Money Managers Urge Market Caution

THE United States stock market looks overvalued, says J. Thomas Allen - but he's not overly worried. Mr. Allen is president and chief investment officer of Advanced Investment Management, a Pittsburgh-based money management firm that is a subsidiary of PNC Financial Corporation. Allen's enhanced index fund charges his clients no management fees on their investments unless the accounts beat the market averages by 3 percentage points or better.

So far, his customers have never gone without paying a fee - which means that he's repeatedly beaten the market averages since his firm was set up back in 1987.

Allen maintains that in the current overvalued market - which reflects a slow-growth economy, weak earnings, and poor dividend yields - it will be possible for investors to continue to turn a profit on their investments. But to do so, he says, the key word is "hedging." Allen's company, which manages assets of some $2.5 billion for large institutional investors, does that through a combination of diverse strategies, including stock indexing, stock arbitrage, program trading, and, to a lesser extent, uti lization of portfolio insurance.

Most individual investors cannot duplicate the intricate computer-driven strategies used by management firms such as Allen's. And Allen is a strong proponent of program trading.

Meanwhile, the Dow Jones industrial average once again flirts with the giddy 3,000 point level, its highest ever. The market reached 3,004.46 points on April 17. Since last October the Dow has shot up over 25 percent.

Allen not only believes that the market is overvalued, but he also sees it heading back down, towards the 2700 point level. Still, he says, the Dow could rebound toward 3,200 later this year.

Allen is not alone in believing the current market is overvalued, and faces a correction.

"At the very least, the market is now fully valued," says Rao Chalasani, chief investment strategist with Kemper Securities Group Inc. "That's why we've cut back on stocks by 5 percent and moved to a 20 percent cash position."

Based on such measurements as price/earnings ratios, book value per share, and dividends, the market is now hovering "on the high-risk side," Mr. Chalasani says. The trading range for the Dow will be between 2,600 points and 3,150 points for the rest of the year, he says.

Dennis Jarrett, a technical strategist for Kidder, Peabody & Co., says the current dividend yield for the market is flashing warning signs. Based on the Standard & Poor's 500 stock index, a market with a dividend yield of under 3 percent historically represents a "high-risk" trading situation, he says. He notes that in 1987, before the market crash of October of that year, the dividend yield on the S&P 500 was down to the 2.6 percent to 2.7 percent zone. A more "normal" dividend yield would be around 4. 5 percent, he says.

Currently, the dividend yield is around 3.1 percent. As the S&P 500 moves toward the 400 zone (it's running in the 380 range as of this writing), there is a presumption that the dividend yield will drop below 3 percent. "That's getting onto very thin ice," says Mr. Jarrett.

Most market technicians see the 1987 market as one of the most overvalued markets in US stock market history, along with 1972 and 1929.

In terms of corporate earnings, says Chalasani, the current market is "trading on 1992 expectations, rather than 1991."

According to Standard & Poor's Corporation, there were fewer dividend hikes in the first quarter of this year than in any first quarter since 1971. Only 304 companies boosted dividends. On the down side, there were more cuts or omissions of dividends than in any quarter since 1960.

"This is a time for selectivity, which means looking for strong individual companies," Chalasani says. He recommends buying "high-quality secondary stocks," rather than the big blue-chip issues, which tend to be the most overvalued.