NEW YORK (MONEY Magazine) - Interviewing Steve Galbraith when he's in front of his Quotron terminal and a television tuned to CNBC is like trying to have a conversation with parents whose toddlers are scurrying about.

They seem to be listening in a I-can-repeat-the-last-thing-you-said sort of way, but what they're really trying to do is make sure their kids don't maul one another or stick their prying fingers into electrical outlets.

In Galbraith's case, however, he's the one who seems shocked. As chief U.S. strategist for Morgan Stanley, his job is to provide levelheaded direction to the firm's institutional client base. It's proving a difficult task. "Everything's red on my screen," he says. "It's really scary out there."

It may look scary, but Galbraith, 39, is optimistic. In the second quarter, he notes, earnings were up for the first time in five quarters and should continue to rise at least through the first quarter of 2003. He predicts that the S&P 500 will grow by 7 percent a year over the next five years. He's quick to put that number in context, though. "That means it's 2009 before we get back to the prior peak," he says.

What could throw his predictions out of whack? There's geopolitical risk, of course, and then there's the risk that an economic recovery doesn't materialize and the markets go into a tailspin. "We have sell-offs, CEOs spend less on capital and fire people, consumers stop buying SUVs because they lose their jobs, and it gets worse and worse," he says. "And the Federal Reserve has very little ammo to fix things." Finally, serious damage could result from the collapse of a major bank or brokerage house.

Galbraith's asset-allocation model recommends 70 percent in stocks, 25 percent in bonds and 5 percent in cash, a slightly more aggressive portfolio than the average strategist's 67-25-8 mix. He suggests keeping an eye on companies that buy back stock. "It tells you who has belief in their business and earnings," he says. Galbraith likes Citigroup, the financial services giant that recently announced a $5 billion buyback plan.

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The strategist also recommends that investors keep an eye on companies paying dividends. "Few companies are spectacular allocators of capital, and paying dividends makes the statement that you're going to be around for a while," he says. He cites General Electric. Not only does it have a 2.7 percent dividend yield, it's one of only 10 triple-A-rated companies in the U.S. and, because the market has decided it's far too complex, trades for $32, just 17 times '03 earnings.

As for sectors, Galbraith would steer clear of telecom. Instead, for safety's sake, he suggests health care. Relative valuations are below average due to a lack of predictable earnings in recent years, yet the group has shown consistent long-term earnings growth with a 36 percent return on equity. He expects double-digit earnings growth from Pfizer and Wyeth.

Stocks to watch: Galbraith       Citigroup Devon Energy ExxonMobil General Electric Pfizer Wyeth

Another safe haven: energy. In an attempt to become more independent from imports, the U.S. government and the private sector will continue to invest in domestic drillers and distributors, says Galbraith, recovery or no recovery. The strategist cites integrated giant ExxonMobil and oil and gas explorer Devon Energy, at $37 and $47, as good plays.