Those Roaring Bulls

By Alexander L Taylor III

Signs of a cooler economy set off a record week on Wall Street

All day long, exuberant shouts and whistles exploded on the floor of the New York Stock Exchange. Tossed paper filled the air, and traders battled their way through small mobs to reach their posts. At midday the ticker slipped 13 minutes behind trading. In mid-afternoon brokers paused briefly to give a cheer when another record for market volume was broken. At one mad moment a message flashed across the exchange's electronic bulletin board that a planned fire drill was canceled because of the heavy trading. Roars of laughter mixed with the buy and sell orders.

Mostly it was buy. When the bell sounded to end trading at 4 p.m., John Phelan, the stock exchange chairman, appeared on a balcony above the exchange floor just as sustained cheering burst out, punctuated by yelps and Indian war whoops. Wall Street had just ended its busiest week ever, twice breaking records for trading volume as the Dow Jones industrial average surged ahead for an 87.46-point gain, the biggest weekly advance in history. "Nineteen years on the floor of the exchange, and I've never seen anything like it," exclaimed Daniel Pratt, a floor broker for Smith Barney.

Nor had anyone else. After moderately heavy trading on the first three days of the week, market volume on Thursday hit 172.8 million shares, smashing the previous one-day record of 159.99 million set on Jan. 5. The Dow Jones went up 31.47 points, the highest single-day increase in nearly two years. Then on Friday, traders came back ready for more. During the first hour after the market's opening, 72.6 million shares changed hands. By the end of the day, traders had obliterated their one-day-old record by exchanging 236.6 million shares. In the process they drove the Dow Jones up an additional 36 points. The Dow closed the week at 1202.08, its highest level since Feb. 2.

A Wall Street summer rally would seem to be just what the White House doctor ordered. For months Reagan Administration officials have been complaining that the financial markets were almost perversely ignoring the strong economic recovery. In some ways they were right. The U.S. economy today is perhaps stronger than it has been in two decades. Growth during the first half of the year was at an astounding annual rate of 8.8%, while inflation was a modest 4.1% on a yearly basis.

Nonetheless, Wall Street has insisted on going its own way. Since the first week in January, the Dow Jones has fallen almost steadily, from 1286.64 to a low point of 1086.57 on July 24. At each sign of a strong economy, the market seemed to drop defiantly. Economists study a myriad of obscure numbers to discern the state of the economy, but millions of Americans just look to the stock market--and what they saw did not jibe with the Administration's cheerleading. If the economy was so healthy, what was wrong with Wall Street?

The answer was that the financial world feared that Ronald Reagan's huge budget deficits would lead to rising interest rates and eventually slower growth. Wall Street does not live for tomorrow but for the day after tomorrow, and many investors did not like the higher interest rates and inflation levels they thought they saw ahead.

Then last week everything changed. Suddenly Wall Street was awash with optimists. "People are excited, very excited," said Michael Creem, vice chairman of the New York Stock Exchange. "They are smiling again after a long and difficult period." The Reagan Administration was also smiling. Said White House Spokesman Marlin Fitzwater: "It is the most important signal so far that the markets have some confidence in the long-term durability of the recovery."

Oddly, it was bad, or not so good, economic news that set off the August rally. The first poor report of the week was the announcement that the index of leading economic indicators, which attempts to predict the future performance of the economy, declined .9% in June, its first drop in nearly two years. That sign of slowing momentum was reinforced by figures on factory orders and housing starts. Orders received by companies fell 1.4% in June. New-home sales edged up only a fractional .6%.

The worst economic news of all came on Friday, when the Bureau of Labor Statistics announced that unemployment, which had declined steadily since its recession peak of 10.8% in December 1982, jumped .4% in July to 7.5%. Experts were surprised by the sharp increase, which could either reflect weaker growth or prove to be a statistical anomaly.

Another downbeat sign was a report from the Census Bureau that the U.S. poverty rate rose from 15% in 1982 to 15.2% in 1983, its highest level in 18 years. The bureau said the number of poor people grew to 35.3 million last year, from 34.4 million, an increase it called "unexpectedly high." The rise contradicted predictions of Reagan Administration officials that the economic recovery would bring prosperity to all groups of society. Democrats were quick to use the report to go on the offensive. House Speaker Tip O'Neill called it a "smoking gun" that proves President Reagan's budget policies hurt the poor.

The stock market's leap forward in the face of such bad news reinforced Wall Street's reputation as a financial fun house, where nothing is quite what it seems to be. Yet there was a curious logic in the market's reaction. Said Barry Berlin, an executive with Shearson Lehman/American Express: "The slowdown in the economy was the catalyst for the rally because it reduced fears of still higher interest rates. Inflation has been well contained, and now investors perceive continued earnings progress without the hindrance of rising rates."

While moneymen were whooping it up on Wall Street last week, they should have offered at least a silent toast to a man who conducts his business some 230 miles away: Federal Reserve Board Chairman Paul Volcker. It was Volcker's testimony before the Senate Banking Committee two weeks ago that is credited with returning optimism to Wall Street. Volcker announced at the time that the Fed was satisfied with the current economic growth and the inflation outlook, adding that the central bank would not be tightening monetary policy any further. That was seen as a sign that borrowing costs are likely to stay steady, rather than rise, during the next several months. The stock market almost immediately headed up. It gained 10.38 points the day Volcker testified, and it hardly looked back last week.

Volcker's comments answered a question that has plagued investors and professional money managers for months: Just what will happen to interest rates? Since January the prime rate has moved from 11% to 13%, pushing up the cost of borrowed money. Market watchers have feared that the Government's need for funds to finance the deficit and the loan demand of corporations trying to keep up with the quickly growing economy would force the Federal Reserve to tighten the money supply. The result: higher borrowing costs, which would cause depressed corporate profits.

The relief felt in the financial community from Volcker's comments was strong. Bond prices have been tumbling for months as interest rates climbed, but they immediately picked up after he spoke. The strong bond market helped set the stage for the stock rally. With some top-grade corporate bonds paying 13%, there has been little incentive to invest in the shares of corporations, where the dividends are lower and the risk of potential capital loss much higher. But when evidence began to pour in that bond yields had at least leveled off and might fall, stocks suddenly became more attractive.

Leading the charge into stocks were pension funds and other large investors. For the past several months, as the market fell, they have been gradually selling shares. But last week they moved back into stocks in a hurry, buying blue chips, transportation, technology and energy issues. Said Edward Yardeni, chief economist at Prudential Bache Securities: "What happened can only be characterized as a buying panic. Institutional investors decided they just could not afford to miss such a wonderful party."

Despite the excitement, market watchers were divided on how long the party would last. In the past their predictions have gone wide of the mark. A bull market began almost exactly two years ago on Friday, Aug. 13, when the Dow Jones stood at 776.92. The Dow went upward for ten months, until the middle of 1983, and forecasters confidently predicted it would reach 1400 or 1500. Instead, it then began drifting sideways. This year, while many money managers expected the market to pick up steam again, it sank instead. The price of an average share of stock on the New York Stock Exchange has fallen 25% this year.

The argument among investors and market watchers is whether they are witnessing just a brief spurt or a true second leg on the bull market that would take the averages even higher. John Paulus, the chief economist for Morgan Stanley, the investment banking house, had a note of caution. Said he: "The economy still has a good deal of upward momentum, which will have to be moderated by rising interest rates at some point. The gross national product rose 8.8% in the first half of the year and is now moving ahead at between 4% and 5%. That is still too rapid a rate to be consistent with stable inflation."

Others, however, were convinced that the summer rally will pay dividends in the fall. Robert Stovall, director of investment policy for Dean Witter, points out that during the past 38 years a summer rally has occurred 19 times, and the average gain has been 9.4%. From its low on May 29 of 1101.24, the market by the end of last week had risen just that much. In a few wild days, Wall Street had already enjoyed its summer rally. This week traders will try to push for new records. --By Alexander L Taylor III. Reported by Adam Zagorin/New York

With reporting by Adam Zagorin