Real Rally or Real Folly? Buy Side's on Both Sides of This Fence

Is it for real?

The past few days have featured the first extended broad-based rally since mid-January that hasn't been quickly cannibalized by aggressive short-selling and renewed panic. A smattering of economic releases have recently displayed a bit more strength in demand than was originally thought -- and this morning Goldman Sachs' Abby Joseph Cohen gave the market a bit of lift by increasing her equity allocation.

Related Stories

Goldman's Abby Cohen Boosts Equity Allocation

Whoa, Nellie! CSFB Says Micron Upswing Unwarranted

For investors, it's hard not to be cautious, given the slow, steady slide the market's endured since last March, and the near-daily pronouncements during the past three months that today (everyone now!) "had to be the bottom" of the market. That said, a number of value managers expressed the belief that this has become a strong buying opportunity if the intent is to hold stocks for the long term. Technology valuations, in particular, are again looking attractive.

It's a view the broader market has embraced in recent days, but of course, many money managers are waiting to see if the current rally truly has legs. The market is operating in a bit of a dead news period, having stumbled through fourth-quarter earnings and awaiting the Federal Reserve's March 20 meeting and the upcoming first-quarter preannouncement season.

Giving value managers hope is this: Previously, the corrections in valuations reflected significant optimism in a quick recovery; now, they reflect a lousy environment for the whole year -- to some managers, that's a signal to buy. These same managers are pleased to see earnings warnings are no longer causing a decimation of share price of a particular stock.

Buying the Dip

"Whether this rally is sustainable or not -- and there's a lot of people who think we'll have another correction -- I'm buying stocks for the next two or three years," says Nancy Tengler, president and chief investment officer of Fremont Investment Advisors. "If I can buy Cisco (CSCO Quote) and General Electric (GE Quote) and Solectron (SLR Quote) at these levels, I'm going to be happy in the next 12 months."

For example, Tengler contrasts the forward price-to-earnings ratio of Cisco and Coca-Cola (KO Quote). At a price of $24.63, Cisco's forward P/E using fiscal 2002 earnings estimates is around 31; Coke, using 2001 estimates, also has a P/E of 31. But the growth in revenue expected for Cisco far exceeds that for Coca-Cola, no matter how many people have one with a smile. To her, the tech company is the more attractive investment because at this time it's now pricing in bad news and an utter lack of earnings visibility.

There's that other catch phrase that's become so popular in recent months -- visibility. The inability for companies to predict how earnings are going to turn out in coming quarters is a chief reason for the market's lousy performance in recent weeks. If investors believe the economy will recover by the end of the year, profits should follow at some point. Some investors believe when companies do the corporate equivalent of throwing up their hands, it's a time to buy stocks.

Of course, there has to be improvement in demand for equipment and goods in order to realize gains. Right now, stock prices reflect improved demand far off in the future, although they are clearly discounting weakness for several more months. Some investors don't believe there's enough evidence yet for such a stance.

"On a fundamental basis, I don't think you're seeing improvement in the things that were responsible for driving prices down in the first place," says John Leonard, managing director and head of North American core equities at Brinson Partners in Chicago. "Managements and most investors were leaning in the direction of a V-shaped recovery, and now people have thrown in the towel on that. It's not clear to me that they've got a good sense of when you come out of it."

However, he and others recognize that technical indicators are improving. Stocks are starting to become immune to warnings and analyst downgrades, especially the semiconductors, which have performed well for several weeks despite a slew of downgrades and continued earnings weakness. For example, Micron Technology's (MU Quote) stock has surged in recent days despite caution urged by analysts.

"We think as the sell side continues to downgrade the group, it becomes more attractive," says Irene O'Neill, portfolio manager at the Evergreen Equity Income Fund.