My

last column revealed my increasing appetite for equities. But I do not want my readers to misunderstand my position. I'm buying stocks for the first time in quite a while -- really. However, I'm hardly bullish. My firm's portfolio is about one-third invested after adjusting for the volatility of the existing stocks. This compares with very little net equity exposure for the first half of 2004.

My forecast for calendar 2004 included a prediction for a year of mediocre returns with a poor first half and a modest recovery in the second half. The correction occurred later than I expected, but it did happen. A typical seasonal recovery should happen in the fourth quarter, especially if we get another leg down. This would generate better valuations and healthier market sentiment, from a contrarian point of view. Assuming no fundamental disaster, I would expect to get more invested in that scenario.

Many professional investors trot out a historical statistic to support the case for a big second-half rally during election years. Since 1932, the July-December period of election years has appreciated 10.1%, well above the 3.8% returns of the January-June season. However, the market declined 43% in the first half of 1932 and recovered strongly, rising 63%, in the second half. Excluding 1932 from the calculation, both halves of an election year return around 7%. Except for this outlier, there is little seasonal bias in an election year. I would not want to base a ragingly bullish case on an anomaly. Would you?

Evaluating Valuation Conditions

With the market's recent decline and good corporate earnings, valuations on shares have declined quite a bit lately. Fundamentals remain solid: Corporate profits and cash flows are strong, interest rates are low, and tax conditions are favorable to the equity investors. The market should be acting better, but it's not. Why?

Despite improving valuations, shares are hardly cheap. As this chart of the Value Line median price-to-earnings ratio shows, valuations have corrected recently but are nowhere near historical valuation bottom levels. Valuation support for a fundamental disappointment or deterioration is much lower than current levels, especially for many individual stocks. You know what I mean if one of your companies guided lower recently.

While many fundamental conditions remain healthy, legitimate concerns still exist. Skyrocketing energy prices pose a threat to consumption and corporate profit margins. Geopolitical risks and terrorism endanger consumer and business confidence. Heavy consumer debt loads and a runaway housing market generate concerns about a material retrenchment in the durable sectors. Massive fiscal and trade deficits threaten stability in the fixed-income and currency markets. In general, current healthy economic conditions appear dependent on real but unsustainable imbalances. Could the stock market finally be anticipating the end of the free money trade -- or as I call it,

Easy Al's 1% wonder?

Value Line Median P/E Ratio
Valuations still aren't low enough to be near a bottom

Source: Value Line

With valuations reasonable but spreads quite narrow, what should investors do? My investment process employs a barbell strategy; my portfolio includes companies that are cheap, should the economic recovery continue, but also a large slug of interest rate-sensitive positions that would outperform should the recovery falter.

As I have written, I like a few deep-value (read: technology) turnarounds, companies at compelling valuations on normalized profits, should the economic recovery continue.

A Deep-Value Strategy

I also have a set of long positions that are "too cheap not to own." These include modest positions in out-of-favor sectors such as housing, insurance, energy and health care. Many of these stocks trade for less than 10 times current earnings. Against these positions, I'm holding a fair amount of short hedges and cash. The average stock, at 17 times midcycle profits under plateauing fundamental conditions, does not inspire me. This strategy offers the opportunity to participate in an up market but should protect me somewhat in a market decline. Some of my favorite deep-value names follow, one in each capitalization segment of the market and a "value concept" stock.

Large-cap

ConocoPhillips

(COP) - Get Report

is one of the cheapest major integrated oil stocks in the market today. While the stock has done well with rising energy prices and refining margins, it still is very cheap. At current prices, ConocoPhillips trades for about 8 times current profits and only 12 times normalized earnings, assuming oil in the mid- to high $20 range. The company has more leverage to oil, gas and refining than most majors. If the stock market ever prices the shares at $35 oil, ConocoPhillips would have a major move upward.

Mid-cap

Reebok

( RBK) represents one of the few truly low P/E stocks in the consumer soft goods sector. At current prices, its shares trade for around 11 times the consensus 2005 estimate, with a significant free cash flow yield. The company has a handful of growth opportunities, including basketball (with a Yao Ming endorsement in China), a top-rated running shoe, new products aimed at the hip-hop crowd and a new Pump product that has fad potential written all over it. I don't know if the company will regain momentum in the shoe market, but the stock is very cheap if it does.

Small-cap

JLG Industries

( JLG) is one of my few industrial stocks. The leading global supplier of aerial work platforms and material handling equipment trades for 10 times consensus estimates for the current fiscal year. The construction equipment industry has experienced four good quarters of recovery. Should economic growth continue, midcycle profits should be much higher. The company has benefited from a major consolidation in the U.S.; only two players are left. Also, Europe represents a significant growth opportunity, because aerials have much share to take from scaffolding.

My "value concept" stock is

Abiomed

(ABMD) - Get Report

. The company's existing business is cardiac assist pumps and consoles, which are sold to hospitals. It's growing very rapidly, turning in 46% revenue growth last quarter, and it has new products and applications. That business and the $2-per-share cash position support a price of $8 to $10 per share. At current prices, investors get a free call option on the success of the company's Abiocor product, a totally implantable artificial heart. The company hopes to sell the heart commercially next year under a humanitarian device exemption. A successful product in this area would generate hundreds of millions of dollars in profitable revenue. I don't know if Abiocor will succeed, but the new kick-butt management team that came from

GE

Medical certainly thinks so.

The recent decline has provided me with a much longer list of investment candidates because of my investment process of buying average companies at big discounts. I'm taking advantage of the pullback to build positions -- but I'm buying cautiously. I expect to continue to add equity exposure, especially on another pullback from current levels.

What could cause that? Maybe $50 oil and its impact on earnings forecasts in October. Maybe a contentious election campaign. Maybe a geopolitical event. Or maybe a highly visible pause in the economic recovery that casts doubt on record corporate profit margins. I don't know what the market will bring this autumn, but it's still prime season for corrections.

Please note that due to factors including low market capitalization and/or insufficient public float, we consider Abiomed to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

At the time of publication, Marcin was long ConocoPhillips, Reebok, JLG Industries and Abiomed, although positions may change at any time.

Robert Marcin is the founder and general partner of Defiance Asset Management. Formerly, Marcin was a partner at Miller, Anderson & Sherrerd and a managing director at Morgan Stanley, where he managed the MAS Value fund (currently Morgan Stanley Institutional Value). Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Marcin appreciates your feedback and invites you to send it to

robert.marcin@thestreet.com.