Stocks savaged by bonds' appeal: some head for a textbook
| New York
There is one big concern in the stock market today: the battered bond market. The much-feared ''credit crunch'' - where government and private-sector borrowing needs collide - appears to have arrived. This is driving up interest rates and making anything other than the latest, highest-interest government bonds unattractive. Despite a Friday rally in the bond market, the Dow Jones industrial average closed down 23.35 points for the week, at 1,133.79.
Right now you can buy a government bond that returns 131/2 percent. That beats the historic return on stocks by at least 11/2 percent. Simple arithmetic makes it difficult for an investor to justify putting money into stocks - likewise bonds that are sold on the secondary market. Until now, these have returned less than 131/2 percent.
Ironically, even the new 131/2 percent bonds can appear unattractive because of the possibility that interest rates will rise again and the owner of a 131/2 -percenter will be locked in when new bonds are offering even more of a return.
''Stocks are overpriced in relation to bonds,'' says Leon G. Cooperman, an influential market analyst with Goldman, Sachs & Co. brokerage. ''You cannot be bullish on stocks unless you are bullish on bonds.''
Mr. Cooperman was speaking last week at a seminar of investment bankers, market analysts, and academic experts to mark the 50th anniversary of the publication of the landmark text ''Security Analysis,'' by two Columbia University professors, Benjamin Graham and David Dodd.
The book is highly influential - and particularly appropriate in today's wind-swept market - in that it eschews attempts to outguess the markets and advocates measuring the inherent value and margin of safety of companies that you invest in.
Cooperman's counterpart at Merrill Lynch, Robert. J. Farrell, takes a little more optimistic approach, but he, too, sees the correlation between the bond and the stock markets: ''The stock market will rally on the first bond market rally.''
What has been happening on Wall Street the past few weeks is that stock and bond prices have been declining in order to establish equilibrium with the new, higher interest rates. As if by a law of physics, the quickest way to improve the return of a stock or bond is for its price to drop. That makes the yield increase.
The biggest influence on the bond and the stock market is interest rates. The biggest influence on interest rates, most analysts believe, is demand from government and business borrowing. The record federal budget deficit necessitates heavy government borrowing.
At the same time, many economists believe American business is at a point where its borrowing needs are at record heights. The economy is racing ahead, plants are running near capacity, inventories are low, consumer confidence and spending are robust. Money is needed for businesses to expand their operations to meet demand.
And there is concern that credit needs may accelerate to cover some of the risky loans held by many of the leading banks in the country. The Federal Deposit Insurance Corporation and a group of banks last week agreed to provide the troubled Continental Bank & Trust Company of Chicago with $2 billion to keep it solvent. The FDIC also said it would protect Continental's depositors and creditors, and the Federal Reserve System promised to cover the bank also. The move was meant to avert a banking crisis.
Some of Continental's problem can be traced back to past-due third-world loans. Many other US banks carry such loans on their books, so there is worry that the government could be involved in more such bailouts. That, too, would soak up credit and drive up interest rates.
In such an environment, Mr. Cooperman predicts, ''the No. 1 asset at the end of the year will prove to be 90-day CDs (certificates of deposit) rolled over at 11 percent interest.'' The bond market at year-end will be where it was at the beginning of the year, he adds, and the stock market will remain about where it was, perhaps down 10 percent.
Cooperman contends there are only three ways for the stock market to improve: (1) if interest rates drop; (2) if stock prices drop; (3) if corporate earnings improve. The first, he thinks, is unlikely; the second is what is now happening; and the third will only be known at year-end. If your taxes are structured appropriately, fixed-income returns can be exceedingly attractive and, says Cooperman, ''you shouldn't be buying common stock today.''
Even so, he notes that institutional money managers still are heavily involved in equities, and he calls for higher cash levels and greater liquidity by these institutions.
Mr. Farrell takes the longer view. He contends that the market has been rising since 1974 and is still far from being overvalued. It is now halfway through a two-year correction, he says, and the underlying bull market ''will resume late this year or early next.''
What do you do if you insist on buying stocks in a market like this one?
Perhaps the best answer is provided by two other participants in the Columbia seminar honoring Professors Graham and Dodd.
''Buy a widely diversified portfolio of stocks with just above-average market risk and hold on forever,'' argues Charles Ellis, president of Greenwich Research Associates. ''There is no greed at the top (of the market) and no fear at the bottom.'' Mr. Ellis contends such an approach is the only feasible one, since it is impossible to outsmart other investment experts consistently and it is physically punishing to try to work harder and thereby ''front run'' competitors.
Warren Buffett, chairman of the Omaha-based Berkshire Hathaway Corporation, is one of the staunchest advocates of analyzing companies using the Graham & Dodd approach. Mr. Buffett recommends that individuals or institutions buy a stock only after determining the market value of a company if it were broken up and sold tomorrow. One then multiplies the number of shares in the company by the stock price. It will then be apparent whether he's getting value for his money.
Buffett's stocks tend to be rather obscure. They are not typically the big-capitalization powerhouses nor the exotic high-tech companies. His ideal, he says, would be ''the unregulated waterworks.'' With these stocks, the ups and downs of the Dow Jones industrial average are not much concern - in fact, he says, ''we figure that if the stock market were to close its doors tomorrow, we'd still have a good company.''