The Bull Tops 2000
By George Russell
For years it was viewed as an almost impossibly small dot on the financial horizon, a historic goal to be pursued in frustrating fits and starts. Suddenly, in 1986, the target became closer and more tantalizing. As 1987 brought a fresh frenzy of trading on the New York Stock Exchange, everyone on Wall Street, as well as investors across the U.S. and around the world, was caught up in the drama: Just when would the Dow Jones industrial average gather its full force and break through the psychologically portentous barrier of 2000?
Last week, more than 14 years after the Dow leaped the 1000 mark, the big moment finally arrived. As Big Board floor traders cheered and filled the air with confetti, the closing bell rang last Thursday with the index solidly perched at 2002.25. Then on Friday, after briefly falling from its record height, the Dow rallied to its sixth straight gain of the new year and finished the week at 2005.91.
If shattering the 2000 mark was primarily a symbolic triumph, it was still the most exhilarating achievement yet in one of the longest and strongest bull markets in U.S. history. Since the advance began in 1982, stock prices have more than doubled, raining hundreds of millions of dollars of profits on investors.
On Wall Street, however, today's victories always make way for tomorrow's doubts. Will passing 2000 propel the Dow to still greater heights? Or will the rise run out of momentum now that the magic goal has been reached? (Students of stock-market history recall all too well that after the Dow passed 1000, it stalled for a decade before it cracked 1100.) And perhaps most important of all, why is the market so high when the economy continues to be so lackluster?
Considering such questions mere quibbles, many optimistic analysts are convinced that the crashing of the 2000 barrier is the start of another major market upsurge that might last anywhere from two to five years. That would be a truly extraordinary event, since the current bull has already lasted for 52 months, nearly twice as long as the 30-month average life of postwar bull markets. Nonetheless, declares Steven Einhorn, chief portfolio strategist for the Goldman Sachs investment house, "there is a lot of life left in this bull market."
Other sages of the investment community agree. One of Wall Street's hottest gurus, Georgia-based Robert Prechter, has used an arcane branch of analysis known as Elliott Wave Theory to predict that the Dow is on a march that will peak at 3600 by 1988. In December 1985, Yale Hirsch, editor of the newsletter Smart Money, forecast the date of the Dow's 2000 day within roughly a week. Now Hirsch predicts that the index may climb to 2300 within three months and reach 2700 later this year.
On the other hand, no less a figure than Liberal Economist John Kenneth Galbraith, writing in the January Atlantic Monthly, warns of parallels between the current breathtaking stock-market expansion and the pre-Crash era of 1929. Maintains Galbraith: "The question now, in the winter of 1987, is whether the stock market is or has been repeating its history . . . The wise, though for most the improbable course, is to assume the worst."
The strength of the Dow's performance last week, however, seemed to indicate that the worst, whatever it might be, is not yet in evidence. On Monday the 30-stock industrial index, which contains the securities of such prominent companies as IBM, Westinghouse, General Electric and General Motors, exploded with an unprecedented one-day rise of 44.01 points. That mark eclipsed the record of 43.41 set on Nov. 3, 1982. By the end of the week the Dow had climbed a total of 78.6 points, its best performance in ten months.
Significantly, the furious rally was not limited to the blue chips. Broadly based stock-market indicators scored spectacular gains as well. The Standard & Poor's index of 500 N.Y.S.E. stocks, for example, hopped up 12.28 points last week, to 258.73, a 5% advance compared with the Dow's 4.1% increase. In the all-electronic over-the-counter marketplace, an index of some 4,230 stocks quoted by the National Association of Securities Dealers rose 27.39, to 380.65, a 7.75% gain.
The bullish feeling seemed to be shared worldwide. At the Tokyo Stock Exchange, where the 225-stock Nikkei index climbed by 43% in 1986, investors followed the Big Board's lead in pushing the average up an additional 1.3%, to a record 18936.76. The London exchange, where the Financial Times 500-Stock Index rose 21% last year, also racked up new records.
One clear factor in Wall Street's surge was pent-up demand. As 1986 drew to a close, many investors had worried about a general sell-off of stocks caused by a rush to take advantage of low capital-gains tax rates that were about to disappear with the onset of tax reform. The sell-off, with an attendant sharp drop in stock prices, never materialized. Once 1986 was gone, investors apparently felt free to jump back into the market.
What makes the U.S. market's current performance particularly striking -- and somewhat puzzling -- is that the health of the rest of the economy is mixed at best. Overall growth is nothing to brag about and is expected to continue at only 2.5% in 1987. Despite expectations of improvement, the nation's trade deficit remains abysmal, running at year's end at an estimated $168 billion annual rate. Last week there was at least a little good news, as the Labor Department announced that the unemployment rate had dropped in December from 6.9% to 6.7%, the lowest level of last year, making the rate 7% for all of 1986. At the same time, Washington revealed that wholesale prices for the month had remained flat, indicating that inflation was firmly in check. Indeed, for the entire year wholesale prices actually dropped by 2.5%, the first decline since 1963.
The rising stock market is also a bit surprising in view of the tepid performance of many of the U.S. corporations whose shares are increasing in value. In 1984, for example, the 30 companies that make up the Dow industrials produced collective earnings of $120.43 a share. Last year the same firms earned only $118.40. Looking at projected 1987 corporate profits for the entire U.S., Morgan Stanley Economist Stephen Roach predicts a dismal earnings drop of 16.1% in the first quarter.
But this bull market has never been driven by corporate profits. Instead, it has been fueled principally -- some would say only -- by the decline in U.S. interest rates. Every fall in rates makes bonds and other fixed-income investments seem less attractive to investors and thus increases the desirability of common stocks. In the past two years, for example, the return on 90-day Treasury bills, ordinarily a staple for conservative investors, has dropped from about 9.5% to 5.5%.
If the bull market has a father and protector, the honor can be claimed by Federal Reserve Chairman Paul Volcker. When the Dow hit a trough of 776.92 in August 1982 and the economy seemed hopelessly trapped in a recession, Volcker and his colleagues at the Fed were convinced that interest rates had to come down. No sooner had they loosened monetary policy than investors came storming back into the market. And as interest rates kept falling, the bulls kept buying. By November 1983 the Dow had reached a high of 1287.20. For the next year, the index more or less stagnated, partly as a result of uncertainty about the outcome of the 1984 presidential elections. After President Reagan's landslide victory, the bulls started stampeding again. By January of 1986, the Dow had climbed to 1502.
Then came the biggest three-month burst in stock-market history. The Dow roared to 1856 in April, sparking tremendous euphoria on Wall Street. Just as suddenly, the market then began to dipsy-doodle, going through unprecedented one-day drops and climbs, including the worst ever single-day fall on Sept. 11 (86.61 points). The eye-popping volatility of the market was made possible by the steadily increasing computerization that allowed hundreds of millions of dollars to flush through the markets at the push of a button. But for all the action, the Dow managed to spend most of its time in the region of about 1880.
When the bulls made yet another return at year's end, they owed thanks once again to the Fed. "There is a lot of fresh money in the marketplace," said one happy Wall Street broker last week -- and Volcker's current policies get much of the credit for its presence. For months, the economy's relatively sluggish growth has stirred fears of recession, and that in turn has spurred the Fed to allow the money supply to expand rapidly. Interest rates have thus continued to fall, and investors seeking a healthy return have turned back to stocks. Says Sam Nakagama, president of Nakagama & Wallace, a Wall Street consulting firm: "The forces of expansion at this point are quite powerful."
The tumble in interest rates, many economists agree, may be far from over. John Paulus, chief economist at Morgan Stanley, predicts a further drop in interest rates on Government securities of almost one percentage point in 1987, sending the return on a 90-day Treasury bill, for example, from the current 5.5% to 4.5%. Such a decline would probably prompt a further move into equities.
Partly because of those anticipated expansionary policies, many analysts foresee a tide of money pouring into stocks. An estimated $950 billion worth of stocks was traded on the N.Y.S.E. during 1986. Some analysts have speculated that as much as $450 billion more could flow into U.S. stocks over the next twelve months from such sources as pension funds, money-market-fund investors and companies that are buying up their own shares to avoid takeovers.
Another increasing source of fresh capital in the bull market is money from foreign investors. In the view of Goldman Sachs' Einhorn, foreigners have become the "single largest group of net buyers of U.S. common stocks." In 1986 such investors, largely from Western Europe, bought anywhere from $25 billion to $30 billion worth of additional U.S. equities. This year the total could reach $40 billion. Foreigners remain interested in American stocks even at a time when overseas stock markets are booming, largely because their own markets are much smaller than those in the U.S.
Some analysts, however, see less money flowing into the market than others. Morgan Stanley Economist Roach, for example, warns that increasing levels of installment debt may crimp consumer spending this year, dampening the economy even further than predicted. Roach forecasts growth this year of 1.8%, well below the 2.5% expected by many other economists. Allen Sinai, chief economist of the Shearson Lehman Bros. investment house, warns that the same consumer- debt problem may prevent households from putting their savings from income tax reform into the stock market. Says he: "Consumers are still likely to be retrenching before responding."
The fact is that however closely the continuing bull market is parsed, dissected and analyzed, it will still retain its capacity to confound the experts, just as it has done so often in the past. That leads some analysts, as in the past, to resort jestingly to whimsical or far-out market tools. One current favorite is the Super Bowl theory. It holds that whenever a team from the original National Football League wins the championship crown, the stock market rises for that year; whenever a team from the old American Football League triumphs, the market falls. As ridiculous as this pigskin prognostication may appear, the Super Bowl indicator has proved to be right in 18 of the past 20 years, based on the Dow's performance. The theory worked to perfection last year when the Chicago Bears, of the original N.F.L., trounced the New England Patriots. But as the Bears discovered anew in their upset loss in this season's playoffs, glory on the gridiron can be fleeting. No less unpredictable, indeed, is the outcome of the contests that are waged on the rough-and-tumble playing fields of Wall Street.
With reporting by Frederick Ungeheuer/New York