Market drenching in early April yields to a new burst of sun
Has that long-waited selling storm passed so quickly? Is the correction really over? A week ago, sellers gave the Dow Jones industrial average a record 82.5-point bath. Now it appears investors are basking in a warm April and detecting the sweet smell of freshly cut interest rates.
At midweek, the scent first came wafting out of a meeting in Washington among international finance ministers. The talk about the benefits of another coordinated drop in interest rates sent bond prices soaring.
Bond yields, which move inversely to prices, sank to levels not seen since 1977. Three-month Treasury bills fell to a smidgen over 6 percent and yields on 30-year Treasury bonds bond slipped to 7.3 percent.
By week's end, an uneven mix of economic data did nothing to quell speculation that a rate cut was in the air. March retail sales plunged 0.8 percent. IBM quarterly earnings of $1.65 a share -- up 3.1 percent -- weren't bad, but they weren't a pleasant surprise, either.
But the tax-cutting effect of cheap oil could still bode well for business in coming months. Wholesale prices fell a record 12.1 percent in the first quarter, mostly owing to a drop the cost of gasoline and heating oil.
This news and the potential pep another cut in the discount rate could give to business were not lost on equity investors. Even last week's rise in oil futures prices wasn't enough to offset the optimism.
Bidding on stocks that make up the Dow Jones industrial average pushed up the index a total of 50.96 points last week. The Dow closed Friday at 1,790.18.
When might a rate cut come, if it comes?
The comments last week by Federal Researve chairman Paul Volcker were typically noncommittal. If the Fed does choose to shave the discount rate to 6.5 percent (the rate it charges on loans to financial institutions), it may wait until after the release of March industrial production figures (tomorrow) and the first-quarter gross national product report (on Thursday).
Reports on business activity so far have sent many economists scrambling to reduce their first-quarter estimates.
A survey of 51 economists by Blue Chip Economic Indicators of Sedona, Ariz., shows a consensus dropping growth estimates for real GNP in 1986 from 3.2 to 3.1 percent. The Reagan administration is predicting 3.4 percent growth.
Many economists now expect the second half of the year to be more robust, and the Blue Chip survey shows a brighter forecast for 1987. Real GNP should rise 3.4 percent next year, up from last month's 3.1 percent guesstimate, most of Blue Chip's economists say.
That should push out prospects for the next recession until early 1988.
But what's retarding the economy now? What happened to the boost the last interest rate cut was supposed to provide? And what about the stimulus of lower oil prices?
Economist John Lonski at Moody's Investors Service cites four deadweights on business:
Consumers are up to their eyeballs in debt, based on historical measures.
Cutbacks in federal spending mean less money is flowing out of Washington and into the economy.
State and local government surpluses are dwindling, so spending is slowing here, too.
Oil and gas companies are making drastic spending cuts.
Mr. Lonski looks for a 2.5 percent growth rate this year. ``Whatever expansion we have will be offset by cutbacks in capital spending and employment in the energy sector.''
He adds: ``The auto industry has gotten as much mileage out of incentive programs as they are going to get. So I don't see much room for additional growth in auto sales. Corporate spending appears lackluster so far -- look at the problems IBM has been having.''
Yet he remains bullish on stocks. He and many others on Wall Street point to the wider than normal spread between the yield curve of corporate bonds and the dividend yield of stocks. In other words, stock prices haven't kept pace with the big rally in the bond market.
Lonski attributes the lag in stocks to ``a good deal of hesitancy by investors to embrace a rosy corporate-earnings outlook.'' But he basically agrees with Byron Wien, domestic equity strategist at Morgan Stanley & Co.
Mr. Wien says the yield spread justifies a move to 2,000 on the Dow. ``Interest rates have come down far enough to drive this market further.''
That kind of confidence worries Justin Mamis.
``They didn't get scared on this last correction,'' says Mr. Mamis, technical analyst at Cowen & Co., a New York brokerage. ``They're still imbued with a sense that the market is going to 2,000 or 3,000.''
Mamis sees the 82.5-point drop during the first week of April as a ``warning crack'' typical of a bull market a few months away from its demise.
He recalls sell-offs in 1967, 1981, and '83. Each time, the drop presaged a new high on the Dow but was quickly followed by a year or so of weakness.
Says Mamis: ``Given the momentum, the index could sail into August or September. But you don't want to turn your back on this one. It could be sooner.''