Bearish second thoughts on interest rates

Revisionist historians are at work on Wall Street: Did Federal Reserve chairman Paul Volcker really imply a few weeks back that interest rates could fall in the near term? Or were the optimists just inferring that?

Whatever the answer, it is evident that those optimists, who as recently as a week ago were predicting lower interest rates, are now being submerged in a sea of concern about rates rising once again. This is dampening the recently robust stock market and turning attention to the unbeatably safe 13 percent returns you can receive with government bonds.

Still, there has not been wholesale disillusionment with the market. Perhaps the best word for investors in recent days is ''temporizers.'' If a typical big investor were to be found he would be concerned about the future, about interest rates, about the economy's being either too credit-hungry or perhaps on the verge of a stall-out; he would be looking at the 150-point climb of the Dow Jones industrial average in August and be wondering if there was much oomph left.

There was not much oomph last week. The Dow finished a lackluster week Friday at 1,224.38, down 12.15 points in five sessions. But more often than not the market, which was closed on Labor Day, tends to be stronger in September. In the past five presidential years, except for 1972, it has posted modest gains for the month. (September 1972, as it happens, saw a Republican incumbent heading for a big victory, and was a modestly down month for the market.)

In general, investors still seem hung up on interest rates, hoping for a decline in the prime rate but seeing few signs of one.

The most telling barometer of interest rates is the bond market, and it drifted for most of last week, unable to attain higher prices because of worries that interest rates were neither firm nor declining. The bond market has rallied from the depths of last May: Recent evidence was the United States Treasury's sale of $6.5 billion worth of five-year notes for an average yield of 12.78 percent, down from 13.93 percent in June's auction.

But the interest-rate bears think the bond and stock markets have already exploited the softening of interest rates. Without the prospect of a drop in the prime, there is little reason for either market to climb, they argue.

Alvan Markle, director of fixed-income research for the Philadelphia-based Butcher & Singer brokerage, traces the summer rally to the ''tremendous amount of money that the Fed had to put into the economy for Continental Illinois,'' referring to the Fed's bailout of the troubled Chicago bank. That increased supply of money, which he estimates at $7.3 billion, caused interest rates to ease. But now, Mr. Markle says, the Fed ''is doing everthing it can to neutralize the effect'' of that infusion of cash - the most worrisome effect being a step-up of inflation.

That leads him to think tighter money will be a Fed policy for some time to come and that ''this fall, interest rates will rise again'' - by up to 2 percent. Each 1 percent rise in interest rates, he says, causes a 10 percent drop in bond resale prices. Consequently, he sees much vulnerability on the bond and stock markets today.

But Markle also sees hope on the horizon. By next spring, he says, the economy should be cooling and interest rates will be on the decline. Thus his strategy is to build reserves now in anticipation of buying some of those higher-rate bonds.

Another interest-rate bear is Ronald A. Glantz, economic and financial market specialist with Paine Webber. He says, simply: ''Getting 13 percent on a government bond is awfully attractive - much more so than stocks.'' Although he admits to being less pessimistic about stocks than he was a month ago, Mr. Glantz is reticent to recommend any industry groups or types of stocks, so powerful is the fixed-income attraction to him.

Much of the financial community had been hoping for a slower economy - the theory being that that would ease credit demand. But Glantz contends there is a very gray cloud inside the silver lining of slowdown: A slower economy could cause the federal budget deficit to increase; corporate earnings would decrease; and interest rates typically rise during the capital-expansion and inventory-building phase at the end of an economic cycle.

That is a little too pessimistic for Monte Gordon, director of research at the Dreyfus mutual fund group: ''As I see it, there is more strength than the (economic) indexes reveal. Construction is up; housing is unchanged; August retail and auto sales are OK. There are high imports, but this is evidence that the economy is sucking them in, due to high demand. The US just can't supply enough.''

With that in mind, Mr. Gordon says, the economy is stronger than many realize - except for the Fed, which may ''tighten rather than ease'' credit conditions. In such a climate, he says, the only stocks to buy would be top-quality issues. He predicts the Dow will trade in a very narrow range, perhaps rising as high as 1,300 on a piece of very good news, but otherwise performing in a lackluster manner.

Optimism persists, but it is usually tempered. At the Advest brokerage in Hartford, Conn., technical analyst Philip Erlanger contends that the attractiveness of 13 percent bonds actually has little to do with stocks: They are ''apples and oranges,'' he says, different types of investments.

Mr. Erlanger says the stock market has done well in containing most of the huge gain it chalked up in August. He sees the market and interest rates now ''correcting somewhat.''

This analyst is somewhat troubled by the high levels of bullishness that exist today - the highest, he says, since September of 1978. But with the big August surge one might have expected even more bullishness, he notes. The number of people selling short is still high, he points out, and those represent future purchases (since in a short sale one borrows stock and sells it, hoping to buy it back at a cheaper price as it falls.)

So as autumn approaches, Wall Street is reassessing. Perhaps, some believe, the optimism was overdone. Few analysts are recommending risky ventures. The main attitude seems to be wait and see.