Wall Street's Merry-Go-Round

By Stephen Koepp

Until last week, many Wall Street investors thought the fun was over. The extraordinary bull-market surge that began last September seemed to have sputtered as of April 21, when the Dow Jones industrial average hit a peak at 1855.90. Between then and May 19, the Dow plunged 97.72 points, to 1758.18, losing more than 5% of its value. But when Wall Streeters returned to their command posts, computer terminals and telephone consoles after the Memorial Day hiatus, they happily resumed some unfinished business: a dizzying bull- market comeback.

The first sign of a rebound came in the two trading days before the holiday, May 22 and 23, when the Dow jumped a total 48.12, to 1823.29. Since Wall Street customarily quiets down before a long weekend, many investors had to scramble to take part in the sudden rise. "There's no doubt it caught them absolutely by surprise," said Eugene Lerner, a professor of finance at Northwestern University and president of a Chicago investment-management firm.

Even so, the steep upward direction of stocks prompted traders to hang on to their investments over the weekend rather than sell them off to lock in profits. The mood was still ebullient when the market reopened. The Dow leaped 29.74 on Tuesday and 25.25 on Wednesday to a record 1878.28. The unprecedented four-day rise was 103.11, which more than recouped the index's recent losses. The Dow inched ahead 4.07 on Thursday to set another record close and then slipped back 5.64 on Friday to end the week at 1876.71.

Many investors believe that the market is now taking off on another leg of its stampede toward the 2000 mark. Says Thomas Kelley, chairman of BankAmerica's investment-management subsidiary, which handles about $15 billion: "It was so obvious the market was going to come back." Notes Richard Goforth, a broker for the Los Angeles investment firm Crowell, Weedon: "People feel like we're in a good bull market that's going to last for another year or so."

The latest rally seemed all the more remarkable because it happened without one of the usual triggering events, like a sudden drop in interest rates or oil prices. Instead, investors took heart in expectations of robust economic growth this year and an anticipated rise in corporate profits. They were reassured about their hunch later in the week when the Commerce Department reported that its index of leading indicators, the Government's primary gauge for forecasting business trends, jumped 1.5% in April; it was the best performance since October 1983. Said David Wyss, an economist with the Data Resources forecasting firm: "Now that we've had three months in a row of strong increases, that's very good news for the summer economy." President Reagan, in a speech to the National Association of Manufacturers, hailed the statistic as a signal of "good times ahead."

The market might not have reached such heights last week, though, without some attention-grabbing moves by a few blue-chip companies. IBM, Celanese and Philip Morris all skyrocketed in price after each firm offered to buy back large blocks of stock from investors. IBM, which announced plans on Tuesday to buy as many as 10 million of its 616 million outstanding shares, saw its stock jump 4 3/8 the next day, to 151 3/8. The stock buy-backs indicated that the companies thought their shares were priced too low, which signaled to investors that perhaps other stocks in the market were bargains too.

Wall Street's near euphoria about the Dow masked its uneasiness over a widening insider-trading scandal. The market's once thriving trade in hot tips has stalled since May 12, when the Securities and Exchange Commission accused Dennis Levine, a merger specialist for the Drexel Burnham Lambert investment firm, of illegally using privileged information to reap $12.6 million in stock-trading profits.

The Government's continuing crackdown last week netted five more suspects, all in their 20s, in a separate scam. A federal grand jury indicted Michael David, a former associate with a Manhattan law firm, on charges that he stole information from his employer about prospective mergers and passed it along to two securities analysts, a stock broker and a private investor. In one case, David and two of the others allegedly used the inside information to earn $140,000 in three days by buying stock options. The accused, three of whom reportedly share an apartment on Manhattan's pricey Upper East Side, could face prison terms of five years if they are found guilty.

The probe has produced some anxiety among investors but apparently not enough so far to change their long-standing bullishness. The Dow has been climbing since August 1982 when, at 776.92, it started its long-term upsurge in anticipation of the economic recovery. It then slept through most of 1985 but began another big charge last September at 1297.94, inspired by sharp declines in interest rates and oil prices. Many investors think further rate - declines could be on the way, since inflation at the moment is virtually nonexistent. During the past three months, consumer prices have actually fallen at an annual rate of 4.3%, the strongest deflation in 37 years. Henry Kaufman, the influential chief economist for the Salomon Brothers investment firm, predicted last week in a speech to bankers in Switzerland that the industrial countries may embark on another round of interest-rate cuts, possibly this month, to stimulate growth.

More important, though, is that Wall Street boomed last week without waiting for any new rate breaks. This could mean that investors have begun to lose their high sensitivity to interest rates and are instead finding encouragement in other developments. One such prospect is the Senate Finance Committee's proposed tax-reform bill. While it would boost the total corporate burden by curbing deductions, it would also reduce the maximum business tax rate from 46% to 33%. That will allow many heavily taxed companies, which have never been able to claim large deductions, to enjoy a hefty increase in after- tax profits. Another welcome feature of the reform bill is its near abolition of tax shelters, which should encourage people to put their money back into stocks.

Many investors look forward to the continuation of a vibrant economy. After the gross national product expanded only 2.2% in 1985, growth revived to a healthy 3.7% annual rate during this year's first quarter. Says Allen Sinai, chief economist for the investment firm Shearson Lehman Bros.: "There is widespread expectation of renewed expansion and rising corporate profits." Edward Yardeni, chief economist for Prudential-Bache Securities, predicts that the economy will expand at a 4% rate during the year's second half.

The growth will be bolstered by the strongest housing boom in nearly a decade, which was sparked by low mortgage rates. Though new-home sales slipped by 3.5% in April, compared with the previous month, they remained 33% above their rate of a year earlier, according to the Commerce Department. The housing surge will stir consumer demand for many other products. Says Yardeni: "More houses mean more appliances, carpets, furniture and cars as yuppies move out of the city and into the suburbs."

Another spur to growth could be an easing of the trade deficit. The Commerce Department announced last week that the gap between imports and export narrowed sharply in April, to $12.1 billion, down 16.6% from March, thanks in part to the lower cost of imported oil. The trade deficit may also be showing the effects of the decline in the value of the dollar over the past year. That drop has made imports more expensive and American products cheaper overseas. Because of this change, the trade deficit is expected to continue to improve over the next year or so.

One especially reliable source of fuel for the bull market is the takeover boom. Each major acquisition shrinks the pool of stock on the market and boosts interest in other potential takeover candidates. Says Harvey Eisen, president of Integrated Asset Management, which handles accounts worth $1.1 billion: "In the current year, we've had more than half a dozen takeover targets in our portfolio." Among them: Sperry, Quotron and Leaseway Transportation.

One concern of investors is the seismic dimensions of the market's sudden movements. Since March the Dow has had nine one-day swings, either up or down, of 30 points or more. Generally, only the big-time investors with elaborate computer-trading setups are able to profit from these short, volatile changes in direction. Says Ira Kaufman, chairman of the Chicago brokerage Rodman & Renshaw: "I think the market's going higher, but I'd like to see it do so in a more orderly way, rather than in two or three weeks or days." Adds Northwestern's Lerner: "If you respond to these short-term emotional things without having discipline, I guarantee you'll lose a lot of money."

The volatility should be dampened somewhat by the return to the market of more small investors, who tend to leave their money in one place longer than portfolio managers do. Individuals by the millions have been switching to stocks and mutual funds because of their growing dissatisfaction with the shrinking returns on money-market accounts. Richard Bonner, a flower grower in Fallbrook, Calif., near San Diego, happened to boost his stake in the market just one day before the 100-point surge began. He then watched in delight last week as his $150,000 portfolio blossomed by an additional $6,000 in just a week. Said he: "I think the market's headed higher. It's the place to be." Gerald Butrimovitz, a San Francisco biotechnology consultant, has felt confident enough to increase his stock holdings 40%. He has invested primarily in mutual funds that specialize in small, over-the-counter stocks and foreign securities.

Despite the giddy gains, almost everyone is investing with an eye out for so-called corrections, when the market reverses course temporarily. Investors see that caution as a healthy sign; if too many of their kind were blindly optimistic, the market could set itself up for a big fall. "There is widespread disbelief, and that's the sign of the best kind of advance," says Newton Zinder, E.F. Hutton's senior market analyst. In fact, the recent one- month slump, triggered in part by a brief upsurge in oil prices, makes investors feel better because they have it out of the way, like a dose of castor oil. Says Donald De Lutis, a money manager at San Francisco's Robert C. Brown investment firm: "I think 5% to 10% corrections are part of the normal activity of a great bull market."

Many investors feel compelled to go along with the stampede even if they doubt the common wisdom behind it. Says Mason Sexton, president of the market-forecasting firm Harmonic Research: "I have been urging investors since September not to stand in the way of this beast. Wall Street is littered with the bodies of traders who underestimated the power of this bull market." Others see a worrisome possibility that the stock market will lose any realistic relationship with economic growth. Says De Lutis: "If the market has a substantial rise and gets way ahead of the economy, then it would be a risky situation." In the months ahead, high-riding investors may want to look back over their shoulders occasionally to make sure the rest of the country is following along.

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With reporting by Charles Pelton/San Francisco and Raji Samghabadi/New York