New Quarter, New Stock Market Leaders?

By JAMES F. PELTZ

April 1, 1997 12 AM PT

The stock market’s bull run is faltering this year because of rising interest rates and other developments now brewing--and that could prompt a second-quarter shake-up in the sectors leading Wall Street.

Few investors should be surprised. After the market sailed to another double-digit percentage gain in 1996 (20% for the Standard & Poor’s 500), analysts warned that stocks would probably face tougher going this year.

Their premise: Interest rates were likely to creep higher in 1997, putting a damper on economic growth and on the corporate profits whose rises have been propelling the market higher.

Sure enough, the Federal Reserve Board last week moved to head off any surge in inflation by lifting a key short-term lending rate--the federal funds rate, at which commercial banks lend to each other overnight--by a quarter of a point, to 5.5%.

That move, combined with additional government data that pointed to a still-robust economy, sent market rates higher as well, including the yield on the benchmark 30-year Treasury bond, which jumped above 7%.

All of which has sent stocks sharply lower and changed its dynamics as the first quarter came to a close Monday.

For instance, one of the quarter’s strongest sectors was savings-and-loan stocks. They benefited not only from stable rates earlier in the year, but also from the frenzy surrounding takeover contests like the one being waged for Great Western Financial Corp. (ticker symbol: GWF) by H.F. Ahmanson & Co. (AHM) and Washington Mutual Inc. (WAMU).

But the spike in interest rates is poison to stocks of thrifts, banks and other financial companies, because it narrows the spread between what they charge for loans and their costs of raising funds.

History shows that S&L; stocks “are likely to be twice as sensitive to rate changes as regional bank stocks, and three times as sensitive as the S&P; 500,” thrift analyst Kenneth Posner of Morgan Stanley & Co. in New York noted recently.

An exception is TCF Financial Corp. (TCB), a Minneapolis-based thrift that does a good job of matching the maturities of its assets and liabilities and thus of shielding itself from rate volatility, Posner said. But despite his “strong buy” recommendation on the stock, TCF lost 9% in the first quarter, to its recent $39.50 a share.

Then there are the brokerage stocks. They, too, continued to score well in the first quarter on the market’s climb to uncharted heights, among them Merrill Lynch & Co. (MER), which gained 5% in the three months to $86, and Salomon Inc. (SB), up 6% to $50 a share.

But with the stock market now struggling to maintain its momentum, the brokerage issues are already losing favor. For instance, Donaldson, Lufkin & Jenrette Inc. (DLJ) has tumbled 15% over the last month, to a recent $36.75 a share.

Interest rates aren’t the only concern for investors these days. There’s also the prospect that Washington will cut the capital gains tax rate this year. That might sound favorable, but its initial impact could be a market sell-off as investors sitting on big long-term gains rush to sell.

So not surprisingly, investors are getting more defensive as they search for promising sectors in an otherwise troubled market.

In the first quarter, for instance, other top gainers included such defensive sectors--defensive in that they tend to hold up well even if the market, and the economy, lose strength--as retailers, beverage makers, hardware suppliers, food companies and health-care providers.

Real estate investment trusts, or REITs, also made for a popular sector because they have high dividend yields, which offer a source of financial comfort even if the REITs’ prices suffer with the overall market.

Forecasters say those sectors should perform well in the second quarter as interest rate changes and capital gains tax matters continue to unfold.

Take foods. S&P;’s index of 13 food stocks climbed 5.4% in the first quarter, easily surpassing the 2.2% advance of the total S&P; 500. It was led by Hershey Foods Corp. (HSY), up a sizzling 14.3% to $50, and Campbell Soup Co. (CPB), up 15.6% to $46.25 a share.

And their run isn’t over, some analysts predict, because, if anything, investors are likely to get even more defensive as the stock market wobbles. At Lehman Bros., for example, Campbell Soup remains on the firm’s recommended list. So do Coca-Cola Co. (KO) and PepsiCo Inc. (PEP), even though the beverage giants’ stocks jumped 6% and 11%, respectively, in the first quarter.

Some suppliers of hardware and home-repair goods are also still being touted even though they were strong gainers in the first quarter. Case in point: Home Depot Inc. (HD), which is a favorite of Dean Witter Reynolds analyst Donald Trott, among others.

Home Depot, up 6.7% in the quarter to a recent $53.50, remains “a premier longer-term core investment” because of the chain’s continued strong same-store sales (that is, sales at outlets open a year or more), Trott wrote recently.

Health-care stocks, including those of drug companies and health maintenance organizations, or HMOs, also remain big favorites on Wall Street--seemingly no matter where the broader market is headed.

The brokerage house Edward D. Jones & Co. in St. Louis said that “over the last 17 years, health-care companies have outperformed the market 14 times, better than any other industry group.” Given that members of the baby boom generation are now approaching “their expensive health-care years,” there’s no reason to think that pattern will change, it said in a new report.

Jones’ favorites in the group include Abbott Laboratories (ABT), trading recently at $56 a share; Johnson & Johnson (JNJ), $53 a share; and American Home Products Corp. (AHP), $60 a share.

Boeing Co. (BA), though not considered a classic defensive stock and down 7.4% in the first quarter to $98.50 a share, is nonetheless strongly recommended by several analysts, including Cowen & Co.’s Cai von Rumohr. They contend that the surge in commercial aircraft orders plus Boeing’s pending dominance in defense with its planned purchase of McDonnell Douglas Corp. (MD) make Boeing attractive.

Finally, even with all this talk about being cautious in a weakening stock market, analysts still have a few picks in the always woolly technology sector. And that’s despite the 5% first-quarter declines in the technology-laden Nasdaq composite and Russell 2,000 indexes.

Lehman Bros. technology analyst Michael Gumport is among several analysts who still have buy recommendations for chip powerhouse Intel Corp. (INTC), even though the stock has slumped 14% since Feb. 1, to a recent $139 a share. He likes Intel’s prospects for exploiting such developing markets as advanced video applications and image sensors.

Synopsys Inc. (SNPS) is a favorite of Morgan Stanley analyst Alkesh Shah, even though the designer of software for semiconductor production plunged 46% in the first quarter, to $25 a share. The company still enjoys strong demand for its products and profits are growing, according to Shah, so its recent price drop offers a buying opportunity.

Times staff writer James F. Peltz can be reached at james.peltz@latimes.com

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Best and Worst Stock Groups

Here are the best- and worst- performing groups within the Standard & Poor’s index *:

Best Performers:

Hardware and tools: 18.42%

Savings and loans: 17.80

Retail stores -- general: 17.22

Transportation -- misc.: 13.03

Publishing -- newspapers: 11.53

Worst Performers:

Cosmetics: -6.10%