WHICH WAY WALL STREET? ANALYSTS PREDICT MORE STOCK MARKET TUMULT.

Byline: Deborah Adamson Daily News Staff Writer

Investors, fasten your financial seat belts: The stock market is expected to continue its turbulent flight for the next few weeks.

But here's the good news: The underlying conditions of a bull market haven't changed. So once the market is through the turbulence, it should be smooth sailing. Well, smooth compared to the last few weeks.

``We're in the midst of a good, old-fashioned correction,'' said Al Kugel, senior investment strategist for Stein Roe & Farnham mutual funds in Chicago.

Correction, indeed. What investor hasn't been scarred by the market blood bath in the past three weeks? Even a recreational investor would have felt the market's volatile mood.

The carnage has been especially harsh for the Nasdaq composite index, which is off almost 7 percent from its April 26 high of 2652.05. It was down as much as 10 percent, until the 75-point rally on Friday. The Dow Jones industrial average is down 3 percent from its May 13 high of 11,107.47. The Standard & Poor's 500 is down 3.5 percent from its high of 1375.98.

It's not surprising that Nasdaq's got the bloodiest nose. It's filled with companies whose explosive growth is expected to slow down if interest rates increase.

And the interest-rate outlook has changed with the Federal Reserve's recent announcement of a bias toward an increase. Wall Street is waiting with bated breath for the Federal Open Market Committee meeting at the end of this month, when board members are expected to increase the interest rate the Fed charges banks for overnight loans.

Higher interest rates are bad for businesses, making it more expensive for them to borrow for expansion. Growth and earnings typically slow as interest rates increase. In such an environment, stocks with the highest prices relative to earnings will be hardest hit since investors find it difficult to justify these valuations.

Nasdaq, of course, is loaded with technology and Internet companies whose price-to-earnings ratios are extremely high.

The possibility of higher interest rates in the near future is only one of a threefold punch taken by the stock market.

The stock market is in the late stages of a bull, believes Rick Berry, director of equity research at J.P. Turner & Co., a brokerage firm in Atlanta.

``Signs of a major market top are excessive speculation and preponderance of stock splits,'' said Berry, pointing to the Internet stock mania. ``I think the stock market has seen its high for the year.''

He expects the Internet sector to decline by an additional 30 percent to 40 percent.

Berry is warning investors to not buy up Internet stocks now because they think the sector's cheap. It's relative: Amazon.com may be down by 50 percent from its high of $221.25, but don't forget that its 52-week low is $13.75.

Psychological indicators are nearing dangerous levels as well.

The Bearish Sentiment Index shows that 62 percent of investment newsletters are bullish - the highest in 12 years - while 28 percent are bearish, according to Investors Intelligence, an investment research firm in New Rochelle, N.Y.

Shouldn't that be good news? Quite the contrary.

The company has studied 140 investment newsletters for years. Company researchers discovered that these newsletters invariably make the wrong call on the market. When too many are bullish, it means the market is heading for a downturn, and vice versa.

Two months before the October 1987 crash, the Bearish Sentiment Index stood at 61 percent bulls and 19 percent bears. In a bull market, a healthy balance would be 45 percent bulls and 35 percent bears, said editor Michael Burke.

``(The market) is getting nervous,'' he said.

Further rocking the boat is the short interest ratio, which has fallen sharply. It means short selling activity is down - another bad sign for the market since short sellers, like newsletters, make the wrong market calls.

In a short sale, investors borrow stock from their brokers to sell in the market in anticipation that its price will drop. If the stock declines, they'll buy it at the reduced price and return the shares to the broker. Short sellers profit by selling shares at a higher price and buying them back cheaper.

When short selling activity falls off from a high, it means a lot of investors finally give up on a market correction. But since common sentiment is often wrong, when short sellers give up, that's when the market will correct.

``As a group, they tend to be more wrong than right,'' Burke said.

An additional bad sign is much higher call versus put volume, according to Steve Todd, a market analyst in Mission Viejo who writes the Todd Market Forecast.

A call option is a contract giving the holder a right to buy stock at a predetermined price, also called a strike price, within a period of time.

When calls outnumber puts, it means more investors are bullish because they want to buy. The masses typically are wrong.

Lastly, high bond yields are also troubling for the stock market.

Yields on the benchmark 30-year Treasury bond rose as high as 5.98 percent this week as prices dropped on fears of an interest rate hike.

Higher interest rates will make new bonds more valuable than existing bonds, causing prices of current bonds to drop. As prices decline, bond yields move up. When investors see high bond yields, they might be enticed to bail out of stocks for the safer, high return of bonds.

``If yields go over 6 percent, people find that worrisome,'' Burke said.

So what makes analysts believe the bull market isn't dead?

The strong economy, healthy corporate earnings, baby boomers piling money into their investment accounts and mutual fund inflows.

The country's economic engine is chugging along nicely with inflation at historic lows. Economic output in the first quarter rose a robust 4 percent and Kugel estimates the second quarter to come in at around 3 percent.

Corporate earnings were surprisingly good in the first quarter, up 10 percent from a year ago. The year should end with a 12 percent to 14 percent gain, Kugel said.

Todd sees the baby boomers as a big factor as well.

Baby boomers buying homes in the 1970s and 1980s led to a strong real estate market. Today, boomers are in their peak earning years and they're putting a lot of money into investments - which will buoy the stock market.

Indeed, $25 billion in net cash flowed into stock mutual funds in April, the largest in a year, according to Investment Company Institute in Washington. Of course, April also benefits from investor contributions to their IRAs.

But the road ahead can get pretty rocky before it gets better.

``We need to survive the CPI numbers (inflation report for May) and the Fed meeting,'' Kugel said.

In the meantime, what should investors do?

Analysts recommend staying on the sidelines - don't put more money into the stock market until the interest rate outlook is clearer.

Keep your eye on stock bargains.

Consider cashing in on stocks that have had good profits.

Long-term investors should stay fully invested.

TOUGH TIMES

Two of the market's major indexes - the Dow Jones industrial average and the Nasdaq composite - have lost a significant amount of their value in recent weeks.

NASDAQ COMPOSITE

March 2: 2,259.03

April 26: 2,652.05

DOW JONES INDUSTRIAL

March 3: 9,297.61

May 13: 11,107.47

March 1 through June 2, 1999

CAPTION(S):

2 Charts

CHART: (1--2) TOUGH TIMES (see text)

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