The peevish Summer of '77

Earlier this year, as the economic recovery picked up momentum, some savvy Wall Street professionals were predicting that stock prices would zoom and the Dow Jones industrial average would easily soar beyond the peak of 1,051.70 it reached in 1973. So much for savvy. Since January the stock averages have wobbled and worried their way down steadily. Last week the 1977 market's peevishness turned into something approaching panic, as a selling stampede slashed share values and drove the Dow down to its lowest level in 18 months.

The slide began early in the week, when both Exxon and U.S. Steel announced lower second-quarter earnings. Then on Wednesday came a shocker from Bethlehem Steel, which reported an operating loss of $75.4 million for the first half and cut its dividend. With that, the slide turned to slaughter: in frantic trading, the Dow plunged almost 20 points. For the week, it closed down 33 points, at 890.07, almost 10% below its January level.

Analysts seeking to explain the market's jitters could point to some cloudy economic news. The index of leading indicators, a widely watched barometer of future trends in the economy, dipped down slightly in June, casting some doubt on the durability of the present brisk expansion. Investors have also been puzzled by the slow progress of the Carter tax and energy programs in Congress; they have been concerned about the growing U.S. trade deficit and fretful that a big increase in the money sup ply in recent weeks might prompt the Federal Reserve Board to tighten credit and thus trigger a rise in interest rates. Another drag on the market: European investors, who have been nervous about the sinking value of the dollar (see following story) and the growing U.S. trade deficit. One analyst, William LeFevre, of Granger & Co., says flatly: "The market slump can be related to the dollar's weakness. Europeans are now selling, and they won't be back until we moderate those tremendous deficits."

Actually, there is much evidence around of continued economic strength. In the second quarter, corporate profits were up more than 11% over the same period last year. At General Motors, quarterly earnings exceeded $1 billion for the first time in the company's history. Real income of employees on non-farm payrolls is up, and housing starts are at near-record levels.

But a pesky psychological climate is overhanging the securities markets. Complains Hiram Moody, of the trust and investment division at New York City's Morgan Guaranty Trust Co.: "Everybody's hyper. I mean, first you are worried about the economy's going to be too strong and you are going to have inflation, and then you worry, my God, we are going to drop off into a mini-recession or worse. The worries change, but what remains constant is the worry --a generalized kind of worry, a malaise, a free-floating anxiety."

What nags institutional investors most of all is the realization that common stocks are no longer a safe hedge against inflation. Robert Salomon Jr., of Salomon Brothers, the New York investment banking house, has measured the compound growth of nine assorted investments from 1968 to June 1977, a period in which the consumer price index increased at an annual rate of 6.2%. His findings:

Chinese ceramics 23.2% Gold 16 Old masters 13 Oil properties 12.5 Coins 12.3 Farm land 11.1 Housing 8.6 Bonds 6.4 Stocks 2.6 Salomon argues that common stocks represent a great bargain at the present depressed prices. Recognizing that shares of many companies are selling at far less than the replacement value of their tangible assets, a number of chief executives have been using corporate cash to buy the assets of other companies at a discount rather than spend on new plant and equipment. Indeed, this is one reason capital spending has remained so stubbornly sluggish. The investment goals of the corporate swashbuckler and the average investor, however, are not necessarily similar. While cash tender offers abound, ordinary investors have been fleeing the stock markets. The number of individual Americans who own stocks is now about 25 million, a decline of more than 5 million since 1970.

With the small fry sitting on the sidelines, the institutions--pension funds, mutual funds, banks and insurance companies--are largely trading shares among themselves. And as the frantic action last week demonstrated, the managers of these big portfolios are a nervous group. One big reason for this is the 1974 Employee Retirement Income Security Act (ERISA), which gives pension-plan participants broad latitude to sue money managers for poor performance. Pension-fund managers now tend to place the preservation of capital above all other goals.

Result: many Wall Street professionals have abandoned any attempt to outperform the stock averages. Instead, they are spreading their investments through, say, the Standard and Poor's index of 500 industrial companies. In this way, they can do no worse than the average.

At present, a lot of portfolio managers are moving into fixed-income securities. Many corporate bonds now yield returns of 8% or more. Says Robert Wade, president of San Francisco-based Crocker National Bank's Investment Management Corp., which has 40% of its portfolio hi bonds: "I see a steady, glacial shift out of equities and into bonds."

Meanwhile, Wall Street is increasingly looking to politicians for help in bringing some spark back into the market. A good many brokerage executives hope that the Administration's tax reform will include the elimination of capital gains taxes on common stocks. Others believe that stocks would get a lift if Jimmy Carter kept his campaign promise to push for the elimination of double taxation on dividends. But what might help most of all would be some more convincing signs that those bad old days of high inflation and climbing unemployment are safely past. As Morgan Guaranty's Moody puts it, individual investors will return to stocks in force only when they believe "that we're not going back to the horror show of the mid-'70s."

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