Market binge fueled by bearish outlook on economic growth
Washington — The greatest two-day stock market trading surge in Wall Street history has been fueled - paradoxically - by the bad news that the US economic recovery is likely to continue weak for some months.
But that bad-news-causes-good-news scenario may be having worldwide benefits.
Stock markets are often irrational on any one day. But they tend to be a meld of thousands of individual specialists' judgments on what the economic future holds perhaps half a year or more into the future.
This week's market explosion - and it was just that by almost any measure - appears to have touched off a chain reaction across the industrial world.
Forecasts of a weak economy in the coming months convinced interest rate specialists such as Henry Kaufman and Albert Wojnilower that the period of prolonged high interest rates was ending. Resolute action by the US Federal Reserve Board has helped the process along.
Convinced that lower rates were here to stay, bond buyers and then stock buyers pumped billions of dollars of reserve cash from pension funds and other institutional investments into the market.
Lower US interest rates in turn will mean the central banks of Europe and other industrial countries can lower their interest rates.
In the longer run the rate reductions in both North America and Europe should mean more buying of houses, cars, and household equipment. That, again in the longer run, should mean rehiring laid-off workers.
So stock markets in London, the European Continent, Tokyo, and Singapore also soared in anticipation of what the chain reaction might mean.
A senior official of the US Federal Reserve Board summed up the way in which news of economic weakness has contributed to the market rally:
''A whole constellation of factors is nudging interest rates down, including the fact that the economy is a lot weaker than anyone had expected.''
At best, he said, ''a very anemic recovery is in sight over the next several quarters and the prospects for business fixed investment are very gloomy.''
If he is right, loan demand from the private sector should not be heavy in coming months, leaving room for the US Treasury to borrow massive amounts of money without putting undue pressure on interest rates.
When interest rates are high, stocks suffer, because investors get a better return from money market funds. When interest rates drop, stocks regain luster.
Stock market buoyancy, which carried the Dow Jones industrial average to a record 38.81 point gain Tuesday, faltered slightly Wednesday. The Dow closed down 1.71 points on an astronomic volume of 134.3 million shares. Nearly 220 million shares were traded during the two-day period.
''It is extremely rare,'' said an independent market technician, ''to get two days running when gainers outpace losers by 10 to 1 or more.'' On Tuesday the ratio was running at a ratio of 14 to 1.
A weak economy may benefit the stock market, to the extent that interest rates decline. In other ways, economic stagnation spells hardship.
Unemployment, for example, is likely to remain at or near post-World War II highs, until interest rates fall low enough to allow recovery to take root.
Former presidential adviser Charles L. Schultze, now a senior fellow at the Brookings Institution, finds the exuberance of the stock market a bit surprising.
After all, he noted in a telephone interview, the experts to whom investors are responding say that ''interest rates are going to be low because the economy is in poor shape.''
He referred to two highly respected Wall Street economists who suddenly have shed bearskins and turned bullish - Henry Kaufman of Salomon Brothers and Albert M. Wojnilower of First Boston Corporation.
Their optimism on interest rates helped to trigger the Dow Jones surge. But the reasons they cite give grounds for caution.
''The business outlook has deteriorated,'' says Mr. Wojnilower. ''The risks of a flare-up in interest rates have therefore diminished, and the prospect of later and lasting declines has been enhanced.''
Overall, says the First Boston chief economist, ''the economic climate turned gloomier toward midyear after having improved during the spring''
''A smart recovery in economic activity in the second half of this year,'' said Mr. Kaufman, ''is not likely to materialize. This removes the immediate threat to long-term interest rates.''
The Federal Reserve Board official, who asked not to be named, cited other factors pushing interest rates down:
* The markets, he said, now think the government is serious about trimming huge federal deficits, especially since President Reagan has gone all-out in support of the $98.3 billion tax-increase bill.
Concern about deficits in the $150 billion range and above has prompted lenders to keep interest rates high, despite a sharp decline in inflation.
* Growth of the money supply has slackened, allowing the Fed to ease up on credit and inject more reserves into the commercial banking system. When bank reserves grow, more money is available for lending. As a result, the prime rate has fallen to 14 percent this week from 15 percent last week.
M-1, a key measure of the supply of money, now is well within the Federal Reserve Board's growth target range for 1982. ''Very tranquil'' is the way a Fed official described the current monetary situation.
Apart from economic factors working on Fed policy, said a key government official, ''there is tremendous political pressure, both from Democrats and Republicans, on the Federal Reserve Board to help interest rates come down.''