An Upward Resolution Looks Good - Some New Buys

After months of indecision and violent fluctuations, the general market appears to be coming together with an upward resolution.

That is not to say that all stocks will go up. That never happens. It does mean that the pieces appear to be in place for enough stocks to go up to take the indexes higher. There are several important internal indicators coming into line. These include the number of stocks trading above their 200 day moving average, the advance/decline line and the ratio of new highs to new lows. While many stocks look to have established their own proprietary bear market, within this group there are many so washed out that they may not keep on going down and the line of least resistance may be upward.

The charts now show the remarkable event of the Dow Jones Utility Index and the New York Composite Index going out to a new high. The Utilities have a reputation for leading the market's general direction, and this is likely to happen again. The strength of the Utilities is particularly remarkable given that they are mostly large consumers of energy. Their productivity improvements look to be exceeding the adverse impact of higher oil prices. Most of these companies have the kind of solidity going for them in terms of value and reliability that has been difficult to find elsewhere, and in most cases along with Some dividends. Sop up they go, and look like continuing to do so.

At the end of July the NASDAQ 100 index completed a monthly Lindahl sell signal, which appeared to be a harbinger of a more serious bear market in high tech stocks even though the monthly moving averages were still pointing higher. Given the relentlessly weak MACD on the weekly chart for this index, the probabilities seemed to favor continuing weakness. The technical picture seemed to be confirmed by anecdotal reports of an economy slowed at least somewhat by higher interest rates. In the meantime of course there has been pronounced weakness in some stocks that seemed to have growth rates and reliability that would allow their business success to justify an apparently high stock price in a relatively short time. We look, for example at Applied Materials and Altera, both seemingly wonderful stocks that have been quite severely beaten up. They seemed to be suggesting that a more serious slowdown in high tech might be on the horizon, and more especially the emergence of overcapacity in semiconductors. This threat seems to have diminished considerably.

We regard it as immensely significant that at the May low the ND 100 held the uptrend line from the October 1998 low. This uptrend line has now been tested again and found good. Similarly, an uptrend line on the S&P 500 index has held.

The Dow Industrial have been more of a technical mess. They stalled out in January, well ahead of the other general indexes. However, they also made their low earlier, in March. Since then they have been going sideways. For a long time it seemed to us that there was weakness in enough in many Dow stocks, and potentially in the economy, for stocks like Dupont and Caterpillar to keep on winching downward. They are still trading decisively below their declining 200 day moving averages but they now appear to be rounding out. This is not the kind of stock we want to own, but they no long look as if one wants to sell them short either.

A problem facing investors in recent months has been the fact that several prominent stocks have seemed to have great charts. Then suddenly there has been a collapse coming out of the blue that could not reasonably have been foreseen according to either technicals or, in most cases, fundamental analysis. Some time back there was the collapse of Proctor & Gamble, which suddenly fell out of bed. More recently Pfizer took a major hit and now there has been an $11 hit in Scientific Atlanta, knocking the stock down to $82. The drop in SFA is particularly ominous because we have long regarded this as the kind of stock we want to own, the kind of stock that could go up by several times, in a year or three if not necessarily in a few months.

With the risk of sudden collapses even in stocks that seemed no-brainer reliable (Remember Lucent and Wal-Mart?), we have intentionally focused on oil and natural gas stocks and oil service industry stocks. There has been the risk that this entire sector might succumb if oil prices started heading back down again. However, our assessment of this risk is that was one we could live with. The price of oil appears to have really solid fundamental and technical underpinnings so that even from the current elevated level the price is more likely to go up than down. We envision a worst case of the oil price heading down perhaps toward $25 or even the low 20s. The upside potential, on the other hand, could be $40 or higher. More to the point is that we expect oil prices to stay relatively high for the long term, and that means staying above $20.

Our assessment of the petroleum market is that consumption has closed in on supply. The result is that there is now only the smallest and most precarious excess of supply capacity over demand. Demand has been steadily increasing both in the developed world and in the newly emerging economies. While it may be possible to curtail consumption to some extent in the developed world by using energy more efficiently, consumption can be limited very little in a newly industrializing economy. You cannot run even an efficient textile plant or steel mill without using any energy at all.

On the supply side, there is considerable evidence that some of the world's major oil fields are in decline, notably those in the North Sea, as well as in much of the US. Apparently recognizing the impending imbalance between supply and demand, Venezuela's President Hugo Chavez recently said that current crude oil prices are fair. He has called on OPEC to resist pressures for lower prices, accusing industrial nations of trying to impose lower prices for their own self interest. In the final analysis, it seems to us that it makes sense for producers to look at the impact of increasing production on the price. Why increase production by 5 or 10 percent, even if that were possible, in order to induce a lowering of price by 20 or 30 percent?

We are not saying that the world is in imminent danger of running out of energy, with what would be a catastrophic impact on the world economy. We are saying however that higher prices are most likely here to stay.

New Recommendations

We still rate every one of our current recommendations in energy stocks a buy and, moreover, as stocks having as good prospects relative to the risk as any on the board. Even with oil prices no better than $25 per barrel, we rate oil stocks as still extremely cheap by all conventional valuation criteria and especially compared with stocks in many areas such as retail, banking and insurance. They have been somewhat lackluster relative to what has been happening to oil prices. However, this relatively quiet market action has done absolutely no technical damage to the major uptrends. On the contrary, the relatively consolidating action reinforces the probability that the move up will be very substantial eventually.

It is worth pointing out that there is immense skepticism about oil prices. They have come down in the past when they have been high. So the investment community almost universally believes that they will come down again. The result is that energy stocks by and large are extremely under-owned by the institutions. In the probable event of oil prices staying high, then there will almost certainly be a combination of immense profits and correspondingly very low Price/Earnings multiples relative to current prices and, most significant, multiple expansion. The stock selling today with a P/E of 8 or 10 on assumed 2001 earnings could both double its earnings in the foreseeable future and go to a P/E of 15 or 20. Realization of that assumption multiplies the stock price by 3 or 4 from current levels.

We have also no come up with a list of seven mostly high tech stocks and four medical/biotech stocks, each of which looks capable of a double or more in due course without too much risk of halving in the meantime or of failing altogether.

High Tech

Applied Micro Circuits (AMCC) $160.13.
Ciena(CIEN) $163.69. One of the best performing stocks in broadband.
Corning(GLW) $281.13. Perhaps three best fiber optics stock, and certainly one that is solid. The stock looks ready to make another step up.
Enron(ENE) $83.50. A curious combination of being a utility and a high tech innovator. It has just broken to a new high and looks ready to go again.
Oracle(ORCL) $82.38. Perhaps the least absurdly overvalued software company, and a stock with one of the best charts.
PMC Sierra(PMCS) $213.19. The most reliable and dynamic components supplier to the computer industry that we know of. It has interests in wireless which give added sex appeal.
Sun Microsystems(SUNW) $114.06. A must-own that continues to hold its own technically and fundamentally.

Medical/Biotech

We have a lot more difficulty in this area. We love the concept but many stocks in this area have been quite beaten up recently, and market action suggests there may be higher risk in this area than we previously supposed.

Biomet(BMET) $33.38
Medimmune(MEDI) $73.75
Novavax(NOX) $8.13
Oxford Health Plans(OXHP) $32.50

Stocks to Sell/Exit

Exit all short positions. We have not made any money but we haven't lost it. No point in holding stocks short when the upside prospect is favorable. The reward to risk just isn't there, even if we are right about a stock like AMZN having the potential to go to zero. We still think AMZN and Ebay warrant holding short but, as we say, we believe that capital could be deployed better elsewhere.

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

5/15/00 Alberta Energy(AOG)# 38.63 38.94 B++
5/15/00 Apache Corp.(APA) 59.88 59.50 B++
5/15/00 British Petroleum Amoco(BPA) 54.44 54.31 B++
5/15/00 Cdn Occidental Petroleum(CXY)# 26.13 25.50 B++
5/15/00 Chieftain Development(CID)# 20.50 19.63 B++
5/15/00 Global Marine(GLM) 26.38 32.00 B++
7/10/00 Suncor(SU) 23.06 21.63 B++
5/15/00 Transocean Sedco(RIG) 51.13 55.81 B++

Short

6/23/00 Amazon(AMZN) 36.63 34.88 Cover short
7/10/00 Ebay(EBAY) 47.50 48.19 Cover short
7/24/00 Cintas(CTAS) 45.25 45.25 Cover short
8/11/00 MCI Worldcom(WCOM) 34.94 33.88 Cover short
8/11/00 Nextel Comm(NXTL) 54.25 54.81 Cover short
8/11/00 Telcom Semi(TLCM) 19.69 18.06 Cover short

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