SECOND-QUARTER MARKETS REPORT : Dow’s Latest Rise Puts It Up 18.8% for Half : Markets: Vision of slow-but-steady economy guides stock and bond investors’ hopes for more gains.
U.S. financial markets capped a spectacular first half of 1995 with modest rallies Friday, as investors tallied their profits--and many bet on more to come.
The Dow industrial stock average surrendered a 30-point midday surge but still closed up 5.54 points at 4,556.10, leaving the blue-chip index up 18.8% year-to-date.
Not since 1987 have stocks roared ahead so powerfully in the first two quarters of the year. But then, rarely has so much gone so right for Wall Street.
Almost as if following a script, the U.S. economy began to slow dramatically at the start of the year, pulling interest rates steadily lower after their surge last year.
Instead of worrying that economic weakness would lead to recession, investors have collectively clung to the belief that a “soft landing” is under way: modest growth with the side benefits of low inflation and relatively low interest rates.
That was the markets’ great hope in January, and that’s still what is behind Wall Street’s widespread bullishness.
“Nothing much has changed--except that stock prices are higher,” says Arnold Kaufman, editor of the Outlook market letter published by Standard & Poor’s Corp.
But one soft-landing assumption that had seemed a certainty just a few days ago--that the Federal Reserve Board would cut short-term interest rates when it meets next week--is now in doubt.
On Thursday, a government report showing an unexpected pickup in new-home sales in May sent the bond market reeling, driving the yield on 30-year Treasury bonds to 6.64% from 6.51% on Wednesday as hopes for a rate cut dimmed.
Meanwhile, the stock market has waffled over the past week, seemingly anticipating bonds’ setback. The Dow has edged down 33.54 points from its all-time high of 4,589.64 set June 22--which was also the day the 30-year T-bond yield hit a 16-month low of 6.47%.
But on Friday, the bond market stabilized after Thursday’s selloff, with the 30-year T-bond yield easing to 6.62%. And stocks, which had slipped only modestly Thursday in the face of bonds’ selloff, closed mostly higher Friday.
All of which hints that markets can live without a Fed rate cut next week after all, some analysts say.
Bond yields, which had fallen to levels that clearly anticipated a Fed cut, could backtrack a bit more, says David Lereah, economist at the Mortgage Bankers Assn. in Washington. But investors may also decide to leave yields where they are, he says, betting that if the Fed does not cut now, it will in August.
As for stocks, “if the Fed doesn’t cut, that’s probably fine too,” says Marshall Acuff, strategist at Smith Barney in New York.
As long as investors can count on moderate growth ahead, they may see no reason to sell stocks if the Fed holds its benchmark short-term interest rate, the federal funds rate, at 6%, the bulls say.
“I think most of us look at a 6% fed funds rate as about normal now,” says James Glassman, economist at Chemical Securities in New York.
But bearish analysts see investors’ increasing tendency to view all news as good news as a classic sign of a mania. With many market indicators flashing warning signs--dividend yields are at a record lows, and corporate insiders have sharply cut back on personal purchases of their own shares--stocks are overdue for a plunge, the bears insist.
Maybe. But Acuff and other market pros say investors should realize that sometimes, things can go right for Wall Street for extended periods. “It’s hard to be overly negative here,” he says.
Among the positive forces underpinning stocks:
* Corporate earnings growth should continue this year and into 1996 so long as the economy can escape recession. And earnings of market-leading companies--especially in the technology sector--are still on fire, analysts note.
* With the average blue-chip stock priced at about 15 times estimated 1995 earnings, that is at worst a fair valuation, but not excessive historically.
* A surge in takeover activity is lending broad support to the market. Securities Data Co. says $163 billion worth of mergers have been announced so far this year, up 19% from the first six months of 1994.
* The dollar appears to have stabilized after its winter dive, while its value is still low enough relative to other major currencies to give U.S. exporters a competitive advantage.
* Investor interest in the market has broadened considerably since the first quarter. While technology and blue-chip multinational stocks are still leading, the Russell 2,000 index of smaller companies zoomed 8.8% in the second quarter, double its first-quarter rise.
* Stocks still seem more attractive to many people than alternatives like commodities and bank CDs. And with most foreign markets badly lagging the U.S. market this year, American investors appear content to keep their money at home.
Yet even the most optimistic Wall Streeters agree that stocks could easily suffer a near-term correction this summer if profit takers swarm. The technology sector in particular looks vulnerable. The Nasdaq composite index, heavy with tech issues, is up 24.1% this year.
But then, says S&P;’s Kaufman, “a lot of people have been advising profit taking all year, and they look silly.”
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Best, Worst Stock Groups
Average gain or loss in leading and lagging stock industry groups during the first half, through Thursday:
LEADERS
Industry First half change Semiconductors +61.2% Electronic instruments +47.7% Airlines +45.3% Defense electronics +40.2% Brokerages +33.9% Computer software +33.3% Aerospace-defense +32.7% S&Ls; +32.7% Money center banks +32.5% Medical supplies +30.1%
LAGGARDS
Industry First half change HMOs -16.9% Truckers -15.4% Steel -5.4% Specialty retail -4.8% Misc. metals -0.8% Shoemakers -0.1% Publishing +0.2% Clothing makers +0.4% Leisure time +0.5% Misc. transports +1.1%
Source: Smith Barney, using S&P; indexes
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Soft Landing, Hot Markets
Widespread belief that the economy is headed for a “soft landing” of modest growth and low inflation pulled bond yields down and sent stocks flying in the first six months of the year.
A big first-half for stocks ...
Index First quarter First half Nasdaq composite +8.7% +24.1% Dow industrials +8.4% +18.8% S&P; 500 +9.0% +18.6% Russell 2000 +4.2% +13.3% Dow utilities +3.4% +11.3%
... as rates fall with the weak economy ...
Monty-end closes since December, 1993:
Jan. 1995: 5 year Treasury note: 5.97% 3-mont Treasury bill: 5.58%
... and the dollar steadies.
Dollar in yen since Jan. 1, weekly closes: Jan. 1995: 84.71
Sources: TradeLine, Bloomberg Business News
