Sure, the

Dow Jones Industrial Average is back above 11,000 and isn't far from its all-time high. And in the past few weeks, investor sentiment has regained some bullish fever, long absent from the careening market of months gone by.


Jack Holden
Value Manager,
Fort Washington Investment Advisors

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The

Federal Reserve has been aggressively cutting interest rates, the bond market is pointing to an economic recovery, and the stock market is happy about all these factors.

Today's Daily Interview checks in with Jack Holden of

Fort Washington Investment Advisors

, who can't help but think the market is getting ahead of itself. Holden is a value manager who oversees $1 billion in assets, including the $76 million

(TVPAX)

Touchstone Value Plus fund.

Holden says it is incorrect to think a year-end economic turnaround is a done deal. By his reckoning, a recovery will show itself -- just not as quickly as the market seems to believe. So his approach is cautious: Holden says companies in the capital goods sector that have made efforts to diversify their earnings bases are attractive. And he likes a number of communications service providers.

TSC: What do you think of the recent run-up in the market?

Holden:

Personally, we don't think it's sustainable at these levels. We fall into the camp that the economy still has some critical issues to get through. The poor earnings we've seen will last into the third and fourth quarter and possibly till the beginning of next year. We think you're going to continue to see difficult sales-growth numbers. And that's going to translate into poor earnings guidance by the companies.

We've just come through a 10-year capital-spending boom in corporate America. I really don't want any companies to increase capacity.

Cisco

(CSCO) - Get Report

proved it can make the product -- they just wrote down

$2.5 billion in inventory.

What we need is the consumer to spend more. But when you look at the profile of the consumer and consumer spending, retailers are reporting OK numbers. But these are reduced numbers. Now, we have the lowest savings rate, the highest debt-to-income level we've ever had and consumers are concerned about jobs now because of the layoffs we've seen and will continue to see. So I'm not willing to bet on that horse, either. There's not a catalyst to bring us out of this.

I'll say something else because I don't want to be thought of as a major bear on this. The good news is, clearly an injection of liquidity will ultimately provide for a better environment. We're seeing a rally in the stocks -- and potential tax cuts down the road, which would help. While we think this rally is sort of a bear-market rally, if you will, we think we're closer to the end of the bear market than the beginning.

The slowdown will not last another two years, but we think investors' expectations are that it will rebound in the second half. We don't think that will be the case, so the market could be set up for more disappointment.

TSC: Do you think the market has gotten ahead of itself?

Holden:

I would say so. I don't know the exact numbers, but the

S&P 500 is up almost 14% from its lows, in about the mid-double digits. The

Nasdaq has risen more than that. I just don't think

fundamentals support that. That's been psychologically driven, and a lot of it has been short-covering. We haven't seen the volume we like to see in these up days. There's been a lot written on cash positions, but a lot of this move has been short-coverings from people who have done well. The Fed continues to cut interest rates, so they continue to cover positions. If

the market moves were driven by the reduction of cash levels, we would have seen a lot more volume.

For lack of a better word, this is a rally in a bear market.

TSC: But what do you think of the mantra "don't fight the Fed"?

Holden:

I think that's why we've seen the rally. You've got to be a little careful with making blanket statements like that. Clearly the injection of liquidity will ultimately be a positive. I'm not really sure when it

last was that the Fed was decreasing interest rates where the consumer has been in as fragile a state as he has been in -- or we've had a 10-year capital-spending boom. Usually, they're lowering interest rates to get people to spend. There's been a bunch of articles written about how the market has done well when they've cut interest rates. I would be cautious; the environment may be a little different this time.

That doesn't mean the market has to go down 30% from here. Wall Street likes to use an alphabet soup scenario for recovery. There's the V recovery, which is straight down and straight up, which we think is very unlikely. Then there's the U recovery, which we think we're more likely to see -- it's just, how long is the U? Then there's the dreaded L, which is the Japanese version, which is where you go down and never come back. We think that's unlikely.

People who believe on the surface that, because the Fed has cut five times, we'll be up in the next 12 months because the market has always been, those people are believing we'll have a V recovery. But people should be cautious at accepting that at face value because of the undertones in the marketplace.

TSC: What sectors or stocks look most attractive to you at this time?

Holden:

This may sound a little contrary to what I said. The reality is I like the capital goods area as a value manager. The reason we like that -- and there are a lot of companies -- they've performed well in this environment as well. But one must remember they never had the run-up that the tech stocks did. These are companies like

Tyco

(TYC)

and

Ingersoll-Rand

(IR) - Get Report

,

which have taken the opportunity to wring costs out of the system and diversify their earnings base.

They've been acquiring companies with a more consistent earnings pattern and less of a cyclical nature. It'll smooth the earnings out, which we hope will increase their multiples. As we come out of this earnings scenario in the middle of next year, sometime in the latter part of this year, we think those stocks are poised to capture sales growth down to the bottom line and benefit from costs they have been taking out of the system.

The other area would be communications services companies -- the providers, not the equipment makers. That's companies like

WorldCom

(WCOM)

,

Broadwing

(BRW)

and

Verizon

(VZ) - Get Report

. The rationale there is, these companies will be cutting back capital spending a bit, which is going to hurt equipment companies like

Nortel

(NT)

,

Lucent

(LU)

and anybody who makes networking-type equipment. But that's good for these companies because it will increase their cash flow.

They will have pricing pressures as well, but they'll be able to decrease their costs. These stocks have been pummeled over the last 12 to 18 months. Some of the money will flow from equipment makers such as Nortel and Cisco into the providers because people want to be exposed to this part of the market. We think the providers offer good opportunity over the next 12 months.

TSC: Back on the capital goods thing, it does sound a bit contrary.

Holden:

Some of these stocks, like Ingersoll or Tyco, they're not as deep of a cyclical play as

Caterpillar

(CAT) - Get Report

or

Deere

(DE) - Get Report

, which is a very deep cyclical in that it's a volatile, all-or-nothing type business. And while

in my comments earlier, I stated we'll continue in an economic slowdown, if we start to come out of this, the market is a discounting mechanism and will start to view that six months or more in advance, or the third and fourth quarter this year. We're trying to position our portfolio to capture that.