feasted on all kinds of funds, from those that purchase slow-growth utility stocks to aggressive acquirers of speculative new firms. But the binge failed to satisfy the public's ravenous appetite for shares. "If I had more money, I think I'd put it all in the market," says Winston Mason, 72, a Los Angeles retiree. "Oh yes, I think right now is the time."

This stampede into the risky world of stocks has only heightened concern that the market may soon come tumbling down. Never far from bearish minds is the 1987 crash, which saw the Dow Jones industrial average plunge 508 points on Black Monday. Even more frightening was the more recent, and more devastating, collapse of the Japanese stock market that began in 1990, when the bloated Nikkei average plummeted from nearly 39,000 to less than 15,000 in 2 1/2 years. Then there are recollections of the Great Crash itself, which have become part of America's memory. "People start thinking of the '20s and '30s," says author and retired fund manager Peter Lynch, "and almost everyone seems to have had an Uncle Louie who lost everything and ended up selling pencils."

So is this the time to get out of stocks? In spite of the danger signs, few Wall Street gurus foresee a sharp downturn anytime soon, as long as interest rates stay low. That's because investors still have plenty of liquid funds left: they hold nearly $3 trillion in low-yielding investments like bank CDs and are likely to continue moving them into stocks. Even if share prices start to tumble, experts say, fund managers and cash-rich individuals will swiftly scoop up bargains and thereby halt the slide before it can erode the market 20% -- the level that indicates a bear market has begun. Last Friday the market closed at 3437.19, up 9.64 points for the week and down 41.42 points from its April 16 peak.

Still, many investors -- and especially small investors -- are starting to get nervous. "The mood is sour but not panicky," says John Markese, research director of the American Association of Individual Investors. "People are ! less certain about the economy, less optimistic about the political environment than they were at the start of the year, and not quite certain that the recovery is taking hold."

One source of concern is the Clinton Administration, which many on Wall Street now regard with disdain. Investors fret that Clinton's proposed tax hikes and forthcoming plans to finance health-care reform would slow the economy, squeeze corporate profits and thereby bring stock prices down. At the same time, critics charge that Clinton's often wishy-washy style has helped chill business and consumer confidence. "A weak presidency always makes markets very nervous," says Stephen Bell, the Washington-based managing director of Salomon Brothers. "We saw that late in the Bush Administration, and we're seeing it now under Clinton. People are having doubts that Clinton is up to the task."

The national economy is throwing off its own confusing messages. A continuing sluggish recovery is certainly bad news: it threatens to trim corporate profits and cause stock prices to slump. But a robust recovery might have the same effect: by boosting interest rates it could entice investors back to banks and money markets and put the bull to flight. The key to everything seems to be interest rates. "If you get a major rise in rates, it will kill the market," says Marty Zweig, who runs the Zweig Funds.

A big jump in interest rates would also clobber the bond market, to which mutual-fund buyers have flocked as well. Bonds took off on a powerful rally last November that has pushed long-term yields to their lowest level in 20 years (the higher a bond's price, the lower its interest yield). A spurt in interest rates would have the opposite effect, halting the boom and sending bond prices spiraling down.

Even without higher interest rates, Wall Street bears argue, the market is perilously overvalued. On average, stocks now fetch prices that are 23 times as high as corporate profits as measured by earnings per share; the stock of a company with profits of $3 per share would therefore sell for a whopping $69. This heady price-earnings multiple is nearly twice the average for past markets and stands even higher than the one just before the 1987 Wall Street crash.

The bears further point out that stocks are returning little to investors in the way of dividends. On average, dividend payouts currently equal just 2.8% of stock prices, the lowest yield since August 1987. "The market has rarely been this high in terms of price to earnings or dividends," says James Grant, an investment-magazine editor who predicts a break in prices. "The eternal paradox is that people will buy more cars or canned goods when the price is down, but they seem to buy more stocks when the price is up."

Many investors are increasingly hunting for bargains abroad, where stock prices and yields are often more attractive. "We are moving to markets in Europe, where levels are clearly a lot cheaper than in the U.S.," says Barton Biggs, managing director of equity research for Morgan Stanley. "And to Asia, where the real economic growth in the world is taking place." Chicago's Wanger Asset Group has already collected $160 million in its overseas funds only seven months after opening for business. Much of the money is headed for Japan, where the stock market is slowly recovering from its speculative meltdown. Americans invested more than $3 billion in Japanese stocks in this year's first quarter alone.

Wall Street's numerous bulls, however, counter that traditional measures of stock value have become misleading in today's fitful economy. They say price- earnings ratios are out of whack because many companies wrote off restructuring costs and took other special charges that depressed profits last year. "Anyone who says the market is overvalued is not looking at the whole picture," asserts Bill LeFevre, a veteran Wall Street watcher who puts out an investment newsletter. "Why did we have such crummy earnings? A lot of it was the huge write-offs."

In the same way, bulls say the current low dividend yields remain in line with the returns on bonds and other interest-bearing investments. A 2.8% dividend payout doesn't look so bad, they note, when compared with the low level of interest rates in general. "This cycle is unlike anything since the Second World War, because we haven't got to the point where rates have gone up, and a rise doesn't seem to be on the radar scope," says Charles Blood, director of financial-markets analysis at Brown Brothers Harriman. Concurs LeFevre: "With lower interest rates it is understandable that stocks command a lower dividend yield because stocks have growth whereas bonds don't."

Most market watchers doubt that a sharp spike in interest rates is on the horizon. With inflation still hovering near a mild 3%, the Federal Reserve Board would seem to have little reason to tighten the money supply and push + interest rates up. Moreover, Fed Chairman Alan Greenspan has been calling for years for the White House and Congress to take the tough action needed to bring down the deficit. Now that such efforts are under way, a Federal Reserve source notes, "Alan doesn't want to discredit the enterprise" of deficit reduction by jacking up rates and further weakening the recovery.

Market optimists also fiercely dispute the conventional wisdom that small investors rush into the stock market just before it crashes and then sell out in a panic. On the contrary, many experts say, the little guy is increasingly in for the long haul, with an eye toward putting his children through college or investing for retirement. In the 1987 crash, for example, it was institutional investors, rather than individuals, who fled wholesale from the market.

Still, there is no way to avoid risk when buying and selling stocks. Unwary investors who switch from risk-free CDs or Treasury bills to the stock market can find themselves in a frightening new world where prices can rapidly decline. Minneapolis, Minnesota, high roller Irwin Jacobs says that because of low interest rates, "people are being forced to make investments where they never would have been otherwise. That is going to be scary for a lot of people who are very naive and inexperienced out there." Says Blood of Brown Brothers Harriman: "You just know that some people are making inappropriate investments. There are people who are buying funds who don't realize that one day they can wake up and lose three years of accumulated income."

Experts say the remedy for such roller-coaster rides is to invest for the long term rather than trade frequently in an effort to time market swings. "Stock market declines are normal," says Peter Lynch, who notes that the Fidelity Magellan Fund he managed fell nine times during his 13-year tenure. "Stocks have still averaged an 11% return through depressions and world wars," Lynch adds. "But if you're unable to stand volatility, you should not be in. If you spend more than 14 minutes a year worrying about the market, you've wasted 12 minutes."

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With reporting by John F. Dickerson and Jane Van Tassel/New York and William McWhirter/Chicago