THIRD-QUARTER MARKETS REPORT : Bulls Charge to End Third Quarter : Markets: Dow nears its record, is up 24.9% for the year. But analysts see signs that typically suggest a pullback is near.

By TOM PETRUNO

Sept. 30, 1995 12 AM PT

TIMES STAFF WRITER

Wall Street closed the third quarter just under record highs Friday, as the bulls tried to show the bears who’s still in charge--on the eve of what is traditionally a worrisome month for stocks.

Capping a quarter that saw another spectacular leap in share prices overall, the Dow Jones industrials inched up 1.44 points to 4,789.08 on Friday, after hitting a record high early in the day. For the quarter, the Dow rose 5.1%, bringing its year-to-date price gain to 24.9%.

But although those numbers suggest the market’s advance remains on track, the real story of the third quarter was what happened below the surface:

* Technology shares, the market’s leading sector for most of this year, have been churning in recent weeks as some investors reassess the stocks’ prices relative to earnings prospects.

Two bellwether tech stocks--Intel and Microsoft--peaked in summer and now are far below their highs, a troubling sign to some market veterans.

* Since mid-September, a flurry of companies have warned that third-quarter earnings won’t meet expectations because of the seemingly sluggish economy. Coincidentally, the Dow reached its all-time high of 4,801.80 on Sept. 14, though it tried to break through that level Friday.

* Some investors have begun to shift heavily into so-called defensive stocks such as drug, food and electric utility issues. Because of the relative stability of their earnings growth, those stocks are often regarded as safe havens when the market turns ugly.

* With the dollar’s surprising rally in July and August--threatening the overseas-generated earnings of major blue-chip companies--stocks of smaller companies that are more domestically oriented finally began to burn up the charts. The Russell 2,000 index of smaller stocks zoomed 9.3% in the third quarter, nearly double the Dow’s gain.

The problem with many of these undercurrents is that they historically have signaled at least a near-term top in hot markets, analysts note.

“It’s very symptomatic of a mature bull market,” concedes Marshall Acuff, investment strategist at brokerage Smith Barney in New York.

Other barometers of stocks’ health have also been flashing red, notes A.C. Moore, money manager at Dunvegan Associates in Santa Barbara.

Corporate insiders, for example, have turned from being net buyers of their own companies’ stocks early in the year to being heavy net sellers.

Moore argues that the stock market is showing “some critical signs of strain today.” At the start of the year, he says, “we were looking for those signs but they weren’t there,” so the market was able to rally in spite of many investors’ fears.

Now, he says, the opposite is true: The signals are bearish, “but many people are choosing to ignore them,” believing that stocks’ bull run is simply destined to continue.

But with October looming, nervousness may rise. October has a nasty, if overstated, reputation for deflating high-flying markets. Most memorable, of course, was the market crash of October, 1987.

Yet many Wall Streeters point out that two factors remain very much in stocks’ favor: low interest rates and low inflation.

Indeed, the Federal Reserve Board helped prime the market’s pump in the third quarter by cutting short-term rates a quarter of a point on July 6, the first such easing of credit in three years.

That has allowed long-term bond yields to drift down to 19-month lows recently, after a brief blip upward in midsummer. The 30-year Treasury bond yield ended at 6.50% on Friday, down from 6.58% on Thursday, after a Chicago-area manufacturing report suggested that the economy remains weak enough to justify another Fed rate cut in coming months.

“We still think the odds favor one more easing move this year,” says John R. Williams, economist at Bankers Trust Co. in New York.

In addition, if the dollar can show that its direction still is up--though not at too fast a pace--long-absent foreign investors could come pouring into U.S. stocks, some pros say. The dollar ended Friday at 99.80 Japanese yen, up from 99.35 on Thursday and well up from 84.71 yen on June 30, despite a pullback in recent weeks.

If interest rates remain contained while the economy expands at a moderate pace and the dollar inches up, many bulls say stocks can rise further. “The path of least resistance is still up,” argues Michael Burke, analyst at Investors Intelligence in New Rochelle, N.Y.

Individual investors, experts note, continue to pour cash into stock mutual funds at a brisk pace. But even those inflows have begun to wane somewhat this month.

The key in the near term, most Wall Streeters agree, is whether the bulk of third-quarter earnings reports will at least meet expectations.

If not, the long-awaited 10% to 15% “correction” in stock prices could well be at hand, some say.

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Markets’ Hot Year Gets Hotter Still

Blue-chip stocks made a run to all-time highs on Friday before falling back, capping another big quarter for Wall Street. The largest gains in the quarter were made in small- and mid-sized stocks: The Standard & Poor’s mid-cap index, for example, leaped 9.3% for the quarter. Long-term interest rates, meanwhile, remain near 19-month lows after a brief summer rise.

The Dow’s Long Climb

Dow Jones industrial average, weekly closes

Friday: 4,789.08, up 954.64 since Jan. 1

Key U.S. stock indexes

Nasdaq composite

Third quarter: 11.8%

Year-to-date: 38.8

S&P; mid-cap

Third quarter: 9.3

Year-to-date: 27.3

S&P; 500

Third quarter: 7.3