Stock Fever Hits Epidemic Stage

By TOM PETRUNO

July 1, 1997 12 AM PT

TIMES STAFF WRITER

The hardest-working investors on Earth were those who lost money in stocks in the first six months of 1997--because you had to work very hard indeed to pick a loser.

Equity fever was virtually epidemic in the first half ended Monday, as investors bid share prices sharply higher in nearly every major world market.

The average U.S. blue-chip stock, as represented by the Standard & Poor’s 500 index, shot up 17% in the second quarter alone, bringing the first-half gain to 19.5%--despite a harrowing pullback in March and April.

While smaller shares trailed blue chips, the market advance was broad enough to generate a 15% total return for the average general U.S. stock mutual fund in the first half, according to fund tracker Lipper Analytical Services. That followed a 19.5% gain in 1996 and a 31% surge in 1995.

But the bigger story was the ravenous demand for stocks in many foreign markets in the first half, pushing key stock indexes up more than 30% in markets as diverse as Brazil, India, Spain, Germany and Taiwan.

Naturally, some Wall Streeters view the global stock surge as just another sign of crazed speculation that will eventually--maybe sooner than later--lead to catastrophic declines.

Yet in every world region almost without exception, analysts could point to the same basic fundamental forces at work in driving investors to stocks: low inflation and relatively low interest rates, which together give investors both a high comfort level with equities and the sense that stocks are pretty much the only intelligent place to put their money.

After nearly seven years of a mostly expanding world economy, the great surprise is that the trend toward disinflation remains intact, many economists say. Most credit the rise of freer trade and the continued globalization of the economy, forcing businesses everywhere to constantly work to keep prices down and productivity up.

“Inflation is the dog that didn’t bark,” noted Bruce Steinberg, economist at Merrill Lynch & Co. in New York.

That, in turn, has allowed long-term interest rates to continue falling in many countries, lowering the appeal of bonds and other fixed-income instruments as competition for stocks.

In the United States, the yield on the 30-year Treasury bond, the benchmark for long-term interest rates, closed the first half at 6.78% on Monday, down from 7.10% at the end of the first quarter.

Even so, the quarter hardly started out so promising for bonds--or for stocks: The Federal Reserve Board raised short-term interest rates on March 25 for the first time in more than two years, in a widely expected move aimed at slowing the U.S. economy from its torrid first-quarter pace of growth and easing inflationary pressures.

The Fed’s decision to boost its key short-term interest rate from 5.25% to 5.50% sent a shock wave through the U.S. stock market and some foreign markets by raising the specter of a prolonged period of tightening credit.

The move provoked a violent sell-off in the U.S. stock market that drove the Dow Jones industrial average down nearly 10% from mid-March to mid-April.

But then, almost on cue, government data in April began to suggest that the economy was in fact slowing--at least in terms of retail sales and other indicators of consumer demand.

By late April, U.S. bond yields were diving again, after having initially surged in tandem with the Fed’s rate boost.

That was all it took to revive stocks’ bull market. The Dow index went almost vertical, rocketing from 6,391 in mid-April to a record 7,796.51 as of June 20, barely pausing for breath. The Dow has since eased slightly, ending the quarter at 7,672.79.

What’s more, buyers also fanned into many smaller stocks, which had suffered even steeper declines than the Dow in the spring pullback.

The average small-stock mutual fund rebounded 16.9% in the second quarter, nearly matching the gain in the blue-chip S&P; 500 index.

The result was a May and June rally that veteran market technicians said was almost historic in breadth.

Likewise, the U.S. market’s renewed strength lent support to surging markets overseas.

Adding even more support to world equity markets was the continuing boom in corporate takeovers, which has the dual effect of boosting takeover target’s share prices, and, eventually, putting money in the hands of the target’s shareholders--money which often then finds its way back into other stocks.

Mergers worldwide rose 10% in the second quarter, on pace to make 1997 the best year ever for corporate marriages.

The value of deals announced in the second quarter around the globe was $332.3 billion, up from $301.2 billion in the second quarter of 1996, and ahead of last year’s record pace, when $1.14 trillion of mergers were announced, according to Securities Data Co.

Still, as the third quarter begins, Wall Street finds itself facing a familiar worry: that the Fed will tighten credit again in the next few months if recent signs of strength in consumer demand persist and the economy’s growth rate begins to rev up--threatening the inflation boost that has so far remained elusive.

The Fed, which meets today and Wednesday, is expected to leave rates unchanged for now: A Reuters poll of 36 economists found that not one believes the central bank will raise rates at this meeting.

But as summer unfolds, an expected pickup in consumer demand should fuel a faster pace of growth that will force the Fed to raise rates another notch by fall, many economists say.

“When you look at consumer confidence, [low] joblessness and income growth, you have to conclude that the consumer is going to spend again in the second half” after the lull of recent months, said David Munro, economist at High Frequency Economics in New York.

Moreover, with Japan’s economy showing unexpected strength this spring, the nightmare for Wall Street’s bulls is that the Fed and the Bank of Japan could be raising rates in tandem by fall--a double whammy that could be devastating for world stock markets, with prices at record highs almost everywhere.

IBES International, which tracks corporate earnings, calculates that the S&P; 500 index now is valued at about 18.5 times expected earnings per share over the next 12 months--a postwar record price-to-earnings ratio.

Because stock prices are largely a function of two things--underlying earnings and market interest rates--any negative change in either factor can bring prices down in a hurry.

Yet some experts wonder if even a tandem rate boost by the Fed and the Bank of Japan would produce more than another temporary correction in prices, like the ones that struck the U.S. market in 1994, last summer and again this spring.

Although there is no question that stock prices are at lofty levels, many analysts say that unless interest rates were to rise dramatically, it would be hard to shake most investors out of stocks for long--if they believe that economic growth will continue, and with it corporate earnings growth.

Indeed, central banks have tightened credit in Britain and Canada as well this year, without significant damage to stock prices.

Allen Sinai, economist at Primark Decision Economics in Boston, believes that long-term U.S. bond yields won’t rise much even if the Fed tightens credit later this year. His assumption is that the bond market will believe that the Fed will succeed in its mission to keep the economy from overheating, thus keeping inflation subdued.

Stocks are certain to face violent and sharp corrections ahead, Sinai said, but he still doesn’t see the potential for a deep bear market any time soon, given the world economy’s healthy tone.

Yes, stocks are high, Sinai said. “But we have a sensational economy, and that’s why we have a sensational stock market,” he said.

James Bianco, analyst at Arbor Trading and a market historian, calls the current global stock boom a dangerous mania, perhaps the biggest of all time. But he adds, “The mania might not be over yet.”

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Global Bull Romps Again

Stock markets surged around the world in the first half, as the same positive forces that boosted the U.S. market -- including low inflation and relatively low interest rates -- lured more investors to equities. Here are first-half returns for key indexes of major markets, in local currencies. (First-half loser, Investor Spotlight, D22):

India: 38%

Spain: 33.6%

Mexico: 32.6%

Germany: 31.1%

Taiwan: 30.2%

Sweden: 25.9%

Argentina: 24.7%

France: 23.4%

United States: 19.5%

Pakistan: 16%

South Korea: 14.5%

Hong Kong: 13%