The Tight-Money Market

By every logical standard, inflation should be strong tonic for the stock market. But the market is not logical, and ever since inflation began to loom large, it has retreated in fright. The Dow-Jones industrial average has fallen almost 70 points since early February, and last week, in a frenzy of deep plunges and brief rallies, it lost another four points to close at 927.95. Wall Street is worried that the fight on inflation and the war in Viet Nam may oblige the Government to take harsh steps that will pinch prosperity. That specifically includes the likelihood of higher taxes, but many investors would rather see Lyndon Johnson raise taxes than rely on Federal Reserve Chairman William McChesney Martin Jr. to make the nation's money still tighter. Sums up Walter C. Gorey, head of his own San Francisco brokerage firm: "When Mr. Martin puts his foot on the brake, he scares hell out of the big investors and the little old ladies and orphans too."

Stocks v. Bonds. Money is costlier to borrow now than it has ever been since the Depression, and the effects of that phenomenon on the market are tremendous. A promising market rally last week fell flat after Morgan Guaranty President Thomas Gates announced a boost in the prime rate to an alltime high of 5 1/2% . That announcement hit at 2:15 p.m. on Thursday, March 10, and by closing time at 3:30 the New York Stock Exchange floor was still a scene of frantic selling activity. Within little more than an hour after Morgan Guaranty's pattern-setting declaration, the Dow-Jones industrial average fell from a plus of more than seven points to a minus 0.61.

As an almost immediate result, Merrill Lynch, Pierce, Fenner & Smith boosted its rates for margin loans from 6 1/2% to 6 3/4% for small investors and from 5 3/4% to 6% for big ones. Most important, from Wall Street's viewpoint, tight money has made bonds more attractive than at any time since 1921. Many a $1,000-par medium-grade corporate bond is selling close to $900 and yielding about 6% ; some tax-free municipal bonds pay interest of 4%, which is as good as an 8% stock dividend return to an investor in a high-tax bracket. The current struggle in Wall Street's market is not between bulls and bears, but between stocks and bonds. Calling some important turns are the faceless but formidable institutions-mutual funds, pension and profit-sharing funds, insurance companies and banks --which account for about 31% of all trading on the major exchanges. Now they are socking more and more of their millions into the high-yield, no-risk bonds. In the past four months, Pittsburgh's Federated Growth Fund has reduced the proportion of stocks in its portfolio from 98% to 83%, putting the remainder into bonds. This week the Boston Fund will announce that it cut its common-stock investments from 63.7% to 58.2%. Other funds, such as the Keystone group and the Putnam group have also been transferring from stocks to bonds.

Black & Blue. Because the institutions deal largely in the stock of big, established companies, the latest selloff has particularly hurt the traditional blue chips. Result: the Dow-Jones index of blue chips has sold off 6.8% while the much broader Standard & Poor's index of 500 stocks has dropped 5.5% .

Critics argue that the Dow-Jones is inflated, exaggerated and inaccurate--and they are partly right. It is the sum of only 30 selected stocks, ranging alphabetically from Allied Chemical to Woolworth; that sum is then divided by a divisor (currently 2.245) to adjust for past stock splits and dividends. Not only is the Dow a severely limited gauge of the 1,625 stocks on the Big Board, but it gives undue power to higher-priced stocks. Example: Du Pont is only one-sixth the size of General Motors, but carries more than twice as much weight in the Dow because it sells for about $218, as compared to G.M.'s $97.

Flying High. While the Dow has been in the dumps, the little-noticed Standard & Poor's index of low-priced issues (below $20) last week reached an all-time high of 130.71, up 10% since the last week of 1965. Even high-priced stocks have continued to rise in a number of high-flying groups, notably electronics and airlines. Since Feb. 9, when the Dow-Jones decline be gan, Collins Radio has moved from 48 to 71, Pan Am from 57 to 60, Gulf & Western from 97 to 106 and Texas Instruments from 200 to 210. On the bearish side, there have been sharp drops in several groups, including aircraft manufacturing, life insurance, oil and utilities.

Where will the market go next? Brokers are generally optimistic but have a standard hedge: all bets are off if the Viet Nam war forces the Government to openly control prices and credit and thereby curb profits. Except for that, most insiders believe that the market has just about touched bottom, and many of them are talking about cracking the elusive 1,000 mark on the Dow before long. One prime reason is that the blue chips are conservatively priced, selling at little more than 16 times the estimated per-share earnings for 1966--lower even than the 17-to-l ratio at the bottom of the 1962 market break. U.S. investors for 20 years have ridden one long bull market, with only slight or brief interruptions, and nobody who believes in the, long-term growth of the nation's economy is ready to say that the party is over.

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