- The Washington Times - Wednesday, October 11, 2006

During the Dow Jones Industrial Average’s seven long years of recovery, investors looked elsewhere for faster profits, pumping money into everything from Las Vegas town houses to Brazilian paper companies to gold.

Now that the Dow has topped the heights of January 2000 and is hitting records nearly every day while real estate and gold are wilting, analysts say that investors shouldn’t ignore the blue-chip stocks that were once the mainstay of their portfolios.

“Investors should not miss the message that larger stocks might be coming back,” wrote Richard Bernstein, Merrill Lynch’s chief strategist.

The Dow is an index built of 30 big companies, a menu of household names meant to represent the market as a whole. Dow components include Alcoa, Boeing, Citigroup, DuPont, McDonald’s and AT&T.; Its bigger cousin, the Standard & Poor’s 500 Index, tracks 500 mostly large company stocks, including all 30 stocks in the Dow.

Anyone trumpeting the Dow’s return to lofty heights at the beginning of the year would have been lonely. But the Dow’s fortunes turned in the spring, when the winning investments of the past five years — commodities such as oil and gold, stocks in emerging markets such as India, home-building companies and energy stocks — started to decline.

Investors who had been ready to bet it all on climbing zinc prices woke up and realized their investments were no safer than a day at the track. Suddenly, boring looked good.

“Money that a year ago would have been invested in Miami condos and six months ago would have been invested in crude oil futures is now looking for a home,” said John Skjervem, chief investment officer of Northern Trust’s personal financial services business.

Money is like water — it has to go somewhere. As it was, it flowed into many of the big stocks that make up the Dow last month. Not every Dow stock had a September to brag about, but the ones that did, such as Boeing and McDonald’s, muscled the index to new heights.

If happy days for the lumbering giants of the stock market depend on riskier investments taking a tumble, the Dow may stay in the clouds.

Merrill Lynch said in a September note that prices for commodities, including oil and precious metals, were 60 percent above what could be explained by the rational economics of supply and demand. Merrill said September’s decline in commodities prices may be “the beginning of a protracted bear market.”

Stock in smaller companies have also had a great run over the past four years. But investment companies, such as Wachovia Securities, are beginning to tell clients to sell some of these stocks and lock in profits.

Emerging markets were another area that won investors over. While stocks in countries such as India and Indonesia continue to see exceptional advances for the year, a continued decline in commodities prices could hurt stocks in commodities-rich countries such as Brazil and Russia.

As for housing, it stopped looking like a sure-thing investment months ago. Moody’s Economy.com has said that housing prices could decline in 133 of the nation’s 379 metropolitan areas, with prices continuing to drop in some areas until 2008. Declines in home prices, in turn, mean lower prices for materials used to build new homes.

Of course, all these tumbles could leave some investors with a much smaller amount of money to invest in stocks. But the declines have also helped keep inflation in check. And temperate inflation has kept Federal Reserve interest rate increases on hold and pushed overall interest rates lower, which is almost always good for corporate profits.

Low interest rates mean “it’s cheaper to borrow money than go bankrupt,” said Dennis J. Block, a mergers and acquisitions partner at law firm Cadwalader, Wickersham & Taft.

The consensus on Wall Street is that the economy will slow, without diving into a recession. Analysts forecast the 18th straight quarter of double-digit earnings growth for the companies in the S&P; 500, which, while far from its heights, is up 8 percent for the year.

Shares of big companies also have another thing going for them: They look cheap.

Seventeen quarters of double-digit corporate earnings growth, coupled with tepid increases in stock prices, have taken the group’s price-to-earnings multiples, the most popular method of valuation, to low levels not sustained since 1995, said Ed Keon, Prudential’s chief strategist.

“The combination of a poor outlook for alternatives and a good outlook for stocks is what’s brought people back to the market,” Mr. Keon said.

One potential pothole for the economy would be if weakness from the auto and home sectors spread elsewhere, Mr. Skjervem said.

“None of this would be constructive for stocks unless the economy were going to keep growing,” said Harvey Hirschhorn, portfolio strategist at Bank of America.


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