Stock Market Soars as Fears of Inflation Ebb
The stock market soared to record heights Friday for the first time since May, as interest-rate worries calmed in the wake of a benign inflation report.
The Dow Jones industrial average surged 66.58 points to a record 5,838.52, marking the blue-chip index’s complete recovery from a steep summer sell-off and defying skeptics who had predicted that Americans’ love affair with stocks was ebbing.
“What we’re seeing is that the public is coming back and buying stocks again,” said Laszlo Birinyi, head of the Birinyi Associates investment firm in Greenwich, Conn.
Indeed, some Wall Street veterans said the Dow’s record-setting session on a Friday the 13th was appropriately ironic for a stock market that has been anything but unlucky since 1990, as interest rates, inflation, demographics and the general world economic trend all have nearly consistently pushed investors toward stocks above all other assets.
“I think the economic framework still is almost ideal for financial assets like stocks,” said Peter Anderson, head of IDS Advisory Group in Minneapolis.
The trigger for Friday’s rally was the government’s report that the consumer price index rose just 0.1% in August, well below expectations despite the economy’s surprising strength in recent months.
The Federal Reserve Board, the nation’s central bank, had been widely expected to raise short-term interest rates later this month to slow the economy’s growth. But Fed governors have been openly debating whether growth should be restrained if there are no concrete signs that the economy is advancing so quickly as to drive up prices for goods and services.
“The stock market is saying the Fed may not raise [rates] now,” said David Shulman, investment strategist at the Salomon Bros. brokerage in New York.
Yet share prices had been rallying even before Friday, gradually rebounding from an abrupt July decline that was sparked by worries about interest rates and growth in corporate earnings.
In recent weeks investors have paid little attention to problems that were expected to be major obstacles to new highs in the market, including uncertainty over the presidential election and the revival of tensions between the United States and Iraq.
Even as oil prices jumped in recent weeks, for example, the stock market failed to be shaken by Mideast concerns.
“Saddam Hussein is just not viewed as a credible threat” by investors, Shulman said.
Perhaps most important to the 6-year-old bull market’s resurgence, however, is that individual investors have continued to feed billions of dollars into stock mutual funds since the market’s July downturn, indicating that the 1990s mentality of buying into stock market declines remains intact.
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The mutual funds’ chief trade group estimated this week that stock funds took in a net $19 billion in fresh cash in August, up from just $5.8 billion in July, when blue-chip stocks dropped an average of 10%.
The public is saying it “wants more of the market,” said Brian Rogers, manager of T. Rowe Price Associates’ Equity Income stock fund in Baltimore.
Individual investors, including many baby boomers saving for retirement, have been a principal catalyst for stocks’ gains in this decade, pouring record sums into mutual funds.
Those dollars have made the bull market’s longevity a self-fulfilling prophecy, some analysts argue. And investors have been conditioned to buy more when stocks have declined because such “buying on dips” has been rewarded every time since the late 1980s.
With Friday’s gain the average U.S. stock mutual fund is up more than 11% this year, after soaring 31% in 1995. Over the past five years the average stock fund has gained 106%.
Although some experts say stock prices have reached dangerously high levels relative to underlying corporate earnings, many analysts say that without significantly higher interest rates stocks face little real competition from bank CDs or bonds.
And Friday’s mild inflation report was more ammunition for Fed board members who want to refrain from tightening credit just yet, analysts said.
“I think they’ve been looking for an excuse” not to boost interest rates before the presidential election, said David Blitzer, economist at Standard & Poor’s Corp. The consumer-inflation report, he said, may give Fed Chairman Alan Greenspan that excuse.
When analysts focus on whether stocks can continue to rise, they usually look at two variables: interest rates and corporate earnings.
Fear that companies’ profit margins would begin to be squeezed this year, after three years of sensational earnings growth, helped spark the stock market’s sell-off in July. The Dow index slumped more than 10% from its May high of 5,778.00, falling to 5,170 at its July low point.
In particular, an acceleration in average worker wages this year has worried the Fed and investors, because it suggests that labor markets are tightening, forcing companies to pay more to get workers. That, in turn, could cause more companies to raise prices for their products or services, sparking an upward inflation spiral.
Average hourly wages of nonsupervisory workers have risen at an annual rate of 3.4% this year, the fastest since 1990.
Yet Friday’s consumer inflation report bolstered some Wall Street analysts’ argument that inflation will remain tame even with the increase in wage growth.
Jeffrey Applegate, investment strategist at the Lehman Bros. brokerage in New York, contends that the economy is performing “remarkably” after five years of expansion, with wages growing, corporate profits still rising and price inflation still subdued.
The key, he said, is that businesses are wringing much bigger productivity gains out of their work forces. In theory, at least, more productive workers can be paid higher wages without forcing their companies to raise prices, if the companies also earn more, thanks to a rising level of output per employee.
Although the government’s measures of productivity show only modest gains this year, “the only way this economy makes sense is that labor productivity is much better than what the government says it is,” Applegate said.
That is why Applegate said he wasn’t surprised that stock prices rebounded sharply in late July and early August as selling quickly dried up. In August, the Dow traded in a narrow range for most of the month before surging over the past week.
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The July market decline now appears to have been a textbook case of a temporary “correction” in prices, one that takes some of the froth out of a heady market as some investors cash out, even though most stay put.
Indeed, smaller stocks, which had led the market up in the spring in frenetic trading, lost the most in the July pullback, falling more than 20% on average. Many of those shares still aren’t back to new highs.
Bullish analysts note that it isn’t surprising for blue-chip stocks in the Dow, such as General Electric, IBM and Coca-Cola, to lead the market higher after a sell-off. Investors tend to stay with those big-name stocks because they are viewed as safer investments.
For the market as a whole, many experts contend the outlook remains bullish, so long as the economy avoids recession, corporate profits continue to grow and interest rates remain subdued.
IDS’ Anderson noted that Wall Street opinion is largely split between those who believe the market is vulnerable to a deeper sell-off and those who expect only a modest advance for the rest of 1996 and 1997.
“I don’t know anyone who says the market is going to be up 20% from here,” he said. And given that stocks often fool the majority, a powerful new advance can’t be ruled out, Anderson said.
Birinyi said individual investors’ demand for stocks will probably continue to hold the key to the market’s direction, and there is no sign that Americans are losing interest in investing.
“He who has the gold makes the rules,” Birinyi said.
* INVESTOR CHEER
A closer look at inflation report, market action. D1, D3
