Investors who were confused and frustrated by the stock market in 1978 can anticipate more of the same in 1979.
The economy remains a big question mark. While the stock market may go through daily or weekly gyrations in response to this or that economic statistic or presidential initiative, no major improvements in stock prices can be expected until the economic climate improves.
Inflation has not yet slowed despite the efforts of the Federal Reserve Board and the Carter administration. The President's wage-price guidelines will face their first serious tests within the next few months.
Interest rates, which have been on a plateau for the past few weeks as money growth slowed abruptly, could climb even higher if the money supply beings growing again. Some analysts, such as the highly respected Henry Kaufman of Salomon Brothers, anticipate the prime rate will climb above 13 percent in 1979.
Inflation and high interests seldom co-exist successfully with confident investors.
The future value of the U.S. dollar also remains a question mark, especially in the wake of the recently announced increase in oil prices by major producing countries. Not only does a declining dollar sap confidence and contribute to inflation in the United States, it makes foreign investors -- who played a key role in last year's market -- wary of buying U.S. stocks.The Swiss, for example, are getting sick of owning U.S. stocks, noted Robert Farrell, chief analyst at Merrill Lynch, Pierce, Fenner & Smith. "Whatever they made on the investment they lost in the currency transaction."
"The fact is that no one on Wall Street knows what's going to happen to the economy," according to Carolyn Cole, vice president of Paine Webber Mitchell Hutchins. She said Paine Webber is less pessimistic than some, but the company still sees nothing better than slow growth and high inflation in 1979. Even so, she said, there is a high probability that the economy could grow faster than anticipated, which will push short-term interest rates, such as the prime rate, as high as 14 percent or more this year.
There is a lot of cash waiting on the sidelines, so to speak, that could plunge into equity investments. There were big market rises and declines last year, set off by small amounts of that money moving in and out of stocks.
Big institutions have billions of dollars in Treasury bills, bonds and other short-term investments, that could be shifted into stocks. Pension funds, for example, that had more than 70 percent of their assets in stocks in 1972, have only about 50 percent in equities today. Foreigners, who touched off last spring's giddy market climb then triggered its glum October plunge, could re-enter the stock market at any time, too.
But the winners in 1978, for the most part, were not those who based most of their portfolios on investment in a broad range of stocks. And most analysts appear to feel the same way about 1979.
In some ways that is a puzzling picture, because stocks are not nearly as overvalued as they were a decade or even five years ago. While investments such as housing, gems, artwork and gold have been climbing at a rate that begs for a bubble burst, stock prices have not risen, despite healthy corporate performances. On the average, real stock prices are lower today than they were 10 years ago. But what makes for good long-term investments, is not always good for short-term investments, especially with interest rates in the double-digit range.
The Dow Jones Industrial Average of 30 stocks closed 1977 at 831.17 and 1978 at 805.01, a decline of 3.1 percent. The broader New York Stock Exchange Index rose 2.1 percent, while Standard & Poor's 500-stock index rose 1.1 percent. Both were far below the nation's inflation rate.
For those who believe in omens, 1979's start was auspicious. January sets the tone for the year and the first five trading days set the tone for January, the old adage goes. It has some validity statistically, at least. About 80 percent of the time since World War II, the direction the market pursued early in the year is the direction it took, on averge, for the entire 12 months.
But analysts such as Dean Witter Reynolds's Frank Korth discount the early ebuilience. "Our posture is a defensive one," Korth said. "We're into the last phases of a year-end rally that might run until the end of January. But after that everything is biased downwards." He said the Dow average could hit about 750 in March, rise somewhat in April and fall below 750 in May.
Then, he said, if interest rates do peak, then some of that big money that is waiting to be invested in stocks -- Korth estimates it at $40 billion -- could trigger an upswing. With good economic news -- including success on the inflation front, which should spark confidence in the dollar and ease pressures on interest rates -- the Dow could move into the high 800s by December.
But, cautioned Korth, who is Dean Witter's director of market analysis, if interest rates stay as high as Salomon Brothers' Kaufman expects, the Dow could be as low as 650 in mid-October, before starting a year-end rise.
If the economy moves into a recession in 1979, as most economists think it will, that would be good news for stock prices.
"The market rarely bottoms out before the economy peaks," noted Merrill Lynch's Farrell. "The last time that happened was in 1926. The market doesn't turn up until interest rates peak."
The nation is in an unusual situation, he said, because the economic expansion has lasted much longer than normal and it is taking much higher interest rates to slow it down.
If the economy keeps growing through March, which appears likely, it will mark the fourth anniversary of economic growth that started at the end of the worst recession since the Great Depression.
The performance of the dollar may be the biggest key to the stock market's performance, for a dollar rally could bring foreign money back into Wall Street. U.S. stocks are relatively cheap for most European investors because of the erosion of the dollar. If foreign investors perceive a halt in the dollar's decline, so they don't lose their investment gains when they translate their dollars back into their own currencies, they may well move their money back into American equities.
Despite the other "negatives" nagging Wall Street last April, foreign stock purchases kicked off a springsummer rally that saw the Dow shoot up 150 points. But when the dollar sagged ferociously in October, foreigners and others began to sell. In the last 12 trading days in October, the Dow average fell 104.62 points.
The massive dollar support program President Carter launched in November has had a beneficial effect on the dollar, but foreign currency markets are still wary of continuing U.S. inflation. The oil price rise announced by oil producing countries last month (a four-step rise that will average 10 percent this year) further compounds the dollar's problems, although the U.S. is less dependent on foreign oil than most of the major industrial countries.
Paine Webber's Cole, like Dean Witter's Korth, recommends a selective investment in growth companies that are recession resistant but can be expected to outperform the economy in periods of high inflation as well.
She said industries such as health care, leisure, energy, and some steel companies will probably peform best in 1979. The Paine Webber rocommended list of stocks appreciated 17.2 percent in 1978, far better than the market as a whole.
The brokerage industry itself was bolstered by the spring-summer surge in stock prices, so much so that the spate of major mergers of brokerage houses that hit the industry in 1975, 1976 and 1977 ended in 1978. But the steep decline in prices in October and the low volume of trading in November and December created new profit problems on Wall Street.
Analysts expect more mergers in 1979 as well as a renewed emphasis by major brokerage companies to diversify themselves to lessen their dependence on volatile commission incomes.