When will the little investor start buying? Scant cause seen now, but one analyst sees attractive market by year-end

It's time to trot out the little-investor theory. Actually, there's not much else to trot out these days. Mushy blue-chip earnings are coming out against the backdrop of a speculative melee in merger-prone stocks. The bulls are bumping into bears in ``utter confusion,'' one Wall Streeter says in utter disgust.

And the stock market is going almost nowhere. The Dow Jones industrial average managed to scrape together a 0.88-point gain for the week, to close at 1,266.56 on Friday.

To some extent, the confusion is understandable.

On the downside, investors must consider the following:

The economy is dogging it, according to reports from the Commerce Department last week. Gross national product plodded along at mere 1.3 percent annual growth rate in the first quarter, the slowest pace in two years. Imports were blamed for the sluggishness.

Consumers are getting a mite tightfisted. Consumer spending, a key factor in the economy's expansion, fell sharply in March.

A revised downward estimate of fourth-quarter corporate profits cast an uneasy pall over trading late last week.

Taken together, these make investors wonder if even the modest earnings predictions issued from the prophets/analysts on Wall Street are a bit too high.

There's the upside news to ponder, however:

The din of hammers pounding nails rose in March as housing construction soared 16.2 percent -- the biggest gain in almost two years.

The bond market rallied on signs of a sagging economy. Traders figured, ``The boys at the Fed have got to loosen the money belt if they want to prevent the economy from folding.'' In the past couple of weeks, interest rates on short- and long-term Treasury issues have fallen about half a point. Last week, Veterans Administration home mortgages slipped to 12.5 percent, from 13 percent. There's talk now of the prime rate coming down.

The US dollar plummeted when the GNP report came out last week. Since February, the dollar has lost 15 percent of its value against the West German mark and 25 percent against the British pound. A weaker dollar benefits US exporters and companies here facing stiff competition from imports.

Considering the mixed signals, Michael Metz doesn't think the stock market is ready for marching orders. Wait until a midsummer sun is beating down, says this Oppenheimer & Co. portfolio strategist. Then, he thinks, the effects of the weaker dollar will become evident. Confidence in the durabilty of this recovery will return.

And by the last quarter, the market will erupt, Mr. Metz says, because the little investor will return. ``If inflation holds, you could see a really significant influx of funds from small to moderate-size investors.''

Over the last decade the stock market has been increasingly dominated by institutions. About 70 percent of all trades on the exchanges are done by various money managers, pension-fund players, and bank trusts. In the last three years or so brokerage houses have pined for and predicted the return of the small investor. In fact, without individual stock players the Dow just won't reach the highs of 1,400, 1,500, or 1,600, some analysts are prognosticating.

But now the elements for a homecoming may be nearly in place, according to Metz. Interest rates are showing signs of chronic weakness, inflation is low, and small investors are becoming cash-saturated and equity-starved.

``The liquidity is there and the underexposure to stocks is there,'' Metz says. American investors now have about 22 percent of their net worth in stocks, he notes. ``That's getting close to the low level of the late '40s, which was followed by a surge in [investor participation in stocks] in the '50's and '60's.''

The merger binge is contributing to the higher level of liquidity among investors. In 1983, households bought $5 billion in stocks, Citicorp Information Services reports. But that swung to $47 billon in equity sales in 1984 as small investors took profits from the corporate takeovers. Many are socking their gains away in short-term CDs and money market funds. Analysts say the little guy is just waiting for conditions to be right for a move back into equities.

Lower interest rates, which reduce the attractiveness of fixed-income investments, is one condition. Another is continued low inflation.

During the 1970s, investors left stocks for hard assets -- real estate, antiques, art, precious metals -- things that kept pace with inflation. But those assets lose their luster in a period of low inflation.

Metz decribes last week's declaration of bankruptcy by Wheeling-Pittsburgh Steel as ``very significant'' for the inflation outlook. The failure of the seventh-largest domestic steelmaker was the biggest in the industry's history. As it ``restructures'' under Chapter 11, labor costs will probably be cut. ``That could be a major factor in tempering wage gains by organized labor in major industries,'' Metz opines.

So if Metz were directing this not-yet-evident herd of smaller investors, what stocks might they be buying?

Take a tip from the corporate moguls, he suggests. ``The great fortunes are shifting away from oil and real estate. The trailblazers are the Bass Brothers, the Murdochs. Or take Marvin Davis, he made his money in oil and gas. But now he's bought Twentieth Century-Fox. Do you see the Bass Brothers buying oil and gas companies? No. They're buying Disney and others. Look at the Hunt Brothers. They stayed in commodities and they're going under.''

The takeover activity is a healthy part of the restructuring of the US economy, Metz says. He advises investors to do as the financiers: Look for undervalued consumer companies with a good cash flow.

``Capital Cities' takeover of ABC typifies a willingness to pay for market share, franchises, and distributors,'' he says. ``Institutions are undervaluing the consumer companies,'' pointing to General Foods, H & R Block, and Polaroid as examples.

While Metz points to a move of wealthy individuals away from oil and gas properties, the takeover activity in that segement has boosted stock prices. Many Wall Street analysts say the speculation has puffed natural pipeline stocks, in particular, beyond what their earnings would warrant.

True to the nonconformist mold, Fidelity's Contrafund manager, Alan Leifer, is rather bullish on the diversified natural gas companies -- they constitute the largest segment of his fund. The takeover speculation is just ``gravy,'' he says. Despite the bidding going on, he still considers these issues good investments. ``Natural gas pipeline stocks are characterized by high cash flow, low price/earnings ratios relative to the market, and higher yields than stocks generally.''

The Contrafund natural gas holdings include Coastal Corporation, Lear Petroleum, Equitable Resources, United Energy, and Transco. And Mr. Leifer also has a fair number of electric utility stocks. When interest rates fall, these issues tend to lead the general market, and this has been so during the last month.

Leifer's fund, up 11.2 percent in the first quarter, has outperformed the market. In contrast, the Dow rose 4.6 percent and the Standard & Poor's 500 is up 8 percent. Chart: Interest rates. Source: Bank of Boston.

Percent Prime rate 10.50 Discount rate 8.00 Federal funds 7.75 3-Mo. Treasury bills 7.78 6-Mo. Treasury bills 7.97 7-Yr. Treasury notes 11.05* 30-Yr. Treasury bonds 11.25* *Yields