Dow at 10000 does not sway the 'bears'

All the usual ways of measuring the stock market reach the same conclusion: The market is overvalued, investors are financial nuts, and a correction - possibly a severe one - lies ahead.

But that hasn't slowed the rampaging Dow Jones Industrial Average. The Blue Chip index reached yet another milestone March 29, when it finally closed above 10000 for the first time.

Indeed, investors seem oblivious to anything negative, from a record-high trade imbalance to war in Yugoslavia. Behind the celebratory cheers on Wall Street, however, can be heard an unsettling roar: the ever-louder growling of the stock-market bears.

These are the analysts who believe those traditional measurements of value, which show that, by and large, people are paying more to amass shares of America's corporations than the stocks are worth. Depending on which of them is giving the assessment, the stock market is currently overvalued by between 25 and 50 percent.

"But do fundamentals matter?" asks Edward Yardeni, chief economist for Deutsche Bank Research, New York. "Maybe all that matters is money. Lots of money pours into the market automatically, no matter what happens."

His reference to 401(k) pension plans, in which investment money is automatically deducted from many Americans' wages, is one explanation for why the market keeps heading higher. Another is the exuberance of ordinary investors.

"There's no way of separating out psychology and mania in the short run from the fundamentals," says Robert Parks, a Wall Street economist. "Where's the market headed? I don't know. The bull market could last for months or all year."

Although their warnings of a future price decline are much ignored, he and a growing number of analysts believe there will be a downturn at some point. "This is going to end in grief," says consulting economist A. Gary Shilling, one of many analysts who maintain that stocks are overvalued.

Of course, the bears have been saying that for two years or so, even as the market marched onward and upward (with only a couple of breathtaking but short-lived freefalls). So now, they usually note that prices could continue to climb, despite poor real values.

MOST brokerage house analysts say the 18.6 percent average annual return since 1982 is unlikely to continue. Many forecast single-digit gains in stock prices this year and next.

But the bears see high risk in the market, if not worse.

Mr. Shilling, one of the growliest, talks of a 40 to 50 percent drop in stock prices, stretching over a longer period than the 20 percent "correction" of last fall.

Mr. Yardeni sees "a classic speculative bubble" in the market. Though he describes himself as bullish in the long term, his estimate is that the market is 30 percent overvalued.

Standard & Poor's DRI has an economic model that finds the stock market overpriced by about 25 percent, says Cynthia Latta, an economist with the Lexington, Mass., consulting firm.

An economic model used at the Federal Reserve finds the same degree of overvaluation. The central bank's model determines "fair value" by dividing corporations' estimated earnings for the year ahead by the yield on 10-year Treasury bonds. Presumably Fed Chairman Alan Greenspan looked at results from this model when he asked in 1997 whether stock prices were manifesting "irrational exuberance."

But the majority of investors, at least those in the favored big stocks and technical stocks that are carrying the stock price indexes higher, must disagree.

Michael Flament, chief economist of Wright Investors Service, a Bridgeport, Conn., investment management firm, speaks of "momentum investing." Stock prices are going up. Investors see that, he says, and keep on riding the wave with more investment money.

If investor enthusiasm has pushed stock prices too high, what could send them plunging?

Bears have varying views, but here are some of the oft-cited dangers:

*Corporate profits are disappointing, perhaps as a result of weak economies in Europe, Asia, Latin America, and Japan. "There is not much room for disappointment at these price levels," says Shilling of Springfield, N.J.

Most analysts expect a small rise in corporate profits this year, after a drop last year. Merrill Lynch economist Bruce Steinberg is among the more optimistic, predicting a 7 percent gain this year for the S&P 500 stocks.

DRI notes that corporate accounting standards have toughened since 1990. So if earnings were calculated on a pre-1990 accounting basis, the price-earnings ratio of the stocks in the S&P 500 index would be 26, rather than the 31 estimated from reported earnings.

But 26 remains far higher than historic averages.

Mr. Flament figures the market is close to the overvaluation level just before a 1987 plunge.

*The Fed raises interest rates as a preemptive strike against a rebirth of inflation.

Wall Street would be shocked if the Fed had raised interest rates March 30 at a policymakers' meeting in Washington. But a revival of inflation is hard to detect.

Some analysts expect the Fed to hike rates later this year should higher oil and other commodity prices, plus tight labor markets, start pushing up corporate costs and consumer prices.

*The economy goes into a period of deflation.

This is a rare view.

But Shilling argues that, historically, the US has experienced long periods of declining consumer prices in periods of sustained peace. Now, with the end of the cold war, the US has enjoyed a relatively long period of peace. As a result, he says, inflation has not returned, and deflation is "now the norm."

This will be a "big shock" for the stock market when deflation is recognized, Shilling says. Corporations will not be able to rely on rising consumer prices to boost their earnings and cut the real value of wage hikes.

*The Y2K threat - in which America's computers fail to recognize that '00 means the year 2000 and not 1900 - turns out to be serious, hurting the economy.

If so, Yardeni expects a 30 percent drop in prices later this year. After that, he says, the market will recover and the Dow will reach 15000 by 2005.

For the time being, says Yardeni, "enjoy the bubble."