The first six months of 1984 was a depressing period for most North American stock markets. Prices sagged, demand was sluggish and investors expressed growing concern that the rapid expansion of the U.S. economy would rekindle an inflationary storm. Then, late in July, after hitting rock bottom, the market staged a sudden, overwhelming recovery and jolted the investment community out of its sevenmonth slump. Early this month widespread expectations of lower interest rates in the United States helped to shoot the widely followed Dow Jones Industrial Average of 30 U.S. stocks up like a missile. Canadian and international markets followed. Late last week there was a renewed surge—following a brief lull—caused partly by a drop of half a percentage point in the prime lending rate charged by the five major Canadian banks to 13 per cent. Said Eric Miller, chief investment officer at the New York-based brokerage firm Donaldson, Lufkin & Jenrette: “The direction is still clearly and strongly upward.”
The renewed upswing took place while the investment community was still
reeling from the previous week’s recordshattering rise. Said Robert Dorrance, portfolio strategist at the Torontobased investment firm Nesbitt Thomson Bongard Inc.: “No one has ever seen that kind of rally before.” Indeed, the Dow Jones Industrial Average set a double record by shooting up 87.46 points on a volume of 696 million shares in the week of July 30 to Aug. 3. Following the
U.S. lead, the Toronto Stock Exchange composite index of 300 stocks rose an unprecedented 154.38 points in the same period on a volume of 52 million shares. Last week, the Dow Jones average advanced 15.89 points and the TSE index was up 48.41 points. Declared Rocco Marcello, vice-chairman of the Toronto Stock Exchange and chief executive officer of Davidson Partners Ltd.: “It’s like rain after 40 days of drought.”
For the hard-pressed brokerage industry, the turnaround was a welcome development. Early this year the market plummeted by 20 per cent to a low of 2079.69 points in July from a high of 2585.73 points in January. Said David McLeish, executive vice-president of Toronto-based Walwyn Stodgell Cochran Murray Ltd.: “At the start of the year, everybody was full of euphoria and no one thought it would ever stop. Then it stopped, almost the next day.” The major stumbling block was the unexpected vigor of the U.S. economy, which rose at a startling rate of 10.1 per cent in the first quarter and 7.5 per cent in the second quarter of the year. The rapid pace of growth drove up interest rates because of an increase in demand for credit and a desire to take out loans before inflation again took root.
But indications that the recovery might be slowing swiftly sent the markets soaring again. Recently, Washington announced that unemployment rose in July while factory orders, construction spending and the index of leading economic indicators declined. Those developments eased concerns about inflation. As well, Federal Reserve Board Chairman Paul Volcker told a Senate banking committee that the Fed had
For the hard-pressed brokerage industry, the markets' turnaround was like a rain that follows a drought
decided not to tighten its monetary policy, signalling that short-term rates had peaked, at least temporarily. The result: long-term rates paid on bonds fell significantly, generating expectations that short-term interest rates such as the prime would follow suit.
The flurry of positive developments sent investors into a buying panic which caught even the most bullish investment firms off guard. Stockbrokers postponed their vacations, and firms hired extra trading staff to accommodate the sudden surge in volume. “It’s crazy. It’s wacky. It’s lost all semblance of reason,” said Dudley Eppel, chief of trading at Donaldson, Lufkin & Jenrette, during the height of the stampede on Aug. 3. The major buyers were large institu-
tional investors, such as pension funds, which had accumulated large cash reserves in readiness for a shift in the economic climate. And as the rush to the market gathered momentum, some analysts saw similarities with the dramatic rally that erupted in August, 1982, and continued for five months.
Money managers who failed to participate in the initial stages of that upswing were anxious not to miss out on a potential repeat performance, particularly after many had scored poorly in the market so far this year. Small investors, by contrast, have been more reluctant to commit themselves. As Miriam Varadi, a retail stockbroker at Nesbitt Thomson Bongard, noted, “Business has been brisk, but the phones are not ringing off the hook. The little guy is suspicious of dramatic movements and waits to see how the trend develops.”
From bungalows to boardrooms the anxious debate over where the market is heading raged throughout last week. Even the most pessimistic experts agreed that the volume and momentum demonstrated over the previous two weeks were too powerful to fizzle overnight. But they disagreed over how long it could last. At the same time, the most positive observers contended that the rally might continue into 1985. Said Dominik Dlouhy, chairman of Montrealbased Maison Placements Canada Inc.: “There is little doubt in my mind we are entering a new era for stock prices in North America.” Others predict that the rally will fizzle in weeks.
The debate over the rally has also highlighted the sharply diverging current views about the general course of the economy. Bullish forecasters, including Dorrance, subscribe to the socalled soft-landing theory. According to that view, interest rates will fall gradually and enable the economy to slow down to a rate of sustainable growth in
1985 without a sudden crash. But other analysts argue that the falling rates are the last gasp of an economy that is heading into a deep recession. Rick Sales, director of research at Vancouver-based Odium Brown Ltd., predicts that the rally will continue until just after the U.S. election in November and then tumble. Said Sales: “People are looking to lower interest rates to fuel the second leg of the bull market. But the only way interest rates will come down is with a recession.”
Still, the direction of interest rates will determine the course of the market in the coming weeks. Said William LeFevre, a market strategist with the New York investment firm Purcell Graham and Co.: “The next couple of weeks will be critical. Without a moderation in short-term rates the rally is unsustainable.” Last week’s drop in the trendsetting Bank of Canada rate of 12.65 to 12.44 per cent, made possible by a strengthening in the value of the dollar, was the first break in a pattern of five consecutive increases which began in March. The central bank’s action led the five major chartered banks to pare their prime rate—what they charge their biggest and best customers—back to 13 per cent from 13.5 per cent.
So far, U.S. short-term rates have remained firm despite declines in longterm rates which have fallen in response to diminished fears about inflation. Low commodity prices and moderate wage settlements have kept inflation below four per cent in the United States. Some observers believe short-term rates will drop for the same reason. Other analysts contend that the economy is still robust, and continued heavy demand for funds on the part of business and government could push rates as high as 15 per cent next year.
The outcome of the U.S. elections in November is another influence on interest rates. In general, investors are counting on a Republican victory. As LeFevre put it, “The market has pretty much re-elected Ronald Reagan.” Although Reagan’s reluctance to cut government spending significantly—especially military spending—to reduce the record $180-billion deficit has been unpopular on Wall Street, he is still widely preferred to Democratic candidate Walter Mondale. Generally, the Democrats are considered by large investors to favor higher taxes and more government spending, leading to a less hospitable business climate. At the same time, a continued run-up in the market would probably enhance Reagan’s chances.
Despite the confusion and uncertainty over the market’s direction, many investors are enjoying their return to good fortune. Said broker Miller: “After such a difficult year, they are basking in the enjoyment of it all.”
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