It wasn't Black Tuesday, but Wall Street's canyons still quake

In case you somehow missed it, that whooshing noise heard around the world last week was the sound of stock and bond prices plummeting from lofty levels. In a classic bear trap, there was nary a hint of trouble on Sept. 4, when the Dow Jones industrial average shot to a new high; it was 1,919.71. But exactly a week later, the Dow was pummeled by a spate of panic selling.

The average of 30 industrials lost 86.61 points (a 4.6 percent dive) in the biggest one-day point drop ever. And the New York Stock Exchange saw its busiest session in history, trading 237.6 million shares.

The sell-off continued on Friday. By the closing bell, exhausted NYSE floor traders were staring at 1758.72 on the Dow, down 141.03 points in five trading sessions.

Is the free fall over? Time to snap up some bargains? Or is this four-year-old bull market finally to be sent to pasture?

Take a two- to five-month break, Robert Prechter advises. ``The major averages are going to fall 8 to 16 percent. It's going to be much worse for the secondaries. It wouldn't surprise me to see them drop 30 percent off their July highs.''

Mr. Prechter, editor of The Elliott Wave Theorist, a Gainesville, Ga.-based newsletter, has become known as the bull-market guru of the '80s. Long before it became fashionable, Prechter was unabashedly predicting a Dow of 1,500, 2,000, and upward.

On Sept. 2, for the first time since June 1984, he warned both traders and long-term investors to ``take your profits now. Shift your funds into money market accounts.''

Prechter bases his forecasts on conventional technical analysis and a more arcane branch developed by Robert Elliott in the 1930s. The theory says the stock market operates on a basic rhythm that produces a pattern of five waves. Prechter says the market is at the start of the fourth wave (a selling wave), which will be followed by the fifth and final bull-market wave in the cycle.

``At the end of the year, everyone will be talking about 1929 and the Dow will fool them again. My target is still 3,600,'' says Prechter confidently.

While last week's record drop frightened many investors, it's not in the same league with the Black Tuesday sell-off on Oct. 28, 1929. That day saw the Dow tumble 12.82 percent.

On a percentage point basis, a comparable fall today would have to be on the order of 240 points.

Indeed, some fundamental analysts say it may be premature to call this the end of the bull market. Yes, interest rates are rising. Yes, inflation may be rising. But for how long?

``The selling's an overreaction to a whiff of inflation,'' says Thomas B. O'Donnell, a fixed-income portfolio manager at J. & W. Seligman & Co.

The scent of inflation was triggered by a rise in commodity prices. Platinum, gold, and silver prices have run up in recent weeks. The OPEC price-holding agreement appears to be working. Oil prices are firming at about $16 a barrel.

Demand for commodities also often indicates that business is perking up. And there have been some signs of renewed economic vigor. The unemployment rate slipped. July factory orders were robust. Retail sales in August were up.

Suddenly, the strategy of investing on a drop in interest rates appears to have gone out of vogue.

Now, investors are figuring rates may rise as businesses start to borrow to finance expansion plans.

This kind of thinking was manifested first in the bond markets last week. Just a day before the Dow's plummet, there was heavy bond selling in Tokyo and London. The wave hit the New York bond market and spread to the stock market.

Even so, United States bond prices were already in a downtrend. During the five days preceding last week's big sell-off, the price of 30-year Treasury bonds slid a full 5 percent. The difference or spread between yields of long-term government bonds and three-month Treasury bills stretched to 2.35 percent, far above the average 1.5 percent spread.

``People were and are moving out of the long end into the short end in anticiaption of a rise in rates,'' explains Mr. O'Donnell. Investors don't want to get locked into long-term bonds now if yields are rising.

A skeptic of the rising-yields trend is Edward L. Martin, director of fixed-income trading at David L. Babson & Co., an investment advisory service. ``It's too early to say commodity prices have bottomed. And it's too early to say economic growth is on its way up.'' Despite the jump in long-term yields last week, Mr. Martin says, rates are going down, not up.

``The trend in rates is lower. Later in 1987, '88 we'll start to see rates moving back up as the economy gets stronger. But now there's still a tremendous amount of excess [industrial] capacity in the world that has to be worked out before rates rise.''

O'Donnell says that drawing a bead on the economy and interest rates is ``very tricky'' now. A German, Japanese, and US coordinated rate cut could come as soon as the September 30 IMF-World Bank meeting. But ``the Fed is in the same boat as we are,'' he says. ``They'll continue to look at the economic data as it comes out.'' He says it's more likely that by November or December another discount rate cut could be in the offing.

But James Grant, editor of Grant's Interest Rate Observer, doesn't agree. He thinks interest rates will continue to rise -- but not because of inflation.

Mr. Grant says commodity prices are up because inventories got low while speculators pumped up precious-metal prices. ``Reflation? It won't happen. What we're seeing is a road show. A fake.''

As for the rise in yields, Grant says that may be due to less buying by foreigners, who have been heavy purchasers. He thinks that ``there's a growing perception that the credit worthiness of the US government is not what it should be.'' He points to a 1987 budget deficit of $225 billion forecast by the Conference Board last week. ``That's a far cry from the $144 billion mandated by Gramm-Rudman.''