Prudent investors can brave a bearish market


January 09, 1994|By JANE BRYANT QUINN | JANE BRYANT QUINN,1994, Washington Post Writers Group

NEW YORK -- If you're a long-term stock investor, this may be the year that tests your resolve. The market is now in its longest-ever uptrend without so much as a 10 percent drop. Sooner or later, a correction will come. When it does, will you stick to your steady, disciplined investment program? Or are you going to cut and run?

This question greatly worries investment professionals. Because of the low interest rates at banks and money-market funds, people who normally don't buy stocks jumped into the market with both feet last year.

A record $104.7 billion of new money flooded into stock-owning mutual funds through October of 1993, compared with $78.1 billion for all of 1992.

If, in a panic, that money flooded out -- or even if people just quit their new buying -- a normal downturn could become immeasurably worse.

A large percentage of these investors (as well as their stockbrokers or mutual fund managers) have never seen a true bear market.

I don't count the 1987 Crash or 1989 Crashette, because both were over before anyone could agonize over what to do. Even the 1990 Gulf war scare didn't last very long.

I'm thinking of the terrible 1973-1974 decline, when stockspainfully, inexorably lost nearly half their value. Every day for two years, investors had to ask themselves, "Will it get worse? Should I sell? Should I stick? Should I buy?"

And almost every day, the value of their college or retirement investments slipped a little more.

Of those who fear a downturn this year, most don't predict a drop of nearly that magnitude.

The economy's fundamentals are in the best shape anyone has seen for years. Business is moving from a caterpillar crawl into a sustainable functional recovery. Such an outlook is bullish for stocks, even starting from last week's 3,800 level on the Dow Jones industrial average.

Elaine Garzarelli, Lehman Bros.' director of sector analysis and an unrestrained optimist, sees at least 4,000 on the Dow -- and predicted it a year ago, when many of her colleagues were biting their nails.

So why should anybody worry? Here is the pessimist's case:

* The economy's strong momentum will force the Federal Reserve to snug up on short-term interest rates. This might scare money out of stocks. For all the talk about jumpy individual investors, it's the professionals everyone has to worry about. Their knee-jerk computer sales programs and complex, untested new types of market instruments have driven the market into its past three dives.

* We've got a speculative bubble in stocks and other financial instruments, loosed by the Fed's easy-money policy. Raymond DeVoe Jr., top technical analyst for Legg Mason Wood Walker, calls this a "Boston Chicken Co. Market Top," reflecting the fantasy he sees in the prices of new stock offerings. Boston Chicken recently went public at $20 and soared to $51 the same day.

* Technical weaknesses are showing up, according to Smith Barney Shearson analyst Alan Shaw. Measures of breadth and momentum are slowing.

He thinks the upturn is still in place, but wouldn't be surprised to see a correction of at least 10 percent, perhaps late this winter.

Whether it might develop into a full-fledged bear market, defined as a decline exceeding 20 percent, is at this point hard to say, Mr. Shaw adds.

* Michael Metz, Oppenheimer's market strategist, thinks the drop will indeed exceed 10 percent -- assuming, as he does, an economy strong enough to push inflation and short-term interest rates over 4 percent (from around 3 percent today) and long-term Treasury bonds over 7 percent (up from 6.2 percent today).

Rates at that level would not only pull money out of stocks; they could also slow business down again.

* Historically, the second year of any president's four-year term yields the smallest gains (an average of 3.6 percent, Mr. Shaw says) and often contains a downturn.

But the bulls haven't given up yet. In the opinion of S. G. WarburgResearch, nothing now suggests a serious bounce in inflation.

Oil prices are slack, wages slow, productivity strong and consumer demand only moderate.

What's more, Warburg says, the first round of monetary tightening in any cycle has historically been a signal to buy, not a signal to sell.

So what's an individual investor to do? Keep up your steady investment programs but avoid margin loans, swear off frothy new stock offerings and diversify into international funds. If the market faints, just wait till next year: Ever since 1885, the years ending in '5' have always produced markets that went up.

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