How now, stock market? Turnaround possible
Having slipped sharply, the stock market may fall farther in the days ahead. But with an eye on underlying values and encouraging economic signals, a turnaround still seems possible.
Though the Dow Jones industrial average has broken below the important 1,200 level, it should be noted that:
* Not all stocks fell in the recent decline.
* Stocks and bonds remain a sound investment based on returns they produce.
* Being an election year, the economy - and most important, interest rates - should continue to improve.
When viewing the rather substantial drop in the Dow Jones industrial average since early January, one should keep in mind that this index is tracking 30 leading industrial stocks - not the whole stock market. Other measuring devices have shown substantial drops in other sectors of the market - over-the-counter stocks, smaller-capitalization companies, etc. - during the past eight months, while the Dow has gained points.
Lately, it has been the Dow's turn. It dropped below 1,200 Friday, closing at 1,197.03 and breaking through an important ''sentiment'' barrier for investors. That could either compound investor pessimism or trigger institutional signals to buy or sell en masse. The DJIA is now at its lowest level since Aug. 30, 1983 .
Market analyst William LeFevre of Purcell, Graham & Co. in New York sees this as having been part of a rotational correction that has been taking place since last summer. By his reckoning, over-the-counter stocks have dropped 18.4 percent since summer and lower-cap American Exchange stocks by 12.4 percent. Since early January the DJIA has fallen 5.2 percent; the Standard & Poor's 500, 5.4 percent; and the New York Stock Exchange Composite, 5.3 percent.
''The Dow 30,'' says Mr. LeFevre, ''has been getting caught lately, and it looks like the higher-quality stocks were getting it in sequence.''
LeFevre noted that by the third week of the January decline investors were beginning to show fairly widespread pessimism. This he attributes more to watching the drop in the Dow's 30 stocks than to the individual experience of investors or the performance of the market as a whole.
''In many mass-circulation publications, the Dow Jones industrial average is the stock market,'' he says. ''Because of the impact of that, concern is greater.''
Though there is always a danger that bearish sentiment can feed on itself, LeFevre thinks the three-week drop brought the Dow close to the bottom limit of its decline.
Eventually, he says, the bull market will resume, mainly because examination of corporate earnings shows stocks as a fundamentally sound place to put money today.
Even during the final quarter of 1983, when the stock market correction was quite active in non-DJIA areas, the total returns (dividend plus capital gains) realized on common stocks and intermediate-term bonds was a reasonable 2 percent , according to a recent report by Salomon Brothers. For all of a rather volatile 1983, total returns on DJIA stocks still achieved 25.6 percent. Standard & Poor's 400 industrials gained 22.8 percent, and the S&P 500 22.3 percent.
Analyst William Raftery of the Smith Barney, Harris Upham brokerage is not so sure the bottom of the near-term decline has been reached. He admits the stocks of some industrial groups have become ''oversold'' recently, and he thinks the Dow will remain close to 1,200, but he sees this as a slide that could resume.
''We are saying, 'Be extremely selective and use this as an opportunity to pick up structurally sound stocks,''' Mr. Raftery says. He recommends ''very selectively'' choosing consumer-oriented stocks such as airlines and foods.
Although corporate profits apparently have not been up to the expectations of many securities analysts, they remain positive overall - and really quite strong. Looking at a broad measure of earnings per share, the Value Line industrial composite - which tracks more than 950 industrial companies - estimates there was a 20 percent increase in earnings per share in 1983. Value Line attributes this mostly to improvements in operating margins, not increasing sales.
There appears much room for future expansion: ''With factories operating at less than 80 percent of capacity,'' says Value Line, increases in output can occur without increases in general and administration expenses or depreciation charges. Price competition should ease, the report says, while wages and raw material prices stay modest. Moreover, sales should strengthen during 1984 (estimate: a 9.4 percent gain). A more moderate dollar and economic recovery overseas should aid the international operations of US companies.
As was apparent from the drop in the Dow, many investors have been leaving the stock market. Last week the Investment Company Institute reported that assets of money market mutual funds reached their highest level in 10 weeks. Moody's Bond Survey notes: ''As long as inflation and expectations concerning its course remain favorable, high interest rates are likely to lure an adequate flow of funds into fixed-income investments.''
For most investors, interest rates remain a big concern. Still, this is an election year, and a look at the history of election years shows that the money supply becomes somewhat looser and interest rates decline a bit. The Reagan administration is stepping up the pressure on the Federal Reserve to do just that. Last week Treasury Secretary Donald Regan said the Fed must be careful not to tighten credit and choke off the economic recovery.