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Merrill's Bernstein, Longtime Bull, Gets Very Wary

Richard Bernstein, director of quantitative research at Merrill Lynch, turned "extremely cautious" Tuesday morning. Even after the market snapped back from Monday's debacle, the strategist staunchly stuck with his new position.

"There's going to be a shortage of attractive investment vehicles around the world," said Bernstein. "And that means that people will look for the highest-quality, safest investments."

"Highest-quality," "safest" and "stocks" are not always found in the same sentence. For that reason, Bernstein is steering investors more aggressively into Treasuries, the "highest-quality item around."

By recommending bonds more aggressively and backing off from his bullish stock-market call, Bernstein has, in his own words, rejoined "the brotherhood" at Merrill Lynch. For a long time Chuck Clough, the global strategist at Merrill, has argued that bonds are the place to be and that the global economy is headed for a deflationary slowdown. "Not a crisis," he insists. Just a tough time ahead for those who prefer to invest in U.S. stocks.

Why should anyone care? Bernstein's track record on this market is quietly among the best. According to his records, he has made the following investment allocation recommendations:

Beginning of 1995

: Tells clients to be fully invested. The

Dow Jones Industrial Average

is just under 4000.

Third quarter 1995

: Starts moving clients into a more "normally bullish" position. Recommends allocation of 60% stocks, 30% bonds, 10% cash. Dow is around 4700.

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December 1996

: Tells investors to dive back in and become fully invested at 100% stock allocation. Dow is at 6500.

Oct. 31, 1997

: With the Dow having raced sharply higher and the Asian problems surfacing, Bernstein recommends clients move to a 60-30-10 positioning again. Dow is at 7442.

June 2, 1998

: Dow heads steadily higher, but Bernstein starts to feel the market is getting rich. His proprietary "sell-side" indicator, a measure of sentiment, tells him trouble is approaching. He shifts his asset model to 55-35-10, arguing that bonds will start to look very good. Dow is at 8890.

Sept. 1, 1998

: Bonds have indeed moved sharply higher and the Dow has sailed south. Still, Bernstein has grown more pessimistic. He shifts recommended asset position to 50-50-0.

"We're in a profits recession right now, and most people simply don't realize it," Bernstein said. "Our concern remains that earnings expectations are too optimistic."

What's interesting (terrifying?) is that Bernstein, for all his qualms about U.S. stocks, believes the U.S. market is the best of the now-ailing bunch. He believes the evolution of investment action is fairly simple to assess. In the past several years, investors have steadily tossed aside "lower-quality" investments. First to go were commodities, then small-caps, then big-caps without quality growth patterns and, finally, big-caps with stable growth patterns.

In the stock market, Bernstein sees high-quality consumer growth companies, especially retailers, as the best positioned of the lot. But like any reasonable pundit, he allows that he could be wrong.

"If the profit cycle is going to slow, as we believe, then you want to move up the quality cycle," Bernstein said. "If I'm wrong? Then overweight emerging markets and underweight the U.S."