NEW YORK -- A continued plunge in interest rates to the lowest level in decades is causing many money managers to make fundamental shifts in their investment strategies, flocking to stocks in search of higher returns.
Their enthusiasm has propelled some market averages to within inches of new highs this week, with stocks regaining all the ground they lost two weeks ago as President Clinton presented his proposed budget.
The consequences go far beyond the investment community. The stock market's vigor, if sustained, can help companies sell stock to pay down debt, expand and, often, add employees.
"All the things happening in the financial markets are extraordinarily constructive for corporate America," said Bruce Steinberg, a senior economist at Merrill Lynch, referring both to lower interest rates and increased stock issuance. "The cost of capital has really come down dramatically in the last year. By many measures, it's lower for American companies than Japanese companies."
Although some money managers say stocks are already expensive, many consider the alternatives so unrewarding that they are willing to take some chances. Yesterday, the yield on the 30-year bond dropped to 6.73 percent, down from 6.78 percent the day before.
"When bond yields are down in the 6 or 7 percent range," said Andrew R. Harmstone, who manages more than $2 billion for J. P. Morgan, "you get paid more to take on extra risk with stocks."
Although short-term thinking often rules the markets, the managers of pension funds and some other large investment pools move cautiously in changing their mix of stocks, bonds and cash -- the general term for risk-free but low-yielding investments.
The nation's 1,000 largest pension funds intend to put 55 percent of their assets into stocks, up from a goal of 52 percent a year ago, according to a survey in January by Callan Associates, a financial consulting firm, as the plunge in bond yields was still gathering momentum.
With pension funds controlling more than $2.7 trillion in assets -- an amount nearly twice the national budget -- even a slight shift can make the markets jump.
For these money managers, the migration to stocks parallels the course already taken by individual investors. Individuals fled their low-yielding money market accounts and certificates of deposits become net buyers of stocks in 1992 for the first time in 30 years.
It remains uncertain how long the shift into stocks will continue. Some investors consider stock prices much higher than corporate earnings can support. The Dow Jones industrial average fell 5.13 points yesterday, to 3398.91, though bond prices rose.
Mr. Clinton and his aides have claimed credit for the fall in interest rates, saying that investors are confident that their plans to cut the government deficit will succeed. A lower deficit, with less government borrowing, readily translates into lower interest rates.
The 6.7 percent interest now available on the Treasury's highest-yielding, 30-year bond, falls far short of the returns many money managers have promised to deliver.
To meet a target of 8.75 percent, the $72 billion California Public Employees Retirement System appears likely to be among those switching money from bonds to stocks.
"With yields well below 7 percent, it makes you look at other alternatives," said DeWitt Bowman, the fund's chief investment officer. The prospect for enhancing these yields with further gains in bond prices is limited, he added, explaining, "The bond market can't go to zero."
California's fund assesses its basic stance only once a year.
Stocks are more risky than bonds, with their returns varying more widely from year to year. But over the long term, stocks return about 10 percent annually, several percentage points more than bonds and much more than cash.
Changes by a few large money managers, sometimes taking place step-by-step over days or weeks, can sometimes result in jagged market reactions that have little apparent relation to the day's news.
Analysts saw major institutions shifting from bonds to stocks on Tuesday afternoon, when the Dow Jones industrial average jumpedabout 30 points, or almost 1 percent, to pass the 3,400 mark in the last hour.
The Dow now stands about 1 percent below the record of 3,442 set Feb. 5, with such broader market indexes as the Standard & Poor's 500 even closer to their highs.
Stocks have recovered since their mid-month fall despite a round of weak economic reports and Mr. Clinton's calls for larger tax increases on corporations and individuals than he had previously specified.
While such events might normally depress stock prices, the bond market shot high enough to more than compensate, analysts said.