Election Elation on the Street

By Charles P. Alexander

The stock market signals a recovery with a record-breaking surge

The financial markets hate surprises. For that reason Wall Street was even edgier than usual on the eve of a crucial mid-term election that might generate a sudden shake-up in national economic policy. But when the news came from the polls that the Republicans had kept control of the Senate and lost no more House seats than expected the New York Stock Exchange was overwhelmed by relief--and euphoria.

By 1 p.m. on the day after the election, the Dow Jones industrial average was up 26 points, to 1048. Suddenly the Dow was within easy striking distance of a record that had stood unsurpassed for nearly a decade: the peak of 1051.7 reached on Jan. 11, 1973. For about two hours the average slipped, as it has every time the record has been threatened in the past. Then, like a long-distance runner sprinting those last yards toward the tape, the market surged ahead by 20 points in the final hour. When the closing bell rang amid the boisterous cheers of the floor traders, the Dow had climbed to an alltime high of 1065.49. The rise of 43.41 points on the day was also a new record, eclipsing the 38.81-point increase of last Aug. 17.

Leading the buying charge were the big institutional investors, including pension funds, insurance companies and bank trust departments. Scared of being caught on the sidelines during Wall Street's greatest rally, portfolio managers snapped up stocks at a panic pace. Their favorites were the blue chip shares of giant corporations. IBM was up 3 3/8 to 85 1/4. AT&T jumped 2 1/4, to 62 3/4.

Once the Dow's record high had been broken, the institutional investors got the jitters. On Thursday thousands who feared that the rally might stall decided to take their profits while they had a chance. But individual investors, many of whom were jumping back into the market for the first time in years, continued to buy with abandon. As the deluge of orders poured in, the electronic tape that records trades lagged behind by as much as 64 minutes. When the selling frenzy ended, the Dow average of blue chips had lost 15 points during the day. Hundreds of second-tier stocks, however, continued to rise. The immense trading volume of 149.4 million shares broke the one-day record of 147.1 million set on Oct. 7. On Friday the Dow rested. It eased ahead by 1.56 points to finish at 1051.78, up 60.60 for the week.

Several encouraging economic trends have sparked and sustained the rally, which has pushed the Dow up by an astounding 275 points (35%) since mid-August. Inflation slowed to an annual rate of only 2.4% in September, a crawl by comparison with the 8.9% pace of last year. Because prices are rising less rapidly and the Federal Reserve Board has eased its monetary policy, interest rates have dropped sharply in the past three months. The bench-mark prime rate charged for corporate loans, for example, has dipped at some banks to 11.5%, from 16% in July. Investors are increasingly confident that this dramatic progress on the inflation and interest-rate fronts will spur a brisk economic recovery next year.

The markets appeared to be elated that the election outcome seems unlikely to bring about any major shifts in economic policy. Some financial analysts were concerned that if the Democrats gained control of Congress, the lawmakers might enact a big emergency spending program to create new jobs. That would speed up the recovery, but could also rekindle inflation.

Security analysts, though, are not entirely satisfied with Reaganomics. Their chief worry is the ballooning federal deficit, which threatens to swell past $175 billion this year. They hope that a few more Democrats in the House will force the President to compromise on the budget, perhaps by scaling back his demands for huge increases in defense spending. Says Edward Yardeni, chief economist for the Prudential-Bache brokerage house: "Investors did not want a rejection of Reaganomics, but they wanted a policy that was a little more flexible, a little more toward the center."

Many chief executives of major corporations agreed with that view. "The President is going to have to make more trade-offs," says David Mahoney, chairman of Norton Simon. "Both parties need to ignore extremes and concentrate on getting the economy rolling again." Asserted John Nevin, chairman of Firestone Tire & Rubber: "There will be a more pragmatic attitude toward intolerable budget deficits."

Jubilant Administration officials saw the rally as a rousing endorsement of the President's policies. Said Treasury Secretary Donald Regan: "The stock market is bullish on America. The seeds of economic recovery planted last year are now bearing fruit." There was more than a touch of irony in the Administration's praise of the stock market's wisdom. Only about 18 months ago, when share prices started falling, President Reagan said, "I have never found Wall Street a source of good economic advice."

The financial markets may be signaling a rebound ahead, but few signs of it can be found in the industrial heartland. Despite the break in interest rates, company profits for the third quarter were down by about 21% on average from the same period a year ago. Many recession-battered firms in such bedrock industries as mining, steel and autos suffered stunning losses. Aluminum Co. of America ran a $14 million deficit, Bethlehem Steel Corp. lost $209 million, and Ford Motor Co. $325 million.

As their earnings have sagged, corporations have been forced to let more and more workers go. The Department of Labor announced last week that the unemployment rate had risen in October from 10.1% to 10.4%, its highest level since 1940. In the auto industry alone, some 250,000 employees, or 21% of the unionized work force, have been laid off indefinitely.

Companies are bedeviled not only by the slump in the U.S. economy but also by tough competition from abroad. Foreign firms have captured 21% of the U.S. steel market and 28% of American car sales. Moreover, the surprising strength of the dollar is intensifying the threat from overseas. The decline in the U.S. inflation rate has helped bolster foreign confidence in the value of American currency. In the past two weeks the dollar has reached record highs against the French franc and the Italian lira. As a result of the dollar's rise, imports have grown steadily cheaper to American buyers and U.S. exports more expensive to foreigners. The Commerce Department reported last week that the U.S. trade deficit hit a record $13.1 billion in the third quarter.

Even in the face of this bad news, many economists believe that Wall Street's optimism may be somewhat justified. As interest rates drop and lower inflation boosts purchasing power, more and more families will be able to afford the homes, autos and appliances that they have been forgoing for three years. Says Norman Robertson, chief economist for Pittsburgh's Mellon Bank: "Once we pull out of this recession, I think there could be a sharp burst of consumer spending."

Although rising unemployment is tragic for those losing jobs, the layoffs have made many companies more efficient. As a result, productivity has risen sharply. Jack Lavery, chief economist at Merrill Lynch, predicts that corporate profits may rise by 16% next year and 26% in the first quarter of 1984.

Slowest to recover will be the capital-goods companies that produce the materials and machinery for building and equipping new factories. Since American industry is operating at only 69% of its capacity, it will be a long time before many firms think about expanding. Otto Eckstein, chairman of the Data Resources economic consulting firm in Lexington, Mass., forecasts that capital spending will fall by 5% this year and 4% more in 1983.

Despite the mixed economic signals, some financial analysts believe that Wall Street is in the early stages of its longest and strongest bull market in history. They point out that the Dow average when adjusted for inflation is no higher now than it was in the late 1930s. By that standard, stocks are still way undervalued. David Bostian, who heads his own Wall Street investment management firm, predicts that the Dow could eventually reach 1400 to 1500. Other market watchers are more restrained. "This surge makes me wonder how long it can go on,"says Robert Fomon, chairman of E.F. Hutton. "I think it will continue, but you have to expect a correction at some point." Says Stanley Shopkorn, a managing director at the Salomon Brothers investment banking firm: "We could see this market go up another 100 points or just 100." as easily Nagging we could doubts see it about drop the by economy's future keep most analysts from making hard predictions. The bulls of Wall Street are confident that a rebound is on the way, but they are far from certain how robust--and lasting--that certain how ro recovery will be. --By Charles P. Alexander. Reported by Adam Zagorin/New York

With reporting by Adam Zagorin

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