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Stockscom Report for
Sunday April 15, 2001
Stocks
up, bonds down--for this week, but not a trend reversal
Strong
likelihood of a bear market rally in stocks
Oils
and oil service companies look better than ever
Market Synopsis
Our interpretation of recent
market action, and particularly last week, is that stocks have experienced a
substantial rally, but one with dimensions that are routine and which do
nothing to suggest the end of the major downtrend, let alone to suggest the
start of a new bull market. The other side of the coin is that the downdraft
in bonds is also substantial, and possibly enough to suggest caution.
During the bull market, those
of us who were aware of the unprecedented high valuations in the stock market
were concerned that every downdraft in stocks might be the start of a bear
market. Of course, it didn’t happen for a very long time. The upward zigzag
in the indexes continued inexorably higher. That was, until the eventual top,
and the start of a downward zigzag. During the bull market, you had to keep
the faith in the technicals, which kept the bull market designation in force.
After so much downward
correction in many stocks, and particularly in high tech, there is a
temptation to revert to the previously successful methodology of buying the
dips. The logical corollary of this thinking is that the bigger the dip, the
better the buying opportunity. Put into practice, this means that money sitting
on the sidelines, often in the hands of pension fund managers, is poured into
stocks. It is human nature to want to buy great stocks at or near the bottom,
when they seem to offer much better value than before.
The problem with this approach
is that it fails to consider either history or the technical implications of
a bear market. Let’s say it again: A bull market designation derives from a
series of upward zigzags on the monthly chart and a bear market comprises the
opposite, a downward zigzag on the monthly chart. Although you can be certain
that one apparent low will put in the bottom of the market, you can do no
more than guess which one it will be until after the event, when a new upward
zigzag starts.
From a long-term historical
perspective, it is extremely unlikely that the bear market has run its
course, or that it is even close to doing so. It’s possible that it has done
so, but the probabilities are very heavily weighted against this being the
case. Yes, of course, the NASDAQ has come off by two thirds from its high.
Nevertheless, it is still immensely high by all normal valuation criteria
even for high tech stocks, and more so when you consider that price/earnings
multiples are based on earnings still near the peak of the cycle. Consider that
you could buy Intel in 1990 for some 10 times earnings. How then can the
stock now be worth 19 times earnings, which probably don’t even exist?
Certainly, conditions in the chip business are about as bad as anyone has
ever known and normally that’s a signal to buy the stocks. But there's still
the possibility that worse problems are camouflaged and consequently their
stock prices are simply nearer the bottom than the top they left behind last
year.
It is our strongly held view
that the current downturn in stocks will be accompanied by a mild recession
at a minimum and, more to the point, a much more serious profits recession
than most people are currently expecting. Memories of an ever-expanding
economy and the ever-rising stock market are still quite fresh in the minds
of ordinary investors. Even now there is still no serious fear, let alone the
kind of loathing for stocks that is associated with bear market bottoms.
Telecom Commentary
At a gathering this weekend in
Kanata, home of major Nortel operations, the view prevails that this is one
powerful company which must prosper in the long term. Until recently, the
same could have been said about Lucent and their major customer British
Telecom, for example. The fact is that Nortel has been cash-flow negative for
well over a year. With perhaps a billion dollars in the kitty, Nortel is
actually in serious danger of duplicating Lucent's fall and running out of
money. Sales booked by lending the purchase cost AND the cost of setup,
configuration, etc. to your customers can go only so far before you run out
of money to pay for the production of the goods sold on credit.
In due course, the impact of
cash pressures on the likes of Cisco and Nortel, which of course are the
strong companies in high tech, must lead to layoffs and contraction in
expenditures that feed on themselves. Then this impact flows through to
retailing, banking, real estate and so on, leading uncontrollably to a
continuing vicious downward spiral in stocks. That’s what makes a business
contraction.
Historical Perspective
We think you can largely
disregard the action of NASDAQ stocks as a barometer for the general market.
(In fact, despite the massive tumble that we've witnessed in the NASDAQ, the
upward trendline, beginning in 1995 for this market, was only breached in
February of 2001). Regardless of the smaller sampling of stocks, the action
of the Dow Jones Industrials is probably more indicative of the overall
strength or weakness in the economy. Here we find ourselves looking at the
possibilities for the current bear market by looking at some historical
precedents, and not just the extent of the decline and the duration of the
bear market beginning in 1929:
Top Bottom
Duration %Decline
Oct. 1919 119 Aug. 1921 67 22
months 44%
Aug. 1929 380 Jun. 1932 42 34 89
July 1937 185 Mar 1938 98 8 47
Nov. 1972 1018 Dec 1974 616 26 40
Bear Market to date
Jan 2000 11,750 Mar 2001 9106 14 23
Looking at the above sample of
bear markets, we believe that the current one has done nowhere near enough in
either time or price to prove the argument that a mere 23 percent decline is
enough to cleanse the excesses of the greatest bull market in history. On the
contrary, we believe in the general concept that market reactions tend to
have a relationship to the preceding major bull or bear market. Our best
guess is that the Dow will decline to at least 7400 (a decline of 37%), and
that the major downtrend is unlikely to end until the third or fourth quarter
of 2002. Then there will be the opportunity of a lifetime to buy stocks.
Recommended Actions
Despite our outwardly bearish
sentiment, we continue to search for potential purchases. Given that in a
general bear market 90% of all stock prices decline, the challenge is
admittedly difficult. However, we still see a few stocks where the reward to
risk justifies continuing ownership, mostly among the energy and energy
service stocks. Oil and natural gas do not look as if they are likely to go
down substantially, although there is a strong probability that their highs
last winter will not be exceeded by much, if at all. The main reason for
holding them, is that downside risk is comparably much smaller. Moreover, the
addition of a strong dividend increases the likelihood of never seeing a loss
procured. The pipelines are especially preferable as a balance against the
volatility of world prices for energy.
We continue our Fed Watch with
the expectation of a rate cut sometime before the next Fed meeting in May. On
Tuesday, we will see the publication of consumer price inflation figures,
housing starts and industrial production numbers, which could steer the
market into a new direction or prolong the rally. Naturally, extending the
current rally a notch further would seriously endanger our portfolio of
equities held short.
Regardless of the market
action, we see continuation of the considerable deterioration of the economy
due to a glut in the inventory cycle and the end to the capital investment
boom. A rate cut of 0.5% will do little to correct this weakness and will not
change the downward trend of the markets. The excesses of the past few years
will be worked out of the system through the actions of the same forces that
worked out previous excesses - lower production, layoffs, bankruptcies, etc.
and not through the use of new technological gadgets.
New Buy 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 gotten 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 two. 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. In the case of stocks held short, the rating is
S where positions should be retained. S+ and S++ indicate stocks for which
there is a technical case to add to the positions with plusses adding weight
similar to long positions. The maximum number of plus signs is 2.
Stocks marked # are eligible for Canadian RSP funds. Otherwise there is a
20pc restriction on foreign stocks held in these accounts.
|
Date of Entry
|
Name
|
Symbol
|
Entry Price
|
Current Price
|
Action Rating
|
|
02/01/01
|
Acm Government Income Fund
|
ACG
|
8.07
|
7.94
|
H
|
|
02/01/01
|
Acm Government Opportunity
Fund
|
AOF
|
7.99
|
8.00
|
H
|
|
12/18/00
|
Alberta Energy Co.
|
AOG #
|
42.63
|
45.60
|
B
|
|
12/18/00
|
Kinder Morgan
|
KMP
|
50.00
|
64.09
|
B++
|
|
12/18/00
|
Occidental Petroleum
|
OXY
|
21.88
|
26.11
|
B+
|
|
02/01/01
|
Pioneer Interest Shares
|
MUO
|
11.95
|
11.45
|
H
|
|
12/18/00
|
Precision Drilling
|
PDS #
|
33.19
|
39.29
|
B+
|
|
12/18/00
|
Trans Canada Pipelines
|
TRP #
|
11.19
|
11.45
|
B
|
|
12/18/00
|
Ultramar Diamond Shamrock
|
UDS
|
28.38
|
39.63
|
B+
|
|
02/12/01
|
US Treasury 20 Year Bonds
|
USH
|
104.21
|
104.21
|
B
|
·
Rolled from the March contract
and price adjusted
Short Sales
|
Date of entry
|
Name
|
Symbol
|
Entry Price
|
Current Price
|
Action Rating
|
|
03/21/01
|
Amazon.com
|
AMZN
|
10.38
|
14.67
|
S
|
|
03/21/01
|
Citigroup
|
C
|
44.31
|
47.30
|
S
|
|
12/18/00
|
Coca-Cola
|
KO
|
54.00
|
44.57
|
S
|
|
03/21/01
|
Juniper Networks
|
JNPR
|
53.00
|
50.38
|
S
|
|
03/21/01
|
McDonalds
|
MCD
|
25.60
|
26.89
|
S
|
xxx
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