Wall Street pauses to ask, How high?

It's the biggest bull market since 24 merchants and brokers began trading US government securities around a buttonwood tree on Wall Street 190 years ago.

The Dow Jones industrial average had streaked 236 points since Aug. 12 - the fastest and biggest move ever. Billions of dollars of paper profits were produced. Stockbrokers could hardly keep up with the record-breaking volume.

Now, with the blue-chip average having breasted the 1,000 level once again, investors are asking both how high the market can go and when the economy will start to make the dramatic recovery anticipated by stock prices.

As these questions bounced along Wall Street's canyons, the market continued to get its fuel from lower interest rates. Morgan Guaranty Trust lowered its prime interest rate to 12 percent Tuesday. Other banks followed, and more are expected to, since the Federal Reserve Board has lowered the discount rate to 10 percent and indicated it would change how it measured the nation's money supply. Monte Gordon, director of research at the Dreyfus Corporation, a mutual fund company, pointed out that these lower rates will be absorbed quickly by the economy.

''The economy is like a parched sponge,'' he said. ''It can absorb huge amounts of money without a quick response.''

In fact, to some investors the economy will remain parched despite the dollops of money introduced into the system by the Federal Reserve Board.

Walter Peters, president of the Unicorn Group, a money management concern that looks after $1 billion in foreign and domestic money, noted that ''there is no economic recovery in sight so far as we can determine.'' But, he adds, so far this hasn't deterred investors from plunging headfirst into the market.

Historically, points out William LeFevre, an investment strategist at Purcell , Graham & Co., the average bull market has run about 31 percent before profit taking - known on Wall Street as a ''correction'' - takes place. Such profit taking has already begun to buffet the market. Yesterday stock prices, under selling pressure all day, were down 9.11 to 1003.67.

Adding to the pressure was some preprogrammed selling done by institutions once the Dow average reached 1,000, regarded as a danger zone by some investors.

Gary Capen, executive vice-president of St. Paul Advisers Inc., says his strategy has been to sell weaker stocks when the market has been rising. ''We're not going to raise our cash level just because the market is going through a correction,'' he said.

Mr. LeFevre, who has studied the Dow averages assiduously, said such corrections have generally been about 44 percent of the first rise. Thus, an average correction would lower this market by about 105 points before the market resumed its upward march.

In the past, he continued, such bull market moves have averaged 57.9 percent from the market lows. This would take the Dow to a peak of 1,226. The ultimate peak, he said, fudging, ''could be higher or lower.''

Some investors believe the market will continue to soar. Mr. Peters of the Unicorn Group said, ''We believe the market has a ways to go on the upside. The institutions who have missed this rally since August will continue to be supportive, buying stocks at this level. ''Should the economy not turn around in the next four to six months,'' he adds, ''the market will reverse itself.''

President Reagan has announced that the dramatic rally on Wall Street is a vote of confidence in his economic policies. In a speech in Dallas on Monday, he called the stock market surge ''a leading indicator of the economy'' and said investors' ''commitment to put cold, hard cash on the line signals a vote of confidence in America's future.'' The President is expected to repeat this theme again when he gives a speech on the economy today.

Wall Street's traders, however, are less sure. ''I don't think President Reagan's responsible for this rally,'' said Mr. Gordon of the Dreyfus Corporation, with a chuckle. ''The market's not up on the premise Reaganomics is working. The deficit is still there and industry is working at 70 percent of capacity.'' Rather, Mr. Gordon said, ''The thing that's changed is the attitude of the Federal Reserve Board.''

But Frank Parrish, senior vice-president of the Boston-based Fidelity Management Trust, which runs $500 million, said he believes that ''getting inflation down was a big part of getting the stock market up.'' He went on, ''The tax structure helped psychology. And we're only talking psychology, since there are no fundamentals to push the market up like this.''

Contrariwise, Mr. Gordon figures that the main reason inflation is down is the recession. Oil prices, housing prices, and farm prices have all fallen because of the slack economy, not the President's policies.

Even more important, he asks, ''When the economy recovers, will inflation stay down or go back up?''

Paul Volcker, chairman of the Federal Reserve Board, maintains that inflation has been largely wrung out of the economy. In a weekend speech to the Business Council, an association made up of current and some former heads of the nation's largest corporations, Mr. Volcker said the aim of monetary policy should be to aid the recovery.

He then indicated that the Fed would make a shift in the way it gauges the money supply, partly because of the expiration this fall of $30 billion in All-Savers accounts.

One sign that Volcker's comments were taken seriously is the relative strength of the dollar at a time when interest rates are falling. Normally when interest rates fall in the United States, the dollar falls, too. But it has remained exceptionally strong. Mr. Capen, at St. Paul Advisers, commented, ''International investors vote with their feet, and they are hanging in there.''

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