Why Wall Street's bulls keep up their stampede
The irrepressible stock market!
Investors, cheered by election results that were better than they expected and anticipating that the Federal Reserve Board will act more aggressively to lower interest rates now that the elections are over, have once more rushed in.
After a buying binge Wednesday, profit taking knocked the Dow Jones industrial average down 15.27 points Thursday in record volume. Whatever, the market is well ahead of the economy. Many economists expect the October unemployment rate to move to 10.3 percent, up from 10.1 percent in September, when it is announced this morning.
On the other hand, the market is anticipating a stronger recovery next year than earlier forecasts indicated, with the output of goods and services expected to grow as much as 5 or 6 percent for part of the year.
As can typically happen in a bull market, investors chose to interpret the results of the elections positively, no matter what their political persuasion. Many had expected the Democrats to win more seats in Congress than they did.
Arnold Moskowitz, first vice-president and economist at Dean Witter Reynolds Inc., said some talk on Wall Street had the Democrats picking up 30 to 40 House seats. When that didn't happen, he said, buyers who had been sitting on the sidelines rushed in. Yet, Arnold Kaufman, editor of the Standard & Poor's Outlook, an investment advisory publication, said the market was also cheered by the prospect of having more freer-spending Democrats in Washington. A larger deficit, he claimed ''is not particularly intimidating in a limp economy.''
Treasury Secretary Donald Regan, a former Merrill-Lynch chairman, indicated the market's historic surge may be only the beginning. ''On a constant dollar basis the Dow Jones averages are nowhere near their all-time high and they have a long way to go to show the true value of what our leading corporations should be,'' he said.
Analysts also said investors were buying stocks in anticipation of further cuts in the discount rate by the Federal Reserve Board. To avoid appearances of partisanship, they argue, the Fed in the weeks before the election had taken a low profile, allowing interest rates to drift. Now many economists and Fed-watchers, as well as many investors on Wall Street, expect the Fed will move more vigorously to lower rates again. Initially, this would mean a cut in the discount rate, the rate the Fed charges its member banks, from 91/2 percent to 9 percent. Within another week, some forecast, the discount rate will drop to 81/2 percent.
The only possible impediment to a cut in the discount rate this week is the huge Treasury financing taking place. If the Federal Reserve doesn't cut the discount rate by half of a percentage point this week, says Edward Yardeni, chief economist at Prudential-Bache, a brokerage house, it may cut it a full point by next Friday. Either way, once the discount rate starts to fall again, the prime interest rate - the rate banks tend to charge their most creditworthy customers - will likewise start to tumble from the current 111/2-percent level. The bond market, anticipating such cuts, has staged a massive rally this week.
At this point, Wall Street economists differ only on how much lower the rates will fall.
On the more pessimistic side of the spectrum are economists such as William Sullivan, senior vice-president of the Bank of New York, who holds that rates will come down slowly from these levels. He expects possibly another one percentage point drop in the prime by year-end.
On the more optimistic side are economists such as Henry Kaufman, the widely followed economist with Salomon Brothers, the investment banking house, who is predicting rates will drop another 2 to 3 points. He reasons that the Federal Reserve will want lower interest rates to ''encourage consumers.'' The economy remains sluggish despite repeated reductions in the interest rates.
The lower rates have already been a big enticement to corporations, however, which have flooded the long-term bond markets with new issues. Within the past month, Mr.
Economists note that the Federal Reserve Board has some room to maneuver. Mr. Yardeni says the Fed has the money supply ''pretty much in hand.'' Besides, he points out, it is not so much concerned about the money supply as it is about the level of real interest rates. And, with inflation down, he points out, the Fed is not so concerned that it may rekindle the inflationary fires.
''Paul Volcker is my favorite Pavlovian economist,'' he quips, ''because he rewards you for progress on inflation.''
Jack Lavery, chief economist at Merrill Lynch & Co., says the inflation rate should remain low through next year, averaging 4 to 5 percent.
Wall Street has also stopped worrying about the federal deficit. ''Private borrowing is the lowest it's been since 1977,'' explains Mr. Moskowitz, ''so the government should have no problem funding the deficit - there will be no crowding out.''
Even though Wall Street has been expecting interest rates to fall, most market observers were surprised by the strong showing of the stock market the day after the elections. Richard Hoffman, a market strategist at Merrill Lynch, thinks many investors may have sold stocks short in anticipation that the market would fall sharply as a result of the elections. (Investors sell stocks short by borrowing shares from other investors, and selling them in the market, hoping to buy them back later at a lower price to return them to the original owners.) When the market refused to fall, he said, a huge ''short squeeze'' took place, forcing people to cover their short sales by buying the stock, thereby jolting prices higher.
But it wasn't just a short squeeze that shot prices up. Mr. Mastrapasqua notes that ''the herd instinct'' remains strong on Wall Street. Thus, when institutional buyers of stocks noticed that the predicted pullback was not occurring, they immediately began buying again.
The public, or individual stockholder, is becoming interested in the market once more. Prices on the American Stock Exchange and the over-the-counter markets have been quite strong. On Wednesday evening, when Merrill Lynch held a teleconference at 26 cities simultaneously, it had no trouble finding eager investors to fill the seats. At the Statler Hotel here, 1,000 investors gasped when Mr. Hoffman predicted the Dow would crest the 1,700-to-1,800 level before the bull market finally ran out of steam.
''We are only in the first half of the first leg of a bull market,'' he stated.