Stock sell-off raises strategy questions

November 25, 1994|By David Conn | David Conn,Sun Staff Writer

For investors frustrated and shaken by the whipsaw movements of the past week, the clues to where the markets are headed can be found in their immediate past.

The trick is picking the right interpretation of those clues, and there is no shortage of spin on the recent events: higher rates have made bonds irresistible; the Federal Reserve Board's rate increases will strangle the economy, cutting off corporate profits; the market blinked because of the threat to GATT.

One thing that's clear is that higher interest rates played an important, if not exclusive role in the drubbing stock market investors experienced in the past five days. Before stocks recovered at midday Wednesday, the Dow Jones industrial average had lost about 40 points for the day, and had fallen 206 points, or 5.4 percent, since late last week.

The Dow rallied for a gain of about 7 points, then slipped again to end with a 3.4-point loss.

The bond market, meanwhile, continued its gains. The yield on the 30-year Treasury bond fell nine basis points to 7.95 percent Wednesday, as prices rose $9.69 per $1,000 bond. That completed the bond market's biggest two-day gain since the end of July.

Reinforcing an optimistic outlook for bonds, Dean Witter Reynolds advised investors to raise the amount of their portfolios devoted to bonds to 50 percent from 35 percent. Dean Witter left the 50 percent stock weighting unchanged, and lowered the recommended amount held in cash to zero from 5 percent.

But cash is exactly where a good bit of mutual fund money has been flowing recently, as bond prices have climbed since the Fed began raising rates in February. In the past month, T. Rowe Price Associates' customers have moved about 2 percent of their $9 billion in bond fund holdings into money market funds, according to spokesman Steven Norwitz.

Likewise at Fidelity Investments in Boston, although "I think the big story is we're starting to see some positive flows into bonds for the first time in a while," said Roger Servison, president of Fidelity's discount brokerage.

Mr. Servison said purchases of individual bonds have tripled in the past day or two, compared with a week ago. Unlike bond funds, whose prices are affected not only by rates but by investor sentiment as well, a specific bond provides a guaranteed rate of return if held until maturity.

That guaranteed return clearly has drawn many investors frustrated with a stock market that has fallen just over 2 percent so far this year, as measured by the Dow.

"It's kind of obvious what has precipitated the decline, which is the asset reallocation" toward bonds, said Richard E. Cripps, chief market strategist at Legg Mason Inc.

"It's too late to be a seller -- you're obviously not selling at the top of the market," he said. "The question is should you be a buyer or just hold onto your stocks?

"Our best guess is that sometime in the first or second quarter [of 1995] short rates will peak," Mr. Cripps said. "And when they peak the market will probably turn."

Legg Mason is focusing on "early cyclicals," such as bank and other financial stocks with low price-to-earnings ratios that have suffered through the rate rise this year.

Mr. Cripps advised buying strong companies whose stocks have fallen only because the overall market has, companies such as J. P. Morgan, AT&T and Eastman Kodak.

"If you have a time horizon of two years or longer you ought to go in and buy the highest quality companies you can find," Mr. Cripps said.

C. Frazier Evans, senior economist at Colonial Investor Services, the Boston-based mutual fund company, agreed that higher interest rates are partly to blame for the market's moves. But largely overlooked in the recent turmoil, he said, was the threat to the General Agreement on Tariffs and Trade, the worldwide trade treaty that Congress is scheduled to vote on next week.

"The stock market historically has always been very sensitive to any indication of rising protectionist sentiment in Congress," Mr. Evans explained.

That threat appeared to have passed by Wednesday, as Bob Dole of Kansas, the next Senate majority leader, worked out a compromise with the Clinton administration that should allow approval of GATT.

Along with the anticipated passage of GATT, Mr. Evans believes the Federal Reserve's efforts to raise rates will accomplish exactly what Chairman Alan Greenspan has attempted: to prolong the steady, if slow, economic recovery.

That recovery will continue well beyond the next few quarters, he said, which will become apparent after Jan. 1. Once the new year arrives, all of Wall Street's analysts will sit down and calculate estimated corporate earnings for 1996. Based on Colonial's predictions, the Dow is now trading at only 12 times estimated 1996 earnings, a historically inexpensive level, Mr. Evans said.

Economist John Maynard "Keynes said that successful investing requires anticipating the anticipation of others," he added.

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