Big Selloff Hits Stocks, Bonds; Dow Falls 33.60 : Rising Interest Rates, Tax Reform Worries, Sluggish Profits Cloud Outlook

NEW YORK —  The stock market showed signs of exhaustion Thursday as the Dow Jones industrial average fell 33.60 points to close at 1,774.68.

“I think the stock market’s been looking for an excuse to go down,” said Michael Metz, market strategist for the Oppenheimer & Co. brokerage house.

Thursday’s decline, he said, even throws doubt on the Dow index’s 22.94-point rally Wednesday. While that rise was limited mainly to blue chips, Thursday’s selloff spread throughout the market. Losing issues outnumbered gainers by more than five to two.

It was the seventh-largest point drop in the history of the industrial average and the largest since the all-time record decrease of 41.91 points on April 30.

The Standard & Poor’s index of 500 major companies fell 3.10 points to 234.43. The American Stock Exchange’s market value index closed at 272.07, down 1.36. The New York Stock Exchange composite index closed at 135.29, down 1.61. Trading volume on the NYSE was a moderate 131.57 million shares, compared to 132.14 million in the previous session.

Several Factors Depress Market

“Wednesday’s rise was just a fluke,” Metz said. “The blue chips gave it up with a vengeance today.”

Among the factors depressing the market, Wall Street professionals said, are:

- The fall in interest rates appears to be over for now in the United States, Japan and West Germany.

- Corporate profits, which fell in the first quarter of the year, are not expected to rebound until at least the second half.

- The surge in individuals’ investment cash coming from individual retirement and Keogh accounts petered out after the April 15 income tax filing deadline.

- The Senate Finance Committee tax reform proposal would raise the marginal tax rate on stock market profits by eliminating capital gains treatment, encouraging investors to take stock market profits now rather than waiting for next year.

Finance officials in West Germany, Japan and the United States have expressed a disinclination recently to drive interest rates lower, a factor that depressed the bond market Thursday as well as equity trading. West German and Japanese officials have indicated that they are reluctant to reduce their own discount rates any further.

Volcker Remarks on Yen

In Washington, Federal Reserve Board Chairman Paul A. Volcker has said he would not like to see the dollar fall much further against the Japanese yen, a sign that the Fed will resist attempts to lower rates. And Allen D. Sinai, market economist at Shearson Lehman Bros. in New York, said in a report issued Thursday that he does not expect the Fed’s Open Market Committee to take any action to stimulate the economy by reducing rates when it meets next Tuesday.

“If stocks are going to resume their rally, there will have to be good news somewhere else,” said William M. LeFevre, market analyst for the Purcell, Graham stock brokerage here.

There is not much good news in corporate profits, which were generally disappointing in the first quarter ended March 31 and are not seen to be improving in the current quarter. The economy remains sluggish, as many economists believe that the gross national product grew at scarcely more than an annual rate of 2% in the first quarter.

Some analysts expect the market to coast lower over the next few months, perhaps to a Dow index level of 1,670 or even 1,600. For one thing, the annual surge of investment cash generated by IRA accounts--estimated at anywhere from $15 billion to $50 billion--is largely exhausted, since the money had to be mostly invested by tax filing time.

Although Sinai said in his report that the tax reform bill passed recently by the Senate Finance Committee should, if finally adopted, stimulate the economy over time by creating an incentive to save and a disincentive to borrow, the bill’s immediate impact on investors is anything but bullish.

The proposal would eliminate capital gains tax advantages while reducing maximum income tax rates to 27% for most middle-income taxpayers and 32% for the wealthy. The current maximum tax rate is 50%; because capital gains rules allow the exclusion of 60% of any gain from taxes, the maximum rate on long-term capital gains is currently 20%.

“That’s an added incentive to sell now, so you can take your gain at 20% instead of 27%,” LeFevre said.

Safeway Up on Heavy Volume

Safeway Stores was the Big Board’s second most active issue, closing up 3 3/4 at 41 1/2 on turnover of 3.5 million shares. Harry D. Sunderland, a Safeway executive vice president, said he knew of no developments that might explain the heavy trading.

Among Thursday’s prominent losers were International Business Machines, down 2 3/4 to 145 3/8; McDonald’s, 1 5/8 to 103 3/8; Merck, 4 to 183 1/2; Eastman Kodak, 2 to 57; Minnesota Mining & Manufacturing, 1 5/8 to 100 5/8; Exxon, 1 1/8 to 58; Citicorp, 1 1/8 to 56 3/4; Chase Manhattan, 1 1/2 to 40 3/8; J. P. Morgan, 1 3/8 to 82 1/2, and Manufacturers Hanover, 1 1/8 to 51 3/4.

Bond prices fell sharply and yields rose because of an unexpected jump in the nation’s basic money supply and investor nervousness over the outlook for interest rates, the Associated Press reported.

The Treasury Department’s key 30-year bond dropped nearly $12 for every $1,000 amount in face value, and its yield rose to 7.57% from 7.46% late Wednesday. Some long-term issues fell as much as $25 for each $1,000 in face amount.

Prices remained weak for much of the session, starting with the release of a Federal Reserve Board report that showed industrial production increased fractionally last month, defying predictions of a decline.

Any sign of economic strength tends to depress the market for fixed-income securities.

The big drop in bond prices came after the Federal Reserve Board announced that the money supply known as M1 grew to a seasonally adjusted $654.7 billion in the week ended May 5 from $648.6 billion in the previous week.

The increase, double the amount widely predicted, led to fears of renewed inflation, which would discourage the Fed from easing credit conditions by lowering the discount rate. The prospect of lower interest rates has been a major force behind the bond market’s strength.

Economy ‘in a Quagmire’

Bond prices recovered a bit later, which some analysts said was a reflection of the widely held belief that the Fed pays little attention to M1 growth because it is an unreliable indicator of economic health.

“The economy remains in a quagmire with sluggish growth,” said Philip Braverman, chief economist with Irving Securities Corp. in New York. The prospect of a lower discount rate, he said, “is somewhere down the road, perhaps June or July.”

In the secondary market for Treasury bonds, prices of short-term governments fell about 1/2 point, intermediate maturities fell one point and long-term issues were down as much as 2 1/2 points, the investment firm of Salomon Bros. said.

The Merrill Lynch daily Treasury index, which measures price movements on all outstanding Treasury issues with maturities of a year or longer, fell 0.67 to 116.01.

In corporate trading, industrials and utilities fell one point in active trading. Among tax-exempt municipal bonds, general obligations and revenue bonds both fell one point in moderate trading.

Yields on three-month Treasury bills were up 19 basis points to 6.28%. A basis point is one-hundredth of a percentage point. Six-month bills rose 22 basis points to 6.27%, and one-year bills were up 19 basis points at 6.39%.

The federal funds rate, the interest on overnight loans between banks, traded at 7%, up from 6.6875% late Wednesday.