Last year, on October 8, the Dow Jones Industrial Average touched a low of 7932, climaxing a sickening slide that began three months earlier. Precipitated by the Russian debt implosion and the crisis surrounding the debacle of the Long Term Capital hedge fund, the scramble to liquidate assets led to a classic flight to safety. At the height of the panic, 30-year U.S. Treasury bonds bottomed at a 4.71% yield. Into the fray charged Alan Greenspan and the Federal Reserve, which turned on the money spigot and lowered the key federal funds rate three times between late September and mid-November 1998. Investors breathed a collective sigh of relief, jumped back into the liquidity pool, and returned to the equity markets with renewed vigor.

From October 1998 until spring 1999, nearly all stock market indices climbed upward. During this period, a broad spectrum of stocks benefited from the liquidity rush injected by the Fed. Value stocks and mid- and small-cap stocks galloped upward alongside the technology-laden NASDAQ and S&P 500. Then beginning in April this year, just as in spring 1998, most stocks began to de-couple from the liquidity gravy train, and gains diminished. The NASDAQ 100 index, dominated by big-cap tech stocks, worked irregularly higher through the end of the just-finished third quarter, but the rest of the market was hard pressed to eke out a gain. The average stock shriveled like a wizened, old prune.

Complicating matters for nervous investors, the Fed goblins reappeared during the second quarter this year, donning Halloween costumes early. Just as investors were again getting comfortable with buying every dip, the Fed began squeezing money supply growth, raising interest rates, and warning of "asset bubble" inflation.

The Goldilocks economy of low inflation, low interest rates, and reasonable profit growth awakened to see the Three Bears of inflationary fears, rising interest rates, and profit disappointments. The financial markets were placed on Fed watch as the ubiquitous gurus and CNBC talking heads droned on about what the Fed would or would not do. Now, after the Fed's recent stand-pat posture with a tightening bias, we will be subjected to another round of incessant babbling about Fed intentions. The recent uptick in the September Producer Price Index has also put a chill over the markets and significantly increased the odds for further Fed tightening.

At the same time that the Federal Reserve played spoiler this year, other termites began gnawing at investors' confidence. The yield on the 30-year U.S. Treasury moved inexorably higher, hastened in part by the Fed, to close third quarter 1999 at 6.05% and more recently flirt with 6.40%. With rising yields came lower bond prices. For the first nine months of the year, the total return (coupon income plus price change) on a 30-year Treasury was a negative 11.4%. Further eroding stock and bond prices is the dollar's decline vis-a-vis the Japanese yen and, of late, the European euro. As if this isn't enough, the U.S. trade deficit ballooned to record highs. And with Asian and European economies newly energized, foreign investors have been liquidating their U.S. securities and dollar holdings to reinvest funds in their own markets. Another drag on the equity markets was President Clinton's veto of legislation that would have reduced the capital gains tax and estate tax.

And finally, there is Y2K. FDR admonished that "The only thing we have to fear is fear itself," which at century end is apropos of widespread computer angst. While preparing for Y2K, individual and institutional investors have themselves contributed to the market's recent downturn. Individuals withdraw funds primarily because they fear a myriad of problems both probable and improbable; institutions fear what individuals might or might not do with funds entrusted to them. In short, a cycle of fear has begun to feed on itself and compound existing problems.

So, as we journey through the final quarter of a year which has proved increasingly difficult for investors, the U.S. financial markets labor under the weight of a churlish Fed, a sliding dollar, rising commodity prices, nervousness about renewed inflation, and unpleasant earnings surprises from the likes of Xerox, Hewlett-Packard, Coca-Cola, Gillette, Intel, Avon, and Apple Computer. Adding to the witches' brew are a rising trade deficit and higher energy costs. Even more disconcerting is the continued rocket ride of a literal handful of stocks whose valuations require supreme faith in the future. Internet stocks run alongside and in many cases well in front of the handful of tech leaders; they appear to be in a valuation orbit of another universe. And yet the rest of the market has descended into an eddy of lower prices. The average stock now wallows in a bear market dating from April 1998.

After a rally off the climax lows of last year and in the face of new dynamics weighing on the market, stock prices in many sectors began to roll over in spring 1999, camouflaged by a few strong stock groups. Oil stocks, benefiting from the production discipline imposed by major producing nations, rallied strongly from their lows in earlier quarters. Telecommunication stocks, fueled by both technological revolution and consolidation sweeping the industry, also turned in a stellar performance. But it is the technology stocks, especially the behemoths of the industry, which have propelled the major indices higher.

Ironically, this year's rise in technology stocks has been fueled in part by an illusory flight to safety similar to 1998. Foreign and domestic investors continue to pour money into technology stocks or mutual funds that invest in these stocks. "Liquidity is safety" is the mantra of momentum investors, crowd-followers fixated on index funds, closet indexers, foreign investors, and John Q. Public, all investing in the same stocks at higher and higher levels. As the rest of the market languishes, the big have gotten richer in price as well as valuation.

Some results are mind-boggling. As Fred Hickey points out in the September 1999 issue of The High-Tech Strategist, "The six biggest capitalization tech stocks (Microsoft, Intel, IBM, Cisco, Lucent and Dell) are valued at $1.65 trillion, up $460 billion this year to date. Since the beginning of 1998, the total valuation of these six has more than tripled." Other benchmarks are equally astounding. Says Hickey, "Just the increase in the valuation of these six tech stocks over the past 20 months ($1.1 trillion) is more than what all U.S. stocks were worth in 1982. . . . [O]n September 3, 1999 the melt-up caused by the 'favorable' unemployment report added $63 billion to the market valuation of the 'Big 6.' One day's gain. At their lows in late 1990, all of the stocks in my top-ten 'nifty-techie' list . . . of IBM, Hewlett-Packard, Intel, Microsoft, Motorola, Cisco, Sun Microsystems, Texas Instruments, Oracle and Micron Tech could have been purchased for a grand total of $52 billion. Essentially most of the technology industry in 1990 is an even swap for one day's gain of 6 stocks today."

Of course, if you've had all or most of your money in the top six or seven tech stocks, give yourself a pat on the back and thank your lucky stars. And if you've owned an index fund or a closet index fund, you also fared well. But that was yesterday, and the odds are that most investors have fared far worse than the major averages. More importantly, do you still want to risk your retirement or children's college fund on a handful of stocks whose valuations leave no room for disappointment?

A case in point is provided by Coca-Cola, a former market leader whose stock hit a high of $89 on July 15, 1998. However, Coke's growth and earnings deteriorated over several quarters, and by market vote investors dramatically adjusted Coke's price. At the end of this past quarter, Coke closed at $48, a drop of 46% over 15 months.

You can see Coke redux in Intel, a high-tech darling and proxy for conventional tech mania. As BARRON'S recently pointed out, at its closing price of $74 on September 30, Intel traded at 33 times 1999 earnings estimates and 28 times 2000 estimates, or about twice its underlying growth in earnings. The S&P 500 trades at roughly 1.5 times 1999 earnings growth estimates. Intel typically has tracked the S&P at about the same ratio. Yet Intel, like so many tech stocks, was priced for perfection. To assess Intel's prospects and the whole issue of technology stock valuations, more investors should ponder BARRON'S points. "What if . . . the competition for server chips from the likes of Sun, Hewlett-Packard and IBM proves fiercer than expected? And what if Intel has a tough time trying to dictate networking standards and that new Internet architecture fails to catch on as quickly as hoped? And what if Intel's new Merced chip, already delayed for a year, faces even further delays next year? And what if the rollout of broadband Internet services to American homes takes longer to accomplish than the phone companies and cable companies, which are racing to get there first, anticipate?"

With current risk factored in, Intel should trade at best at the more traditional ratio of 1.5 times earnings growth, not twice the growth rate projected by its most ardent supporters. We agree with BARRON'S that realism would put the stock below $60, a huge drop from $74. BARRON'S states bluntly, "No matter how good Intel management and how bullish the prospects, anything above that is all fluff." Indeed, Intel reported disappointing earnings on October 12, and its stock dropped precipitously. Apparently the air is already rushing out of the Intel soufflé.

If Intel is indeed a proxy for the market segment priced for perfection, should investors liquidate and flee to the sidelines to await the "big correction"? A hasty dash to the exits would only be appropriate for those investors whose portfolios are already anticipating high growth well into the next millennium. For nearly all other investors, the bear has already mauled its victims. In the current bear market, many publicized problems, real or imagined, have already been well discounted by the debilitating slide in the price of the average stock. Hand-wringing over the market's very poor breadth (advancing issues versus declining issues) and its long extended decline begs a basic question: Hasn't the average stock already declined to a price level that makes its risk/reward far more attractive than at its peak price of the last 18 months?

Apparently far too many investors haven't yet come to this analysis. In the last few months, they've tossed away caution, rationality, and hundreds if not thousands of companies whose economic fundamentals and price potential are sound and quite compelling. These investors move more and more money into assets deemed "safe havens"- all in response to rising interest rates, excessive fears that inflation will return with a vengeance, a declining dollar, a bulging trade deficit, earnings disappointments, and Y2K phobias. Quite a laundry list, with no reliable grease-cutter. Their new goal: To chase the New Nifty Fifty and the Internet hot-rods to stratospheric levels.

Is it time to join the crowd by seeking "safety" in the leadership stocks and shunning everything else? We say no. Our Business Valuation Approach* says invest in or stay in undervalued stocks. At the same time, if large numbers of pundits and investors were more optimistic about the broader market, we would be very concerned. What do we see ahead? If the economy is developing an asset bubble as the Fed fears, we believe that it is concentrated in market segments fueled by excessive speculation, liquidity-driven momentum and index investors, and the blind embracing of nearly all things related to the Internet. No question that there are excesses in certain areas of the financial markets. There always are. And the markets eventually will eliminate those excesses, just as undervalued situations do not remain so forever. The issues that trouble investors today will yield the seeds of their own correction.

Inflation might pick up in the months ahead, but it is unlikely to escalate dramatically as in the late 1970s and early 1980s; thank the improving global economy for that. The global economy now has a tremendous excess capacity available for producing raw materials and finished goods and for introducing labor resources outside the U.S. China and Japan still flirt with deflation, not inflation. Japan's Toyota Motors recently introduced a $10,000 car. The price of computers is dropping like a rock. In the U.S. and internationally, long-distance telephone and data transmission charges are sliding down as competition intensifies from capacity growth. Manufacturers now use the Internet to get the best price for everything from paperclips to tons of steel. The past two decades' collapsing political barriers have fueled dramatic growth in international economic competition and accelerated widespread corporate restructuring. Spurred on by technological and telecommunications revolutions still in their infancy, these developments exert significant downward pressure on prices.

As for the trade deficit, self-correcting mechanisms already are at work to redress the picture. The trade deficit partially reflects the slowdown in Asian and European economies over the past couple of years. As these economies begin to recover, U.S. exports there should pick up momentum. At the same time, U.S. imports should begin to moderate due to higher interest rates. Higher interest rates gradually will slow consumer spending, and a weaker dollar will make imports more expensive. Many would argue that a U.S. trade deficit is actually a major positive reflecting a very strong economy that enables consumers and companies to import goods and services at attractive prices, thus helping keep inflation low.

As international and domestic growth stabilizes in 2000, fears of runaway inflation should diminish and interest rates also should stabilize, even if at somewhat higher levels. The bond outlook should become less negative while corporate profits should continue to grow, albeit at a less heady pace. Overall, the negative drumbeat that has so frightened investors will slow down. It will be time to stop obsessing about the river of reasons why things can go wrong, and instead envision a modestly brighter future.

Bullish investors recently have gobbled up publications forecasting that in the next few years the Dow will reach levels of 30,000, 36,000, and even 100,000. Wow! Considering that the Dow closed the recent quarter at 10,337, reaching even the lowest of these optimistic forecasts would spell great wealth for investors. While anything is possible, we think these projections are somewhat ambitious. Likewise, we are very skeptical of doomsayers who agonize over every word uttered by Mr. Greenspan, fret over the possibility of Internet mania infecting all investments, view each monthly economic report as signaling momentous and critical change, and generally engage in an incessant call for the end of the bull market. These trigger-happy bears are as far afield of reality as the most optimistic bulls.

We also think that it's naive to talk of an end to the bull market. Most stocks have been in a stealth bear market that started at least 18 months ago but which has been overshadowed by an extraordinarily narrow list of large-cap stocks that have ballooned certain key indices to record highs. For the large majority of stocks now in the doghouse, we think we are close to the end of a bear market and the start of a bull market of a very different character. We're due, perhaps almost overdue, a real and widespread bull market. When we examine the potential for stock price appreciation over three to five years, we would not be surprised to find many stocks increasing anywhere from 50 percent to 300 percent. Were it to parallel such appreciation, the Dow would rise to 15,000 to 40,000. So who are we to say where the Dow will go?

This unknown plus the problems of the day will encourage much pointless haranguing in the closing months of 1999. But outside the New Nifty Fifty, much of the bad news already has been factored into current prices. There may be complacency and misplaced confidence among high-tech and Internet investors, but there are lots of long faces among the holders of most U.S. securities. Investor sentiment on the bond market is at its most negative level since 1987. The major stock indices have declined over 10% from their recent highs and, much more important, the vast majority of stocks are down well over 20%. Flows into money market funds are increasing dramatically, while flows into equity and bond funds have been slowing down. All these are major correction and bear market numbers that some investors are coming to understand, and expound on, only now. On a more constructive note, some discussion should begin to focus on many companies now offering what appear to be very compelling risk/reward relationships viewed over a multi-year period.

Looking ahead to 2000, Mr. Greenspan and his colleagues will satiate themselves by administering a goodly portion of their monetary castor oil. The Internet will continue to flourish, but its luster will fade somewhat: Many charlatan Internet wannabes likely will fail because they are ultimately unprofitable, or they will be supplanted by old-line companies that regroup and successfully transform operations. Money flows to overextended stock groups likely will slow, and a re-allocation of assets to a broader spectrum of stocks should drive up average stock prices.

As for Y2K, note that we are not so Pollyannaish that we underestimate the gravity of Y2K problems if not attended to in advance, or fail to recognize that there will be some inevitable and costly glitches associated with Y2K failures. But we think it is even more foolish to engage in needless anxiety or unwarranted, potentially costly decision-making. On January 1, 2000 and thereafter, the lights will go on, the water will flow, the car will start, and the key to the office will still work. After all is said and done, we will hear about interesting "calamities" caused by Y2K shut-downs during the first week or two of the new year, and then probably read follow-up stories toward the end of the January that there was much ado about nothing. Y2K will begin to take its place as a footnote in economic history. And this brings us to some of our best advice for you now.

In a world in which millions of "investors" seem to know the price of everything and the value of nothing, we think that patient investors are presented now with very attractive investment opportunities. Yes, this is our mantra through virtually every economic environment, but there's extra gravy this time. As usual, the markets will remain volatile and there is great risk in many stocks. But as excesses are unwound abruptly or gradually in market sectors that are overextended or marked by irrational speculation, the stage will be set for an end to upward pressures on interest rates and the start of a prolonged and more widespread bull market. At KING we will continue to focus on stocks whose public market price is significantly below true private market value and to buy growth at a reduced price, not just any price. We are confident that we can achieve solid returns for our clients through the remaining months of this century and long into the future.

Although we typically take a long-term view, there is an unusual, short-term twist in our millennium-end approach to Y2K investing. We view Y2K fears as creating a possibly very positive window of opportunity for investors in the upcoming weeks. Throughout the current bear market, most stocks have been under steady selling pressures. Most individual investors and mutual fund managers who are liquidating now indicate that they will return to the markets when the coast is clear, probably in early January. As Y2K phobia passes and these Nervous Nellies work to get back in, a buying frenzy may result. In our view, large re-investments at that time will cause a market melt-up during the first month or two of the new year, for a broad universe of stocks. In short, we think that investors should now view Y2K anxieties as Y2K investment opportunities.