Interest rates become investors' guessing game

By , Business and financial correspondent of The Christian Science Monitor

Next Christmas someone should market a new game: Interest Rates. The object of the game is to pick the peak in interest rates; not short-term peaks, but them peak. Penalties are incurred for calling the blips, and major losses are sustained for guessing the wrong trend.

Each player is armed with several billion dollars to invest and encounters a variety of calamities: Drought pushes up food prices; Congress decides to enact the infamous "Pork Barrel Act of the Decade," tacking on an extra trillion dollars in new spending; and the Federal Reserve Board discovers that its computer programmer was a plant from the KGB which has completely fouled up the nation's adding machines. Of course, there are other screnarios, too, such as perfect weather and bumper crops, a balanced budget, and a credible Fed. But that's no fun.

Guessing the peak in interest rates has been the biggest game on Wall Street for years. Only a week ago, for example, when rates were screaming upward, some observers were talking about a 25 percent prime rate; now, with some of the major banks peeling 1 percent off their prime, slipping it to 20 1/2 percent, there is talk of a 13-percent rate by mid-1981. It's like the old Wall Street joke: Only two men on Wall Street know for certain which way the market is going next year and they both disagree.

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If you want to be one of those seers, E. F. Hutton has issued an "Economics Alert" describing "How to Recognize the Peark in Money Market Rates." What Hutton says you should watch are: short-term business credit, money supply, and borrowed reserves.

Writes Dr. Edward yardeni, assistant vice-president and economist at Hutton, "Between early August and mid-November, commercial and industrial loans at large weekly reporting banks increased by a whopping $10 billion. This surge in loan demand was associated with an equally impressive rebound in money demand. The Fed accommodated enough of this money demand so that the money supply measures exploded." But since loan demand even outstripped the Fed's printing presses, interest rates soared.

More recently, loan demand has continued very strong. In the past three weeks it has steadily increased despite spiraling rates. Loan demand is expected to peak this week.

In the meantime, it appears the Fed has finally gotten a grip on the money supply. In the past three weeks, the growth in the monetary aggregates seems to have slowed considerably, and some experts are expecting a contraction in the new year.

Finally, on the borrowed-reserves front, a contraction appears to be under way as member banks borrow less from the Federal Reserve at the discount window -- an indication of increased liquidity.

Put it all in the hopper and what do you get? At least a stabilization in interest rates, if not a decline -- and if the trend continues, a decline. of course, as anyone on Wall Street will tell you, all this is subject to change without notice. And the rules of the game change all the time.

--stocks overvalued? Or are large-capitalized growth stocks undervalued?

--"positive" surprise potential in earnings in relation to general expectations? And which of these securities are truly undervalued?

--price-appreciation potential for investors in high-yielding securities?

Merrill Lynch, Pierce, Fenner & Smith Inc., the nation's largest brokerage house, hopes to be able to answer questions like these next month when it introduces a new research service with the heavy name of "Quantitative analysis." According to a Merrill Lynch research report, the new service deals with the risk-and-return relationship among equities, as well as the attractiveness of the equity market compared with the fixed-income market.

Merrill's analysis will include each of the 900 stocks it follows as well as specific industries and sectors. According to the report, "Each of the 900 securities is assigned to economic, yield, growth, capitalization, and risk sectors. These sector breakdowns will provide a valuation profile of the market that can easily be related to economic trends and market factors that influence stock prices."

In its approach, Merrill Lynch will value securities according to what it terms the "Dividend Discount Approach," short-term earnings expectations, and the relative strength of the company and industry. The dividend-discount approach tries to determine what the future dividend prospects of a company are and model that into a total-return (capital appreciation plus income) evaluation.

Since Merrill Lynch represents such a large segment of the market, it's worth noting what the firm is doing. In the past, its buy or sell recommendations have been known to cause major swings in the marketplace. The new service, a spokesman says, will begin Jan. 15.

Santa Claus came to Wall Street last week, carrying higher stock prices on his sleigh. The market staged a nice year-end recovery, gaining back 29.18 points after its disastrous losses in early December. Still, the close at 966. 38 left it below its peak of 1000.17 set in mid-November, when the market was more excited about President-elect Reagan. Last week also marked the start of tax selling (for a profit) for 1981. Losses can be taken until Dec. 31.

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