Fed's 'word' on continuing restraint eases stock run-up

Paul Volcker, chairman of the Federal Reserve Board, took some of the fun out of Wall Street's party last week. The chairman announced that he would continue an anti-inflation policy of monetary restraint, and he added that he thought fiscal restraint should be continued as well.

On Wall Street, where higher interest rates are frowned on, the reaction was less than enthusiastic and the stock market eased off from its recent gains. For the week, the Dow Jones industrial average dropped 5.89 points, closing at 918.09. Volume was moderately active.

Mr. Volcker's comments, says Eileen E. Spinner, an economist with Smith Barney, Harris Upham & Co., left Wall Street confused. Recently, she notes, the Fed has allowed interest rates to drift downward while allowing banks to remain flush with cash. However, between Mr. Volcker's comments and some Fed tightening last week, the markets aren't sure what to expect. Thus, buyers in the bond market, in particular, pulled to the sidelines to see where the Fed is going to take interest rates next.

Arnold X. Moskowitz, first vice-president at Dean Witter Reynolds Inc., believes Mr. Volcker may not be the only party spoiler. He notes the consensus on Wall Street that the recession is rapidly coming to an end. And he agrees that as far as the consumer is concerned, this is true. Auto sales, after slumping to an annual level of 5.25 million units, should bounce back to 7.5 million units. Likewise, housing, after dipping to a depressed 900,000 units, will rebound to 1.2 million units. But he warns that business spending is just entering the recession cycle.

"Capital spending has just started to decline this quarter," he explains, "and it still has another four quarters left before it bounces back." Furthermore, Mr. Moskowitz notes, there is some $40 billion in manufacturing inventories that must be liquidated. This will tend to keep a damper on industrial activity. He concludes that Wall Street hasn't factored this into stock prices yet.

With the presidential election less than four months away, Wall Street economists began trying to figure out how large a tax cut can be expected for this year. Carol Stone, a senior economist with Merrill Lynch Economics Inc., says it is beginning to look increasingly as if a cut of at least $20 billion will take effect in October, just before the election. On top of additional government spending, this could produce an $80 billion deficit for fiscal year 1981.

Concern over such a deficit and subsequent government borrowing, combined with a heavy corporate calendar, helped to drive bond prices down and yields up last week. Miss Stone, however, says investors shouldn't hit the panic button. She holds that reduced consumer demand and lower inflationary expectations will act to lower interest rates in 1981. She argues that the inflation rate will justify high-grade corporate yields in a range of 9 to 9.5 percent or lower.

If lower inflation rates are around the corner, they did not show up last week. The government reported that consumer prices climbed 1 percent in June, up slightly from April and May, but down from the average of the first quarter.

Inflation won't be President Carter's only problem this fall. According to Rosanne Hersh, an economist with Goldman Sachs & Co., the number of unemployed workers this year could amount to about 25 percent of the voting population and 20 percent of the total work force. Ms. Hersh notes that this large block of workers could have major political implications for November.

The effects of the recession began to cause some grimacing in Detroit. General Motors reported a quarterly loss of $412 million, a record for the company, and predicted an even bigger deficit in the third quarter. American Motors also reported a loss of $85 million, and Ford and Chrysler are expected to report losses totaling $500 million. However, many analysts think the worst may be over for the auto companies. Furthermore, in two months, the new models debut; the new cars often pull consumers into showrooms. On Wall Street, however, the earnings declines depressed the stocks.

In the market last week, City Investing was active and lower. Its board met and turned down a merger often from Tamco Enterprises that was valued at over $1 billion.