Stock Fluctuations Now Far Removed From Reality : Wall Street: With massive computer trading, the market gyrations do not reflect investers’ mood or even reliable stock performance.

The small investor wandering into a modern stock market must feel like a tiny creature of the forest scuttling between the restive feet of giants. Whether the big animals are bears or bulls makes little difference--the little guy is likely to get stepped on either way.

In times past, the stock market was a reasonable indicator of the country’s investment mood. Almost all stock was held by individuals--a thin slice of the upper and upper-middle classes, to be sure--but still a fairly broad sample of the public who made such day-to-day economic decisions as buying a car, or a washing machine, or expanding a small business.

In times past as well, companies raised capital by selling shares on the stock market. Good stock performance over the years meant that companies could readily sell more shares when they needed to raise money. The ups and downs of the stock market, therefore, tracked the willingness of the public to invest in American companies--not a bad measure of the country’s economic state of mind.

None of that is true anymore. In the first place, companies rarely, if ever, raise capital through the stock market. Since 1983, in fact, companies have been buying back their shares, at the rate of about 5% of the total value of listed stocks each year. Buy-backs during 1988 represented about $130 billion of stock.

At the same time, the public has been getting out of the market at a headlong rate. Since 1984, individuals have reduced their stock holdings by almost 40%. More and more, the listed shares are now owned by institutions, mostly pension funds, but also insurance company portfolios, mutual funds and the like.

One Harvard professor has calculated that, at this rate, the last individual who owns a publicly traded share of stock will grudgingly turn it in about 13 years from now, slamming it down on the trading room counter and demanding his cash.

Although the proportion of company value traded on the stock exchanges has been steadily decreasing, the volume of each day’s trading has been steadily increasing, and institutions account for about 90% of the activity. Not long ago, it was almost unheard of for 100 million shares to change hands on the New York Stock Exchange in one day. On the first trading day after the “mini-crash” of Oct. 13, almost 100 million shares changed hands in the first hour.

As institutions have taken over the market, trading has increasingly been the province of the “quants,” or the “rocket scientists,” whose trades follow arcane program trading strategies dictated by computers.

Index arbitrage is the classic example of modern program trading. To take a simple case: Suppose I own a broad selection of stocks that are a good sample of some major index like the Standard and Poor’s 100. Suppose that the interest rate on Treasury bills is higher than the dividends on my stock.

Problem: How can I get the higher cash return on Treasury bills without forfeiting the capital gains I expect on the stocks? Answer: Sell the stock, and buy Treasury bills plus a stock-index futures contract that will allow me to buy back a basket of stocks mirroring the S&P; 100 at some future date.

Now, well-functioning markets will eliminate such easy profit opportunities. The price of index futures will rise to offset exactly the kind of profit opportunity in the example. But, of course, markets are not perfect. Futures are traded in Chicago, stocks mostly in New York and the exchanges have different rules, so stock and futures prices are often slightly out of sync with each other.

Enter the index arbitragers. Their computers spot tiny anomalies between prices of futures and stocks and instantly generate huge volumes of buying and selling, chasing pennies of profit per share. The result is wild market gyrations for reasons having nothing to do with the underlying values of the stocks traded.

Then there are the risk arbitragers. In this day of the takeover boom, institutions buy stock on the bet that a takeover artist will bid up share prices during a hostile raid. During a booming takeover market, it is hard to lose money, on average, making bets like that. Of course, a little inside information helps a lot, too.

Since almost every junk-bond financed takeover between 1982 and about 1985 was hugely successful, takeover prices got higher and higher. Speculators always believe they will be the last ones out before the crash, so financial fads always last longer than common sense says they should. About 1986 or so, raiders started overpaying for their prizes, and most recent takeovers seem to be in some kind of trouble.

As always, it has taken a while for investors to figure that out. But sooner or later, as in the United Airlines fiasco, it dawns even on the smart money that a deal is crazily overpriced. But it was too late for the arbitragers, who had snapped up almost all outstanding UAL stock at wildly inflated prices. Their paper losses are in the billion dollar range--hard on the monogrammed-shirt trade.

There is nothing inherently wrong or unsafe about junk bonds. Junk bonds at fair prices in good companies are excellent values. And there’s a lot of evidence that the cash disciplines imposed by junk-bond financing have played a big role in snapping sleepy corporate managements back into line. But many recent issues have been flagrantly overpriced, and the geniuses running the institutional junk-bond funds are taking a bath.

What does all this mean for the average investor? Not much. Wall Street’s daily dramas make fascinating headlines, but the day-to-day fluctuations of the stock market have decoupled from the real economy.

Over the longer term, of course, market prices will inevitably fall more or less into line with fundamental values. The problem is that no one knows how long the “long term” is. For investors with a bullish view of the global economy, there will be high returns from buying a broad selection of stocks and sitting on them--if the bullish view is right, of course.

But each day’s market drama is a fool’s tale--all sound and fury signifying nothing. And the individual who thinks he can make money by active trading in a fool’s market is equally the fool.