Have Stocks Broken Into the Clear at Last?

Many Wall Streeters are dubious about last week’s big rally in stocks. But Stefan Abrams, investment strategist at giant Trust Co. of the West, thinks it’s foolish to underestimate this market.

Why? Abrams believes the Federal Reserve Board has given the market exactly what it has been praying for: an economy growing at a moderate pace, without undue upward pressure on long-term bond yields or inflation.

The July durable-goods orders report last Wednesday and the second-quarter gross domestic product revision on Friday both suggested that growth is slowing, which must in large part be attributable to the Fed’s five credit-tightening moves since Feb. 4.

Abrams, who helps manage $50 billion at giant TCW, gushes with praise for Fed Chairman Alan Greenspan. “He’s proving to be the most skillful Fed chief since (William) McChesney Martin,” who ruled the Fed from 1951 to 1970, Abrams argues.


The way he sees it, Greenspan has brilliantly managed the Fed’s program to keep the economy from overheating. First, Abrams notes, Greenspan has been telling investors in advance what the Fed plans to do, which “gives the markets time to condition themselves” rather than be taken by surprise.

Second, Abrams lauds Greenspan for abandoning the Fed’s initial plan of quarter-point increases in short-term interest rates, in favor of half-point increases on May 16 and again on Aug. 16.

Instead of nickel-and-diming the markets to death with frequent quarter-point hikes, the Fed’s use of half-point increases that are more spaced out provides time for the nation’s economy--and investors--to digest the effect of higher rates without excessive trauma, Abrams says.

“Bigger boosts less frequently give corporate profits a chance to catch up to the higher level of interest rates,” he says.


And make no mistake, Abrams says: Corporate profits will continue to grow. While the Fed’s rate hikes have slowed the housing sector and auto sales, Abrams believes investors are underestimating the potential for continued strong export growth at American companies large and small, as the world economy revives.

Export demand, he says, will offset slower domestic growth enough to keep the economy on the moderate track that the Fed, and the markets, view as idyllic.

At TCW, Abrams says, “The CEOs of all the major companies come through here once a year, and they’re all telling us that all of their growth for the rest of the century will be coming from overseas.”

But the market has yet to fully grasp the importance of international business for a soaring number of American companies, Abrams argues. As more investors come to understand how large a contribution foreign sales will make to corporate earnings, he says, stock prices will increasingly be viewed as undervalued.


At current price levels, the average blue chip stock sells for about 16 times estimated 1994 earnings per share.

By Abrams’ calculations based on profit growth and interest rates, stock prices on average should be 10% higher, he says. That would put the Dow industrial average at about 4,270, versus 3,881.05 Friday.

“The guy who tells you the market is overvalued is living in the past,” Abrams says.



Making Money Again: One of the psychological negatives for the market since March has been that most money managers and small investors have been fighting just to get back to even for the year.

After last week’s rally, that barrier has finally been hurdled.

At the start of last week, the Standard & Poor’s 500-stock index was at 463.68, or 0.6% below its year-end close of 466.45.

Despite several rally attempts since the market’s late-March plunge, the S&P; had been unable to rise past its year-end level.


Until now. With last week’s 2.2% surge in the S&P;, the index closed Friday at 473.80, which means it’s up 1.6% year to date.

Likewise, the Dow industrials and the New York Stock Exchange composite index also are back in the black for the year. Still in the red, but coming up fast, are smaller-stock measures such as the Nasdaq composite and the Russell 2,000 index.

The significance of these indexes being above their 1993 closes is that money managers and individuals may begin to feel more confident about putting new money to work, if they’re no longer in the hole with their existing portfolios.

For most small investors, a more important indicator than the broad market indexes is the return on the average stock mutual fund. At June 30, the average general stock fund was down 5.84% year to date, according to fund-tracker Lipper Analytical Services in New York.


By last Thursday, the average fund’s year-to-date loss had shrunk to 0.4%. Lipper calculates the average returns only once a week (on Thursdays), but given the magnitude of Friday’s stock market rally, it’s likely that the typical fund now is even with the year or slightly ahead--for the first time since March.


Briefly: Further proof that stocks are insistent on going their own way, perhaps regardless of what happens with bonds: The benchmark 30-year Treasury bond yield closed last week at 7.48%, exactly where it finished the week before.

In other words, the stock market managed to rally spectacularly even though bonds didn’t, despite new evidence pointing to slower economic growth. . . .


A New York Times story last week caused a stir by noting that a chunk of last Wednesday’s 70.90-point Dow rally was the product of institutional trading games in the session’s final minutes, involving specialized stock-option contracts.

But some money managers warn against trying to paint the rally as artificial. As with “program” trading in the late-1980s, options games today generally don’t create market trends--they just magnify moves already underway.

Back Into the Black

Last week’s rally in stocks was powerful enough to lift some of the market’s key indexes back into positive territory for the year-to-date, for the first time since last winter.


Change Fri. Pct. change: Index Dec. 31 last week close Week Y-T-D Dow industrials 3,754.09 +125.94 3,881.05 +3.4% +3.4% S&P; 500 466.45 +10.12 473.80 +2.2% +1.6% NYSE composite 259.08 +5.01 260.82 +2.0% +0.7% Wilshire 5000 4,657.83 +94.30 4,681.90 +2.1% +0.5% S&P; mid-cap 179.38 +3.45 177.80 +2.0% -0.9% Russell 2000 258.59 +4.90 254.59 +2.0% -1.5% Nasdaq composite 776.80 +20.51 762.94 +2.8% -1.8% Dow transports 1,762.32 +32.20 1,614.40 +2.0% -8.4% Dow utilities 229.30 +0.66 188.44 +0.4% -17.8%