Too Much Risk To Trust the Last Buy Signal

In the last Report we said: "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."

We now believe that there is less than a 50 percent chance of a significant upside break in stocks generally and as much as a 60 percent probability of a very substantial downside break in stocks, at least to the June lows and possibly to the 2000 lows.

Earlier this year we got deflation of the dot-com bubble. It now looks as if there could be a general deflation among high-tech stocks across such a wide range that the risk of owning any of them is in our view prohibitive. What happened to our recommended stock Tellabs was bad enough. Now turn to the chart for Copper Mountain, a stock in the broadband sector that we thought we really liked. It had a very good chart pattern. However, it dropped from $125 to 85 in four days of rapid drop, and we don't begin to see a bottom in sight. This year there have been many, many stocks that have defaulted by 75 percent or more, while it has become ever harder to find good ones without also finding horrendous losers. When the probabilities are no higher than 50 percent that you will find a stock that goes up by 10 percent as compared with one that drops by 10 percent, it's not a good time to be in the market.

It happens that there have been some stellar winners among financial stocks, but can this last? If it turns out that Fed Chairman Alan Greenspan's forecast of a lower rate of growth comes through, then even financial stocks could take a fearful beating. There are anecdotal stories of a severe deterioration in credit quality. Even as the economy has been booming, defaults have also been soaring of late on corporate debt. With any slowing in the pace of business, there could be a serious credit contraction. This would accompany a downturn in corporate profits, an unwinding of margin debt and a real bear market that takes stocks down a very long way indeed.

When we look at upside potential, we think we see something of the order of 5 to 10 percent maximum. On the other hand, we a downside risk of more than 50 percent, with a risk of many individual stocks declining by 75 to 90 percent.

You have only to look at one of our previously recommended stocks, Research in Motion (RIMM) to see what can happen to stocks. The range from its high to its low this years was from $175 to 23. And this occurred in market conditions that did not comprise a general and major bear market!

Now consider the mighty JDS Uniphase(JDSU). Yes, this has been one powerful stock to own and it has had a powerful company behind it. Nevertheless, its forthcoming acquisition of SDLI involves purchasing that company at some 150 times last year's TOTAL SALES REVENUE. What are they actually getting: a license to print million dollar bills? We doubt it. The road from here to a return better than buying Treasury Bonds is an exercise in projecting light years. In our view, even the cautious acquisitors like Nortel paying mighty prices for nebulous assets. What happens if someone says the emperor has no clothes? We could see in due course the $135 JDSU becoming a ten dollar tragedy for those that ride the stock down.

There are, of course, some wonderful high tech companies that have been executing a brilliant business plan with a combination of superb management and good luck. Among these we include Nortel, Corning and Sun Microsystems.

Consider further, however, that even Microsoft looked for an extremely long time as if its 30 percent plus rate of annual expansion could go on to infinity. It is now our view that this company might have to consolidate for longer than most people expect, and that it might never regain its former rate of growth. Remember IBM in the 1960s. A forward projection of IBM's growth to the current year had the company with sales surpassing the GDP of the entire world. Of course, it hasn't happened.

In sum, we want out of all except our oils and oil service stocks.

The Case for Oil, and the Dangers

The hiccup in oil and gas and oil service company stocks has continued burping a bit, though the corrective forces have been significantly tempered by reports of wonderful earnings for the most recent quarter.

Consider Suncor. This company has had a near tripling of per-share earnings compared with last year. We reckon the company is making money at a rate of about $4 per share at present given an oil price of the order of $25 per barrel. That puts the stock today on a Price/Earnings basis of under 6. Over the next four or five years the company should increase production by about four times and also lower production costs a little more on all of its output. We can see Suncor earning its current share price by 2005! By then, however, the company should be on track to quadruple oil production over the subsequent five years. Give the stock a P/E of just 10 in 2005 and you have a tenfold increase in the stock price from here. There could, moreover, be multiple expansion and an increase in oil prices in the meantime. We are assuming a $25 oil price. It could easily be nearer to $40 without the occurrence of any unusual developments, although we settle for $25 for now for use in our assumptions.

We believe that similar if less spectacular expectations are reasonable for a basket of well-selected oil and gas and oil service company stocks.

And you want to own JDSU rather than Suncor?

Yes, you may be right in the near term, but we doubt it. The very thought brings to mind such expressions as skating on thin ice and sailing close to the wind.

New Recommendations

No new buys.

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.

Sell Cintas Corp(CTAS) $45.25. The stock has a superb weekly sell signal, with a double top now versus the week ending June 1. There is also a major double top versus the one in February last year at $52.28. In this week's Barron's, there's a story about the company and its business. It's a great company, supplying company uniforms. However, this is not a growth industry any more and its P/E at 42 is, shall we say, rather high for a company growing at perhaps 8 percent annually even in good times. Part of that growth comes from acquisitions bought with its high-priced stock rather than from internal growth as such. Given any economic weakness and more widespread de-formalization of business attire and there could be a decline ion corporate profits.

Stocks to Sell/Exit

Sell all stocks except for oils and oil service. However among them there is also one sale, Shell Transport & Trading.

List of Current Stock Recommendations:

Note the sell signals on the list. No new buys unless you venture into Suncor, our Number One Favorite.

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 68.00 SELL
5/15/00 Alberta Energy(AOG)# 38.63 37.44 H
7/7/00 Angen(AMGN) 73.75 78.00 SELL
5/15/00 Apache Corp.(APA) 59.88 48.69 H
7/10/00 Apple Comp(AAPL) 54.09 53.56 SELL
5/15/00 British Petroleum Amoco(BPA) 54.44 51.31 H
5/15/00 Cdn Occidental Petroleum(CXY)# 26.13 26.00 H
5/15/00 Chieftain Development(CID)# 20.50 17.88 H
7/7/00 Chiron(CHIR) 56.31 51.94 H
5/15/00 Global Marine(GLM) 26.38 27.00 H
7/7/00 Home Depot(HD) 53.00 57.12 H
7/700 Idec Pharma(IDPH) 133.13 119.31 H
7/10/00 Scientific Atlanta(SFA) 87.44 81.62 SELL
5/15/00 Shell Transport & Trading(SC) 51.75 47.44 SELL
7/10/00 Suncor(SU) 23.06 22.06 B
7/10/00 Sycamore Net(SCMR) 130.62 138.75 SELL
7/10/00 Tellabs(TLAB) 73.62 63.00 SELL
5/15/00 Transocean Sedco(RIG) 51.13 50.00 H
7/7/00 Wal-Mart(WMT) 57.94 59.69 SELL

Short

6/23/00 Amazon(AMZN) 36.63 36.13 SELL SHORT
7/10/00 Ebay(EBAY) 47.50 58.75 SELL SHORT

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