Guru Zweig Figures Momentum In Market’s Favor Analysis Of Past S&P; Movement Indicates Rally Not Yet Over

The trend, as they say on Wall Street, is your friend. And what a trend! Since Thanksgiving, the stock market has been rising at a lovable 45-degree angle. The Dow is up a thousand points. Fidelity Magellan, the largest mutual fund in the world, has returned 30 percent so far this year; Microsoft Corp., 50 percent.

But is the market getting too friendly? Is it luring unwary investors into a trap?

Martin Zweig, a well-respected money manager, has some thoughts. The stock recommendations in his Zweig Forecast rank No. 1 for risk-adjusted return since 1980 out of all the newsletters followed by the Hulbert Financial Digest.

Zweig is a technician who bases his judgment on the record. History, of course, is not a perfect guide to the future, but as a research tool it’s far better than your gut.

One good indication of the strength of the market’s rise, says Zweig, is that the Standard & Poor’s 500, a broad stock-market index, is now 12.5 percent above its own 200-day average. This is roughly the equivalent of a regular .270 hitter batting .350.

Will the streak continue? Or is it a warning that the batter will soon “regress to the mean” - that is, start batting poorly to get back to his longtime average?

Zweig’s research shows that, in the stock market at least, momentum counts. In a recent article, Zweig said he found that since 1940 there have been 18 run-ups in which the S&P climbed at least 12 percent above its 200-day average. Here’s what happened subsequently in those cases:

After three months, the S&P had risen an average of another 3.1 percent and was up 78 percent of the time.

After six months, the S&P had risen 5.5 percent, gaining ground in 83 percent of the cases.

And after nine months, it was up an average of 9.6 percent, rising 89 percent of the time.

“All of these results,” wrote Zweig, “were close to double the average gains for the respective periods.”

Zweig probed further and came up with more good numbers. He noticed that the S&P had risen during each of the preceding six months, without a decline, “so we tested this feature as well.”

He found only 22 previous cases since 1928 in which the S&P posted consecutive six-month gains. Three months later, it was up another 3.6 percent vs. an average increase of 1.3 percent.

Six months later it was up 7.0 percent vs. an average of 2.6 percent. And 12 months later, the S&P had risen 10.4 percent - exactly double the average gain. And, again, these figures don’t include dividends, which would boost them by another 3 or 4 percent.

Statistics like these have made Zweig a confirmed “momentum” investor. He waits until a trend is established, then gets on board for the ride. As he wrote in his book, “Winning on Wall Street”: “One of the frustrating things for people who miss the first rally in a bull market is that they wait for the big correction and it never comes. The market just keeps climbing and climbing.” That sounds like a familiar lament for 1995.

In fact, the mutual funds that Zweig himself manages have lagged the market this year - mainly because, at the start of 1995, he was keeping a large proportion of the assets out of stocks, waiting for a clear trend to develop. As late as March 31, for example, Zweig Strategy was 39 percent in cash; so far in 1995 it’s returned 17 percent, compared with 21 percent for the S&P 500.

Zweig’s research is important because it shows there’s no reason to fear a market just because it’s strong. His numbers should give the cowardly some courage.

The courage to do what? To play it safe, purchase new shares by concentrating on undervalued, overlooked companies.

Since this market has been rotating - moving from one favored group to another - it’s a good idea first to consider the laggards.

For example, Morningstar Inc. of Chicago recently calculated that so far this year, mutual funds that specialize in large-capitalization stocks have outperformed small-cap funds by 30 percent. So take a close look at funds like MFS Emerging Growth, Franklin Small-Cap Growth, Invesco Emerging Growth, Lazard Small Cap, Fidelity Low-Priced Stock and Royce Premier. (All receive Morningstar’s top rating of five stars.)

Dow Theory Forecasts, a conservative newsletter that leans toward value, is recommending stocks that have been moving up lately but are still below their historic highs: Humana Inc., which should benefit as Medicare becomes more HMO-intensive; Merck & Co., the drugmaker; Safety-Kleen Corp., a recycler of industrial wastes that’s down more than 50 percent in three years; retailers Kmart Corp. and Family Dollar Stores; and Hanson PLC, the British conglomerate.

Finally, Zweig would add a pick - Oklahoma Gas & Electric - as would Peter Lynch, the former manager of Magellan, who likes Toy’s R Us.

The moral: You don’t have to fear a hot market as long as you stick to cool stocks.