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Equity Watch: Welcome to the Bull Market

A "perma bear" money manager tells why he got happy about equities.

Everyone seems to hate equities. Main Street, once absolutely obsessed with the stock market, now seems to want nothing to do with it. Even professional investors are apprehensive and discouraged, and some are downright depressed. So, here's to a fourth consecutive down year, right?

Not so fast. Sure, the stock market and the economy have now run into just about every kind of hurdle known to man: The three-year bear market, global recession, crooked CEOs, cooked books, domestic terrorism and war. But all of these problems are in the past. Okay, maybe a few are also in the present. In either case, investors must focus on what is going to happen to the markets and the economy in the future.

To be a successful investor, you should look ahead. Anticipate. Do not react to yesterday's news. In our research reports and in conversations, I have been urging our clients to bear that in mind and remember that you can only make money in the future. “You're probably right about that,” one advisor told me. “But our clients are refusing to take any risk, until they see resounding upside momentum.” Sorry to say, very often, those who wait to see what happens before committing might find the attractive buying opportunity long gone.

Retail investors are not alone. Surprisingly, many corporate pension fund administrators and investment committees are also “waiting for more signs.”

While it could be the right investment call to buy now, it is inappropriate for you to go against your clients' wishes. That's for sure.

As money managers, we can read our disciplines and maintain flexibility, with no bullish or bearish axe to grind. We're on a quest for truth. And this spring that quest leads me to be bullish. I seem to have little bullish company, but I don't mind being a lonely bull. Actually, I'm quite comfortable being in the minority, going against today's investor crowd. By nature, I have a contrarian's bent, and that can be particularly helpful at critical stock market junctures such as this one.

There are signs of stock market strength.

Based on our examination of the underlying market and economic data, the market is in recovery mode. In fact, in our funds we're now at our maximum guideline equity exposure, 70 percent. Despite intraday rides on the tide of news, the stock market trend is undeniably rising, climbing the wall of worry. Be certain: the U.S. economy is alive, and getting stronger. However, by the time the economic recovery is evident to all, and the “bad” news a distant memory, the stock market will have already jumped.

We believe it might be appropriate to advise clients to consider taking a more aggressive equity stance. First, one disclosure: We at Leuthold seeking value using quantitative measures along with fundamental and technical analyses.

Based on our multifactor measure of valuations, we believe the market bottomed on October 9 (that's when we started increasing equity exposure). Since World War II, 75 percent of bear markets have bottomed around median levels — essentially, we have been hovering near those medians since the October lows.

Inflation is not a problem (particularly now that oil prices are falling). Lower energy costs can really boost the economy, since they free up extra spending in consumer budgets. And we anticipate interest rates to creep up, but, at least for the remainder of 2003, we expect them to remain at historically low levels.

On the technical side, market breadth has been outstanding, and the S&P 500 appears poised to take out the 940 resistance level. The Nasdaq was recently trading 12 percent above its 200-day moving average, the highest since the bear market began. Nearly 70 percent of NYSE stocks are trading above their 200-day average.

Consumers have plenty of money, with $4.5 trillion sitting in ultra-low-yield money market funds and savings accounts. This pile of cash is equal to almost 60 percent of the value of the Wilshire 5000 index; by comparison, cash represented only 22 percent of the Wilshire two years ago. As the stock market climate improves, investors will likely channel some of this extremely low-return cash into stocks.

Contrary to popular opinion, consumers are not nearly tapped out. Consumer debt is now at 12.5 percent of total assets, down from 14.4 percent in 1998. Consumer debt service (excluding mortgage debt) now represents 7.8 percent of income, in line with the 20-year average. The argument that consumer debt is ballooning ignores the fact that 80 percent of the growth in household debt in the last three years is mortgage-related.

Corporate earnings are gaining momentum. In the first quarter, GDP measure of non-financial profits is up 10 percent from the previous quarter and up 26 percent from the 2000 low. Non-financial earnings are now at their highest level since the second quarter of 2000.

April's consumer confidence reading posted the biggest single monthly jump since 1991. The quick resolution of the Iraq war was a factor, of course. But such a big jump also bodes well for expectations that consumers will continue to keep the economy humming along.

And equity mutual fund flows are improving. Sure, you could argue that the number is dirty, since the majority of April's $9 billion estimated net inflow into stock funds came during the April 15 deadline for IRA contributions. But the weekly numbers show money starting to trickle in on the strength of recent market action. Either way, the inflow is positive relief from the selling pressure in previous months.

Wall Street analysts are probably underestimating earnings growth potential in 2003 and 2004. We also think they are misjudging the impact of corporate cost-cutting and failing to recognize improvement in pricing power. Interest costs continue to decline and unit labor costs are flat. Analysts too pessimistic? This may be a “first!”

Our extensive analysis of over 170 market and economic indicators tells us that the better odds are with the “Lonely Bulls.” If your clients won't move, then do it with your own account.

Steve Leuthold, is chairman of Leuthold Weeden Capital Management.

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