Making money in stocks was easy in 1985. Lower interest rates, low inflation, takeover fever and other factors helped the Dow Jones average of 30 industrial stocks rise 27.66%, its best yearly gain since 1975. Thirty-two record highs were set. Stocks in nearly every industry rose. Gainers led losers by 1,957 to 356--better than five to one.
The festivities were not confined to the United States. Traders in Tokyo, London and other foreign markets also toasted healthy stock gains.
Many traders, analysts and money managers expect the bull market to continue upward through the rest of the decade. Some even predict that the Dow average will rise to nearly 2,000 this year and double to 3,000 by the year 1990--up from 1,546.67 now and the record closing high of 1,553.10 set Dec. 16. Such a twofold rise would match the market's gain since August, 1982, when the Dow stood at a measly 775.
However, experts caution, the market is also due for one or more downturns this year. Contending that stocks have become overpriced, some analysts predict that the market could fall by more than 10% sometime this year before resuming its upward trend.
"The market has been propelled by a lot of good news. But there's not much tolerance for disappointments" such as poor corporate earnings or slower-than-expected economic growth, says Thomas J. Foster, research director of Wedbush, Noble, Cooke, a Los Angeles-based brokerage.
But, while the market may slip somewhat during this year, the factors that fueled last year's phenomenal rally still remain in force and are seen by many market watchers as fueling a long-term bull market.
Lower interest rates are expected to continue making stocks attractive against money-market investments such as Treasury bills or bank accounts. They also spark optimism that the economy will improve from its estimated 2.4% growth rate of 1985.
If rates decline further, such as three-month Treasury bill rates dropping to 6% from the current 7%, "you're going to see a rip-roaring stock and bond market," predicts Werner Keller, director of research at the Los Angeles-based brokerage of Bateman Eichler, Hill Richards.
Optimism about lower rates has prompted many analysts to recommend stocks in such interest-sensitive industries as banks, savings and loans, insurance and housing.
But a rise in the Treasury bill rate to 8% could trigger at least a 10% to 15% slide in the market, says Elaine M. Garzarelli, director of sector analysis for Shearson Lehman Bros. She notes that every double-digit sell-off over the past 20 years has been preceded by a 20% rise in the Treasury bill rate. An 8% T-bill rate would represent a 20% rise from the low of 6.7%.
No Tightening of Money Supply
Another positive is low inflation. This has made stocks, bonds and other financial assets relatively attractive against such inflation hedges as real estate and precious metals. And as long as inflation stays low, the Federal Reserve will not tighten the money supply and throw the economy into a recession, analysts contend.
Many Wall Street analysts say declining interest rates, low inflation, a fast-growing money supply and falling dollar will boost 1986 economic growth to above the 2.4% rate estimated for 1985.
Consequently, many analysts are recommending stocks in such "cyclical" industries as chemicals, metals and paper, which will benefit disproportionately from a continued strong economy.
However, some analysts, such as Robert M. Hanisee, research director at Los Angeles-based Seidler Amdec Securities, predict that the recovery will run out of steam and that a recession will begin as early as the first quarter of 1987. Evidence of such a recession will show up as early as mid-1986, triggering a major market downturn, he predicts.
If the economy turns in a respectable growth rate as most expect, corporate profits should expand. David Blitzer, chief economist for Standard & Poor's, expects earnings for firms in S&P's 500-stock composite index to rise 18% this year over 1985. That would be a marked improvement over what S&P expects for 1985 compared to 1984--a 2% earnings decline or, at best, no change.
Higher expected earnings already are a major reason why stocks of blue chip multinationals such as International Business Machines and General Electric have led the current market rally. These firms benefit from the decline in the dollar, which makes their foreign earnings worth more in U.S. currency. The falling dollar is also a reason why some analysts are recommending stocks of soft-drink firms and others with extensive foreign operations.
The market should continue to benefit from the declining supply of stocks. The rash of mergers, leveraged buy-outs, stock buy-backs and corporate restructurings has removed billions of dollars of stock from the market. Only a fraction has been replaced through issuance of new equities. The Federal Reserve estimates that the net outflow of stock totaled $75.5 billion in 1985, following a $77-billion outflow in 1984.