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The Market Looks Up -- Cautiously

Stocks finished higher but didn't respond especially well to a positive manufacturing report.

SAN FRANCISCO -- Those looking for the new year to bring clarity to equities were likely disappointed today as stocks meandered in a tight range between modestly below to marginally above break-even for much of the session. But major averages closed at or near intraday highs after mounting a more discernible rally in the final hour of trading.

The

Dow Jones Industrial Average

rose 0.5% to 10,073.40 after trading as low as 9935.70. The

S&P 500

gained 0.6% to 1154.67 after sitting as low as 1136.23. Buoyed by renewed optimism about pricing for DRAM semiconductors, the

Nasdaq Composite

was relatively strong throughout the session, closing up 1.5% to 1979.25. The Philadelphia Stock Exchange Semiconductor Index rose 4.4% after South Korea's

Hynix Semiconductor

announced its third price increase in the past 30 days.

Given frustrations over the Comp's inability to sustain its year-end push above 2000 (reached briefly intraday on Friday), not to mention the burdens of another down year for stocks, the optimists were rightfully emboldened by the market's late-day push.

Additionally, "the first day sets the tone for the first week, which sets the tone for January, which sets the tone for the year," said Dirk Van Dijk, equity strategist at Dean Investment Associates, a value-oriented shop in Dayton, Ohio, which has about $1 billion under management.

The

Dean Large Cap Value fund rose 10.9% in 2001 while the

(DASCX) - Get Report

Dean Small Cap Value fund climbed 19.5%, according to Morningstar.

The strategist jokingly admitted to "extrapolating a wee bit," but the initial trading days of January are often a harbinger for the year. Since 1950, gains in the first five trading days in January have been followed by whole-year gains in 28 of 32 occurrences, according to

The Stock Trader's Almanac

.

Although trading volume improved from last week -- 1.2 billion shares traded in

New York Stock Exchange

activity and 1.5 billion in over-the-counter action -- it's a mistake to read too much into today's session, as a quasi-holiday atmosphere persists. (And yes, I would have written the same thing if the averages had closed lower.)

"There's a lot of nothing going on; the volume is anemic," said one institutional trader who requested anonymity. "It's so quiet here. Large institutions aren't doing much, and people away

on vacations are taking extra time."

Next to apathy, confusion may be the most common emotion on trading desks right now, the source said. "People believe the pickup will happen sooner rather than later, but how meaningful it's going to be is really up in the air," he said. "People

are very cautious as they get out of the gates after two crappy years."

That mind-set was evident early today in the stock market's reaction to a stronger-than-expected report on manufacturing activity from the Institute for Supply Management (formerly the National Association of Purchasing Management). The index rose to 48.2 in December from 44.5 in November, its highest level in 14 months and better than the 46 expected by economists.

But the market's reflexive rally thereafter was short-lived, and major averages failed to sustain a move above break-even until late in the day.

Notably, the ISM report provoked a much more dramatic and sustained reaction in the bond market, in which prices fell amid this latest bit of evidence of economic recovery. The price of the benchmark 10-year Treasury fell 1 1/32 to 98 25/32, its yield rising to 5.16%.

One explanation for the stock market's inability to benefit more directly from the ISM data today is that valuation concerns are preventing institutions from making big equity bets until there's more concrete evidence of the recovery translating into rising corporate earnings.

"It's real hard to call the market cheap at current levels unless you can make the case for a strong rebound in earnings," said Van Dijk. "It's not unthinkable, but the jury is still out."

For much of the 1990s, corporate profits were rising as a percentage of GDP, but that is no longer the case, Van Dijk noted. "Are companies going to have pricing power to restore profit margins? That will be the key determinant" of the market's direction in 2002, he continued. "Until you get that solid evidence

yea or nay, I suspect the market is going to zigzag a bit."

TST Recommends

That said, the strategist spied opportunities in the energy sector, particularly natural gas plays, including

Devon Energy

(DVN) - Get Report

and

Anadarko Petroleum

(APC) - Get Report

. Dean Investments is currently long each.

Coincidentally, Anadarko shares fell 3.2% today after UBS Warburg cut its recommendation to hold from buy.

"People are concerned about the price of natural gas because of the big build in inventories in last year," Van Dijk said. But he believes the inventories will be depleted by a combination of colder weather in much of North America, prospects for economic recovery, and a recent slackening in production. Thus, he's bullish on the underlying commodity and the aforementioned stocks, adding: "The time you pick them up is when they're depressed."

On the oil side, Van Dijk recommended deep-water drillers

Transocean Sedco Forex

(RIG) - Get Report

and

Diamond Offshore Drilling

(DO) - Get Report

.

Other holdings we discussed included

Compaq

(CPQ)

, which Van Dijk said will be a home run if the merger with

Hewlett-Packard

(HWP)

goes through. If the deal doesn't go down, it's still a "decent company" trading at reasonable levels relative to its book value, he said.

Dean Investments' other tech holdings include

NCR

(NCR) - Get Report

and

Intel

(INTC) - Get Report

, though Van Dijk said he'd be unlikely to add to the Intel holding at current levels.

As a value-oriented investor, Van Dijk isn't naturally drawn to growth names, but "we're not anti-tech," he said. "I

just have a hard-enough time with 25 times earnings, let alone 25 times sales."

Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to

Aaron L. Task.