Stockscom Report for Monday, January 1, 2001

A Time of Uncertainty, a Time for Caution

Some Stocks are a Buy, and Some are a Short

As we go into the New Year, the conflicts are immense. On the one hand, there are many good values and also some excellent chart patterns that are by no means restricted to natural gas and interest rate sensitive issues. On the other hand, the indexes for the most part look quite bad, especially the NASDAQ. Historically, once a bear market starts, it does not end until it has gone a very long way beyond what one might expect. After so far exceeding any semblance of fair value on the upside, it would be normal to expect a corresponding decline to levels where most major blue chip stocks look like the proverbial steal.

So what do we think now? Well, for certain we can say that hardly any blue chip stocks are that proverbial steal. In fact the ones you might want to own, like Johnson & Johnson look ever less like a steal, as they continue working higher and thereby continue looking ever more expensive. It is worth recalling that just such a scenario, of stocks that looked like defensive blue chips, like General Electric, started rolling over and beginning their own proprietary bear market.

The question ahead is whether the US economy is merely slowing or whether it’s heading into recession, or worse. Again, the lesson of history is that major economic expansions such as the record one of recent years seldom end without a severe hangover. Yet, it is possible that there is so much power in the economy that a mere slowing will be all the comes through. We are inclined to doubt that scenario, but we have to recognize that possibility.

In the meantime, we want to try to own stocks that will come through for us whatever happens, within reason, and similarly we want to be short stocks that look unlikely to go anywhere but down.

On the buy side, as you can see from our recommendations, we want to own natural gas producers and selected oil service stocks, as well as gas pipeline stocks. Our entry just a couple of weeks or so ago, as the stocks looked all set to break out, was a very good one. Although there is obviously more downside risk for new money than when we bought, we could still see buying these stocks lightly even now, or better still on a pullback if one comes. It looks as if the natural gas squeeze is real, and that it will last for some time. We suspect too that the new President may promote domestic oil and gas drilling so as to try to alleviate dependence on oil imports from the ever risky Middle East. Should any substantial initiatives come on this front, the upside potential for our stocks could be a double from here in the current year.

The gas pipeline stocks look like win/win virtually whatever happens. Regardless of the price of gas, they stand to take their cut from gas transmission. For the most part these stocks pay enough of a dividend to be useful and, again, pretty much whatever happens to the price of gas or to interest rates, there should be some scope for dividend increases over time. Therefore, these stocks, even if they yield less than you can get from bonds, would still earn their keep and they could deliver significant capital gains. They might not go up as much as the natural gas producers and the oil service stocks, but the risk is lower.

On the downside, we see no sign of a bottom in our high tech stocks. There are anecdotal reports that US computer sales were severely down in December versus last year, and possibly down as much as 50 percent in Europe. For the likes of Dell and Microsoft, that is a disaster which in our view is still by no means fully reflected in the stock price.

Recently there has been considerable strength in the financials, widely regarded as a good place to invest when interest rates are starting to decline. They have been quite a mixed bag but some bank and insurance company stocks have been doing exceptionally well. From our perspective of trying to combine long-term upside potential with manageable risk, we don’t feel at all comfortable in this area. Yes, the stocks could keep on going up, and there are still many which appear to reflect good value. However, we fear that the risk of a recession is not priced into these stocks, with the corresponding danger of big loan losses for the banks. While it might seem that insurance stocks are a safe haven, here too we just don’t feel comfortable.

The Japanese Risk

We want to draw your attention to a risk hanging over all world stock markets that is greater than just the threat of a recession in the US. It is that the Japanese financial situation is a potential disaster that could be far worse for the entire world economy than anything seen for many decades. The problem is that the Japanese economy is rife with structural inefficiency on a mind-boggling scale. As a while the Japanese economy compares with the worst of the decaying US rust-belt economy of the 1970s except that there is no sign that there could ever be a real market cleansing so that Japan can rebuild.

Here are the facts as we understand them:

1. The economy is in severe depression, with the jobless rate at a new high since World War Two.

2. Many major corporations are, in effect, bankrupt but, because they have seemed too big to fail, have been propped up by the government.

3. The normal remedy of consumers spending their way out of a depression is not available for these reasons:

a) Because of fear of joblessness, any extra money goes into savings rather than spending; and

b) those who live in the cities and who potentially have money to spend have nowhere in their small homes to, put anything. On the other hand, those who live in the country and have space to put things don't have any money.

4. Bank of Japan attempts to prime the economy with easy credit and low interest rates have merely added to the national debt and the deficit without succeeding in priming the economy.

The sum of these considerations is that the Japanese government itself is a candidate for bankruptcy, with the threat of a total implosion of the economy. The alternative potential outcome is that BOJ’s printing money may make its debt unsaleable on world markets. Then there could be a currency collapse of historic proportions, as happened with the Mexican Peso. The difference in impact between Mexico and Japan would be quite different, however. Mexico has a relatively small economy, whereas Japan has the world’s second largest.

It is important to note that major financial crises seldom sound alarm bells before they occur, as we saw with Mexico in 1994. It happens suddenly that debt cannot be rolled over and then you are into the maelstrom before you know it and without any way of getting out. Should there be an implosion in Japan, the re would almost certainly be a huge surge in the US Dollar and in bonds and interest rate sensitive issues, like our gas pipeline stocks. However, there could be a big and sudden slump in the general list of stocks, and recovery might take a considerable time. The Japanese market topped in 1989 and it is still even now in a bear market, and threatening to make a serious break to new lows.

New Recommendations None

New Short Sales None

Stock Positions to Sell/Exit None

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

12/18/00 Alberta Energy Co. (AOG)# 42.63 48.25 B++

12/18/00 Kinder Morgan(KMP) 50.00 56.31 B++

12/18/00 Occidental Petroleum(OXY) 21.88 24.25 B++

12/18/00 Precision Drilling(PDS)# 33.19 37.56 B++

12/18/00 Trans Canada Pipelines(TRP)# 11.19 11.50 B++

12/18/00 Ultramar Diamond Shamrock(UDS) 28.38 30.88 B++

Short Sales

12/13/00 Amazon.com(AMZN) 26.56 15.56 Hold Short

12/18/00 Bank One(ONE) 33.63 36.63 Hold Short

12/18/00 Coca-Cola(KO) 54.00 60.94 Hold Short

12/1300 Cisco(CSCO) 55.19 38.25 Hold Short

12/13/00 Dell(DELL) 21.50 17.44 Hold Short

12/18/00 General Electric (GE) 50.56 47.94 Hold Short

12/13/00 IBM 94.88 85.00 Hold Short

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