Saint Paul Pioneer Press, Minn., Investor's Eye Column.

Knight Ridder/Tribune Business News

Apr. 25 -- What a confusing market!

For a couple of days, it looked as if investors had finally decided it was crazy to buy overpriced pharmaceutical, technology and Internet stocks. Instead, they gave manufacturing and other cyclical stocks a try. Then, after a few days of bargain hunting in manufacturing, energy and chemical stocks, investors returned to their old ways -- piling back into the stocks that have dominated the market for months.

Although investors cooled to cyclicals, they didn't abandon them. And since they've also been dabbling in long-neglected small-caps optimists have speculated that the market is becoming a less dangerous place for investors because more than a handful of stocks are getting some action.

But the move back to the old pattern of buying hot stocks regardless of their price is raising concern. Although some analysts suggest it's time for investors to throw some money into value and small-cap funds, the future is murky. Some don't think the market will really change until after a major correction.

"It's perplexing," says Claudia Mott, small-cap analyst for Prudential. "People are starting to spread their wings, and it looks like money is trickling down to small caps."

But she's guarded: "My concern is that this is another one of those head fakes." Even if it's not, she doesn't think this marks the beginning of a multiyear cycle in which small caps will outperform other stocks. "I think it's just a catch-up rally," she says, noting that the future may appear clearer after a couple of weeks.

Oakmark large-value fund manager Robert Sanborn, on the other hand, thinks "this last week marks the very beginning of a seismic shift" that will favor the value stocks he puts in his funds. However, he thinks the change will show up in fits and starts.

Sanborn, like other value fund managers, has had a rough time holding on to investors impatient with low-priced cyclical stocks. Value stocks have badly trailed growth stocks since 1994.

"People have been mindlessly buying what's previously gone up," Sanborn says. "They've been a group of lemmings." But he's so sure the trend is ending that he's been shorting Internet stocks. It hasn't worked for him so far, but he doesn't think he's the person taking chances with a risky strategy.

The people buying Internet and overvalued tech companies "have received a gift from God," says Sanborn. "They should be thankful and take this opportunity to sell and buy something else."

But information being digested by Wall Street is anything but clear.

Cyclical stocks like Caterpillar do well when the economy is strong. Obviously, if countries are in recessions, demand for products -- including those from the United States -- is down. When economic conditions improve, manufacturing picks up. So analysts are trying to determine whether Asia and Latin America are really on the mend.

Moody's analyst John Lonski said last Thursday that "perhaps the worst is over." Initial earnings reports for 1999's first quarter "hint of an improved performance for U.S. corporations," he said.

Lonski has sampled revenue reports from about 500 companies -- 37 percent of the market. In the sample group, sales from the last quarter have grown about 6.2 percent compared with the previous quarter's 2.2 percent.

"There are definitely signs that profits and revenues are on the upswing," he says. Yet, "in the end, corporate performance will probably not be as robust as our initial data indicates."

Deutsche Bank Chief Economist and Global Strategist Edward Yardeni is more skeptical. "Stock investors, who've aggressively bid up the stock prices of chemical, paper and aluminum companies in recent days, are making a leap of faith in a global industrial recovery that commodity traders are not yet willing to make," he says. "The United States is booming, but I expect continued weakness in Europe and Japan."

He also thinks global production is recovering more quickly than demand, so excess supply will continue to be deflationary in many markets.

In the meantime, while investors try to figure out if cyclicals are real bargains, warnings continue on the 10 giant companies that have been driving the rise in the Standard & Poor's 500.

Morgan Stanley analyst Byron Wein notes that the traditional measures analysts have used to determine fair stock prices have been discarded. "Book value, cash flow and even revenues have little relevance to the total value investors are willing to assign to a corporation," he says.

He uses IBM as an example. When he analyzed the high-fliers in the Standard & Poor's 500 on April 6, he found IBM ranking only 10th in the index even though it had once been the dominant stock in the index. Wein noted that recently America Online was ranking above IBM in market value. Investors were willing to pay a price 638 times America Online's earnings to own that stock. But they were only willing to pay 28 times IBM's earnings.

"Hardware capability is no longer what matters most," Wein notes. "Relative newcomers have pushed major industrial companies employing hundreds of thousands of people, with enormous asset bases far down the list."

In terms of revenue, General Motors is the second-largest company. Its sales totaled $154 billion in 1998, but investors didn't seem to value that as much as the potential of companies like America Online to someday make a lot of money. GM's market value ranks only 46th in the Standard & Poor's, far below AOL. The Internet company ranked ninth, despite sales of only $2.6 billion for 1998.

Since investors are valuing the high-fliers on the basis of future hopes rather than any current demonstration of earnings power, Wein says investors must "keep a watchful eye out for signs of competitive pressures."

Gail MarksJarvis' column, Investor's Eye, appears on Tuesdays, Fridays and Sundays. Reach her at gmarksjarvis@pioneerpress.com or (651) 228-5488.

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