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Third-Quarter Review of Investments and Personal Finance : Does It Get Any Better Than This? : Savor Your Gains, but Have a Plan in Case Trouble Looms

October 01, 1995|TOM PETRUNO | TIMES STAFF WRITER

It's rarely as easy to make money in financial markets as it has been this year. And that's the problem.

With the average U.S. stock mutual fund up a spectacular 28% through the first three quarters, and the average fixed-income fund up a handsome 11%, 1995 is on track to record the best market gains since 1991.

For individual investors, now comes the tough part: controlling your emotions if those paper profits evaporate, and sticking with a long-term investment plan should other investors' time horizons shrink to barely cover the next afternoon.

Those challenges are on the minds of many market pros these days. Nine months ago, optimistic Wall Streeters forecast that this could be a great year for stocks and bonds if the economy managed a "soft landing"--a slowdown in growth without recession.

Bingo.

"The soft landing is now a matter of history," declares Donald Straszheim, chief economist at Merrill Lynch & Co. And the markets have loved it, as predicted.

But in recent weeks the euphoria has begun to fade. The conundrum increasingly dogging investors is the perennial one: What happens next?

Already, fears of widespread weakness in third-quarter corporate earnings are chipping away at stocks, leaving the Dow industrial average at 4,789.08 as of Friday, hovering just below its all-time high of 4,801.80 set on Sept. 14.

In the bond market, the summer conviction that the Federal Reserve Board would continue to lower short-term interest rates has been dissipated by some stronger-than-expected economic data.

And underlying every investment decision, at least to a degree, is the Goldilocks question: Will global business activity in 1996 be too hot, too cold or just right?

Of course, markets' primary job is to worry, so some investors may ask what's really different today. The answer is that the surge in stock prices this year, and the sharp decline in bond yields, have built into financial assets certain expectations that may be tough to fulfill.

For example, with many stocks at or near record highs--and at prices that, historically, are at least average (as opposed to cheap) relative to earnings per share--any disappointments in earnings can provide jittery investors with a reason to sell.

Hence, the slew of major American companies that have recently warned of lower-than-expected third-quarter earnings have generally seen their shares pummeled, undercutting the market overall.

*

In the bond market, the slide in the benchmark 30-year Treasury bond yield from 7.88% on Jan. 1 to 6.50% now--near a 19-month low--amounts to a strong investor vote of confidence that the economy won't dramatically reheat and that annualized inflation will remain under 3%.

Any evidence to the contrary, therefore, is enough to unnerve trigger-fingered bond investors.

Exactly what the collective expectations of stock and bond investors amount to isn't knowable, and in fact during market rushes like this year's it's arguable that many investors aren't quite sure what they want--except for the bullish trend to continue.

That's precisely what makes the stock market, in particular, so dangerous now, bearish analysts argue. The most pessimistic believe stocks have been caught up in a mania, with technology shares at the center, and that this investor "pile-on" has driven the market to heights that allow no room for error.

"If interest rates are destined to keep declining, if inflation is a dead issue, if corporate profits are to experience uninterrupted growth . . . it may well be that almost any price paid for equities today can be justified," says Norman Fosback, the bearish editor of Market Logic newsletter in Deerfield Beach, Fla.

"But if inflation or interest rates ever jump, or earnings or the economy ever slump, today's [stock] prices will be viewed retrospectively as an aberration," Fosback insists. His advice to investors: Keep 60% of your assets in money market funds and wait for stocks to fall to bargain levels again.

For many individuals, however, the idea of trying to time financial markets' moves goes against everything they've learned about investing. Americans have been exhorted to save and invest more, to do so on a regular program (such as through 401[k] retirement plans), to be well diversified and to think very long-term.

Are U.S. stock and bond markets so out of whack with history and with reality that it's time to abandon them completely?

Most Wall Street veterans don't think so. While this year's stock gains are well above historical averages, they follow a small decline in share prices last year and mediocre returns in 1993 and 1992. Thus, 1995 could easily be viewed as a period of catch-up.

What's more, it isn't unusual for a big year like this one to be followed by another up year. It happened in 1985 and 1986, and again in 1988 and 1989.

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