WALL STREET'S SEASON OF SUSPENSE

IN its crusade against the worst outbreak of inflation in 18 years, the Government has been struggling for months to create a climate of uncertainty among businessmen, consumers and investors. The rationale is that considerable uncertainty about the future course of the economy is necessary to erase the nation's deep-seated inflationary psychology. As long as people persist in believing that economic growth is perpetual and price rises are inevitable, they will continue to buy and borrow in order to beat still further increases. Once people begin to doubt that "good times" will last forever, the theory goes, then everyone will become more cautious in his buying decisions, demand will slow down--and prices will taper off. This effort to conquer euphoria has at last succeeded in an area of the economy that deeply affects most U.S. adults: the stock market. Wall Street's speculative binge has been replaced by the bear market of 1969.

Who Got Hit. The first victims of Washington's assault on inflationary psychology are the 100 million Americans who either own shares or participate in the stock market indirectly through pension funds and mutual funds. For many families, tumbling stock prices have at least temporarily shattered some cherished dreams. Yet the market's unsettled state brings a wry kind of cheer to Washington's inflation fighters. In their rather clinical view, stock prices are much like spinach prices or durable-goods orders: an economic indicator. Because the market mirrors investors' expectations of the performance of U.S. business, it is a valuable (but sometimes flawed) barometer of the economic future. A stock-market decline is perhaps the strongest signal yet that the Government is finally beginning to bring the overexuberant U.S. economy under control. "Inflation is being wrung out of the stock market," says Walter E. Hoadley, executive vice president of California's Bank of America. "The correction is a prerequisite to a resumption of healthy growth."

Despite a rally last week, the Dow-Jones industrial average is 15% below the year's high of 969, which it reached in mid-May. The Standard & Poor index of lower-priced shares is down 35%, and many other stocks have lost 50% or more of their value. The plunge has hit nearly every industry. From their 1969 peaks, shipping stocks are off 46%, airlines and motion pictures 40%, aerospace 39%, sugar companies 38%. Losses are only slightly less among coal, copper, textile, oil and insurance shares. Most of the leading conglomerate corporations have dropped disastrously: Litton is off 43%, Gulf & Western 50% and Ling-Temco-Vought 63% .

Last week the market moved like a Yoyo. For the first 21 trading sessions, the Dow-Jones fell straight down, dropping briefly below 800 to a point even lower than it was five years ago. At midweek, a long-awaited rally suddenly began. The Dow struggled up H points on Wednesday, its first gain in almost two weeks. In the week's final two days, it jumped 23 points, to close at 827. The rally at first was fired by false rumors that banks planned to reduce their 81% prime interest rate. Brokers called the rebound a sign that investors were eager to jump at almost any chance that the oversold market might reverse itself. Few were willing to predict, however, that the long slide had ended.

Reasons for Unease. Though the slide has come as an unpleasant shock to many investors, it is no surprise at all to economists. Tight money, an inescapable part of the fight to stem inflation, almost always depresses stock prices. Soaring interest rates make bonds an enticing alternative to stock investment and raise corporate borrowing costs enough to hurt earnings. Since the start of the year, the U.S. economy has been pressed down by the severest money and credit stringency since World War II. On top of that, corporate profits are contracting, and the Viet Nam | war is a drag on the economy, causing / distortions and further inflation. |

The fact is that the Federal Reserve | made clear early this year exactly what it would do: fight inflation to the end by restricting the money supply and keeping interest rates high (TIME, Jan. 10). Many stock analysts realized that such moves would lead to lower consumer demand, slower profit growth --and a market decline. But Wall Street, out of greed or its preoccupation with peace hopes, failed to take the Federal Reserve at its word. Now the message has sunk in and the market, if anything, has been overreacting.

The market has also been sent down by political infighting in Washington over the 10% surtax. Bankers and brokers view the surtax as a paramount symbol of the nation's determination to see the inflationary fight through to the end. If Congress relaxed the tax, then the Federal Reserve would have to tighten money still further--and that prospect horrifies Wall Street. Congressmen often seem insensitive to what happens in the stock market. Many of them tend to view Wall Street as a haven for Eastern fat cats, overlooking the fact that most voters have some stake in the market. The dallying over the surtax has accelerated the market slide. One reason for last week's rebound was that the Senate and the Administration finally reached a compromise that extended the tax through year's end (see THE NATION).

Pain Among Brokers. Despite its severity and breadth, the market decline has been surprisingly orderly, without the panic selling that developed during the breaks of 1962 and 1966. "This is the first declining market dominated by professionals," says Donald Regan, president of Merrill Lynch. "The normal rules don't apply." There have been relatively few margin calls because most of the action has involved institutions that do not buy on margin.

Not only stocks but brokerage houses as well have suffered severe reverses. Bache & Co., the nation's second largest house, reported a minuscule $13,237 profit for the quarter ending April 30. Some firms are running in the red. Many are trimming their staffs, closing offices and hunting for more capital or merger partners. The Street's major firms need Big Board trading volumes of at least 10 million shares a day to break even. Volume has slumped to well below that level during the past month. Even in the best of times, many firms earn only a little on trading for their retail customers, and rely on underwriting new issues of stocks and bonds for much of their profit. Because prices have been weak, the market for new issues has virtually vanished.

Buying Pressures. When will the market turn up? Long market slides are generally interrupted by brief rallies that fade. Bears insist that the mid-1969 downswing may continue for several more weeks or even months. On the other hand, buying pressures are growing, especially among institutions. Mutual funds usually hold 5% of their assets in cash and short-term Government securities, but now the figure is up to 8%--or $3.9 billion. Many stocks, at their depressed levels, strike the professionals as bargains. John Cooper, president of the $3.5 billion Massachusetts Investors Trust, believes that some stocks in such groups as banking and credit companies, business machines, foods, oils and retail trade "have reached very attractive prices."

When the turnaround arrives, investors will be unlikely to buy the same kinds of shares that they favored before the drop. After all, those were the stocks that rose the fastest and then fell the fastest. Analysts sense that the buying public may switch from growth stocks--such as nursing homes and franchising companies--to blue chips. That view is strengthened by the comparatively low ratio between the stock price and the earnings-per-share of many big concerns. For the Dow-Jones industrials, the price-earnings ratio stood last week at 14 to 1, well below the 18 to 1 of the mid-1960s and the 24 to 1 in 1961.

The Long Campaign. For the longer haul, the course of the stock market will depend, as always, on the strength and real growth of the U.S. economy. A long campaign against inflation still lies ahead. The peak in interest rates may already be past. Demand for bank loans has declined for three straight weeks. In the sensitive market for short-maturity financial paper, rates on bankers' acceptances have already fallen from 9,1% to 81%. Nevertheless, the Federal Reserve can be expected to keep money relatively scarce and expensive for months, perhaps years. The days of 6% home mortgages are gone for the foreseeable future.

The Reserve Board has little choice: any early moves to ease tight money would only rekindle inflationary expectations and undo what has been achieved so far. The Fed's governors are pursuing a difficult and risky strategy. They must continue to restrict money until they become convinced that inflation is whipped--yet if they wait until many signs of slowdown are apparent, a recession will already be under way.

Soaring prices on goods and services are normally the most persistent symptoms of inflation. Wholesale prices, however, generally fall somewhat sooner than those at retail. Last week the Bureau of Labor Statistics reported that the climb in wholesale prices slowed to only one-tenth of 1% during July, primarily because cattle prices have stabilized; that indicates that meat prices should soon stop rising. On the other hand, U.S. Steel Corp. last week announced the broadest increase in steel prices in a year. Flat rolled steel will go up by 4.8%, and that may give appliance makers, automakers and some other manufacturers an excuse to lift their prices.

Washington's aim is to control price inflation gradually, bringing it down from the present 7.2%-a-year pace to 4%, then to 3% and eventually to 2% or below, in line with productivity gains in the economy. Many economists feel that the Administration will do well if it achieves a 3% rate next year. "The next thing to look for," says Harvard Economist Otto Eckstein, "is a general easing of material prices and wages among unorganized workers--the most competitive parts of industry."

The Right Mix. The Nixon Administration is worried about how to keep organized labor from winning extreme wage increases. Pay and fringe benefits in major labor settlements rose 7.1% in the year's first half, and some unions aim for 10% gains in 1970. If unemployment rises slightly, labor may be more cautious in its demands, and if profits level off or decline, management may stiffen its resistance.

Provided that the Administration and Federal Reserve stick to their present mixture of restraints, the economy seems likely to undergo one or two quarters of slow growth or perhaps no growth at all early next year. Even former Kennedy and Johnson economic advisers Walter Heller and Paul Samuelson find little to criticize about the Nixon Administration's approach. "It is about right for now," says Heller. "There is going to be an uncomfortable period between the soaring '60s and the heavenly '70s." That goes for the stock market as well. Provided inflation is controlled, the economy at some point will be ready to move into a new era of expansion. Investors in stocks should be among the first to share in the resulting prosperity.

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