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Hugh A. Johnson is one investment strategist who believes in listening to what the stock and bond markets are saying.

And despite the stock markets' tumble last week, Johnson, the chief investment officer at First Albany Corp., likes what he's hearing from the U.S. financial markets.

"The message of the markets is that the economy will continue to expand through the rest of 1999 and 2000," he said. "What I tell every economist I talk to is to take the message of the markets seriously."

As a result, Johnson thinks the stock market is heading higher between now and the end of next year, although share prices could fall a bit lower during the next few months as investors adjust their valuations downward to reflect slightly higher interest rates and inflation.

"We've moved from a period of rising earnings and rising price-to-earnings ratios to -- because interest rates are rising -- a period of rising earnings and declining price-to-earnings ratios," Johnson said.

That's part of the reason why share prices have slipped since May and why Johnson thinks the stock market will go back to producing more normal annual returns of between 8 percent and 12 percent. "There has to be an adjustment," he said.

"Once the adjustment is completed, then the bull market can resume," Johnson said. "This is a short-term adjustment in the market and in no way does it tell me we're heading for a time when we need to take significant defensive positions."

In fact, Johnson said the recent decline could turn into a buying opportunity for investors soon.

Despite the sagging dollar, which could lead to foreign investors pulling some of their money out of the U.S. markets, Johnson said liquidity conditions continue to be good, which usually means a solid rise for stock prices.

Also behind Johnson's moderately upbeat outlook for the stock market is an economy that he expects to keep growing, albeit at a slowing rate, while inflation inches higher but remains unusually low.

Johnson expects the U.S. economy to grow at a 3.8 percent rate this year, before growth slows to 2.7 percent in 2000. At the same time, inflation is expected to inch up to 2.4 percent next year after reaching 2.1 percent in 1999.

That could push long-term interest rates a bit higher, with the yield on the benchmark 30-year Treasury bond rising to 6.49 percent by the end of this year, before falling back to 6.38 percent at the end of 2000.

Those predictions are a sign that times are getting a bit more difficult for the stock market, which has produced unusually big gains for the last

five years, but Johnson doesn't see the bull market screeching to a halt.

"They are not telling me now that the bull market is over," he said. "They are not telling me now that we should prepare for a recession."

Still, Johnson sees some potential trouble spots brewing, including a tight labor market and a steep jump in employment costs during the second quarter, that could be a sign of inflation picking up.

At the same time, though, profit margins are strengthening, which eases the pressure on companies to raise prices, although increased global competition makes that difficult to do anyway.

That's one reason why Johnson doesn't expect the Federal Reserve to raise short-term interest rates for a third time during October. Another reason is that rising energy prices are the main factor behind the stronger jump in consumer and wholesale prices this year. Excluding the more volatile food and energy costs, the so-called core rate of inflation is up just 1.9 percent during the last year, which is the smallest increase in the last 33 years.

But Johnson warned that stronger growth in the global economy could increase inflationary pressures, as could a continued rise in energy prices.

Still, Johnson said overvaluation is not a major problem for most stocks, especially since the majority of small- and medium-sized company stocks have not commanded the same lofty price-to-earnings ratios that technology and big company stocks have attained.

Johnson said those technology and big company stocks still show some signs of speculative buying, with shares of companies like America Online, Intel and Cisco Systems trading at multiples that are far above their earnings growth rates. Johnson said investors typically prefer price-to-earnings ratios to be close to a company's earnings growth rate.

In the short-term, Johnson said value stocks, which have fared far worse than big company growth stocks that have dominated that market in recent years, could bounce back in the coming months.

But Johnson doubts that the value stock rebound will last long. "I believe, after the adjustment, that growth stocks will outperform value stocks," he said.

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