The Outlook -- After the Rise: The Market's Message
NEW YORK -- Anyone who questions the remarkable relationship that binds the economy and the stock market should ponder briefly the circumstances that immediately preceded the recent surge in share prices. On July 31, the Commerce Department announced that its composite index of leading economic indicators dropped 0.9% in June. And on Aug. 1, the Dow Jones Industrial Average jumped 19.33 points. Further steep increases followed, so that by last week's end the average was 102.81 points above its July 31 level.</br></br>There's no short, simple explanation of the linkage between the economy and stock market. But any serious effort to appraise one's prospects entails close attention to the other. An obvious tie involves profits. If it becomes clear that a company's profits are on the rise, demand for its shares is likely to increase, tending to push up their price. A subtler connection involves interest rates. Securities that offer fixed rates of interest compete for investors' dollars with common stocks, which offer dividends that may rise or fall according to changes in profitability. When interest rates fall, this renders interest-paying securities relatively less attractive. It's no coincidence that in general before the recent market surge profits were sharply on the rise and interest rates on the decline.</br></br>In all, a wide variety of factors can play upon the market. Among them are shifts in investor confidence, concern about rising or falling prices, worry over higher taxes or stiffer governmental regulations, changes in so-called margin requirements that limit what investors may borrow to buy stocks, the flow of money from overseas, major strikes and the failure of a large corporation. But business-cycle history leaves little doubt that the fundamental influence is the broad economic trend.</br></br>The 0.9% drop in the Commerce Department's leading-indicator index in June has been widely interpreted as a signal that the economy, at the least, will grow at a slower pace in coming months. This, in turn, has been seen as a good reason to invest in common stocks, since a slower-paced expansion would presumably last longer and be accompanied by somewhat lower interest rates.</br></br>The record shows, however, that a decline of only a month or two in the leading-indicator index by no means guarantees an economic slowing. In fact, the June drop was the first monthly decline since August 1982. Moreover, it's possible that subsequent revisions in the various components of the Commerce index may eventually turn the decline into an increase. Several times since August 1982 reported monthly declines in the index have indeed been revised into gains.