Those Wall Street Blues

By Christopher Byron

Investors grow wary of supply-side theory and sell off stocks

The economy slumping, the stock market stumbling, interest rates roaring and inflation rocketing.

Such was the dismal rhythm of the economy last week during the worst week of economic news since Ronald Reagan took office. The Dow Jones index of industrial stocks dropped 28.35 points, including a 20-point free fall on Monday, to its lowest level in 13 months. New figures out of Washington showed that inflation in July had increased at an annual rate of 15.4%. And the Government's index of leading economic indicators, which attempts to predict the future course of business, dropped another .1% in July after falling 1% in June and 1.6% in May. What has happened to all those miracles promised by the practitioners of supply-side economics?

Until now, economic policymaking by the Reagan Administration has been an almost unending parade of triumphs. Next year's budget was cut by more than $37 billion from the figure proposed by President Carter before he left office; a 33-month, 25% tax cut passed Congress by a large margin; inflation dropped from last year's 12.4% to an annual rate of 9.5% in the past six months. As all the good news rolled in, Administration officials confidently predicted that with the budget cuts and the tax reductions in place, interest rates would begin falling, growth would pick up and double-digit inflation would be a thing of the past.

The one problem was that Wall Street never believed supply-side economics in the first place. Although they strongly backed Reagan's election last November and support most of his economic policies now, Wall Street's moneymen are skeptical about a plan that will mean in the short term, at least, increasing the size of the federal deficit in order to stimulate growth. Last week those Wall Street financiers put their money where their minds were. Fearing that Reagan's program would mean even higher interest rates, they heavily sold stocks and drove down bond prices. Said David Jones, chief economist for the New York-based Government securities firm of Aubrey G. Lanston & Co.: "The market is saying, 'Don't give me a lot of supply-side economic theory about what happens when you cut taxes. Don't tell me that in theory people should save more, and that in the end everything will be all right. Just give me the arithmetic and the reality.' "

The bit of reality that most frightens professional investors is the high credit demands of the Federal Government. Washington is now borrowing about $8 billion a week in short-term financing alone, in order to cover the swelling $978 billion national debt. Just paying for the interest on that debt servicing already consumes 15% of federal spending. Since last October, when the current fiscal year began, federal borrowing to finance the deficit has climbed to nearly $60 billion, up $1.5 billion from the previous year.

Moreover, Wall Street was alarmed last week over reports that the flood of red ink may be growing, since that will increase the rate of borrowing even more. Though the Administration is sticking to its July forecast of a fiscal 1982 deficit of no more than $42.5 billion, projections last week by the Congressional Budget Office put the figure at closer to $60 billion. The Data Resources economic forecasting firm expects a budget shortfall of as much as $66 billion in the year ahead. If those figures are correct, Washington next year will have to borrow perhaps $25 billion more than it had originally expected.

That was enough bad news to convince investors that interest rates, instead of falling as the Administration has long promised, are likely to be going higher. Says William LeFevre, market strategist for the Wall Street investment banking firm of Purcell, Graham & Co.: "It is simple. Confidence that interest rates were going to come down has just collapsed. People have given up waiting."

Higher interest rates, of course, are like a plague on the economy. They not only feed inflation by pushing up borrowing costs for business, but they crimp the ability of consumers to buy on credit, which cuts down spending on everything from homes and cars to vacations in the country. The result is lower corporate earnings, and that in turn drives down the value of stocks.

Once that prospect was clear, investors sold highflying stocks and weak performers alike. Oil stocks were among the biggest losers. A key reason was the failure two weeks ago of the 13-nation OPEC oil cartel to agree on a uniform price for petroleum exports.

The oil producers' troubles are expected to push down crude prices, which have already been sagging as the economy slows and consumption diminishes. One OPEC member, Nigeria, last week sliced $4 off the price of a barrel of its high-quality oil, bringing the cost down to $36 per bbl., and inviting price cuts from competitors like Libya and Algeria.

Lower oil prices mean lower profits for oil companies. Many companies own oil reserves in non-OPEC member nations, and thus get less for their petroleum and refined products when cartel prices drop on the world market. As a result, energy stocks themselves dropped. The price of a share of Getty Oil Co. slumped 6.2%, to 68 1/4 on Monday alone. Shell dropped 4 3/8 to an end-of-week low of 41 1/8. Phillips Petroleum dropped 7%, to 39 7/8.

The stocks of companies involved in the battered housing industry, which has suffered from soaring mortgage costs, also fell sharply. The shares of Georgia Pacific, a leading lumber producer, dropped 7.1%, to 22 7/8, while Ryan Homes Inc., a Pittsburgh home builder, dropped 5.2%, to 18 1/4. U.S. Home Corp. slumped two points, to 19 5/8.

Meanwhile, the bond market was also hit hard. Bonds have been slumping in value since last summer because of the expectation of ever higher interest rates, and last week they took another big dive. IBM triple-A bonds maturing in the year 2004 slumped 3.7%, to 68 1/2, thereby currently yielding 14.2% to any investor interested in buying them. Bonds of Mountain States Telephone, a Bell System subsidiary, dropped 3.1%, pushing the yield on long-term securities maturing in the year 2021 to 16.7%.

Government bonds, bills and notes fared no better than private issues. To attract buyers at its regular Monday auction of six-month bills, the Treasury had to boost the interest rate on the bills to a record 15.854%. Six months ago, it had to offer only 13.611% to sell the six-month bills.

Administration officials are now trying lamely to find explanations for the Wall Street debacle. Under Secretary of the Treasury Beryl Sprinkel and others argue that interest rates will begin to fall as soon as the Federal Reserve, which controls the nation's money supply, convinces the public that it intends to stand firm with a tight-money policy and squeeze inflation out of the economy. Says a key Reagan policymaker as he points to the infamous light at the end of the tunnel: "If the Federal Reserve can stick with it for six months, then its credibility will be re-established and down will come interest rates."

In fact, no one knows how long that process might take. Federal Reserve Chairman Paul Volcker has lately been sending out strong and convincing signals that the central bank intends to stand firm, but demands that the Federal Reserve ease up are already mounting. Conservative Economist Michael Evans of Evans Economics Inc. last week urged the President to declare an end to tight money. Said he: "The President should say to Mr. Volcker, 'Look, we've made good progress with this policy, but now it is threatening to throw the economy into a serious recession, and it is time to loosen things up.' " The President himself last week took an indirect swipe at the Federal Reserve, when he told a California political fund raiser that high interest rates were "hurting us in what we are trying to do."

But, for now at least, the Federal Reserve shows no signs of easing off its high-interest policy. Instead, there is wide suspicion among bankers that last week's inflation figure will make the Reserve more determined than ever to battle down high prices by keeping money tight.

If so, investors could be headed into some turbulent times. Says Lanston's economist Jones: "It may turn out that in the long run inflation will come down, and maybe some day interest rates will fall too. But the question now is, how much longer can the markets last?" Wall Street's stumble last week gave a sobering indication of what lies ahead if interest rates stay at the current levels or go even higher.

--By Christopher Byron. Reported by Barbara B. Dolan and Sue Raffety/New York

With reporting by Barbara B. Dolan, Sue Raffety/New York

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