Market Rebound Has Bulls Tiptoeing Back Into Stocks

Like many market analysts, newsletter editor Arnold Kaufman has been somewhat pessimistic about stocks in recent months. But the surprisingly strong rally to new post-crash highs above 2,500 for the Dow Jones average has proven him and many other prognosticators wrong--and prompted them to change their tunes.

“Recent action has been so encouraging that we have shifted some of our cash into stocks,” Kaufman, editor of Standard & Poor’s Outlook, said of the newsletter’s recommendations.

But while analysts have become more bullish in recent days, many also warn that today’s lofty level of stocks is increasing risks as well. Some experts--while saying stocks may have more room to go up--are warning that the higher stocks rise, the greater the chance of a strong correction or even another crash. Accordingly, they say that investors should approach the market with caution.

“We will once again go down hard, although we are not there yet,” said Robert T. Gross, editor of Professional Investor, a Pompano Beach, Fla., newsletter. “We’re getting into a very dangerous area.”

“We still have considerable doubts about the market,” Kaufman added.

In some ways, the specter of market advisers growing more bullish while at the same time advising caution rings up memories of attitudes held in the months leading up to the October, 1987, crash.

Then, many experts also expected the market to go higher but warned of a major correction once the party ended. The key for many stock pickers then was to make as much money on the upswing as possible but make sure they got out before the downturn began. History is full of strong bull markets that ended with sharp bear markets, they reasoned.

Of course, no one knows for sure just what will happen this time around. As usual, there are opinions on both bullish and bearish extremes.

Some more bullish forecasters, such as Stephen Leeb, editor of the Indicator Digest newsletter in Palisades Park, N.J., say the recent rally is part of a powerful new bull market that, in the coming weeks, could propel the Dow well above its all-time high of 2,722.42 and eventually push it near the 3,500 level.

Some bulls even are suggesting the possibility of a “melt-up,” a one-day gain of, say, 200 points or more, propelled by computerized program trading and panicked institutions fearful of being left out.

Others characterize the upturn merely a rally in a bear market, saying the Dow will eventually retreat to possibly as low as 1,500. Some, such as newsletter editor Gross, are openly suggesting the possibility of another crash.

But an analysis of bullish arguments shows why many experts are signaling caution.

The recent advance, many analysts say, has been largely underpinned by a growing conviction that the economy will perform a “soft landing,” easing into slower but sustainable growth without a recession or high inflation. That conviction has been fueled by recent declines in interest rates and evidence of slowing economic growth.

Falling Rates a Factor

Falling interest rates are also prompting investors to shift money from Treasury securities, money-market mutual funds and other interest-bearing instruments and into stocks. Definitive signs that the Federal Reserve will loosen the monetary policy to drive interest rates down further could trigger even a bigger shift of institutional and individual money into equities.

Other factors in the rally include the stronger dollar, which has sparked buying of U.S. stocks by Japanese and other foreign investors; the reduced supply of stocks due to takeovers; continued healthy rises in corporate profit and high levels of cash among institutions and individuals that can be used to purchase more stocks.

Also, some experts say, the market may be moving up simply because it’s moving up. The rise has fed on itself and persuaded many previously bearish institutional investors that they must jump in or risk being left out.

Also, the fact that many crash-scarred individuals have not reentered the market in massive numbers means the rally still has room to go higher, bulls say. Market rallies typically don’t end until small investors have spent their wads.

Fragile Footings

Still, these bullish underpinnings are fragile and could easily be shaken by bad news on the economy, inflation or international events.

Most fragile is the soft-landing scenario. Some analysts say it is wishful thinking that the economy--already into its seventh year of expansion without high inflation--can keep avoiding a recession or a sharp surge of inflation.

“The economy could slip off in either direction, toward inflation or recession,” Standard & Poor’s Kaufman said. He added that the Dow easily could drop below 2,000 “if we have what looks like a normal-type recession.”

“It all sounds too good to be true, and it probably is,” wrote Charles LaLoggia, editor of Special Situation Report and Stock Market Forecast, a Rochester, N.Y., newsletter.

Experts also noted that various measures of stock market values show a mixed picture.

On the bullish side, for example, the price-earnings ratio--stock price as a multiple of earnings per share--is about 13 for the Standard & Poor’s 500-stock index. That is well below the 20 level that usually indicates a market top.

Indicators Don’t Agree

On the bearish side, the dividend yield--payout as a percentage of stock price--is about 3.5% on the S&P; 500, near the 3% level that usually marks a market peak.

Other previously bullish factors, such as the degree to which corporate insiders are buying their own firms’ stocks, have become less bullish in recent weeks, noted Market Logic, a Ft. Lauderdale, Fla., newsletter.

Also, many blue chip and over-the-counter stocks have not participated strongly in the rally, an indication that the upturn is not as broad as in true bull markets, contended Stan Weinstein, editor of the Professional Tape Reader, a Hollywood, Fla., newsletter. Blue chip stocks such as Ford Motor, General Motors, Chrysler, Bethlehem Steel, Digital Equipment and International Business Machines have lagged, he said.

“If we had a really healthy rally, you wouldn’t find so many of these,” Weinstein said.

To avoid a sharp correction later, many bullish analysts hope that the upward surge in stocks moderates somewhat, so that investors can catch their breath.

“A lot of people are buying stocks against their own judgment,” said John Connolly, chief investment strategist at Dean Witter, who has been bullish for some time. “It’s never healthy when that happens.”