A New Year's bash that's refused to blow out

Happy New Year! Happy? Try supremely jubilant, deliriously ecstatic, or wildly euphoric. ``Happy'' won't cut it. For more than two weeks, Wall Street has been throwing one of the biggest, longest-running New Year's bash in decades.

``It's been fun,'' bubbles David Hillson, special equity-fund manager with E.F. Hutton in New York. ``But it's gotten very disorderly,'' he concedes. ``This market has to settle down.''

But when? Is Mr. Hillson cashing in some chips now?

``Well, we're taking profits in the regional banks, savings-and-loans - the momentum's been broken there. But we're not getting out of much else.''

Indeed, ``Don't fight the tape'' is a prevalent attitude.

Until Jan. 1, the tape favored the regal blue chip issues. The Dow Jones industrial average rose three times as much as the over-the-counter indexes in 1986. But this year, the foot soldiers are leading the generals.

The NASDAQ industrials index is up nearly 15 percent, while the Dow industrials have posted ``only'' a 10 percent gain, rocketing to a close of 2,076.63 last Friday.

Some analysts call the performance differential nothing more than the fairly consistent seasonal rally in small stocks, known as the ``January effect.'' Not so, says Hillson, Prudential-Bache Securities analysts, and a growing crowd. They argue 1987 will be the year secondary stocks make up for ground lost in 1986.

By almost any measure, says Hillson, the small-capitalization stocks are still undervalued relative to the large-cap stocks.

The Standard & Poor's 500 is trading at about 14 times this year's estimated earnings, says Hillson. ``The average S&P stock expects earnings growth of 9 to 10 percent annually. Small growth stocks are available at the same P/E's [price/earnings ratios], but earnings are growing at more than a 20 percent clip.''

Similarly, the price/earnings multiples on stocks in the Baltimore-based T.Rowe Price New Horizon Fund are at nearly their lowest levels in the fund's 26-year history.

Keeping pace with the broad OTC averages, the $1.1 billion New Horizon fund has jumped 13 percent in January. ``The go power in this rally has come from the technology stocks,'' notes Preston Athey, a New Horizon vice-president.

Some 30 percent of the 220-stock portfolio is in technology. After two years of languishing, prices are soaring. The entire computer spectrum looks strong. Gains of 30 to 50 percent are not uncommon. For example, on Dec. 31, LSI Logic was trading at 10. At this writing on Friday, the stock was at 15.

But Mr. Athey isn't taking profits yet. ``While the numbers look very impressive, it's still a snap-back rally'' from weak previous years. ``Some of these stocks haven't reached 1986 highs and are far from 1983 peaks,'' he says.

Investor enthusiasm has been fed by an unexpected increase in semiconductor orders in December and an improving outlook for personal computer and work-station sales. It's not clear yet if this is a blip or a genuine sales revival. If real, then the belt-tightening many companies have done could result in strong earnings in the quarters ahead.

Fortified earnings are not part of the near-term prospects at International Business Machines. Again, IBM is one of the weaker participants in the technology rally. And the earnings report due out this week is not expected to bolster Big Blue in investors' eyes.

Beyond the tech stocks, what issues are capturing investor dollars?

``Stocks that benefit from a pickup in the economy and higher inflation,'' says Ricky Harrington, technical analyst at Interstate Securities of Charlotte, N.C.

The tumbling greenback (a one-week 4 percent drop against the West German mark), rising crude prices ($19 a barrel), and somewhat higher expectations for the economy are causing a shift in buying.

Disinflation stocks - banks, food, tobacco - are out. Smokestack stocks - chemicals, papers, oils, and gold - are in. ``There aren't too many groups lagging,'' Mr. Harrington notes.

That bothers him a bit. ``I'm bullish short term. But I'm getting very concerned that we're going to see a major top, perhaps the end of the bull market, by the end of the quarter,'' he says. ``I'd be buying low-priced stock with specific exit points up or down: 15 to 20 percent targets.''

Harrington predicts the Dow will run out of steam at 2,150, perhaps 2,200. And if the speculation intensifies, spreading through the over-the-counter issues, ``I'm looking for a sell-off of 300 to 400 points on the Dow.''

But Hillson at E.F. Hutton doesn't think the buying blitz has the appearance of a market top. ``I wouldn't characterize what's happened in the small caps as rampant speculation. The P/E's are not crazy yet.''

An OTC market crest, says Hillson, is preceded by two factors not yet present.

First, the new-issues market gets hot enough that people buy stocks of companies with no earnings. Second, investors latch on to stocks of companies dependent on one product or that have regulatory problems.

``Companies that have a high business risk but are being accorded a crazy P/E multiple because they've put together one year of growth,'' he explains.

And while he's taking profits in only a few issues now, he plans to pocket some of his high-tech gains soon.

How does he sell off a position in a stock? Hillson takes one of two tacks, depending on the stock.

``If it's a stock that hasn't lived up to expectations - the glamour has worn off, earnings are disappointing - this is the time to take advantage of the market's strength. Sell the stock as quickly as possible. Then, substitute a more attractive stock.''

But if the company and its stock are surpassing expectations and ``the world has beaten a path to its door, you've got a real dilemma.'' Hillson advises backing out incrementally. ``Sell a good portion right away, maybe 30 to 50 percent of your holding. Don't equivocate.''

With characteristic optimism, he adds, ``ease out of the remaining position as the stock goes higher.''