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Longtime adviser is bearish on stock market

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Richard Russell has written Dow Theory Letters (P.O. Box 1759, La Jolla, CA 92038) since 1958, making it the oldest service continually written by one person in the investment advisory business. Russell is now bearish on stocks. "It's going to be increasingly difficult to keep the stock market and U.S. economy afloat. I continue to see signs that big money is walking quietly toward the exits. U.S. consumers are tapped out. And consumer buying comprises better than two-thirds of U.S. gross domestic product."

TCW Galileo Select Equities Fund combines top-down and bottom-up analysis, first looking for major sector trends, then focusing on potential beneficiaries of those trends. The fund also prefers companies with unique business models or market niches and lots of free cash flow. It's found enough of them in the past decade to produce heady 11.04 percent average annual gains. Recent favorite stocks: Amgen, Dell, Harley-Davidson, Pixar, Progressive Corp., Qualcomm, Xlinx.

Speaking of market niches, LifePoint Hospitals and Province Healthcare have discovered a very profitable one. The two buy hospitals that are sole providers in rural areas, then add specialized services that patients formerly had to travel long distances to receive. This strategy drives up revenues and profits. "They have monopolies in virtually every market they serve," says Richard Aster, manager of Meridian Growth Fund. "Yet their stocks recently traded at a reasonable 22-to-1 average price/earnings ratio."

It's always a good sign when corporate insiders are buying their own stocks. It's particularly encouraging when the companies have impressive records of earnings growth. The American Association of Individual Investors Journal (625 N. Michigan Ave., Chicago, IL 60611) recently identified seven small growth stocks with double-digit, five-year earnings-growth rates whose corporate officers have been aggressively buying their own stock lately: Empire Resorts, Proxy-Med, ChromaVision Medical Systems, Peoples Community Bancorp, ACADIA Pharmaceuticals, Goodrich Petroleum, Layne Christensen.

Given the prospect of rising interest rates, bond investors with at least 15 years until retirement who can take a little risk should structure a portfolio like this: 50 percent high-quality corporates, 20 percent governments, 20 percent mortgages, 10 percent junk. According to Catherine Gordon, who leads a Vanguard division that studies market trends, the high allocation to corporates is because they deliver better performance over time than Treasurys.

Narasimhan Jegadeesh, a professor of finance at Emory University, has found that from 1965 to 1998, an investor who bought the best-performing stocks from the past six months and held them for the next six would have outperformed the market by an average 6 percentage points annually. Investors underreact to news, says Jegadeesh. But once our views have been validated, usually by rising stock prices, we rush in. That means stocks may move long after good news.

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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.