The Rally That Wasn't

The great importance of monetary policy has been demonstrated lately by the stock market. Brokers normally count on a year-end rally, and they have been disappointed only six times in the past 41 years. Last week was one of those times. Mostly because of the Federal Reserve Board's recent moves to make money scarcer and costlier to borrow, the latest slump in stock prices stretched out to a full month.

On the New York Stock Exchange, the Dow-Jones industrial average, which reached a 1968 peak of 985.21 on Dec. 3, fell to 943.75 at year's end. Despite a rebound when trading resumed after the New Year holiday, the average lost ground for the week, closing at 951.89.

Speculation and Shift. Altogether, 1968 was a fairly disappointing year for blue-chip industrial shares. Propelled by political as well as economic events, the Dow-Jones average bounced erratically, but gained only 4.3% for the year. Broader-based indicators of Big Board securities rose about twice as much. The New York Exchange index of all 1,249 listed common stocks climbed 9.4% and Standard & Poor's index of 500 issues rose 7.7%. On the American Stock Exchange, a haven for low-priced and often volatile issues, prices soared an average 33%.

Brokers now sense that investors are shifting their preferences from speculative stocks to those with more fundamental values. Kenneth Ward, senior vice president of Hayden Stone, expects a rising interest in steel, chemical, airline and utility stocks, which should do better than high flyers in a quieter economic climate. "For the short term, the speculative boom is over," says Research Director Walter Stern of Burnham & Co. "Too many people have been buying too many stocks for the wrong reasons. There has been a race for instant profit based on tips and stories of impending deals. The bubble has to burst."

The vulnerability of some so-called "growth stocks" shows up in the ratio between share prices and corporate earnings. Such issues now sell in the over-the-counter market at an average of 40 times their per-share profits, a height last reached shortly before the market's 1962 plunge. Since 1966, the average price-earnings ratio of American Exchange stocks has jumped from 10-1 to 26-1. By contrast, the Dow-Jones industrial average finished 1968 at a level only 16.7 times the average per-share earnings of its stocks, down from 17.2 a year earlier. The decline suggests that blue chips are anything but overpriced.

Snarl and Slowdown. For the year ahead, there is apprehension over the persistent paperwork backlog, which has snarled delivery of securities. Overruling a last-minute plea from the Securities and Exchange Commission to reconsider, the nation's stock exchanges decided to switch from Wednesday closings, in effect since June 12, to shorter hours. Five-day-a-week trading, with closings at 2 p.m. instead of 3:30 in New York, will resume this week. Some brokers share the SEC's fears that the most severe effects of the paperwork jam are yet to be felt. Industry leaders, however, insist that the new system will reduce operational troubles faster than the old one.

Still, the stock market's major concern is how fast the Federal Reserve will tighten up the money supply in its campaign to squelch the pressures and psychology of inflation. Rising taxes will make the battle easier and will siphon funds away from investors. On Jan. 1, Social Security taxes went up by $3.6 billion a year. By April 15, taxpayers must give Washington an extra $11 billion in catch-up payments for the second quarter of 1968, when the 10% income-tax surcharge was not withheld from salaries. With a shrinking federal deficit also sucking steam from the economy, Wall Street is looking for a noticeable slowdown in U.S. business growth over the next few months. While that may hurt for a while, it should lead to less inflation and easier money. Brokers hope that it will also mean a healthier market, but that prognosis is far from unanimous.

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