A Bull With the Wobblies

‘What a Year!” read the frosting atop the sheet cake that traders devoured at the New York Stock Exchange on Wednesday.

Some wags suggested that a good stiff drink would have been more appropriate.

Stocks closed out the final session of 1997 with a mixed performance, as the Dow Jones industrials slipped 7.72 points to 7,908.25. But the Dow’s gain for the year still came to a stunning 1,459.98 points, or 22.6%--marking the third straight year that the blue-chip index rose 20% or more.

In the 101-year history of the Dow, there has never been a three-year period like 1995 through 1997, a fact that may be lost on many small investors who have come to view rich stock market returns as routine.

Yet the bull market’s advance was considerably more labored in 1997 than in the prior two years. Indeed, what has more than a few Wall Street pros deeply concerned about the 1998 outlook is the amount of pain that accompanied stocks’ full-year gains in ‘97:

* The year saw two significant “corrections,” as the Dow plunged nearly 10% between March 11 and April 11 in the wake of a Federal Reserve Board interest rate hike, then suffered a 13% pullback between Aug. 6 and Oct. 27 as Asia’s economic disaster unfolded.

No other year since this bull market began in 1990 has witnessed two such pullbacks.

* For the blue-chip Standard & Poor’s 500 index, the year’s 31% gain was achieved despite four interim declines of 5% or more (over a period of several weeks)--three of them since August. The S&P; was hit with just one such decline in 1996, and none in 1995.

* The market’s rising volatility was demonstrated in spades on Oct. 27, when the Dow plummeted 555 points--enough to suspend trading for the rest of the day, as a market-closure rule adopted by the New York Stock Exchange in the wake of the 1987 market crash was triggered for the first time.

* The heaviest trading volume ever on the NYSE occurred on Oct. 28, as 1.2 billion shares changed hands amid the market’s recovery that day from the previous day’s plunge.

The bottom line: While investors who were in the market for the entire year don’t have much to complain about, given where the indexes (and the typical stock mutual fund)finished, since early August the market overall has lost ground.

The Dow peaked at 8,259.31 on Aug. 6, which means at Wednesday’s close it was off 4.3% from its record high.

The Nasdaq composite index of mostly smaller stocks, up 21.6%for the year, is off a full 10% from its record high.

Is that loss of momentum serious enough to suggest that the demise of the 7-year-old bull market is imminent?

Ricky Harrington, veteran technical markets analyst at brokerage Interstate/Johnson Lane in Charlotte, N.C., believes there now is a 40% chance of a bear market in 1998 (usually defined as a drop of 20% or more in major indexes), about an equal chance of a trading range market that will see the Dow bounce between 6,500 and 8,500, and just a 10% chance of another great gain.

Those 40% odds of a bear market might not seem overly worrisome, but Harrington puts it this way: “If you knew your home had even a one in 10 chance of being hit by a tornado, you’d move.”

Even so, he concedes, “I’ve been wrong for a long time about this market.”

He has plenty of company, of course. Last year, almost no serious pundit on Wall Street believed that stocks could rise 20% or more in 1997. Most now say the same about 1998.

Arnold Kaufman, editor of Standard & Poor’s Outlook investment newsletter in New York, says that purely from a valuation point of view, U.S. stocks look dangerously high to most veteran market watchers:Based on earnings per share for the four quarters ended Sept. 30, the average blue-chip stock in the S&P; 500 index now is priced at 24 times earnings.

And with Asia’s economic mess threatening to slow global economic growth in 1998--and U.S. multinational companies’ profits--the great risk is that the market’s price-to-earnings ratio could go even higher.

Yet many Wall Street bulls argue that there still are too many positive fundamentals underpinning the U.S. stock market to allow the bears to get control.

A few of those positives: the capital gains tax cut in 1997, which makes stocks more appealing than the alternatives; the federal government’s surprise budget surplus, which supports the dollar’s strength (and thus should attract foreigners to our markets); low inflation; and aging baby boomers’ ongoing shoveling of billions of dollars into retirement accounts.

Perhaps most important, many bulls believe there is significant potential for the slide in long-term bond yields in recent months--which brought the 30-year Treasury bond yield down to 5.92%as of Wednesday, versus 6.64%a year earlier--to accelerate in ‘98, should Asia’s turmoil slow world growth. That could be very supportive of stocks.

The bullish outlook doesn’t allow for the catastrophe scenarios, of course--especially the global deflation scenario. But then, the bears have been waiting on catastrophe for a long time now--and they’ve left a lot of money on the table.

Coming Sunday: Our 1997-98 Investment Review and Outlook will offer insight, tips and information to help you evaluate your portfolio and make money in the new year. For more insight on your investment choices, attend the Los Angeles Times Investment Strategies Conference Feb. 7-8 at the Convention Center, which will feature many of the nation’s leading investment experts. For more information, call (800) 350-3211.