Another squall is going through

On February 9, we issued a bulletin saying to sell all stocks. Then on March 1, we partly reversed that by issuing a new buy list on the assumption that stocks had successfully come through a market cycle low. We did so with some reluctance, saying that many stock prices were living by the Greater Fool Theory, which states that you buy a stock going up in order to sell it in due course to a greater fool than yourself. It is worth repeating one paragraph from our last bulletin:

"In present market conditions, we want to emphasize that we regard it as essential to keep a big cash reserve. We envision even quite aggressive accounts investing no more than amount 50 percent of available funds in common stocks in the current environment. You have to consider two possibilities. The first is that there is a more serious decline and that we do not succeed in getting out of stocks in a timely fashion or at least not at a good price if stocks start sliding. The second possibility is simply that there are certain to be more attractive and/or new opportunities as time passes. It is very difficult to jump on a wonderful new opportunity if all your money is already tied up and especially if it is invested in stocks that are under water."

After considerable time spent examining the case for the continuing bull market, for a significant retracement or simply for an ongoing sideways market like 1994, we now incline somewhat toward the latter scenario. We incline now toward a scenario where some stocks go up substantially and one where some individual stocks may go into a serious decline, and one where the majority of stocks simply wander sideways.

Until recently, there was relatively little risk in buying almost any high tech stock that had a good chart. Things started changing about the middle of January. Then some apparently great charts simply fell apart for no apparent reason. On the positive side, there has been a tendency for stocks having washed out charts to come roaring back, stocks like Dell.

When you go though a period when the majority of stocks you follow seem to be soaring every day, it is difficult to get back on track to remember that these times occur seldom. The majority of them time great stocks are hard to find. It is worth recalling too how we had to live through some serious retracements last year in some stocks that turned out to be our biggest winners. They included EMC and Nokia. Finally, they finished settling back, began regrouping and then went out to new highs.

There is some risk that there may be a structural rotation out of high tech stocks with multiples in the stratosphere, and back into stocks having better so-called value. In our view the most likely scenario is for some of the most highly valued stocks, ones like Cisco and Sun Microsystems, to rest rather than to go into a more serious decline. They should not retrace all that far but it is almost inconceivable that they can maintain their previous rate of climb. If you look back over the long-term chart for Microsoft, you will see that there were quite extended periods when the stock essentially went sideways, and sometimes for 18 months or so. Then there was another growth spurt in the stock price. The extended rest was required in order for sales and profits to catch up with a stock price that had got too far ahead of itself. We see many such stocks now.

In our view the probabilities are not favorable for a major rotation back into stocks of old economy companies. They may appear to offer good value but in most cases that value is only relative to the apparent high price of new economy stocks. The recent example of Proctor & Gamble shows how an apparently powerful, reasonably priced and defensive stock can backfire. In our view PG is still expensive and would be expensive even around half its current price. The old economy has lost pricing power and it is likely to stay lost. A company like Coca-Cola with a real growth rate of perhaps 10 percent deserves a Price/Earnings ratio closer to 10 percent than its present 44. So although the stock has halved, it could easily halve again. If you think this improbable, remember that a declining market can feed on itself just as does a rising market. The lower the price goes, the more depressed holders continue selling. Worse, the dividend yield on a stock like Coca-Cola doesn't come close to paying the interest if you borrowed money to buy it. Then there are margin calls. Margin calls come relentlessly in a stock that halves and is on its way to halving again. If you can't meet the call, you have to sell stock. And so ad infinitum, or at least until you reach a real bear market bottom.

For the intermediate future it looks to us as if stocks may be close to an intermediate low. The monthly stochastic for the Dow Jones Industrials is now below the level of June 1994. The weekly stochastic is below the level at the low in 1998. From these levels new advances tend to come, although generally not with a V bottom. It can take several months of base-building before a new advance starts. The NASDAQ 100 index is almost at the other extremity at an overbought condition that appears only to be starting to unwind. Despite the decline of the past week, it is still in a confirmed bull market, and the probabilities do not suggests that there will be a new bear market in this sector¾just tougher conditions for finding great stocks.

It is worth focusing for a moment on one of our stocks that has done nothing but decline since we recommended it, Sony. Today, when stocks all around were falling apart, Sony gapped up and closed almost $16 above the close for yesterday. This is more likely a buy on this weakness than it is one to give up on. This is the kind of stock we try to find where there is both a fundamental case and a technical one for expecting higher a higher stock price.

Interest Rates

The Federal Open Market Committee meets again next week and there is an almost universal expectation that interest rates will go up another notch, a quarter point or even perhaps a half. If stocks continue weak between now and then, it is very unlikely that the increase will be more than the quarter point.

The bond market is starting to look as if long-term interest rates are stabilizing and may even start heading down. Money not invested in stocks could go with limited risk, and a limited proportion of one's portfolio, into top quality bonds out to 30 years. Of course, investing in bonds may mean that money is not available at short notice for investing in stocks.

It is worth noting that there has almost always been a big surge in stock prices on completion of FOMC meetings even when interest rates have gone up. The probabilities favor a recurrence given that some of the indexes and many individual stocks have corrected quite a lot.

New Recommendations

None. We are looking at Yahoo! and a few other stocks that have corrected substantially and appear to be building a new base. We are also looking at E-Bay and American Power Conversion and are considering going back into Oracle. This is just a few of the stocks that in principle we want to own but for which we are wary of issuing new buy recommendations right now.

List of Current Stock Recommendations:

Action Ratings

The following is the legend for designating immediate action for our stock recommendations. The first is B, meaning the stock is timely to buy but the case for doing so right here is not overwhelming. Either the stock may have got ahead of itself and may be vulnerable to a retracement or else the stock has been performing disappointingly but may simply be regrouping. B+ and B++ indicate stocks for which there is a technical case to buy now, with plusses adding weight according to how many there are, up to a maximum of five. Stocks rated H are ones to hold, awaiting confirmation to buy more or to sell. SELL, of course, means what it says. It seldom pays to override this designation.

Stocks marked # are eligible for Canadian RSP funds. Otherwise there is a 20pc restriction on foreign stocks held in these accounts.

First bought Entry Last

3/2/00 Applied Micro Circuits(AMCC) 255.44 253.00 H
3/2/00 Atmel Corp(ATML) 50.31 49.56 H
3/2/00 Biomira(BIOM) 17.75 12.00 H
3/2/00 Biovail(BVF) 67.56 49.56 H
3/2/00 Broadcom(BRCM) 208.50 200.94 H
3/2/00 Broadvision(BVSN) 85.75 77.56 H
3/2/00 Ciena(CIEN) 181.50 134.00 H
3/2/00 Cognos (COGN) 67.09 64.56 H
3/2/00 Corning(GLW) 200.00 178.50 H
3/2/00 Fusion Medical(FSON) 17.75 16.00 H
3/2/00 Genzyme Molecular(GZMO) 29.00 25.88 H
3/2/00 Idec Pharma(IDPH) 149.88 105.00 H
3/2/00 LSI Logic(LSI) 69.25 77.00 H
3/2/00 QLT Therapeutics(QLTI) 73.25 55.00 H
3/2/00 Rogers Group(RG) 33.75 32.06 B
3/2/00 Royal Phillips(PHG) 200.38 183.25 H
3/2/00 Seagate(SEG) 51.25 65.06 B
3/2/00 Sony(SNE) 303.00 241.31 H
3/2/00 TD Waterhouse(TWE) 19.88 17.75 H

Stockscom