Budget Deadlock Sends Stock Market on a Dive

TIMES STAFF WRITERS

Investors strongly registered their growing frustration with the federal budget stalemate Wednesday, sending the stock market down nearly 100 points as long-term interest rates jumped to the highest levels since mid-December.

The Dow Jones industrial average plunged 97.19 points to 5,032.94, adding to Tuesday's slide of 67.55 points and dropping the blue-chip index to its lowest close since late November.

Word late Tuesday that President Clinton and Republican leaders had suspended budget negotiations helped accelerate the financial markets' decline, and set the stage for Wednesday's continued sell-off, analysts said.

House Speaker Newt Gingrich (R-Ga.) appeared to trigger a burst of selling on Wednesday after he warned that the budget deadlock could last through the November election. Clinton echoed that sentiment in separate comments to reporters.

Because stock and bond markets had rallied dramatically in 1995--in large part on optimism about a long-term balanced-budget plan that could keep interest rates and inflation low--the inability of Clinton and Congress to strike a deal is fraying some investors' nerves.

Indeed, the price of gold, a barometer of investor concern, has been surging in recent days.

"I don't think the markets understood the magnitude of the differences between the two sides," said Leonard Santow, a principal at bond-consulting firm Griggs & Santow in New York.

Yet analysts also note a potential silver lining in the markets' swoon: It could force both sides back to the negotiating table.

In the near-term, however, the budget stalemate is helping to intensify investor jitters over the economy's health. In the wake of dismal holiday retail sales, some surprisingly weak corporate profit reports and increasing gloom in Europe, some analysts have raised concern that the U.S. economy could be on the verge of recession.

That is still a minority view. Most economists forecast that the nation's economy will grow at a real rate of between 2% and 2.5% in 1996, compared with an estimated 3.3% in 1995.

But the government's drawn-out shutdown--first because of the budget fight and this week because of the Eastern blizzard--is adding to confusion about the economy because so little data have been available since November.

Without sufficient clues about the pace of growth, it's unclear what the Federal Reserve Board will decide to do with short-term interest rates at its Jan. 30 meeting.

The Fed cut rates a quarter of a percentage point in late December and has been widely expected to do so again, assuming the economy remains weak. But like private economists, the central bank is largely in the dark without government statistics.

Analysts say that the general sense of confusion is encouraging more investors to sell stocks and bonds and thus lock in some of the spectacular profits booked in 1995, when the Dow index skyrocketed 1,282 points to close the year at 5,117.12, and the yield on the bellwether 30-year Treasury bond plummeted from 7.88% to 5.94%.

In dumping bonds as well as stocks, however, investors are pushing interest rates higher, creating a potential new drag on the economy, Wall Streeters say.

The 30-year T-bond yield, which affects other long-term rates such as those on home mortgages, soared from 6.11% on Tuesday to 6.19% on Wednesday, the highest since Dec. 18.

"The main threat [to the economy] is rising interest rates, particularly long-term rates," warned John O. Wilson, chief economist at the Bank of America in San Francisco.

Until rates began to rise over the past week, he said, "we had an economy that was in the midst of the classic soft landing . . . with no real signs that [growth] would really tank. The politicians are blowing it."

Yet many analysts insist that stock and bond markets are simply experiencing a long-overdue pullback, with the budget morass providing a convenient excuse. The economy should be able to easily withstand some short-term market turmoil, these analysts say.

"Our feeling is that the risks of a recession still appear relatively low," said David Hensley, regional economist with Salomon Bros. in New York.

"The structural imbalances that you would expect to see as trigger points for recession, whether real estate or financial institutions, credit constraints or a deterioration in credit, we are not seeing," he said.

Wall Street's slide so far, while clearly getting politicians' attention, has been minor compared to 1995's bull market gains.

The average blue-chip stock is down 2.8% this year after leaping 34.1% last year.

Historically, it isn't unusual to see stock indexes such as the Dow industrial average pull back by 10% or more following such a huge advance.

"The markets had gotten extremely optimistic about just about everything" by the end of 1995, said James Glassman, economist at Chemical Securities in New York. The budget stalemate, he said, is merely bringing some investors back to more realistic assumptions about interest rates, economic growth and the political backdrop for 1996.

Some economists also say that investors are overreacting to the remaining differences between Clinton's balanced-budget proposal and that of congressional Republicans.

John Williams, economist at Bankers Trust in New York, argued that Wall Street has scored a great victory in that both sides appear to be serious about reaching the same goal: eliminating federal budget deficits within seven years, thus increasingly freeing more capital for private enterprise in the economy.

"We have won the war," Williams said.

Even so, he conceded that markets may continue to be rocked in the short run if Clinton and Republicans fail to agree on exactly how to reach the balanced-budget goal.

Senate Majority Leader Bob Dole (R-Kan.), reacting in part to Wednesday's market turmoil, tried to strike a more positive note than had Clinton and Gingrich. "Can we reach an agreement? I don't know," he said just before the Senate recessed. "Is it doubtful? Probably. Is it possible? Yes."

He said there may be additional talks next Wednesday and "between now and then our attitude should be positive."

But bond-market analyst Santow warned that Clinton has little incentive to strike a deal before his State of the Union speech on Jan. 23. "It's clear that he wants to take his case to the American people in that address," Santow said.

That leaves plenty of time for nervous investors to continue shaving stock and bond holdings, analysts say. Stocks are especially vulnerable because estimates of corporate earnings growth at technology companies and other former market leaders are falling with the sluggish economy.

Still, the lower markets go, the stronger the pressure on Clinton and Congress to reach a budget pact, some Wall Street pros say.

The Dow index plunged 101 points on Dec. 18 as bond yields shot up, partly in reaction to the stalled state of budget talks at that time. The following day Clinton personally entered into negotiations with Republican leaders to move the talks forward.

"This kind of thing can concentrate the mind, particularly for Republicans," said one Clinton aide Wednesday.

Times staff writer Jonathan Peterson in Washington contributed to this story.

* MARKET REVIEW: A closer look at sell-off. D1.

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