Blue chips' stellar show has investors looking in the wings for OTC play

Wow! What a dandy of a bull market. The Dow zipped past the 1,500 mark last week with coattails aflutter. And scarcely a month after breezing through 1,400. By Friday's close the Dow Jones industrial average had scaled to an unprecedented 1,535.21 -- more than a third of the way past 1,500 toward yet the next hundred mark. It chalked up a rousing 58.03-point gain in five sessions. That's the biggest weekly advance this year. Trading volume hit record weekly levels on all the major exchanges.

For two months now, the regal blue chips have strutted their stuff while those plebeian over-the-counter stocks gamely struggled to keep pace. The no-name stocks were disappointingly lethargic, concedes John B. Hoffmann, strategist on emerging growth stocks for Smith Barney, Harris Upham in New York.

But last week the OTC market began to shake, rattle, and roll, too. It enjoyed its most active week in history. Still, the OTC has some catching up to do. The NASDAQ industrial average stands at 328.81 -- some 80 points short of its record high, reached in the summer of 1983. Keep your chin up, though. If you're an aficionado of stocks priced under $20, your rally may be starting.

``We'll see the smaller stocks take the leadership now, while the larger caps will take a breather,'' predicts Joseph H. Barthel, technical analyst at Butcher & Singer, a Philadelphia brokerage house.

``There's always been a window of opportunity for smaller issues after the tax-selling abates in December,'' he notes. ``I wouldn't be surprised to see the NASDAQ outperform the Dow in the next four to six weeks.''

Many analysts agree that a full-blown OTC rally is likely at this juncture. But opinions split when the question of duration arises.

Mr. Barthel believes a rally here would be merely a blip in a long-term bear market already under way in secondary issues. ``The small caps were in a major secular bull market that started in 1974 and ended in June of 1983,'' he asserts.

The last OTC bear market lasted five years. So, he says, ``at best it will be the late '80s or 1990 before you see a new bull in over-the-counter stocks.''

But what about those big percentage gains this year on the NASDAQ indexes? The NASDAQ composite is up about 30 percent this year. By comparison, the New York Stock Exchange composite is up only 24 percent.

Analysts reply that most of the gains in secondary issues took place early in the year, in a seasonal rally like the one expected now. The stocks were coming off severe lows. Also, OTC gains have not been broadly based. Only a few groups -- such as insurance and bank stocks -- have done well.

Barthel says the indexes camouflage technical ``internal weaknesses.'' For instance, the total number of stocks rising vs. the number falling produces a ratio that doesn't jibe with past bull markets. Barthel's advice is to ``stay with the big blues.''

The main theme in this market is buying large-capitalization stocks for steady growth in a so-so economy.

Mr. Hoffmann at Smith Barney agrees that, until now, the themes have favored the large stocks. He ticks off the surge of corporate restructuring and takeovers, lower interest rates, disinflation, and the drop in the dollar.

Restructuring and takeover activity in recent weeks has been responsible for big run-ups in the stocks of Union Carbide, GAF, RCA, and Honeywell. And many analysts feel the Federal Reserve's discount rate -- which it charges member banks for loans -- is due for a decrease soon. That could lead to lower interest rates across the board.

Hoffmann concedes there's yet another shift in thinking that does not bode well for stocks of young companies. The yields on bonds, certificates of deposit, and money market funds are dropping into the 7, 8, and 9 percent range. Many investors find that difficult to swallow. They're switching into higher-yielding equities.

``The retail guy was spoiled by the double-digit yields; now he's hunting for something else,'' Hoffmann says. ``Perhaps a utility with a 7 percent yield and some capital appreciation. He's not going to take his nest egg and put it in a small, growth company. That money will logically go to household names.''

Still, Hoffmann is bullish on the OTC stocks: ``This market will spread to include the smaller issues.'' Behind this optimism is a belief that OTC stocks are historically inexpensive. ``Their p/e [price-to-earnings] ratios are about one-third of where they've been.''

With this huge rally, the undiscovered opportunities in the large blue chips are dwindling, he says. Even the institutions will soon be turning their attention elsewhere. And in a slow economy, investors don't want the large, plodding companies.

``You want small growth companies with a unique product or those expanding and taking away market share from sleepy competitors -- those companies growing easily at 10 to 12 percent or more. If the economy is growing at 2 or 3 percent, the GEs of the world aren't going to grow much faster.''

As a whole, Smith Barney expects the earnings of the 17 growth companies on its buy list to grow an average of 18.1 percent annually over the next five years. The average p/e multiple is now at 11.6 times estimated 1986 earnings.

Smith Barney has another list for the short-term, do-it-yourself bottom fisher. This list is based on the observation that year-end dogs often end up being the best performers in the following year. In 1984, three out of five stocks on this list were big winners. Of the two misfires, one slid slightly, the other plummeted. Chart: Interest Rates. *Yields; Source: Bank of Boston.

Percent Prime rate 9.50 Discount rate 7.50 Federal funds 7.81 3-mo. Treasury bills 6.94 6-mo. Treasury bills 6.95 7-yr. Treasury notes 9.03* 30-yr. Treasury bonds 9.52*