Is It Over Yet? : 1994 Brought Pain; Investors Ask if ’95 Will Be Better


Financial markets’ Year of Misery ended mercifully on Friday, leaving investors worldwide to lick their wounds--and to hope they can avoid a repeat in 1995.

In the U.S. stock market, the Dow Jones industrial average inched up 1.01 points Friday to 3,834.44, or 80.35 points above 1993’s close, for a 2.1% gain.

But that was where the good news ended on Wall Street. Every other major U.S. stock index declined in price for the year, with most losing between 1.5% and 6%. Most foreign markets performed even worse in local currencies.


All in all, stocks posted their worst year--and first losses--since 1990.

The nominal culprit, of course, was the surge in interest rates worldwide: The Federal Reserve Board boosted short-term rates by a dramatic 2.5 percentage points in 1994, ostensibly to keep the robust U.S. economy from overheating.

In the process interest rates jumped across the board here and abroad, producing some of the worst 12-month paper losses for global bond investors in this century.

As the market yield on 30-year U.S. Treasury bonds soared from 6.35% at the start of the year to 7.88% as of Friday, the value of that bond (if purchased a year ago) slumped 17%.

But given the magnitude of the rise in interest rates, some Wall Streeters say the real surprise is that the U.S. stock market didn’t collapse outright after hitting record highs early in the year.

Indeed, with the blue chip Standard & Poor’s 500-stock index off a mere 1.5% in price for the year, “the damage has been so minor that it doesn’t really qualify as a bear market at this point,” admits an otherwise bearish James Stack, publisher of the InvesTech market newsletter in Whitefish, Mont.

Even during the depths of the market’s selloff last spring, major U.S. stock indexes dropped only about 10% from their all-time highs. That is typical of a market “correction”--a short-term pause in a bull market--as opposed to a bear market, in which broad indexes usually decline 20% or more.


And in recent weeks, U.S. stocks have rallied sharply as long-term bond yields have begun to show signs of topping out. The Dow industrial index has jumped 4% since Dec. 8, and now is just 3.6% below its record high of 3,978.36 set on Jan. 31.

What’s more, bullish analysts point out that it was possible to make money in stocks in 1994: Many issues responded well to their companies’ strong underlying earnings growth, despite higher interest rates. Hot industries included shoe making, technology, aluminum and medical supplies.

Still, world stock markets were buffeted by so many cross currents and contradictions in 1994 that it’s hardly surprising if the average investor feels worse than the broad market indexes would imply:

* Market volatility, as measured by the percentage difference between the S&P; 500 index’s high and low values for the entire year, was just under 10%--the second lowest on record, after 1993.

Yet Abby Cohen, investment strategist at Goldman Sachs & Co., calculates that nearly 40% of all actively traded stocks had declined more than 30% from their 1994 highs by Nov. 30. For those issues, the bear market was real.

* Investors who diversified internationally, believing that stock market returns worldwide generally didn’t correlate--i.e., that other markets would zig if the U.S. zagged--found that premise to be mostly false in 1994.


Japanese stocks were the only winners among major markets, as they rallied out of their four-year bear market. In Europe and most Third World markets, stocks declined sharply as interest rates rose, though a weak dollar for much of the year made some foreign markets’ performance appear better to U.S. investors.

* Classic “defensive” issues--stocks that investors normally turn to for protection in times of turmoil--were among the year’s biggest losers. The Dow utility-stock index, for example, plummeted 20.8% for the year, victim of rising interest rates and industry-specific problems.

And gold mining stocks dove 18.9% on average, as the price of bullion fell from $390.80 an ounce a year ago to $383.10 as of Friday, reaping no benefit from worries about higher inflation in the strong economy.

With so much anguish in markets--and with no end in sight to high short-term interest rates that are drawing a tidal wave of cash away from stocks--it’s little wonder that so many Wall Street pros are bearish, analysts say.

Fully 50% of the market newsletter writers polled regularly by Investors Intelligence of New Rochelle, N.Y. now say they’re bearish. Only 35% are bullish. The rest see this market in a short-term correction. The most prevalent forecast is for another slump in stock prices early in 1995, as the Fed tightens credit further to restrain the economy.

But Arnold Kaufman, investment strategist at Standard & Poor’s Corp. in New York, argues that the worst has passed for stocks. He believes the Fed will succeed in slowing--not stopping--the economy in 1995, and that continuing growth in corporate earnings will bolster the market as interest rates begin to stabilize.


“We don’t see this as a bear market. The difference is that we’re buying the ‘soft landing’ concept (for the economy), while others are not,” Kaufman says. He expects the S&P; 500 index to gain 10% in 1995, including dividends.

Corporate earnings are the key, Kaufman says: They advanced so strongly in 1994 that the S&P; 500 index’s price-to-earnings ratio, based on estimated 1994 operating earnings, is just under 15 now. If earnings advance as expected next year, the S&P;’s price-to-earnings ratio is 13.5 based on estimated 1995 results.

Those are not absurdly high “P-E” multiples, Kaufman says. So there’s no overwhelming reason for stocks to plunge from here, he says.

But bears like InvesTech’s Stack say lower P-E ratios can’t help a stock market that’s being assaulted by short-term interest rates above 6% and long-term yields near 8%.

To Stack, U.S. stocks’ relative resilience in 1994 is a bad sign rather than a good one: He thinks the market has just delayed the inevitable--a much deeper decline that finally shakes out many of the investors who’ve entered in the record wave of new stock buyers since 1990.

Market Roundup, D3


The Markets’ Year That Was

Surging interest rates, as the Federal Reserve tightened credit for the first time since 1989, set a mosotly negative tone fr stocks and bonds virtually worldwide in 1994. Yet the Dow industrials eked out a gain for the year--and some stock groups zoomed. ...And Most Stock Indexes Fall...


U.S. MARKET INDEXES Price changes (not including dividends):

Dow industrials: +2.1%

S&P; 500: -1.5

Nasdaq composite: -3.2

S&P; mid-cap: -5.7

Amex market value: -9.1

Dow utilities: -20.8


Price changes in native currencies:

Japan (Nikkei 225): +13.2%

Canada (TSE 300): -2.5

Germany (DAX 30): -7.1

Mexico (Bolsa): -8.7

Britain (FTSE 100): -10.3

France (CAC 40): -17.1

Hong Kong (Hang Seng): -31.1

...But Some Industries Are Red Hot

Best and worst stock industry groups and average percentage change in 1994:


Group: Change


Shoemakers: -33.5%

Computer systems: +29.8

Electronic instruments: +25.2

Cosmetics: +24.8

Computer software: +19.8

Aluminum: +19.6

Semiconductors: +17.9

Medical supplies: +16.6

Drug stores: +13.6

Communications equipment: +13.4


Group: Change


Home builders: -43.0%

Airlines: -31.1%

Bldg. materials: -28.1%

Oil explor./prod.: -21.4%

Furniture/appliances: -19.8%

Oil/gas drilling: -19.6%

Machine tools: -19.6%

Gold miners: -18.9%

Life insurers: -18.7%

Manufac. housing: -18.7%


Note: Data through Thursday’s close. Source: Smith Barney, using S&P; indexes