NEWS ANALYSIS : Reluctance to Buy Feeds on Recession Fear

The stock market has long known that the economy was slowing to a crawl. But on Monday, it began to worry that business growth would stop altogether--that the economy would fall into recession, crippling corporate earnings, wiping out jobs and reducing property values.

So Wall Street investors backed away nervously from stocks, and prices tumbled 56 points on the Dow Jones average, after falling more than 100 early in the session.

However, it was a market characterized by a reluctance to buy rather than heavy waves of panic selling. Investors were taking a cue from nervous business owners, said Jerry Jasinowski, president of the 13,500-member National Assn. of Manufacturers. “The concern among our members is that economic growth will slow even more and they won’t be able to make the money to pay their debts.”

A better indication of the economy’s strength or weakness will come on Friday, he said, when the government reports on economic growth in the second quarter. Recent reports have revealed a sluggish economy: Gross national product grew 1.9% in the first quarter, and only 1.1% in the last three months of 1989.

Meanwhile, the stock market on Monday read deep significance into several factors--including the profits of McDonald’s Corp., the giant hamburger chain.

McDonald’s reported that profits had increased 10% in the second quarter, which ended June 30. But analysts had been anticipating faster growth, so the McDonald’s report sparked disappointment and the sharp early selloff in the market. (McDonald’s stock fell $3 a share to $33.)

The market’s disappointment was particularly acute because analysts and big institutional investors had taken to seeing McDonald’s, which now is opening stores in Eastern Europe and the Soviet Union, as a way to invest in worldwide economic growth. McDonald’s profits would be strong even if the U.S. economy were weak, went the thinking. But with Monday’s earnings, investors began to doubt.

Wall Street began to worry also that interest rates would go higher, after weeks of believing that rates were headed lower. Reports that government assistance may be needed for guarantors of defaulted student loans added to concern about how much the U.S. Treasury will have to borrow to finance the swollen budget deficit. The Bush Administration last week raised its estimate on the deficit to $169 billion--or $231 billion, including the costs of the savings and loan bailout.

“If the U.S. Treasury has to sell even more bonds, investors will demand higher interest rates,” explained economist John Silvia of Kemper Financial Services in Chicago.

High interest rates affect the stock market directly: If an investor can get 8.5% in a Treasury bond, the potential return on stock investments in a sluggish economy looks less attractive.

Doubts about Federal Reserve Board policy on interest rates have also worried investors. Two weeks ago, Fed Chairman Alan Greenspan cut interest rates slightly. But last week--when the government reported a surprising jump in June consumer prices--Greenspan was ambiguous about further rate reductions.

The real problem, said analysts, is that the economy today is ambiguous, a marked contrast to the boom years of the 1980s. Employment growth and consumer spending have been notably slow in recent months. Nationally, conditions are uneven, with industries divided into winners and losers and some large geographic areas fighting full-blown downturns.

Defense contractors, U.S.-based auto makers, home builders and manufacturers of big-ticket consumer items are enduring tough times, for example. Meanwhile, many companies in food, health care and pharmaceuticals are faring well.

“If you happen to work in the health care industry, you think things are terrific,” Sinai said. “If you work in the (Detroit) auto industry, it’s like there’s a stranglehold. But if you work for a Japanese auto company employing American workers, you think things are terrific.

“There’s no standard pattern to explain the economy at this time.”

The pattern is uneven at the regional level, as well. New England, for example, is suffering a recession, fueled by weakness in defense, financial and high-tech industries. New York, Pennsylvania and parts of the Southwest also are viewed as suffering slumps.

Some economists would expand the recession list to include even more of the East Coast--hurt by problems in finance and real estate--and parts of the Midwest. California, despite cutbacks in defense, still enjoys a stronger economy than many other states, according to analysts.

“Depending on how you count it, I’ve seen evidence that up to 70% of the U.S. is in recession,” said David Wyss, an economist with DRI-McGraw Hill in Lexington, Mass., although he would put the figure lower.

One sign of the widespread slowdown: A dozen states have raised taxes or fees for the 1991 fiscal year to get needed income, said Marcia Howard, research director for the National Assn. of State Budget Officers in Washington. (In California, a 5-cent-per-gallon hike in the gasoline tax takes effect Aug. 1.)

Altogether, 25 states have taken some sort of measure to deal with budget problems, such as raising taxes, cutting spending or drawing on reserves. “Unfortunately for the states, many of their spending requirements continue to grow,” Howard said.

Still, signals are not all gloomy. “U.S. employment remains high,” said economist John Hekman of Micronomics, a Los Angeles consulting firm, who adds that consumer spending will not weaken drastically as long as job levels hold up.

What lies ahead, said analysts, is continued uncertainty--in the economy and the stock market. Even before Monday’s decline, experts such as Steven Einhorn, portfolio strategist for Goldman, Sachs & Co., pointed out that the market’s recent advance--to near 3,000 on the Dow Jones--was propelled by only a narrow group of stocks.

Even after the 56-point drop, “stocks are not cheap,” said Kenneth Fisher, a Woodside, Calif., money manager. “That doesn’t mean they will decline precipitously.”

As the legendary J. P. Morgan put it: “Stocks will fluctuate.”

VOLATILE MARKETS: Computerized “program trading” is blamed for Monday’s market gyrations, but the power of institutional investors may represent a bigger problem. D1