Investors may get defensive
about stocks, analysts predict

NEW YORK » In the span of only a few days, Wall Street went from worrying about accelerating inflation and higher interest rates to fretting over deteriorating profits and the specter of a possible economic slowdown.

The resulting gyrations in stocks have puzzled even some professional investors. They also have many analysts predicting a shift in investing trends, away from commodity-driven issues toward less-loved areas of the market, such as health care and consumer staples -- the least-damaged sectors over the last week.

"The shift from a cyclical, almost inflation-driven mindset to one that is defensive with slower growth has put the commodity producers in the leadership role to the downside," said Ned Riley, chief investment officer of Riley Asset Management in Boston. "That masks the fact that the companies with more stable growth, that are less dependent on price increases, are going to eventually be the market's new leadership."

In an otherwise excruciating week for stocks, the exchange-traded fund that tracks the health care issues of the Standard & Poor's 500 posted a 1.2 percent gain, the only sector to show a positive return. Overall, the index shed 3.3 percent for the week, and is now down 5.7 percent for the year.

The week's worst-performing sectors were energy and materials, which sank 6.9 percent and 8.3 percent, respectively.

At the root of at least some of the market's anxiety is the thought of less-robust growth in consumer spending, illustrated by disappointing retail sales for March. This was partly chalked up to higher fuel costs. But even the sagging price of oil, now trading at a two-month low, failed to reassure investors, who remained firmly focused on their fears of slower growth for the rest of 2005.

It's not surprising investors have turned defensive, said Joseph V. Battipaglia, chief investment officer at Ryan Beck & Co. They have so many unanswered questions. How aggressive will the Federal Reserve be as it tightens interest rates? What impact will rates have on the economy? How will energy costs affect consumers? What does the corporate profit picture hold?

"And now they're believing that we are entering a period of economic slowdown. This is where it gets difficult," Battipaglia said. "No one would argue the economy is simmering down. But how far down it simmers is the major question."

In 2004, the second year of the recovery following the bear market, investors benefited from a 4 percent rate of growth in gross domestic product; this year most think it will be about 3 percent. But while the pace of economic growth is slowing, there are still good fundamental underpinnings, including relatively high levels of employment and continued wage gains.

"I think the economy is on solid footing and we're in the middle innings of an expansion and we have a way to go," Battipaglia said. "The message for small investors is, don't make changes to your portfolio allocation because the momentum of the moment is putting you out of favor."