Shaky Fundamentals Make Investors Wary

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IT'S nail-biting time on Wall Street. The investment community continues to wait for an end-of-the-year rally - when, traditionally, the market shoots up after many investors have sold off securities for tax-related purposes. Unfortunately, the wait may prove a bit longer and more uncertain than usual this year. In many recent trading sessions the Dow Jones industrial average has been heading lower, reflecting lackluster US economic growth, far-from robust corporate earnings, and expensive valuation levels. "The stock market is fragile," says David Horn, senior vice president of The Northern Trust Company in Chicago. Mr. Horn oversees the wealth management group of Northern Trust, which monitors the investment programs of super-rich families with assets of $100 million or more. Some $12 billion of assets are administered by Horn's specialized trust department, of which about $4 billion is under the direct management of Northern Trust and the rest under outside managers. Horn notes that because of current economic uncertainties - as well as the need to develop individualized investment programs for large families with diverse and intricate legal and tax situations - many of his wealthy clients are building up their current cash positions, as well as seeking out high-quality investments abroad, particularly in Europe. At the other end of the investing spectrum - the institutional level, which deals with pension and mutual funds held by smaller investors - fund overseers are equally cautious about the current market climate. m not overly crazy about the stock market right now," says Sandip Bhagat, a vice president with TIMCO, an investment subsidiary of The Travelers insurance company. Mr. Bhagat oversees $100 million in assets invested in small-capitalization stocks. Small-cap firms are ones with assets of $500 millio n or less. Bhagat admits to keeping late hours during these days of market turbulence. In most years, he would anticipate a rally around January. Moreover, small-capitalization stocks tend to do especially well in the first 12 months following the end of a recession. But Bhagat wonders to what extent either development will now occur, given a sluggish economy. His conclusion: The market will at best grow "by inches." Some sectors look strong, such as health care. But essentially, he says, this is a "bottom-up" market, where stocks should be acquired based on company fundamentals, rather than broader market or sector trends. He says investors should retain their existing holdings of smaller-cap firms (assuming they have good valuations); new purchases would best be done on a dollar-averaging basis, he says, with investments spread out over time. And while there will likely be some "outperformance" by small-cap stocks in January, he predicts market gains will be modest during the months ahead. Where smaller-cap stocks will do well is over time, such as through the first half of the decade, he adds. Horn also agrees that this is a "bottom-up" market, where each stock transaction must be looked at in terms of quality, although he notes that is a standard investment procedure for his trust office. Earlier this year Northern Trust made Business Week magazine's coveted top 10 list for return on equity, steady earnings, and a safe loan portfolio. Gene Jay Seagle, a vice president with Gruntal & Co. investment house, insists that "time is running out on the current decline in the market" and that stocks will soon move toward a higher trading range. "We are still in a bull market," he says. Yet, investor skittishness here is linked to shaky fundamentals. The price/earnings ratio of the Standard & Poor's 500 stock index has been running at an expensive 21 recently, compared to 18 in July. Moreover, corporate earnings continue to sag. Annualized earnings for the S&P 500 stood at a lackluster 3.86 percent for the third quarter, compared to 4.54 for the second quarter. And blue-chip stocks, which investors flee to during troubled markets, are hurting. "What's a 'blue chip' these days?" asks Bha gat, noting the woes of such companies as IBM and General Motors.

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