Uncertainty over Fed plans colors market

February 23, 1994|By Andrew Leckey | Andrew Leckey,Tribune Media Services

Watch out for the potholes, the bumps and the craters.

Otherwise, it's full speed ahead.

That's the traffic report from Wall Street these days. Talk of 4,100 or 4,200 on the Dow Jones Industrial Average by year's end is quite common, but no one's exactly sure of the condition of the road that might get us there.

No one's certain how the Federal Reserve, which shook up the market with its quarter-point increase in the federal funds rate, will act as traffic policeman, either.

"The Fed could make another move to raise interest rates as soon as March, which could get people thinking about another move beyond that one," said Greg Smith, chief investment strategist for Prudential Securities, who is generally positive about the market's prospects. "We have to be a little cautious because the Fed is acting sooner than it typically has in the past, and when it's a problem for the bond market, it becomes a problem for the stock market as well."

Another move up in short-term rates to about 3.5 percent is anticipated by Smith, while 30-year Treasuries that had been in a tight trading range of 6 percent to 6.5 percent will likely rise to 6.75 percent by year's end. He expects inflation to average around 3 percent, about the same as the last two years.

The double-digit total returns for high-quality bonds in the last three years won't be possible this year, he warned, for they may not do much better than short-term instruments such as Treasury bills.

"The investor should have a healthy perspective on this stock market and realize that stocks don't go up in a smooth line," said William Dodge, chief investment strategist for Dean Witter Reynolds Inc. "There shouldn't be any major trouble, unless Fed policy becomes too restrictive too quickly and interest rates wind up being a whole lot worse than we think."

By year's end, 30-year Treasuries could be as high as 7 percent, Dodge estimates, with one-year Treasury bills at 4.25 percent. Inflation will be somewhat higher at around 3.5 percent.

"We're still positive toward the market, but, while we used to look over 25 names to find a stock to buy, we're now probably looking at 60 names before we find something that interests us," said J. Richard Walton, chief investment officer for Wertheim Shroder. "I think as long as short-term rates stay below 4.5 percent and the economic outlook and earnings are positive, we'll be OK."

He expects short-term rates of 3.5 percent and long bonds in a range of 5.75 percent to 7 percent during the course of the year. Investors, he feels, should be ready to buy on significant drops in the market. The basic strengths of good corporate earnings and a positive economy are intact, but lower rates are no longer part of the equation.

Smith is confident about prospects in the railroad industry, the hotel/motel business, paper, steel and automobiles. He's keeping away from interest-sensitive companies such as utilities, insurance firms and banks, though some might be attractive on individual merits.

Railroad holding company CSX Corp., USX Corp., International Paper Co., La Quinta Motor Inns L.P. and industrial-machine maker Varity Corp. are his favorite stocks.

Meanwhile, automobiles and auto-parts firms, computer companies and software services, engineering construction, electrical companies and industrial machinery get the nod from Dodge.

He likes Chrysler Corp., Ford Motor Co., Amcast Industrial Corp. in metal products, Excel Industries Inc. in vehicle window systems, Pyramid Technology Corp. in super minicomputers, Hewlett-Packard Corp., Novell Inc. in personal computer network systems, Microsoft Corp., General Electric Co., Foster Wheeler Corp. and Fluor Corp. in engineering and construction services, and Ingersoll-Rand in machinery and bearings.

Walton prefers medium-size growth companies in the consumer durables area. He's steering clear of utilities, drug companies and medical firms. Current favorites are Sprint Corp., General Motors Corp., Textron Inc. in aerospace and commercial products and Raytheon in aviation electronics.

Emerson Electric Co., which manufactures a broad range of electrical and electronic products, is recommended by Dodge and Walton. It is emphasizing new-product introductions, the growth of Asian operations and joint ventures.

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