Making sense of a market's mixed message

Sometimes it seems like stock-market recommendations come at you from all sides. Flick on the radio or TV, and a silver-tongued commentator touts the latest XYZ company as "the buy of the decade." Look at a magazine or local business page, and some magnate of the moment suggests you "buy," "sell," or "hold." Add to that billboard ads, mailers, and phone calls from brokerage firms. It's almost to the point that you can't be sure if your dog or cat isn't urging you to "buy, buy, buy."

What's clear is that both federal and industry regulators recognize that one major aspect of the stock-advice game has gotten out of hand: the "buy" side. Regulators are now recommending greater constraints - or, at the least, warning labels on market recommendations by stock analysts.

In an unusual "investor alert" issued last month, the US Securities and Exchange Commission warned investors to take stock recommendations of financial analysts with a healthy tad of skepticism. The move comes on the heels of rising complaints that analysts are too beholden to the investment houses they represent, and that they, not infrequently, have positions in the very companies being touted.

Acting SEC Chairwoman Laura Unger urged the securities industry to eliminate conflicts of interest - such as analysts touting stock they may themselves own, or that are owned by their brokerage or financial houses. Meanwhile, the New York State attorney general's office is conducting a broad inquiry into stock tips, including buy and sell recommendations. Congress has also gotten involved, with at least one House panel looking into the broader issue of Wall Street bias.

Responding to these concerns, the National Association of Securities Dealers, a brokers trade group, has proposed a rule requiring financial analysts to disclose possible conflicts of interest.

There is little wonder about the flurry of activity: Analysis of buy and sell recommendations by brokerage houses show that buy recommendations - even at the height of the recent market downturn - outpaced sell recommendations by 2 to 1. One example: Over the past year, various analysts continued to tout Lucent Technologies, even as its stock price continued to tumble in a virtual free fall. Just under $70 a year ago, Lucent now sells for about $6 per share.

"Any time analysts are recommending stocks that are selling at 50 to 100 times earnings, you have to assume that they know there is danger involved for the investor," says Thomas O'Hara, chairman of the National Association of Investors Corp. (NAIC) in Madison Heights, Mich.

"There are many fine securities analysts, who take their work very seriously," says Mr. O'Hara. But unfortunately, he says, there may also be analysts who "knowingly" misrepresent stocks to a gullible public.

"Listen to every [buy or sell] recommendation, but then do your own independent homework," O'Hara says. Check company fundamentals, such as growth rates of sales and earnings. The more analysis you do on your own - or through investment clubs affiliated with organizations such as the NAIC or the American Association of Individual Investors (AAII) - the more likely you are to select solid companies, O'Hara says.

At a gathering of computer-oriented investors in Florida, last month, O'Hara said he quickly discovered that few of the delegates had gotten caught up in the technology market crash of the past year. Why? The computer-oriented investors, O'Hara says, were especially knowledgeable about checking out alternative sources for investment advice.

"We're finding that our members use both large full-service investment houses and discount brokers, often at the same time," says Maria Crawford Scott, editor of the AAII Journal, published in Chicago. That suggests, says Ms. Scott, that savvy investors will read stock recommendations from large brokerages, but then do their own analytical work to go beyond what they have read. And when they do execute a stock transaction, they may or may not go with the big brokerage house.

That advice seems especially valuable now, as investors turn to the second half of 2001. Experts agree that there will be no easy answers for investing in the period ahead, whether a person is buying individual stocks, or mutual funds.

Small caps surge

For many mutual-fund investors, in particular, the latest quarter was another round in futility. While small-company funds posted steady gains, funds that focused on larger companies posted lackluster returns.

"This has definitely been a tough market," says Russ Kinnel, who heads up equity research for information firm Morningstar Inc. in Chicago.

Still, says Mr. Kinnel, some patterns have become apparent. One of them is the "equalizing" of growth funds and value funds, as well as large-cap funds and small-cap funds over the past five years. Just a few years ago, large-cap growth funds were red hot. In recent months, Kinnel notes, the hot-shots have been small-cap and value funds.

But looking ahead, Kinnel believes it may be time to start moving back into some growth funds on a selective basis. That might even include buying a position in a technology fund, he says. While it would be imprudent to predict the exact direction of the market, he says, "I would not be too compelled to stick with just one type of investing style," such as value stocks over growth, he says.

Kinnel would also put some assets back into a broad-based international fund. Gold, which did very well in the past quarter, is probably best left to specialists, he says. "If you were one of the rare people making money in gold, I'd take your gains and get out," he says with a laugh.

A wintertime rally?

While the consensus forecast among economists suggests a better second half, most market experts believe the real gains will come in the fourth quarter or early next year. "We've had some snappy rallies in the past few weeks," and we will probably get "a few more in the weeks ahead," says Brian Piskorowski, a vice president and market commentator with investment house Prudential Securities Inc. In part, the rallies are the result of the latest interest-rate cut by the Federal Reserve, lower energy prices, and federal income-tax cuts.

"But the rallies may be cases of hope springing eternal," says Mr. Piskorowski. "The main problem is that corporate earnings remain weak." The bottom line, he says: Look for solid gains to come late in the year, not the summer or fall.

Sectors Piskorowski likes include real estate investment trusts (REITs); financial stocks, especially smaller banks and savings & loan associations; selected energy companies; retailers, particularly discount stores; and selected technology issues, such as software firms and makers of semiconductors.

(c) Copyright 2001. The Christian Science Monitor