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Stock Market Bears Are on the March

Maurice Larrain and Maureen Allyn could be described as stock market party poopers.

Both economists forecast a tumble in share prices. Mr. Larrain, proprietor of International Capital Management Corp. in New York, foresees a 20 percent drop in prices in October. Mrs. Allyn, chief economist of Scudder, Stevens & Clark Inc., an investment management firm in New York, is less precise on timing, but talks of a 10 to 11 percent dip.

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"There is some room for disappointment," she says mildly.

Both also forecast recession. Larrain, a Pace University economist who set up a sideline of offering financial and economic advice to major financial institutions, says the slump will come "this fall, if not earlier." Allyn sees a mild recession starting in the second half.

But most economists expect modest real growth to continue this year.

On Wall Street, the mood shifted earlier this week to the bearish side, with stock prices slipping Tuesday and Wednesday, after a long climb in prices. Though mutual-fund investors have been putting more money into aggressive-growth funds that have a greater degree of risk and volatility, a number of major brokerage houses have been advising investors to cut their allocation to stocks and raise cash positions. These include Merrill Lynch, Morgan Stanley, Dean Witter, Smith Barney, and UBS Securities.

"Investors should be thankful for the bears," maintains Arnold Moskowitz, a Wall Street economist with a more cheery view of stocks. "Without them, the market couldn't climb a wall of worry."

Bears are concerned about the low dividend yield on stocks, the lack of a 10 percent "correction" in the past six years, and high prices compared with earnings. The price-earnings ratio for the Standard & Poor's 500 stock index is 19.4 on the basis of the last 12 months of earnings, a high level historically.

If earnings rise over the next 12 months, as Michael Flament, an economist with Wright Investors' Service, money managers in Bridgeport, Conn., expects, the P-E ratio will slip to 17.2. "That is high, but closer to the long-term average, Mr. Flament says.

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But Allyn expects corporate profits to fall 10 percent this year, instead of rising 10 percent or so, as many analysts anticipate. She figures the Federal Reserve's move to hike interest rates in November 1994 and February 1995 put a drag on the economy. Interest rates are 3 percent above the inflation rate, well above the usual 2 percent spread. Overstocked inventories are putting pressure on prices and thus on profits, she says. This will lead to hiring restraints that will push unemployment from 5.5 percent to more than 6 percent by 1997, hurting consumer income and slowing spending. Retail sales volume should drop about 2 percent between March and the end of the year, she predicts.

To make his forecast, Larrain uses a variation on the leading indicators method developed by economists Arthur Burns (who went on to become chairman of the Fed in the 1970s), Wesley Mitchell, and Geoffrey Moore. The idea is to examine various statistical series and see which ones changed direction before, during, or after business contractions. Then the indicators that lead a recession can be followed and used to predict a future recession. This statistical system was maintained by the Commerce Department until recently, when it was given to The Conference Board, a private research group in New York. The Board promises to improve the performance of the indicators, which was signaling all last year that a serious downturn was just ahead. Its reliability, states Paul Boltz of T. Rowe Price Associates Inc., a Baltimore mutual-fund management firm, "seems to be at a particularly low ebb," saying little or nothing of the future.

But Larrain claims to have found a set of "far more sophisticated" leading indicators that work, when tested against historical statistics for the past 25 years. These include some seven indicators, such as the money supply (M-1) over income, and debt of the government and business over nominal gross domestic product. Changes in these are looked at over 18 to 36 months, clearing up some of the short-term noise in the data, he says.

These indicators, Larrain notes, have a forecasting error range of three months. And they don't "account for market psychology, which can undo many forecasts." But he asserts that such psychological forces are short-lived, and that fundamentals ultimately win out. He says that investing in stocks today "is like playing with live grenades." There is a risk of a market crash.

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