Interest rate hikes cloud market's future

The great bull market of the 1960s ended in 1966 when the Dow Jones industrial average hit 1,000 and the economy was strong. Five years into the great bull market of the 1980s, investors are wondering if this is a repeat performance.

Since Aug. 25 when it hit 2,722.42, the Dow Jones industrial average has fallen more than 300 points, including a record 95.46 points Wednesday.

After this tumble, investors are gun-shy of the markets. ``The psychology has obviously turned negative,'' says Peter DaPuzzo, senior executive vice-president of Shearson Lehman Brothers.

For the most part, analysts blame rising interest rates for the falling market.

Long-term government bond rates now yield over 10 percent. With interest rates this high, says Harvey Eisen, president of Integrated Resources Asset Management, ``they are stiff competition for stocks which have yields at record lows.''

Short-term rates are also rising. Yesterday, Chemical Bank raised its prime lending rate to 9 percent, up from 9 percent. This is the second increase in two weeks.

The rise in rates is a surprise. Alan Greenspan, chairman of the Federal Reserve Board, insists the economy is strong without any overt signs of inflationary pressures. The White House in its own forecast yesterday said it expects interest rates to fall shortly.

Bond buyers, however, are skeptical of official claims. Deborah Johnson, a senior economist with Prudential-Bache Securities, notes that the prices of raw industrial commodities, such as steel and paper, have been racheting up daily.

By year-end, Pru-Bache economic guru Edward Yardeni is predicting long-term rates will be 11.5 to 12 percent reflecting inflationary concerns. But next year, he believes rates will fall sharply, to 5 percent. He does not expect to see a recession but a slow, muddling economy.

In addition, Michael Sherman, chief investment strategist at Shearson Lehman Brothers says the bond market is being adversely affected by a $40 billion stock offering of the state-owned telephone company in Tokyo.

``As far as I can tell, Japanese investors are withdrawing liquidity here, which is acting to force rates up,'' he explains.

In Tokyo, Albert Wojnilower, an economist with First Boston, points to rising interest rates as a sign that monetary authorities in the US, Japan, and Europe have lost some of their resolve to coordinate interest rate moves.

Investors are also beginning to consider political changes, says Michael Cosgrove, an economist at the University of Dallas.

The higher bond rates, he says, ``are reflecting a move to the left in economic policies.'' Investors, he believes, are discounting tax increases as well as higher inflation rates.

In addition, part of the market's sell-off consists of profit taking. The stock market is up almost 40 percent this year. ``It was better than most expected,'' says Mr. DaPuzzo, ``and many people do not want to give it back.''

In fact, the stock market sometimes is weak in the fall, says Mr. Eisen, as investors take profits. ``This is a classical fall massacre,'' he says.

Even with the market down sharply, Eisen says he does not believe the bull market is over. The markets are not euphoric or overly speculative.

Informal surveys of portfolio managers reveal that they are afraid of a big market pullback.

Eisen, however, is optimistic. ``Today everyone explains to you why the market is going to go down and that is not the way the game works,'' he concludes.

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