The Bad News Bears

When the stock market talks, everybody listens--even the frowning bad-news bears. The Dow Jones industrial average hit a new high in May, and most of the pessimists beat a retreat. Individual investors have been piling into stocks since December by buying stock-owning mutual funds. That may be bad news. Market lore says the public is always wrong.

Followers of four-year-cycle theories still think that a drop is due. The low in October '87 will be followed by a low in mid 1991. "So it's logical to see a top in mid-1990," says Tony Tabell, of Princeton, N.J.-based Delafield, Harvey, Tabell.

Fundamentalists mope over the economy. "The April numbers were softer than expected in production, retail sales, employment and housing," says Hugh Johnson, chief investment officer at First Albany. "We may miss a recession but not by much." Still, he's feeling cheerier about stocks: "The market is probably looking beyond the next malaise, to a recovery." Economist Lacy Hunt, of CM&M Group in New York, thinks the wimpy April data wrong. He expects proof of a firm economy in May.

What really rivets the mellowing bears is the improvement in liquidity. The money supply is growing faster than production. Those extra funds usually drive markets up.

Justin Mamis of Gordon Capital, an ex-bear but still jumpy about it, was nudged over the line by the rise in the stocks of major brokerage houses: Merrill Lynch, Salomon Brothers, American Express (majority owner of Shearson Lehman Hutton). "The action of Merrill makes you want to own stocks," he says. He thinks that the worst may be over for housing stocks as well as for banks and S&Ls.

Deceptive bull: The accounts of the market's glorious new highs are actually deceptive. Wall Street has been slogging through a hidden bear market--hidden, that is, from all but those unlucky enough to own the smaller stocks. As measured by Maneck Kotwal, of Smith Barney, 17 percent of the companies on the New York Stock Exchange are 40 percent or more below their 12-month highs; 27 percent are down 30 percent or more, and 43 percent are off 20 percent or more. Either they'll catch up to the market leaders or the leaders will slide down to them.

Voting for the slide is Prudential-Bache analyst Melissa Brown, one of the unreconstructed bears. Her target for the stocks in the Dow Jones industrial average: 2400, on disappointing profits--down from the 2800 range today. But she thinks the smaller stocks won't fall that far. Especially cheap, she says, is the financial group, like banks. And she likes the high-technology stocks, whose mutual funds have jumped 9 percent since January.

The case for U.S.-stock mutual funds: I didn't talk to many bulls on stocks because you don't need them. For long-term investors, the case for buying is always good (table). Michael Metz of Oppenheimer, truly a superbull, sees the Dow over 3000 this summer and double the price in two or three years, thanks to lower inflation and interest rates and higher American savings and investments.

But bearish Steve Leuthold, of the Leuthold Group in Minneapolis, isn't budging, and wouldn't expect big profits even if the market rose. When you buy stocks at current levels, as measured by price/earnings ratios, he says, the 10-year return is toward the low end of the historical range--more like 6 to 8 percent.

The case for high-quality bond funds: If stocks will show uninspiring returns, you have to love bonds--and Leuthold does. Even if current interest rates rise a little, he says, longterm Treasuries could stand at 7.5 percent next year, down from 8.8 percent last week. Looking further ahead, he's betting that the government beats the budget deficit (probably after some sort of crisis), which could knock down longterm rates to 6 percent.

Still, none of the fears I heard anywhere last week would trouble a long-term stockholder, except for one--from Tyler Jenks, of Boston-based mutual-fund broker, Kanon Bloch Carrel Stocks, says Jenks, have fallen into a pattern he calls a hyperwave--a series of four steps up in price, followed by three decisive steps down. At the peak, prices rise almost vertically, as they did in the summer of 1987. Next comes a steep collapse (October '87), a recovery and a final phasedown, which Jenks thinks began last January. The hyperwave's last, debilitating decline generally lasts for two or three years and brings the market back to where it started--in this case, around 1000 on the Dow.

Jenks has found other hyperwaves. They include the Crash of '29, as well as the commodity crashes of the late 1970s and early '80s: cocoa, sugar, gold. Japan, says Jenks, is in the penultimate phase, the great relief before the great regret. He says he's out of stocks entirely and into quality bond funds and money-market mutual funds.

The next four weeks will tell the story, says Jenks, who describes his present condition as "ulcerous." If the Dow stays over 2800, if the smaller stocks start to rise and if trading on the Big Board consistently tops 200 million shares a day, he'll become a ravening bull. Stay tuned.

This table shows your odds of making or losing money on stocks, depending on how long you own them. One-year investments are risky. The longer you hold, the more likely you are to come out ahead.

Holding period Your chance of earning[*]: Chance 0-10% 10%-20% over 20% of losing One year 19% 19% 38% 24% Five years 30% 40% 24% 6% Ten years 29% 54% 16% 1% Twenty years 22% 70% 8% 0