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On The Sunny Side Of The Street


No wonder investors are jumpy. For weeks, the market was racked by worries that intensifying inflation would bring sharper Fed rate hikes. Then, following a string of weak economic numbers, pricing woes suddenly gave way to fears of a global slowdown. But just as swiftly, inflation angst came back with a vengeance on Apr. 20, with news that consumer prices jumped sharply in March.

Is the economy overheating or heading for a nasty fall? Both fears have many investors heading for the exits. Equity fund inflows of $14.5 billion in March were about half February's pace, according to an Apr. 20 Lipper Inc. report. But dumping stocks may be the wrong strategy. Boil down all the conflicting economic and earnings data, and the economy appears just to be taking a breather. That's good news for stocks, and it has many money managers concluding that there's a lot of life left in the market -- and just enough growth momentum to keep the economy chugging along without driving up inflation.

Given that mindset, the 4.2% drop in the Standard & Poor's 500-Stock index over the six trading days ended Apr. 20 has convinced many investing pros to bulk up on equities. On Apr. 18, Banc of America Securities (BAC) Chief Investment Strategist Thomas M. McManus, for instance, upped his recommendation on stock holdings by 5 percentage points, to 60%. Robert A. Olstein of the $2 billion Olstein Financial Alert Fund has reduced the fund assets he's holding in cash from 20% to just 3% to buy equities.

Many money managers are using the dip to load up on large-cap, blue-chip names with stable earnings. They like the dividend payments and strong balance sheets. "The decline we've seen in large-cap growth names is making them the most attractive," says Bill Nygren, portfolio manager of the $7 billion Oakmark Funds. Nygren has been adding to already big positions in Citigroup (C) and Wal-Mart Stores Inc. (WMT), for example, which he terms "above-average companies priced as though they are average."

FEAR STRIKES

In fact, many more large-cap stocks appear to be relatively inexpensive. The S&P 400 MidCap and S&P 600 SmallCap indexes are trading at 16.1 times expected forward earnings, nearly a full point higher than the 15.3 p-e of the S&P 500 large-cap stocks. Strategist Edward L. Yardeni of Oak Associates Ltd. figures that means large-cap stocks are "undervalued by almost 33%." Even better, expected earnings for the S&P 500 rose to a record high in April for the 26th straight month. Earnings are forecast to rise in seven of the S&P's 10 broad sectors -- including energy, financials, industrials, and consumer staples.

Plenty could still go wrong. The biggest weight hanging over the market, of course, is the stubborn fear that inflationary pressures are growing. A big jump in the consumer price index on Apr. 20, followed by a Fed report that higher energy prices are forcing companies to raise prices, returned fear to the market after a few days of calm.

Investors also anxiously await the next payroll report, due May 6. Over the current expansion, the market has interpreted big increases in payroll numbers positively, taking them as a sign that the economy is on track. But now, as often happens in the later stages of a recovery, the logic is starting to reverse If the payroll numbers are far stronger than expected -- signaling the greater labor bargaining power that often precedes rising labor costs -- inflationary worries could grow.

Despite the concerns, the smart money knows several bullish indicators are flashing. Ordinary investors are at their bluest since the bear-market bottom in October, 2002 -- often a clear buy signal. What's more, trading volume and volatility have spiked, which generally portends higher market prices. That's why with every new fall in the market, a bunch of pros are out there snatching up stocks.

By Mara Der Hovanesian in New York


Too Cool for Crisis Management
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