Sept 9, 1998

By GRETCHEN MORGENSON

EW YORK -- Back to work. Back to school. Back to the roaring bull market. 

So it went Tuesday as stocks kicked once again into high gear on their biggest one-day point move ever. On a wave of emotional buying that crescendoed in the last half hour of trading, the Dow Jones industrial average rose 380.53 points on the day, a 4.98 percent jump. 

Although there were many players on Tuesday's stock market stage, the hero of the piece was Federal Reserve Chairman Alan Greenspan. In a now well-known speech before students at the University of California in Berkeley on Friday, Greenspan suggested that the Fed may cut interest rates if the financial crisis that has humbled Asia and Russia and now threatens Latin America worsens. 

Investors have come to believe, though it is not always so, that falling interest rates inevitably push stock prices higher. Many of these believers stampeded into stocks Tuesday. 

But traders gave other reasons for the manic move in stocks, all having more to do with psychology than with economics. In other words, the world remains an economically precarious place, higher stock prices notwithstanding. 

For example, investors seemed to return from their Labor Day weekend thinking that the unrelenting selling of the past two weeks had taken stocks to levels that even Chicken Little would consider overdone. It was time to hunt around for bargains. 

Investors may also have done a little check of the calendar and found that it was time again to buy. Why? Because since 1981, all bear markets have lasted an average of about 60 days. This includes the whipping that investors took during the summer of 1983, the crash of 1987, the bear market of 1990 and the decline of early 1994. 

Another factor working in favor of stocks Tuesday was a flood of buying by investors who had made bets that share prices were going to continue their downward spiral, what Wall Street calls short-covering. This is a type of forced buying caused when pessimistic investors who had sold short-selling shares they did not own in the hopes of buying them back later at lower prices see these shares rise in value. Hurrying to cut their losses on trades gone awry, these investors buy back the shares they had sold earlier. 

Then there was Goldman, Sachs market strategist Abby Joseph Cohen appearing on CBS's "Face the Nation" on Sunday, giving her cheery predictions for stock prices. Perhaps this audience, more politically- than equity-inclined, had not yet heard her argument for higher stock prices. Maybe they rushed to call their brokers Tuesday morning. 

While Tuesday's surge was impressive, traders said that its steepness, particularly in the final half hour of trading, looked very much like the work of so-called momentum investors, those who buy stocks only after they have made a strong directional move. Many of these investors execute their trades near the end of the day in the hopes that the surge will draw in other investors the following day. 

Still, Tuesday belonged to Greenspan. His comments telegraphing the possibility of a rate cut were all investors needed to get their grooves back. 

Does this make sense? Yes and no. Some of the stocks that made the biggest moves Tuesday, favorites like America Online, Lucent Technologies and Cisco Systems, do not qualify as interest-rate sensitive stocks. It is to be expected that bank stocks would rally on news of a possible rate cut, but why should lower interest rates propel the shares of Internet darlings and computer makers? 

Conversely, shares of certain companies that would benefit from lower rates barely budged Tuesday. Homebuilders Toll Brothers, Lennar Corp. and Kaufman & Broad Home Corp. only inched up on the day. 

It is, of course, ironic that Greenspan's remarks ignited a new round of stock market euphoria that he has scolded investors for exercising in the past. And one money manager noted Tuesday's move was another example of the market absorbing news almost instantaneously, leaving no time for investors to mull it all over and no room for error. 

Indeed, in Tuesday's trading, a substantial interest rate cut -- one-half of one percentage point, not the one-quarter Greenspan is famous for -- was almost instantly factored into stock prices. What happens if the Fed doesn't ease monetary policy in its meeting Sept. 29? The market would be mighty disappointed. 

Even though a possible rate cut gave fuel to Tuesday's fiery stock prices, traders pointed out that it shouldn't have been news to investors. Bond traders are already counting on not one, not two, but three one-quarter percentage point cuts in rates. Investors can see these expectations in the 5-year Treasury trading at a yield of 4.92 percent Tuesday compared with the federal funds rate of 5.5 percent. 

Sure enough Tuesday, while stocks were racing, bonds yawned. The 30-year Treasury bond yielded 5.36 percent at the end of the day's trading, up from the 5.28 percent close of Friday. 

What stock market investors heard in Greenspan's Berkeley speech was that they now had something they had been sorely lacking for weeks: a backstop. A tower of strength. A grownup in charge. With the world in disarray, the International Monetary Fund weakened and President Clinton hobbled, equity investors seized on Greenspan as the best candidate to save the planet. 

There's no doubt that there is truth to this assessment. Greenspan will do what he has to do to calm markets worldwide. But there is also truth in this: the future health of the stock market depends not so much on interest rates as it does on corporate profits. And those are still looking dicey. 

Analysts in Salomon Smith Barney's economics group lowered their estimates for Standard & Poor's 500 profits for both 1998 and 1999 last Friday. The analysts, led by Mitchell Held, wrote that they were now expecting earnings growth on the S&P of just 1.5 percent this year and, more ominously, a decline of 1 percent next year. They believe that the downturn in Asia will continue well in 1999 and that growth in the emerging markets of Latin America will slow from 3 percent in 1998 to zero next year. Take into account Canada, a country that has seen its currency crater and one that accounts for 25 percent of U.S. exports, and you have questions about the health of nearly 75 percent of the market for U.S. exports. 

The report concluded: "Financial market developments of recent weeks will result in slower economic activity on a global scale in the year ahead, dimming the earnings outlook for domestic companies considerably."