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There's high interest in lower interest.

By Staff writer of The Christian Science Monitor / August 27, 1984



They're talking about interest rates on Wall Street again - but not as a hulking monster scaring the financial markets and the economy. The talk is more optimistic. They're not calling interest rates a pussycat, to be sure, but neither are they describing the blob that ate Wall Street.

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''I look for interest rates tailing down,'' says James Balog, senior executive vice-president of the Drexel Burnham Lambert brokerage in New York.

William LeFevre, technical analyst at Purcell, Graham & Co. of New York, notes: ''We've got the prime at 13 percent, and the next step is a cut.''

And Robert J. Simpkins, technical analyst of Delafield Harvey Tabell in Princeton, N.J., contends, ''We're close to our high interest rate, and we expect that the prime could come down some.''

Interest rates began climbing in July 1983. Since that time, the stock market has been falling, first in the more vulnerable high-tech and secondary-stock sectors; then, since last January, in the blue chips. The Dow Jones industrial average, which tracks this blue-chip sector, fell more than 200 points in seven months, hitting a 17-month low of 1,086.57 on July 24.

But about a month ago Wall Street began to notice microscopic declines in short-term interest rates (detected mostly on the bond market). That - and the anticipation of further declines - sent the Dow soaring. It took only four weeks for it to recover 150 points.

And now some analysts think interest rates may be set for another decline - namely, a half-percentage-point drop in the prime.

That would spur on the stock market. Reason: Investors would perceive that the returns on ''fixed income'' bonds, although extremely safe, were falling below the expected return on high-quality stocks, which are also relatively safe.

Stocks, moreover, have the advantage of being able to appreciate strongly on paper, and, after six months, to achieve the lower, capital-gains tax rate.

A bond's value, however, is fairly well fixed. What you get is an income stream, and that stream is usually subject to constant taxation at your income-tax rate. (You can moderate this by investing in tax-free municipal bonds , but the rates of return on these bonds are accordingly lower because of this advantage.)

In short, stocks look better than bonds when interest rates are falling.

Market-watchers think the prime rate need not fall very far for a dramatic surge of optimism on the stock market. Mr. Simpkins speaks of the ''psychological'' impact of a dip in the prime. Mr. LeFevre points out that, since 80 percent of the market's activity is institutionally based, ''perception'' is crucial. If the perception is that rates are easing, he says, ''we're off to the races.''

Mr. Balog describes the stock market's August surge as ''an interest-rate adjustment rally,'' one that was reacting to the improvement in the bond market during July and to the perception that the Federal Reserve would not tighten credit significantly. Interest rates can now begin to decline, Balog says, because inflation is under control, the economy is slowing down, capital expenditures are remaining moderate, and federal and state budget deficits are not really that bad.

''If you could just say that interest rates are not going up, that would bring the equity markets higher,'' Balog says. This is because interest rates of 12 to 13 percent take into account an inflation level of around 10 percent; the remaining 2 to 3 percent would be the normal return on this investment. With inflation running at an annualized 3.5 percent rate in July, the fear of high inflation is abating. This could help bring about a lower level of interest rates.

What would stimulate a decline in interest rates further would be looser money from the Federal Reserve. The nation's basic money supply (M-1) has been well behaved recently, running in the middle of the Fed's target range; it fell more money into the American economy and thus bring about lower interest rates.

The every-other-day surges on the stock market are a sign that some investors are beginning to believe in slower growth and easing credit conditions. Although analysts say the market is still marking time until there is clear evidence of softer interest rates, the Dow average has been holding its own at its new levels above the 1,200 mark. The Dow closed Friday at 1,236.53, up 24.53 points in five sessions.

Mr. LeFevre sees two schools of thought at work among investors today. One says that the August surge has been only an upturn in an essentially bearish market. The numbers in this group are dwindling, he says.

The second group knows it should have bought stocks when the market was lower and is holding out for dips in the rally to buy.

This, he says, accounts for the spiky movement of the Dow in the past few weeks - up in a big way, then reversing course, then once again up in a big way. This keeps the market's overall trendline upward.

Many analysts see ''structurally higher interest rates'' persisting (perhaps around 10 percent), even if there is a small decline from the 13 percent level. Thus higher-risk stocks still may not be very attractive. Simpkins contends the high-quality sector of the stock market is still comfortably within the four-year bullish cycle that he says began in August 1982. He says the secondary and tertiary sectors, however, are still ''under extreme pressure.''

Balog considers blue chips the safest and best investments today: ''When the trend is not established, quality (stocks) will do better. ... You want to be able to buy a lot and be assured you can sell them fast.''

That seems a sound hedging strategy - just in case the blob of higher interest rates returns.Table -

Interest rates percent Prime rate 13.00 Discount rate 9.00 Federal funds 11.50 3-Mo. Treasury bills 10.87 6-Mo. Treasury bills 11.33 7-Yr. Treasury notes 12.67 30-Yr. Treasury bonds 12.42 Source: Bank of Boston