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NEWS ANALYSIS : Surprise Buying Spree Stirs Bull Fever in Stocks

TIMES STAFF WRITER

A powerful rally in stocks is shaking Wall Street out of its summer stupor, amid signs that individual investors--the market’s major money source since 1991--are once again flocking to buy.

On Friday, a broad market advance pushed the Dow Jones industrial average up 51.16 points to 3,881.05, its highest close since March 18. That followed a 70.90-point Dow surge on Wednesday, which was the blue-chip index’s biggest one-day gain since April 5.

The week’s surprise buying spree caught many vacationing investment pros unaware, and may be setting the stage for an even steeper climb in September when they return, some analysts say.

The newfound bullishness, after more than four months in which stock prices mostly drifted in a narrow range, appears to be rooted in investors’ belief that the economy is finally slowing enough to forestall further interest-rate increases.

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The Dow’s Wednesday rally, for example, followed the government’s report that factory orders for big-ticket goods in July took their steepest drop in 2 1/2 years. On Friday, the government revised its estimate of second-quarter economic growth to 3.8%, well below the 4%-plus figure that many economists had expected.

The excitement on Wall Street over weaker economic statistics, while seemingly counter-intuitive, reflects the market’s hope that the Federal Reserve Board has engineered an often-elusive “soft landing” for the economy.

By raising short-term interest rates this year for the first time since 1989, the central bank’s goal was to keep the burgeoning economy from overheating and thus keep inflation under control.

The first Fed rate increase, on Feb. 4, was greeted with pain and anger on Wall Street, and sparked the first serious decline in stock prices since 1990. The Dow plunged from its all-time high of 3,978.36 on Jan. 31 to 3,593.35 by April 4, a 9.7% drop.

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But the Fed’s successive rate hikes, including the fifth one on Aug. 16, have increasingly been accepted by most stock investors as a necessary tonic.

With this week’s rally, some market pros say investors are effectively declaring the Fed victorious in its quest to maintain a moderately growing, low-inflation economy.

“I think we’ve got the best chance for a soft landing that I’ve seen in my lifetime,” said veteran market strategist Stefan Abrams at Trust Co. of the West, an investment management firm in Los Angeles.

In theory, at least, a moderate pace of growth should stretch out the nation’s economic expansion, allowing corporate profits to continue rising while keeping a lid on interest rates.

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But while that improved scenario is what encouraged money managers to buy stocks this week, many were able to do so only because individual investors have continued to supply the necessary fuel, in the form of their cash savings.

Despite the market’s harrowing spring dive, relatively few individual investors have been shaken out of stock mutual funds, which now hold $800 billion in assets and which have been the driving force in this nearly four-year-old bull market.

“Individuals didn’t run for the exits when we had the market ‘correction’ in the spring,” said Arnold Kaufman, editor of Standard & Poor’s Corp.'s Outlook investment newsletter in New York. “They have stood their ground very nicely.”

In fact, Americans overall have continued to add substantially to their stock fund holdings all year, which has allowed fund managers to build up cash reserves that may only now be finding their way into stocks.

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The Investment Company Institute, trade group for the funds, said individuals’ purchases of stock funds exceeded redemptions by $30.8 billion in the second quarter, even as the market gyrated wildly.

And this month, stock fund purchases are surging anew at some fund sponsors.

Charles Schwab & Co., the nation’s largest discount brokerage and a major marketer of other companies’ mutual funds, says fund purchases have totaled $1.65 billion so far in August, up sharply from $1.27 billion in July.

Meanwhile, investor redemptions of stock fund shares have fallen to $833 million this month, versus $1.04 billion in July, Schwab says.

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Similarly, at fund giant T. Rowe Price Associates in Baltimore, stock fund purchases this month are up one-third from July’s levels. And for the year to date, T. Rowe says its net cash flow into U.S. and international stock funds is double last year’s pace.

Individuals’ continued strong appetite for stock funds has left many portfolio managers with ample purchasing power. The Templeton mutual fund group, which manages billions of dollars worldwide, holds as much as 35% of some of its funds in cash reserves now, said portfolio manager Mark Howlowesko.

Besides providing new purchasing power, the constant stream of investment this year into stock funds--and the relative lack of redemptions--has allowed fund managers to refrain from selling stocks that they feel comfortable holding longer term. That may have limited the market’s spring losses.

William Dutton, manager of the $210-million Skyline Special Equities fund in Chicago, has kept his fund almost fully invested this year, and hasn’t suffered significant redemptions even though the fund’s share price was down more than 4% in the first half.

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Bullish analysts point not only to the chances for a soft landing for the economy, but also to other positive forces at work in the market. Corporate takeover activity is booming, for example, which helps boost stock prices.

What’s more, many traders have been bearish on the market since spring, yet stocks have held up remarkably well. Those bears may now have to cover their bets.

Indeed, an unknown amount of this week’s buying was by “short sellers,” traders who had previously sold borrowed shares, betting on a renewed market decline.

In selling borrowed stock, short-sellers plan to repay the loaned stock later by buying new shares at a cheaper price, assuming the market indeed falls.

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But when stocks rally instead of falling, short-sellers often rush to close out their positions by buying shares on the open market, to avoid serious losses. That buying can add new fuel to any ongoing rally.

Still, many Wall Street pros admit they are suspicious of this week’s rally, and of the market’s ability to rally to new highs.

“I don’t see this as the start of something big,” said Alfred Kugel, senior investment strategist at investment firm Stein Roe & Farnham in Chicago. He worries the economy may slow in the near-term to cause investors new concerns about corporate earnings.

At best, Kugel believes the market will be stuck in a relatively narrow range well into 1995, as earnings growth catches up with three years of rising stock prices.

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But he admits that it’s hard to be too bearish on stocks as long as small investors continue to pump billions into the market.

Few investors are making money in stock funds this year. Through Thursday, the average general U.S. stock fund was down 0.4% year-to-date, according to fund-tracker Lipper Analytical Services.

* RALLY TRIGGER: The economy grew modestly in the second quarter. D1

* WINNERS, LOSERS: Industrial stocks led Friday’s rally. D2

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