New Buy Signal Confirmed - But Don't Be Too Bold!

The consolidation of recent weeks appears to have concluded with an upside breakout in the major indexes. They still need to clear the June highs to confirm the breakout and they may settle back before resuming the bull market. However, the probabilities now favor an erratic upward move that should lead in due course to the indexes challenging their record highs. An important feature of the expected advance, however, is certain to be that there will be considerable rotation in leadership. Although, for example, there is very encouraging strength in Microsoft and the stock looks like a buy, this stock has a very long way to go to reach its record high.

We have been having some difficulty during the past few months differentiating between opportunity and risk. On the one hand, it seemed that interest rates might continue rising, that inflation was a serious threat, and that the economy might falter. A faltering economy for any reason could lead to pressure on profits which in turn could lead, from current valuations, to extreme pressure on stock prices.

The technicals now suggest strongly that the line of least resistance for stocks is likely to be upward from here, not down as seemed likely as recently as a couple of weeks ago. Specifically, the Dow Jones Industrials were setting up a potentially very bearish descending triangle. This pattern often leads to a major decline when price breaks down out of the triangle. Supporting the probability of a serious downward break was the action in many individual stocks with extremely bearish chart patterns. Among these were many former leaders such as IBM, as well as many old-economy stocks such as DuPont and Caterpillar. Even the likes of Home Depot and Wal-Mart were looking quite bearish.

It now appears that the three-month consolidation in the Dow Jones and the smaller but more decisively coiling pattern in the NASDAQ is being resolved with an upside breakout. The theory of consolidations states that when a stand-off between buyers and sellers has been going on for some time, the eventual breakout is likely to follow through for a worthwhile distance.

When NASDAQ stocks were pressing down at the bottom at the end of May, we expected the long-term uptrend line from the 1998 low to hold. However, after the ND regained 50 percent of its loss from the high, we had good reason to fear the possibility that stocks might need to settle back and even test the low. Action in the Dow Jones industrials was favoring that possibility. So was market action in some stocks on which we had inadvertently been focusing that had previously been market leaders but which were becoming market dogs, including Qualcomm and Broadvision. Looking at those two stocks led us to fear risk rather than to reach for opportunity in stocks that were performing well.

We still fear risk in many areas of the market, but less than before. Specifically, we fear risk in stocks which, however wonderful the companies behind them, have stratospheric valuations. Among the latter we now include such high flyers as JDS Uniphase and even Nortel and Corning. We adore the latter two stocks but they could correct a very long way if anything started going wrong. If we owned them, we would certainly retain them but we hesitate to put new money into them. Buying them back after previously owning them must be regarded as an exercise in putting in new money. Every new purchase must be regarded as just that, a decision to invest new money.

The case for Oil, and the Dangers

There has been a small hiccup in oil stocks after the announcement that Saudi Arabia was considering an increase of 500 million barrels per day in production. They are reported as wanting to see the price of oil head back down to $25 or so from the current level around $30 and intermittently a bit above.

From our perspective, we see oil in a major bull market that is not interrupted by a drop in price of a few dollars. In any case, oil stocks are valued in our view on the basis of oil prices no higher than $25 or so. Oil companies have staggering positive cash flows and are selling at multiples that assume prices falling back under $20 and/or a drop in demand. Our interpretation of both the technicals for oil and gas prices as well as the fundamentals is that the next big break in oil prices will be upward, not downward. Our interpretation of the technicals is that the consolidation around $30 in the oil price is a way station on the way to a test of $40. Similarly, we expect an upward break in natural gas prices from their current level around $4.25 toward 5.50 to 6.00 this winter even if there is no extreme cold weather.

The plain fact is that the supply and demand fundamentals for oil have changed radically. There is simply no shut in capacity as there always used to be. Yes, the Saudis could perhaps produce another 2.5 million barrels of oil per day. However, they alone represent almost all the potential for expanding production. Even 2.5 million barrels per day, assuming they could crank up production that much, counts as to nothing compared with expanding demand and currently low inventory levels. The world has gone from being awash with oil to a serious shortage, as often occurs when there has been a long period of low prices in any commodity.

Even under the best of circumstances, it takes some time for most newly discovered oil and gas to come to market. While there is potential for major new discoveries, perhaps most notably in unstable countries as Bangladesh, Egypt and Iraq, many established major oil producing areas are running down. Among the latter are the North Sea and all of continental North America.

If we are even half right in our interpretation of the prospects for petroleum, the reward to risk involved in investing in this area is wonderful. There is in our view almost no serious downside risk but the upside potential is at least a double for almost any stock in this general area, while triple quadruples and more could happen. Not only that, but we might be underrating the prospects for petroleum prices. What happens to oil stocks if the price of crude breaks out to $50 and 60 per barrel. Hard as it may be to believe, we recall the head of Canada's National Energy Board Geoffrey Edge predicting $100 oil by 1990. The forces leading to those conclusions may well have merely been premature rather than totally wrong.

The downside of our speculation about the prospects for oil is what it might do to the rest of the economy. So far there has been considerable complacency about the impact of rising oil prices on inflation. It is said that the impact is much less than it used to be, which is true, but also that the rise in oil prices is temporary. Yes, it often happens and indeed generally happens that commodity prices are in a secular decline. However, there are some commodities for which the supply is not infinite and among them are lumber and petroleum.

Centuries ago, it was assumed that there was an unlimited amount of wood for construction and for burning as energy. That was when much of the world and most of Europe were covered with primeval forest, as much of Brazil still is. The apparently inexhaustible supplies of lumber and corresponding arable land led to desertification of much of the land surrounding the Mediterranean. Today, the pace of change is faster. So environmental deterioration occurs that much faster even as technological innovation accelerates in such areas as computers and bio-tech.

New Recommendations

This is largely a confirmation of our Special Bulletin last Thursday. Despite our reservations about stocks in areas other than petroleum, we believe the reward to risk is very good for some stocks in other areas. Again we come back to selected stocks in high tech and bio-tech., as well as the stalwarts Home Depot and Wal-Mart. When a general market consolidation is ending, it is often an excellent time to move into stocks with strong charts and to shed stocks with weak ones. The strong tend to get stronger while the weak get left behind or, worse, go down.

All our petroleum and oil service stocks are a buy now with new money. They have such strong charts and also a strong fundamental case that we could readily envision investing up to 75 percent of a moderately aggressive account in this relatively narrow area.

Suncor (SU) $22.88. # We seem to have left off our list one of our favorite oil stocks. This company is perhaps the world leader in tarsands technology. The company now has very low production costs and is expecting a quadrupling in production over the next five years or so even if higher oil prices do not lead to a further acceleration in expansion.

We inadvertently marked Transocean Sedco (RIG) as a sell in our last Bulletin despite the fact that this is one of the leading oil service companies. We still consider ourselves owners of the stocks, and we also recommend new purchases.

As further additions to our list on Thursday, we now add the following stocks:

Apple Computer(AAPL) $54.44. This stock has been beaten down but now appears to be coming out of a wonderful base. The reward to risk is superb.

Tellabs (TLAB) $74.50. Recently this stock has been flapping around but now appears set to break out decisively to the upside. It is coming out of a year-long consolidation so the reward to risk is excellent.

Scientific Atlanta (SFA) $87.44. A higher risk situation when chasing such a strong breakout but it could fly a long way.

Sycamore Networks (SCMR) $126.94. This stock had an immense surge on Friday. However, it is coming our of a wonderful base. This is the kind of formation that suggests a stock that could reach for the previous high and keep on going. This stock as well as TLAB and SFA are involved in broadband technology, one of the fastest growing areas of high tech. However, that group also includes the dreaded Qualcomm and the questionably overpriced JDS Uniphase.

New Short Sale

We are adding a short sale, with the perpetual caveat that this is a high risk area that certainly does not suit all investors. There is some merit, however, in intentionally selling short a weak stock while simultaneously buying a strong one.

E-Bay(EBAY) $49.75. This stock appears to be breaking down. Although it is down already from a high of $127, it is up from an initial low of $4.20. We think it can again trade under $10. Business is slow, the valuation is immense and the technicals suggest an impending collapse in price.

Stocks to Sell/Exit

In our special bulletin on Thursday, we recommended covering short positions in the NASDAQ and Dow Jones futures, while staying short Amazon. The ND trade made about $10,000 while the one in the Dow just about exactly broke even.

List of Current Stock Recommendations:

Note that there are several of our current recommendations which might seem to warrant selling on account of the fact that they have fallen hard. Our experience over the past year has been that it generally pays to give a great stock more room to move than many people suggest. We particularly believe that Idec and Sony are outstanding buys on what we believe to have been temporary weakness. Several biotech stocks have come under extreme pressure. Nevertheless, we don't see them going out of business. What we do see is a dynamic sector that has come through a severe thunderstorm, but which is very unlikely to be ending its bull market, let alone starting a bear market.

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

7/7/00 3 Com(COMS) 56.75 56.81 B++
5/15/00 Alberta Energy(AOG)# 38.63 40.56 B++
7/7/00 Angen(AMGN) 73.75 73.94 B++
5/15/00 Apache Corp.(APA) 59.88 56.31 B++
5/15/00 British Petroleum Amoco(BPA) 54.44 57.94 B++
5/15/00 Cdn Occidental Petroleum(CXY)# 26.13 29.06 B++
5/15/00 Chieftain Development(CID)# 20.50 19.62 B++
7/7/00 Chiron(CHIR) 56.31 56.94 B++
5/15/00 Global Marine(GLM) 26.38 29.00 B++
7/7/00 Home Depot(HD) 53.00 55.50 B++
7/700 Idec Pharma(IDPH) 133.13 130.13 B++
5/15/00 Shell Transport & Trading(SC) 51.75 50.69 B++
5/15/00 Transocean Sedco(RIG) 51.13 48.69 B++
7/7/00 Wal-Mart(WMT) 57.94 61.56 B++

Short

6/23/00 Amazon(AMZN) 36.63 36.13 SELL SHORT

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