On the Defensive

The market may continue struggling for a while

By Arnie Kaufman

Investors are in no mood for heroics just now. They see risks as high, and they want some of today's uncertainties resolved before doing any additional buying.

Stocks should be benefiting from the economic recovery and the prospect of improvement in corporate profits. But the cumulative effect of the terrorist acts, earnings quality and disclosure deficiencies, the Israeli-Palestinian impasse, probes of Wall Street analysts' objectivity, and worries about Federal Reserve monetary tightening has been a significant impairment of confidence.

The recent pattern of a small step forward followed by a larger step backward has left the S&P 500 index only slightly above its February low of around 1080 without producing an extreme oversold condition. S&P chief technical analyst Mark Arbeter suspects that the February low will not be breached. But any rally would be modest, he says, because of heavy overhead supply of stock for sale.

The market's malaise reflects in part a leadership void, which conceivably may not be filled until the bellwether technology stocks start showing sustainable improvement. It remains unclear, though, how long it will take the techs to pull out of their long earnings slump and whether the eventual recovery will be sufficiently vigorous to justify current p-e ratios.

We believe, nevertheless, that patience will be rewarded. Barring a further sharp increase in oil prices or additional major terrorist acts in the U.S., the economic expansion should continue to gather momentum. Relatively high productivity is likely to persist, helping corporate profit margins and moderating any increases in interest rates and inflation.

While risks are high, we would keep portfolios weighted toward equities. We continue to expect that stocks will outperform fixed-income investments over the next six to 12 months.

Kaufman is editor of Standard & Poor's weekly investing newsletter, The Outlook

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