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Fed Does No Favor To US Stock Market

THE United States central bank, in the eyes of economist Michael Cosgrove, didn't do stock prices any good by hiking short-term interest rates 0.5 percent this week.

``It is difficult for the equity market to fight the Federal Reserve,'' Mr. Cosgrove says.

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There are a thousand and one market analysts making price predictions for investors. But most aren't academics. This University of Dallas professor has succeeded in building a following for his ``Econoclast Advisory Service'' among a number of institutional investors, such as major commercial banks, mutual funds, and pension funds.

Cosgrove stands out from the pack by having a good forecasting record. In January 1994, his equity model forecast that the Standard & Poor's 500 stock market average would close the year at 460. He hit the bull's-eye - the actual close was 459.26. Cosgrove admits to missing the 1987 stock-market crash, but he says his forecasts since then have been ``okay.''

Cosgrove looks at fundamental economic parameters that eventually govern stock prices. Sheeplike investors may on occasion dash in excited crowds to exit the stock market - or enter it. But over time most investors are reasonably rational, he assumes.

Stock dividend levels are one of his key indicators, and they are still bullish. One dollar of stock dividends last year supported about $30 in stock-market value. That is only slightly more than the average for the past 42 years of $29. In 1973, just before a long-time slump in the stock market, investors paid nearly $45 for each $1 of dividends.

(Cosgrove uses data, from the Fed and the Commerce Department, that cover all stock markets, not just the stocks behind a specific price index such as the S&P 500, as many analysts do.)

Another positive element is overall prosperity. In 1994 it took $0.87 of economic activity (the gross domestic product) to support $1 of stock-market value. That is on the high side of the $0.73 average of the past 42 years but far from the high of $1.12 it reached in 1968 or the low of $0.42 in 1974.

On the negative side is the Fed's tight monetary policy. Investors use money and credit to buy stocks. So the supply of money is important. To measure this influence, Cosgrove divides the nation's money supply (using a measure known as M-1) into the total value of all stocks. At the end of 1993, $1 of M-1 supported $5.73 of stock-market value - an excessive amount considering the $4 average of the past 42 years. At the end of 1994, the number was slightly better - $5.44. A look at bank credit tells a similar story.

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``The Fed began to restrain bank credit in February 1994 and the S&P has eroded since,'' Cosgrove notes. ``History suggests further erosion is likely before the equity market can begin a sustained advance.''

The bottom line of his analysis is that the stock market could experience a ``correction'' in prices in the first part of this year, but that the S&P index should end 1995 about where it began. That would mean two years of little change in stock prices.

Underneath the averages, however, there could be turmoil in stock prices for industrial sectors, he says. Some such shifts will reflect a slowdown in the economy, especially in areas hit by high interest rates such as autos, housing, and consumer goods.

Cosgrove predicts that real growth in the output of goods and services this year will fall in the 2 percent to 2.5 percent range. ``We are in the latter stages of the economic cycle,'' he notes. The expansion began in March 1991, nearly four years ago. As the Fed hikes interest rates, more economists are talking of a recession occurring in 1996; a few see one later this year.

Long-term interest rates may go back up to their peak of 8.1 percent of last November, Cosgrove says. But short-term rates could rise another 100 basis points (1 percentage point) this year. ``The Fed has to see industrial production and industrial capacity utilization stabilize before it stops tightening, he says. That's because prices for industrial materials, such as steel, copper, and cement, rose 16 percent last year.

There is ``always a danger'' of the Fed tightening too much and causing a recession, he warns. ``But we won't know that until 1996.'' It usually takes time for economists to recognize a slump.

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