Like an aging rock superstar returning again for an encore concert, Wall Street turned in another stellar performance in 1986, prolonging the bull market's life for a fourth straight year. But experts say it may be harder for stocks to retain their thunder this year.
Spurred by lower interest rates and low inflation, Wall Street rose far higher than most analysts had expected as stocks generally outshone bonds, precious metals, housing and many other investments. The Dow Jones average of 30 industrial stocks closed Wednesday at 1,895.95, a 22.58% gain during 1986, following 1985's gain of 27.66%. Thirty record highs were set, including the current record of 1,955.57 reached on Dec. 2.
The broader Standard & Poor's 500-stock index gained a more modest--yet still impressive--14.62%, its fifth consecutive annual increase. Gaining stocks led losers on the New York Stock Exchange by more than a 2-to-1 margin.
Such a strong showing came despite the sluggish economy, lagging corporate profits and worries about the Ivan F. Boesky insider trading scandal. Nor was the market hurt significantly by selloffs of stocks from investors seeking to take long-term capital gains before year-end to beat the rise in the top capital gains tax rate to 28% from 20%.
The year was marked by new single-day records in trading volume, including December 19, when 244.68 million shares changed hands. Volume for the full year on the NYSE hit 35.68 billion shares, 29.7% higher than in 1985.
The year also saw wild swings in the Dow average--including a record 86.61-point decline on Sept. 11--spurred by so-called program trading, in which major institutions trade large blocks of stock to profit from price differences between stocks, stock index futures and options.
Credit for much of Wall Street's health goes to lower interest rates, which made Treasury securities, certificates of deposit, corporate bonds and other investments less attractive. Foreign investors and institutions were awash with cash and invested in stocks, despite lackluster corporate profits.
"If you don't have more attractive alternatives, then it doesn't take a robust economy to sustain a strong stock market," said Robert Arnott, president and chief investment officer of TSA Capital Management, an investment management firm in Los Angeles.
But many analysts and investment managers, believing that much if not all of the fall in interest rates and inflation is over, are decidedly cautious about whether the market can shine as well this year as it did in 1986 and 1985.
Indeed, analysts note, the market was lackluster in the second half of the year, with only some stocks continuing to do well in the second half. All of 1986's full-year gain was posted by July 1, when the Dow first closed above 1,900. That period, not coincidentally, corresponded to the bulk of the year's decline in interest rates. And although the Dow index hit its all-time high in early December, many stocks peaked in late spring or early summer, analysts say.
Many see stocks continuing to remain attractive, with the Dow topping the magical 2,000 level, possibly before or after minor corrections that could drive the index back below 1,800.
But for Wall Street to show gains similar to last year or the year before--or reach even 2,500 or possibly 3,000, as some optimistic forecasters predict--investors will need more than just a continuance of low interest rates and low inflation, these experts say. They also will need a vigorous boost in corporate profits.
Profits Have Lagged
So far, earnings have not kept up their end of the bargain. Stock prices have far outpaced gains in corporate profits and stock dividends over the last few years, as shown by rising price-earnings ratios and falling dividend yields. Price-earnings ratios measure how much stocks are selling above their earnings per share.
The median price-earnings ratio of about 15.4 for stocks on the S&P 500 and about 16 for the entire NYSE causes many analysts to worry that stocks may have gotten about as high as they can get without similar gains in earnings. The 15.4 ratio--although still far lower than the 18 and 20 ratios of the go-go 1960s--is much higher than the 12.5 in early 1986 and the 10 that was typical in 1983, noted David Blitzer, chief economist for Standard & Poor's.
Disappointing profits, as well as sharply higher inflation or interest rates, or a recession, could spell the end of the bull market.
"Unless there is a rise in corporate earnings, the market will have problems," said Michael Metz, market strategist at Oppenheimer & Co. in New York. He predicted that the Dow will tumble to about 1,500 this year, thanks in part to what he expects will be disappointing earnings.
Some Key Factors
However, many analysts say, a number of key economic and market conditions still favor stocks, albeit not necessarily pointing to torrid market gains. Among these key factors: