With economy soft and new rate cut in offing, markets perk up

A gaggle of Wall Street gurus expected a boom to be upon us by now. The economic fireworks would begin in the second half of 1986, they said, with a period of robust sales, chugging factories, and escalating stock prices. With congressional elections coming up in November, it seemed a shoo-in.

To stoke the tepid economy, interest rates were cut twice. Both the stock and bond markets responded with tremendous rallies. But by most indications, business has yet to respond.

Now, the consensus is building for another cut in the discount rate (the rate charged by the Federal Reserve for loans to financial institutions). And the financial markets are perking up.

The Dow Jones industrial average climbed 5.72 points last week, closing at 1,885.26 at the final bell on Friday. The bond market surged early in the week on news that Japan's economy contracted for the first time in 11 years. Many considered that an indication that rates here will tumble soon.

The rationale is that as pressure builds for central banks overseas to drop rates (West Germany's economy also looks limp), it eases Fed chairman Paul Volcker's concern that an interest rate cut here would push the United States dollar lower against foreign currencies.

Estimates now are that rates will be cut shortly after the Fed gets a look at unemployment figures on Thursday -- and if Japan cuts rates after its legislative elections (next Sunday). The Fed policymaking committee meets July 8 and 9.

``It's not just Fed policy now [that governs US interest rates]. It's global,'' says Steven Smith, fixed-income fund manager at Provident Capital Management in Philadelphia. ``You've got deflation worldwide. Look at what's left of the tin cartel, the oil cartel. Wage inflation [in the US] has disappeared.''

Mr. Smith says that he is ``extremely bullish'' on the bond market over the next three months. He expects lower interest rates. Although he doesn't expect much of a fall, he doesn't see any reason for rates to rise much, either. He guesses that Treasury bills will drop to about 5 percent and that long-term governments will land just under 7 percent.

Over the next year, rates on long-term bonds could bounce back by as much as 150 basis points (1 percent). ``But I'm not looking for double digits on long-term Treasuries. Not with Japan in a negative growth mode and the German economy so anemic.''

International influences on the financial markets show up in pricing, too. At present, 30-year Treasury bonds are relatively expensive (and yields relatively low) because of strong British and Japanese buying.

``The Treasury market has become a very crowded pool,'' says Daniel Grant, editor of the Grant Interest Rate Observer, a weekly publication.

``The Japanese insist on buying government bonds and staying away from corporate yields. That serves to depress government yields.''

Mr. Smith and Mr. Grant both note that this situation has made municipal bonds, mortgage-backed securities, and corporate bonds relatively cheap. Grant's advice to the long-term fixed-income investor: ``If you're of the conviction that rates are coming down, don't look at Treasuries.''

To support his advice, he points to an A-rated Ralston Purina 30-year corporate bond issued last week. ``It sold at a yield of roughly 9. The [30-year] Treasury yield is roughly 7.4 percent.''

Corporate bonds typically sell at higher yields, because investors believe there is more risk that a company could go bankrupt than that the federal government would ever default. Even so, says Grant, ``That spread between good-quality corporates and Treasuries is wider than in anyone's memory.''

Smith at Provident Management has shifted the asset mix of his bond fund to capitalize on the spreads and the expected rate decline. In recent weeks, he has raised his holdings of corporate bonds (to 30 percent) as well as Fannie Maes and Freddy Macs (also to 30 percent). Government bonds make up 15 percent of the fund and the balance is in federal agency notes, tax-exempts, and Australian bonds.

Smith says that normally, four years into an economic cycle, a fund manager will not hold corporate bonds, because of the increasing risk of bankruptcy. He is typically shortening the maturity of his holdings in expectation of rising rates. But Smith isn't worried about a recession now and is confident enough that rates are coming down that his average maturity is more than 10 years.

On the equity side, investors are using the slow-growth, low-inflation prospect to justify buying consumer and interest-sensitive stocks. One group that is enjoying strong buying, even after substantially outperforming the market for more than a year now, is the food processing group.

``We're pretty bullish on the group,'' says Stephen M. Carnes, a Piper, Jaffray & Hopwood analyst, echoing the sentiments of numerous brokerage firms. The Minneapolis-based brokerage follows 16 food companies. Nine of them -- including such household names as Sara Lee, Pillsbury, and Dart & Kraft -- are on its buy list.

Mr. Carnes says the group's earnings should grow at 14 percent over the next two or three years. Low commodity prices have fattened margins. Many companies have a high debt-to-equity ratio, which means lower interest rates would be a boon. Also, many of them pay high income taxes, so if the tax reform bill goes through, earnings could jump an extra 10 to 20 percent, analysts say.

A recent Value Line report screened the 1,700 stocks it tracks for ones with high timeliness and a low risk rating. Of 34 companies that made the final cut, the food industry had the most ``hits,'' with five represented: Heinz, Hershey, Kellogg, Sara Lee, and Wrigley. Laundering case hits brokerage

Once again the record-breaking bull market has been bumped from the headlines by a Wall Street scandal. Shearson Lehman Brothers was indicted by a federal grand jury last week on charges of money laundering for a sports-gambling syndicate.

Shearson, a subsidiary of American Express, is the first brokerage indicted on charges it failed to report cash deposits of more than $10,000. Federal authorities have been actively using violations of the Bank Secrecy Act to crack down on drugs and organized crime.

This indictment charges Shearson and a former Philadelphia office manager with 2 counts of conspiracy, 36 counts of failure to file currency transaction reports, and 3 counts of concealment of facts. Shearson faces a possible fine of $16.5 million if convicted.

The indictment alleges that former office manager Herbert L. Cantley conducted these activities with the knowledge of other Shearson managers and employees.

Shearson officials object to the unprecedented charges. In a written statement, the firm said it was not responsible for the actions ``committed outside the scope of Mr. Cantley's employment, off company premises, and in violation of Shearson Lehman's own policies.'' Cantley was fired shortly after a raid by federal investigators on Shearson's Philadelphia office in April of 1985.

Federal prosecutors allege Cantley and six other Philadelphia men ran an interstate gambling operation between 1982 and '85.

As in the E. F. Hutton check-float case, it's unusual for an entire firm to be charged with wrongdoing. But federal officials say that by going after Shearson itself, they hope to send a message to other brokerages about the importance of complying with the Bank Secrecy Act.