Stocks for Goldilocks : Dow Loses 101 but Market Still Wraps Up 2nd Straight Strong Year

By TOM PETRUNO

Jan. 1, 1997 12 AM PT

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The U.S. stock market ended 1996 with a split ticket on Tuesday, as blue-chip stocks tumbled while the broad market rose--a suitable final reminder of a year of very divergent, but on balance mostly bullish, trends on Wall Street.

The Dow Jones industrials sank 101.10 points, or 1.5%, to 6,448.27 in a late sell-off triggered by strong economic data that pushed up bond yields and raised the perennial market bugaboo: Is economic growth going to be too fast, too slow, or just right in the near future?

But if the Dow’s dive suggested concern, a rally in the rest of the market hinted that many investors are sanguine that 1997 may bring more of the same “Goldilocks” economy that helped push stocks to record highs in 1996.

Even with Tuesday’s pullback, the Dow ended the year up 1,331.15 points, or 26%--a stunning gain considering that it came atop a 33.5% surge in 1995. The index isn’t far from its record high of 6,560.91 set just last Friday.

Of course, it wasn’t an easy climb for stocks in 1996, despite the Dow’s impressive numbers. Indeed, the market’s year unfolded in distinct chapters: It began with a blue-chip boom, then gave way to a spring mania in smaller stocks, which then set up the abrupt summer pullback that sliced 10% off the Dow from its late-May peak to its intraday low on July 15, and clipped high-flying smaller issues more severely.

By August, investors were back in a buying mood, but the July decline left many wary of being caught by another sudden market slump. So the focus shifted intensely to “safe,” easy-to-buy-and-easy-to-sell blue chips. That trend was reinforced with the November election, as investors cheered the continuing Washington power split, pushing the Dow from 6,081 on Election Day to 6,547 by Nov. 22.

It was left to Federal Reserve Board Chairman Alan Greenspan to help trigger a more modest market pullback in early December, by raising the question of possible “irrational exuberance” in financial markets. But not even Greenspan could bring this market to heel for long.

When all was said and done by Tuesday afternoon, the blue-chip Standard & Poor’s 500 stock index had racked up a 20.3% gain for 1996, not counting dividends. Added to the 34.1% S&P; rise in 1995, the two years together produced the index’s best back-to-back gains since 1954-55.

Smaller stocks lagged noticeably after losing their spring momentum, as investors worried about the stocks’ liquidity, or lack thereof. The Russell 2,000 index of smaller issues rose 14.8% for the year after gaining 26.2% in 1995. But investors’ interest in smaller stocks has been reviving lately: The Russell gained 2.4% in December, while the S&P; 500 lost 2.2%.

Meanwhile, perhaps the bigger story of 1996 was that the public’s appetite for stocks turned robust worldwide. Brazil’s key stock index soared 63.8% for the year; Hong Kong’s key index was up 33.5%, while Paris shares gained 23.7%.

In nearly all markets, the driving force behind demand for stocks was the same: a sense that global economic growth will continue at a moderate, noninflationary pace, keeping interest rates subdued while allowing corporate profits to rise. In effect, the just-right, Goldilocks economic backdrop.

In many countries, long-term bond yields fell in 1996 as central banks made for easier credit (they could afford to with inflation low) and investors’ trust in the Goldilocks scenario took hold. German 10-year government bond yields fell from 6.03% at the start of 1996 to 5.78% by Tuesday; Australian 10-year government bond yields dove from 8.2% at the start of the year to 7.37% by Tuesday.

In the United States, however, long-term bond yields ended the year higher than where they started: The bellwether 30-year Treasury bond yield closed at 6.64% on Tuesday, well above the 5.95% at the end of 1995.

That made for a lackluster year for U.S. bond investors, in large part because of their own “irrational exuberance” at the start of the year. Bond yields had fallen sharply in late 1995 and early 1996 on the assumption that the economy was slowing dramatically, and on hopes for a balanced-budget deal in Washington. Neither of those wishes came true for bonds, causing a whiplash in yields.

Still, the 30-year T-bond yield now is significantly below its 1996 peak of 7.16% reached on July 5, when Wall Street was gripped by one of its periodic bouts of concern that the economy might be growing too fast, and with it, inflationary pressures. That temporary spike in yields helped trigger the July stock market setback--until evidence of Goldilocks returned.

For many individuals, long-term bond yields didn’t figure much in their decision to stay in the stock market in 1996. What matters more to most small investors is what happens with short-term rates--the competition provided by money market funds and bank certificates. And thanks in part to the Fed’s one last cut in short-term rates at the start of the year, short rates stayed in a narrow range in 1996. The 3-month T-bill yield only veered between 4.89% and 5.36% during the year and ended Tuesday at 5.19%, up modestly from 5.07% a year ago.

Unwilling to settle for those relatively low short-term yields, U.S. investors instead continued to vote for stocks, pumping an estimated $220 billion in net new cash into stock mutual funds during the year, far surpassing the previous record of $129.6 billion set in 1993.

Arnold Kaufman, editor of S&P;’s Outlook investment newsletter in New York, notes that the question on many Americans’ minds remains the same: “What else are you going to do with your money?” if not invest in stocks.

As 1997 dawns and Wall Street pros debate the specifics of this market--just how irrational it may be, and whether the now 7-year-old bull is in danger of dying of sheer old age--that simple question of “what else can we do?” still speaks volumes.

* Consumer confidence surged to a seven-year high in December. D3

* The Dow plunges 101 points but most stocks end the day higher. D4

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

In-Your-Face Bull Market Rolls On

U.S. stocks racked up another huge year in 1996, with the Dow Jones industrial average soaring 26.0%, after surging 33.5% in 1995. Moderate U.S. economic growth kept corporate profits rising, while interest rates remained relatively tame. Still, the steep midyear pullback in stocks left many investors wary of smaller, riskier issues.

The Dow Jones Industrial Average

* Daily closes since Dec. 31, 1995:

* Dec. 31, 1995: Dow at 5,117.12; 30-year T-bond at 5.95%.

* Feb. 5: Blue chips soar in wake of Fed rate cut.

* March 20: Market churns as oil prices stage surprise rally.

* May 7: Dow fades as smaller stocks rocket.

* May 23: Jeff Vinik quits as head of Magellan Fund.

* July 15: Stocks plunge on earnings worries, jump in bond yields. T-bond at 7.07%.

* Early Aug.: Stock rebound on signs of moderate growth, low inflation.

* Sept. 13: Dow tops spring peak of 5,778.00 as buyers seek “safe” big stocks.

* Nov. 5: Re-election of Pres. Clinton, Republican Congress sends Dow soaring, yields sliding.

* Dec. 5: Greenspan raises “irrational exuberance” issue.