The Bulls of Summer

By Frederick Ungeheuer

Some Wall Streeters are experiencing acrophobia. Others talk of vertigo. Whatever the buzz word, the feeling is the same: stock speculators have suddenly become woozy about the market's new heights. After a 230-point rise in 1988, the Dow Jones industrial average has zoomed more than 500 points this year, 200 just since the beginning of July. "I've been on this trading floor for 39 years, and I've never seen a market go up so fast for so long without a major break," said Donald Stone, a specialist in consumer stocks on the New York Stock Exchange.

Propelled by good economic news, the Dow pushed ahead an additional 30 points last week in volatile trading, despite heavy profit taking in the final hours Friday. The Government announced that wholesale prices in July fell 0.4%, their biggest monthly drop in three years, which signaled that inflation is ebbing. During the same month, retail sales rose 0.9%, a surge that reassured investors that the economy has not stagnated. Before closing at 2683.99 for the week, the closely watched index briefly topped the all-time record of 2722.42 it set on Aug. 25, 1987. That was the heady peak from which the Dow began its steepest slide in history, culminating in the 508-point crash on Oct. 19.

Now that the Dow has made a nearly 1,000-point recovery in just under two years, Wall Streeters are asking, Can it happen again? Is this boom any different from the last one? "Stock prices have been climbing a wall of worry," says Robert Farrell, the chief market analyst at Merrill Lynch, who sees "a significant correction on the horizon."

In their long stampede, the bulls have managed at least temporarily to overcome their fears about the U.S. budget and trade deficits. Despite a dramatic slowdown in growth, they have been looking on the economy's bright side. "Investors now believe the Federal Reserve Board can deliver a 'soft landing' of subdued inflation by year-end, without a recession," says Byron Wien, chief domestic strategist for the investment firm Morgan Stanley, who since May has been predicting a new all-time high on the Dow. Elaine Garzarelli, a portfolio manager at Shearson Lehman Hutton, who was one of the few forecasters to warn of the crash in 1987, believes the Dow will top 3000 before the end of the year.

The Dow, in fact, has been at the back of the thundering herd of market indexes, partly because it is made up of blue-chip issues favored by relatively conservative investors. Broader market indexes including Standard & Poor's 500 and the Wilshire 5,000 had already reached all-time record levels by early August. Says Justin Mamis, chief strategist for the investment firm Cowen & Co.: "All the Dow can do now is put the lipstick on." The allure of stocks is broadening rapidly as more and more investors join the stampede, which is demonstrated by the big increase in the market's volume. The average daily number of shares traded on the N.Y.S.E. was about 200 million last week, in contrast to a daily average of less than 170 million so far this year. "In August, when many traders are away, this is very unusual," notes Shearson technical analyst Philip Roth.

True-believing bulls think the market rally is based on sound fundamentals, not just glamour and giddiness. Says Martin Zweig, a stock guru who turned bearish just before the 1987 crash: "I'm moderately bullish now. It's a different market." During the fall of 1987, Wall Street faced a sudden array of outside threats, ranging from potential war in the Persian Gulf to congressional attacks on takeover activity. Another catalyst of 1987's slide was a rise in interest rates, which threatened economic growth and siphoned money away from stocks and into interest-paying investments. Two years ago, yields on 30-year Treasury bonds were heading toward 10%; last week they stood around 8% after dropping all year.

Above all, the euphoria of the '87 rally pushed it to extreme heights in relation to the basic measure of stock value: corporate profits. Since the crash, the income of stock-issuing companies has risen 40%, giving them a much larger ratio of earnings per share. At the Dow's current level, its stocks are selling at 13 times their annual earnings, vs. 21 two years ago.

The Dow is getting another boost from the strengthening dollar, which has made U.S. stocks attractive to foreigners. Reason: overseas investors are getting a double dose of appreciation, since both the rally and the rising dollar are driving up the value of their holdings. At the beginning of summer, major Japanese brokerage houses including Nomura and Daiwa stopped shunning U.S. stocks and began buying in earnest. "During the past three months, Japanese investors have bought $7 billion worth," estimates Seiyun Nakao, co- director of Nomura Research in Manhattan. Almost every day last week Nomura alone bought 1.5 million shares of U.S. blue chips.

The prices of U.S. stocks now seem quite reasonable compared with issues on the inflated Tokyo exchange, where shares are selling at six times the Dow's ratio of price to earnings. Even so, Japan can well afford its buying binge at home and abroad. The country is awash in more than $1 billion of fresh savings every day, which keeps the Tokyo market index near the all-time high it achieved late last month. "In this kind of liquidity, I think it's crazy to be scared of another crash," said Noboru Terashima, a senior analyst for Shearson in Tokyo.

London, the world's third largest stock market, is still lagging behind Tokyo and New York, despite a 28% gain for the year on the 100-stock Financial Times index, better known as Footsie. Closing last week at 2354, the London index remains well below the record of 2443 it reached three months before the October crash. Since the crash, says Charles Larkum, a senior strategist at the James Capel investment house, "every morning London looks at where Wall % Street closed before it decides what it's doing. Both markets waited through much of '88 to see when Armageddon was coming, and when it wasn't, they decided they had a bit of catching up to do." One reason London is taking its lead from Wall Street is that, because of British corporate acquisitions, more than 20% of the profits of London's 100 bellwether companies are earned in North America.

But even as investors take comfort in sound fundamentals, they look with alarm at the return of the greedy speculation and electronic sorcery that are blamed for the crash. The market has reacted with near hysteria to the possibility of takeovers, first in the communications industry in response to the Time-Warner deal and now in the airline business in the wake of bids for the companies that own Northwest and United Airlines. The takeover-stock mania has coincided with the return of program trading, a system in which brokerage houses use computers to buy and sell giant blocks of stock to reap quick profits from disparities in price between the equities and futures markets. Restrictions on program trading were imposed after the crash to limit the market's volatility, but have since been removed.

Another reason for nervousness right now is the too-good-to-last superstition. "This could be the eighth up year in a row," says Morgan Stanley's Byron Wien. "That's never happened in this century." During this bull cycle, U.S. stocks have produced a compounded 17% annual return, almost twice their historic 9% average. Even during the crash year of 1987, the Dow managed to rise 3%.

Some analysts are encouraged that investors have been going back into the market slowly and cautiously, in comparison with the mob scene in mid-1987, which made everyone skittish and panic-prone. That is not the mood this time around -- at least, not yet -- and markets rarely hit their peak until all types of stocks are overbought, professionals become exuberant, and even small investors are snapping up stocks with abandon. Peter Lynch, manager of Fidelity's $11.5 billion Magellan mutual fund, recalls that "in the summer of 1987, torrents of cash were coming at us out of money-market funds." There is only a dribble this year.

So far, most of the stock buying has been done by corporations through stock-repurchase programs, mergers, leveraged buyouts or employee-stock- ownership plans. All told, such buybacks have reduced the supply of shares on the market by a record $94 billion during the first half of the year, or nearly 4% of all outstanding stock. The buyout of RJR Nabisco alone took $25 billion worth of stock off the market, while the acquisition of Warner Communications by Time Inc. will reduce supply by another $14 billion.

The shrinkage of available stock has helped increase the value of all shares, since equities are becoming a little bit like land, which Will Rogers once said was his favorite investment "because they ain't making it anymore." But at current stock prices, a whiff of recession or a flare-up of inflation and interest rates could make stocks about as popular as beachfront property in hurricane season.

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CREDIT: TIME CHART BY JOE LERTOLA

CAPTION: Dow Jones Industrials

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CAPTION: WALL STREET STYLE, THEN AND NOW

With reporting by Peter Shaw/London and Norihiko Shirouzu/Tokyo