Will Stock Price Rally End With a Correction?
WALL STREET likes nothing better than a rousing ``rally.'' Not the sporting type, necessarily, although investment houses have many sports fans. Nor even a political rally, although stock brokers are fervent government-watchers, especially when legislation is at stake that could impact on taxes, investments, or savings programs. No, Wall Street's infatuation with rallies involves market-momentum: ensuring a sustained climb in the Dow Jones industrial average, the Standard & Poor 500, or other market indicators.
The growing concern is that the recent market rally - which has propelled the Dow above the 2,500-point level - is about to fizzle.
``The market is now treading water,'' says Hildegard Zagorski, an analyst with Prudential-Bache Securities. ``All the good economic news is out, namely that inflation may be easing a little and that interest rates are starting to come down. There could be a correction of 75 points or so. It's going to take some even better news - especially on the inflation front - to get the momentum going again,'' Ms. Zagorski says.
What kind of better news?
``Something on the order of inflation falling to the 3 percent to 4 percent range for the year, without the economy dramatically slowing,'' she says. ``In the meantime, it looks like a market with not much happening. There may be some rotation among market sectors, with some sectors advancing and others slowing.''
Many of the investment houses urging individuals to get back into the market several weeks ago are now raising warning flags. Moreover, the Dow is not all that far from its peak of 2722.42 points on Aug. 25, 1987. The postcrash high so far is 2518.84, on June 12. Were the Dow to push through the 2520 level, the current ``market wall,'' then, say some contrarians, what is to keep it from roaring right up to the 2700 range?
A number of market technicians and strategists are talking of a major divergence in trading patterns. In recent stock rallies there has also been a strong dollar and bond market, says Abby Joseph Cohen, senior investment strategist with Drexel Burnham Lambert Inc. But since June 9, that pattern has changed. Stocks have remained neutral or gone downward. The bond market has notched up somewhat, thanks to lower interest rates.
Overseas currency traders, have been rushing to buy dollars, partially because of the political unrest in China as well as within the Soviet Union, as ethnic groups have increasingly sought to challenge Moscow's central government. By buying dollars, overseas investors are able to buy bond issues before interest rates drop substantially.
Meanwhile, the stock market, says Ms. Cohen, is already fully valued at current interest rates, even assuming a profit growth this year of 15 percent. Thus, she suggests using the current stock-price strength as an opportunity to ``reduce equity holdings to neutral levels.''
What is ``good for bonds'' - the stronger dollar and slower growth - is ``not necessarily good for stocks,'' Cohen says.
Many US multinational companies, she notes, will be adversely affected by the stronger dollar, including US manufacturing firms that are engaged in stiff competition abroad, as well as multinationals with large currency transactions abroad whose foreign earnings are not worth as much when translated back into dollars.
``It's probably time for a pause, given the sharp run-up on the market over the last few months,'' says Jerrold Mulder, a market strategist with Kidder, Peabody & Company.
He adds: ``All the news about lower interest rates has already been absorbed by the market. So while there probably won't be a big correction, it's hard not to see at least a modest rentrenchment of some type.''
But that does not mean, says Mr. Mulder, that individuals should sit out the stock market entirely. ``There's always a hundred reasons not to get started in the market,'' Mulder says. ``But if a person has no money in the market at all, there's a strong case for putting some investment into high-quality growth stocks.''
Looking at the course of the market over any particular short-term cycle, such as the recent spring rally, is not enough, Mulder says. The important point, Mulder argues, is that ``over time, common stocks, in comparison with other financial assets, provide the superior returns.''