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Lag in average stocks may burst 'bubble'

Perhaps the strongest evidence of a stock market bubble is the wide divergence between the "flying few" big stocks and the vast majority of individual issues, says Profitable Investing newsletter (P.O. Box 60042, Potomac, MD 20859). "Last year 55 percent of all NYSE stocks declined. Never before has the Dow or S&P risen more than 10 percent in a year when the average stock dropped. Only once before did the average stock lag so far behind the leaders. That was in 1929."In 1999's first quarter, Oakmark International Small Cap Fund rose 13.7 percent, vs. just 3 percent for the average international fund. That's because Oakmark's strategy of buying tiny, deep-value foreign stocks trading at big discounts to their estimated future cash flows seems to be back in style after years of disfavor. If that trend continues, OI's type of stock could be in for a long ride. Recent favorites: T.T. Group (United Kingdom), Matichon Public (Thailand), Elevadores Atlas (Brazil), Ishiyoshi Securities (Japan), Parbury (Australia).

Of the dozen best-performing S&P stock indexes in 1998, six were technology-related. This trend has continued into the first half of 1999. Yet some promising tech stocks still lag the field. Standard & Poor's Outlook (25 Broadway, New York, NY 10004) recently recommended five that sell for below-market multiples, are considerably off their two-year highs, yet still carry S&P's "highest" or "next-to-highest" ratings for both safety and timeliness. The quintet: BMC Software, Coherent Inc., Gateway 2000, Innovex, Platinum Technology.

Speaking of bargain stocks, here, according to the Institutional Brokers Estimate System, are five that recently sold for single-digit price-to-earnings levels and at just 0.2 times their annual revenues. Any improvement in their profit margins would translate into significant earnings gains. The five: Boise Cascade Office Products, CellStar (communications equipment), Metals USA (metals products), Nine West Group (shoes), Nortek (building materials).

Historically, Treasury-bond investors have demanded a return 2 to 3.5 points above inflation, notes Money magazine (Time & Life Building, Rockefeller Center, New York, NY 10020). "In recent years, this 'real yield' has exceeded 3.5 percent only twice, in late 1994 and 1997. Both times, yields fell back within this band. Today, with inflation around 1.7 percent and long Treasuries yielding more than 5.7 percent, the real yield is above 4 percent. Thus, Treasury yields should fall back to 5.2 percent or lower."

Professor Seth Anderson of the University of North Florida recently studied 200 different trading strategies for closed-end mutual funds that sold at discounts to their net asset value over the past 30 years. He found that the best returns came from buying funds with discounts of around 20 percent, then selling after a small move. For example, buying funds at a 21 percent discount and selling them at a 19 percent markdown beat the S&P 500 by more than 95 percent.

Public companies are increasingly relying on accounting gimmicks to prop up their otherwise poor bottom-line performance, observes Executive Wealth Advisory (P.O. Box 9266, McLean, VA 22102) "Beware of holding shares in a company that takes massive, one-time charges in consecutive quarters. As an added precaution, check whether the company's cash flow falters even in the face of earnings gains."

Investor's Notebook is a digest of investment opinion from the world's leading financial advisers. It does not recommend any specific investments, and no endorsement is implied or should be inferred. For more information, contact the individual firms cited.