Milder inflation outlook whets US investing appetite

It may be time to trim -- or even transplant -- some of those hedges against inflation. As the inflation rate appears to be dropping, a number of investment advisers are looking for stocks and bonds that might benefit from the improvement.

Finding these issues means looking at a number of factors, says Steven R. Resnick, vice-president and senior investment strategist at Merrill Lynch, Pierce, Fenner & Smith Inc. One of these is the amount of short-term debt the company is carrying. "Highly leveraged companies are in a much better position in this situation," he noted. "If their costs of financing go down, their profits go up."

Among the industries in this group, he said, are airlines -- "particularly short-haul and financially strong larger airlines, like Delta."

Mr. Resnick said appliance stocks should also benefit, because lower inflation increases consumer confidence and people are more willing to make big-ticket purchases, particularly if lower inflation rates are followed by lower interest rates."

"Also, demographic trends work in favor of particular companies," he said. "For instance, because there are more working mothers, Magic Chef, which makes a lot of microwave ovens, can do quite well."

In addition to airlines, Mr. Resnick sees a lower inflation rate benefiting some utility stocks. One of these, American Telephone & Telegraph, should benefit from what he calls "an improved outlook for the regulatory environment and financing burden."

Another analyst considering this sort of investment is Stanley Lanzet of Drexel Burnham Lambert Inc. He agrees that inflation is starting to come down and says that "we are looking for companies that would benefit from that." Like Mr. Resnick, he is interested in stocks that can benefit from lower interest rates. This would include high- technology companies that need to borrow cash so they can continue their double- and triple-digit growth rates.

And if inflation continues going down, a number of consumer and leisure stocks would benefit from increased consumer confidence, Mr. Lanzet says. These might include Standard Brands, Tandy Corporation, and General Electric. "The expectation that prices will go down can do an awful lot for these kinds of stocks," he said.

Lately, investment advisers like Mr. Resnick and Mr. Lanzet have been given ample reason for their search.

In May, producer prices increased 0.4 percent, or at an annual rate of 4.6 percent, less than half of April's 9.9 percent pace. And April's consumer price index rose at a 5.1 percent annual rate, a level that is expected to be lower, but not by much, than the CPI for the next year or two.

"I would say a 7, 8, or 9 percent inflation rate for the next couple of years is perfectly possible," says Steven McNees, a vice-president and economist with the Federal Reserve Bank of Boston.

A number of important factors in the CPI "market basket" help contribute to this lower rate, Mr. McNees said. These include the prices of food, energy, and housing.

"On food, all the experts have been continually revising their forecasts downward," he said.

The freeze in oil prices by the OPEC oil ministers last month, an action that has since led to price cuts by some oil exporting countries, makes energy-future prices "look pretty good," Mr. McNees said. "Food and energy are the kinds of things that feed quickly through cost-of-living indexes and wage negotiations."

While the price of housing has been falling, this has a "small effect" on the CPI, he added.

Giving in to their special talent for jargon, the investment advisers have come up with their own term for this phenomenon: "disinflation." Mr. Resnick recently helped prepare a report on this subject for Merrill Lynch, creatively titled "Good Stocks for a Disinflation Environment."

An important part of defining this term, he said, is the element of surprise. "This can mean positive news developing on inflation which was unexpected by the consensus." The OPEC price freeze was one example.

"Up to two months ago, most forecasters were looking for a 15 to 20 percent increase," he noted. "Now it's zero. That's a major change."

For several weeks analysts have said the market was poised for a big rally that would send the Dow Jones industrial average soaring above the 1,000 mark.

Well, the market is still poised. After Taking off at the beginning of last week on hopes that interest rates had peaked, the Dow slowed down and finished at 993.79, up 20.03 points.

Investor optimism about interest rates was dashed when the Federal Reserve Board allowed the federal funds rate, which banks charge one another for overnight loans, to increase to 21 percent.