Financial markets move cautiously

Nation's Business, Nov, 1996

Prospects for investors in the months ahead; the bottom line on taxable perks; tips on boosting your firm's value.

Like motorists traveling nervously through a busy intersection, investors are continuing to bid up stock and bond prices--cautiously. They remain wary of being broadsided, either by a slowing economy, which would hurt corporate profits, or an overheated economy, which would trigger inflation. Either scenario would be bad news for stocks and bonds.

That both concerns seem to carry equal weight on Wall Street is indicative of just how cautious--and jumpy--investors have become. Indeed they temporarily panicked in early July, sending the Dow Jones industrial average plunging from above 5,700 to below 5,200 over two weeks.

Since then, the market has resolutely reclaimed that lost ground, finally pushing the Dow to a new high above 5,900 on the first day of October. That impressive rebound allowed the average domestic stock mutual fund to post a total return of 2.61 percent for the third quarter, according to Lipper Analytical Services Inc., in Summit, N.J. The third-quarter results put the average domestic fund up 13.73 percent for the first nine months of the year.

Gary Anderson, a market analyst with Anderson & Loe Inc., a research firm in Eugene, Ore., says the market's July tumble had all the markings of a classic bear trap. Bearish investors who sold then must now buy back into the market at even higher prices or risk being stranded in other, lower-yielding investments. Their buying pressure will help push stocks to further gains.

"My suspicion is that the market will continue to go up until the more prominent bears have finally recanted, and then we can start worrying again," Anderson says.

Much of the market's worries during the third quarter centered on inflation and interest rates. The fear was that rising oil prices or upward wage pressures created by the low unemployment rate might ignite inflation, which would prompt the Federal Reserve Board to raise interest rates. (High interest rates dampen the economy, which weakens inflation.)

In mid-September, though, the Fed decided to leave interest rates untouched for at least two months, sparking a rally in the bond market that helped to encourage stock investors, too. The average taxable domestic bond fund posted a total return of 2.08 percent in the third quarter, putting it up 1.83 percent for the first nine months of 1996.

John Zaehringer, vice president and chief economist for Loomis Sayles & Co., a Boston-based investment counseling firm with $45 billion under management, says modest economic growth and inflation should keep the stock and bond markets healthy, but not ebullient, for the foreseeable future.

He predicts that the nation's gross domestic product will show a real gain (adjusted for inflation) of about 2.3 percent in 1996 and a like amount in 1997, and that inflation itself, as measured by the Consumer Price Index, will be about 3 percent for 1996 and 3.2 percent in 1997.

But an economy that grows too slowly would put pressure on corporate earnings, awakening investors' other fear: recession.

Zacks Investment Research, in Chicago, says analysts are already predicting that earnings for the companies in the Standard & Poor's 500-stock index will be up only 8.6 percent for this year vs. a gain of 16 percent in 1995. The analysts are, however, expecting earnings for those companies to rebound in 1997 with a gain of 13.3 percent.

"The market is going to be unforgiving with regard to earnings, so we have redoubled our efforts in that area," observes Stephen Canter, chief investment officer for Dreyfus Corp., a large mutual-fund company. "We want to be absolutely sure there are no disappointments [reported by companies in Dreyfus' stock portfolios] and pay extra attention to our valuation disciplines."

Neither Canter nor Zaehringer sees the stock or bond markets moving dramatically higher or lower as long as the current economic environment remains stable. Still, they say the market could suffer more day-to-day volatility as investors try to divine the economy's prospects through each new piece of economic data released by the government.

The Fed's decision to stand pat on interest rates, Zaehringer says, was "a recipe for continued volatility since the economy can drift one way or another relatively quickly"

Stock funds that performed especially well in the third quarter included those that focused on Canada, financial-services companies, technology issues, and natural resources.

Canada's stock market is dominated by natural-resources companies, and Derek Webb, manager of the GT Global Natural Resources fund (which earned investors 38.6 percent over the first nine months of this year), says funds in that sector did well both because oil prices have been climbing and because the oil-field service industry, after years in the doldrums, is growing again.

Although those funds probably won't be able to maintain their stunning pace much longer, Webb says the ones that buy fast/growing companies regardless of commodities prices should still do well.