Bitter cold enveloped the Northeast, but investors kept the chill away by stoking a 30-point fire on Wall Street. Whenever a rally erupts, there are always some initial sparks that ignite the tinder. The advance this past week was no exception.
The first spark came from a midweek release on United States unemployment figures. The unemployment rate edged up from 7.1 to 7.2 percent last month, but more than 300,000 people went to work, and those working put in more hours on the job.
``That means the 2.8 percent GNP flash for the fourth quarter may not be revised downward, as most expected,'' says John D. Connolly, vice-president at the Dean Witter Reynolds brokerage, referring to last month's preliminary estimate of gross national product. And he adds, ``It now looks like we're entering the first quarter of 1985 with some momentum behind it.''
The second match was struck by the chairman of the Federal Reserve Board. In a luncheon speech, he described the inflation outlook in what were, for Paul Volcker, glowing terms: ``There are some reasons to believe . . . that we're beginning to build into the economy a trend toward more stability of prices.''
Commodity prices are declining -- an important brick in any wall to keep inflation at bay. And Mr. Volcker's comments quashed concerns that the Fed might halt the decline in interest rates as the economy strengthened. In fact, many traders interpret Volcker's remarks to mean the Fed will allow interest rates to fall further. More prominent concerns of the Fed: the ever-growing budget and trade deficits.
Says Dean Witter's Mr. Connolly, ``We may be looking at a $150 billion trade deficit in '85, which means the economy can't explode. That deficit is a depressant on local production. So if the economy chugs along at 2.5 to 3.5 percent growth, is the Fed going to jump on it [by raising interest rates]? I don't think so.''
Instead, further easing is likely in an effort to sap some of the dollar's unflagging strength against other currencies. Last week the dollar pushed the British pound to a new low of $1.13.
In light of these events, the Dow Jones industrial average roared to 1,2xx.xx by week's end. But will a weekend of second thoughts douse the flames? Are the logs really in place for a conflagration?
``The decline in interest rates and gathering evidence of renewed economic growth in '85 definitely give the underpinnings of a nice market in the first part of this year,'' asserts Edward M. Kerschner, chairman of Paine Webber's investment policy committee.
Connolly at Dean Witter sounds a slightly more cautious note. ``I think this might be more than a trading swing.'' To support his position he notes:
The incentive for investing in bonds is weakening. ``Last May, bonds were underpriced relative to stocks. [In light of the bond market's rally since then], I don't think that's true anymore.''
``A month or two ago, you could argue the economy was going soft -- going into a recession. You can't make that case anymore.''
The tax changes proposed by Treasury Secretary Donald Regan appear to be taking a shape more to Wall Street's liking. ``It looks like we may not see an attack on capital expenditures,'' Connolly says. ``The accelerated cost recovery system and investment tax credits may be preserved.''
But analysts agree that to sustain this rally -- for stocks to continue to appreciate -- it will take more buying power than the institutions alone can muster. Indeed, much of last week's purchases were institutional. ``You still do not see much retail activity,'' says Newton Zinder, E. F. Hutton's head of research. To some extent, ``what you're seeing now is the usual January recovery from heavy tax selling in December.''
Small investors can still garner good returns from safer instruments -- such as money market funds, bonds, and certificates of deposit, according to Mr. Zinder.
It will take lower interest rates and time, but ``when the public starts to see money market funds yielding 6 or 7 percent, not 10 or 11, and realizes that the stock market can go up 1 percent a month, giving 10 or 11 percent returns, then they will move,'' says Mr. Kerschner at Paine Webber. Initially, he says, many will not buy stocks directly but will get their feet wet in mutual funds.
At this point, Paine Webber and E. F. Hutton are both recommending banks, savings-and-loans, insurance companies, retail, and consumer nondurable issues. Paine Webber also has a few well-capitalized technology stocks on its buy list. And Dean Witter has heavily overweighted interest-rate sensitive stocks and capital goods/ technology issues. Basic-industry stocks receive a slight overweighting in contrast to Paine Webber's negative outlook for this sector.
On the ``unattractive list'' at Paine Webber are commodity-based chemical companies and aluminum, steel, and machinery manufacturers.