NEW YORK (Money Magazine) - You'd think that a rabid fan of the Tottenham Hotspurs (English soccer's equivalent of a perennially underachieving team like the Chicago Cubs) would be an eternal optimist.

Richard Bernstein, however, is anything but hopeful when it comes to the markets. Instead, Merrill Lynch's chief U.S. strategist, who took the job in late 2001 while retaining his chief quantitative strategist title, is quite the bear.

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One look at his sobering numbers shows how downright, well, down he is on stocks. His target for the S&P 500? A measly 860, down from around 900 recently. His model portfolio? One with 45 percent in stocks, 35 percent in bonds and 20 percent in cash -- a far cry from the average strategist's 68-24-8 mix.

Richard Bernstein, chief U.S. strategist Merrill Lynch

Why so negative? Bernstein points out that the equity markets are still as speculative as they were during the tech bubble. Stocks he calls "lower quality" -- based on stability, long-term earnings and dividend growth -- still sell at a premium to "higher quality" ones.

"It should be the other way around, right?" he asks. "You should pay a premium for safety." Bernstein also thinks that valuations don't reflect the unstable geopolitical environment.

Bernstein insists investors will need to be truly fearful of markets before valuations become attractive. He isn't saying it'll take another Enron; he believes that a string of little events -- such as layoffs -- will return valuations to normal. "I think of it like water torture," he says. "It's going to be a drip here, a drip there, and that will correct the markets."

Rich Bernstein's picks Energy and defense Company (ticker)  1-year return  P/E  Growth  Yield  ChevronTexaco  -18.9%  13.5  12%  4.1%  ConocoPhillips  -14.6  11.2  36  3.3  ExxonMobil  -7.8  18.1  17  2.6  Northrop Grumman  -0.9  19.0  -11 1.7  Raytheon  -1.5  18.4  -20  2.6   1-year return through Jan. 17. P/E based on estimate for next fiscal year. Growth from current estimate to next year's estimate.  Source: Baseline

The strategist is quick to point out, however, that he still has 45 percent allocated to equities. He likes the energy sector in particular. Bernstein notes that during the bubble, capital poured into technology companies, starving other industries.

Biggest loser? Energy.

No new refineries have been built in the U.S. in the past 20 years, he says. Now capital is again flowing into energy companies as the nation moves to become less dependent on oil imports. While the whole sector stands to benefit, Merrill's energy analyst highlights ChevronTexaco, ConocoPhillips and ExxonMobil in particular.

Bernstein's also looking in an interesting place for technology growth: defense stocks.

Not only is Defense Secretary Donald Rumsfeld a big technophile, but now both Defense and a second department, Homeland Security, are investing heavily in technology. "Everybody's talking about enterprise hardware and software, and they're missing the point," he says. "The story isn't the Internet, it's the Pentagon."

Bernstein says Defense and Homeland Security will increasingly reallocate money to companies like Northrop Grumman and Raytheon, two companies that Merrill's defense analyst recommends.