Stockscom Report for Sunday Nov 3 2002

Publisher: Colin Alexander Editor: Ken Wilson (450-691-4617)

Subscriptions and Administration: Pierre Fichaud (toll-free: 866-487-9711)

Market Synopsis

First there was a rising stock market that generated riches beyond belief, then the bubble burst and stocks took a long nose-dive. For the first two to three years, of the bear market, the consumer continued to spend and supported the economy through its adjustment phase. However the long great climb in stocks was due in major part to over-investment and building industrial capacity so having overshot in business investment, the opposite was now true and there was a severe slowdown in business investment as profits were squeezed leaving nothing for future investment. Besides, the large idle capacity limited businesses need for additional investment.

Though this scenario may sound familiar, it doesn’t refer to the situation occurring in the markets today but rather to what happened in Japan starting around 1990 when the Nikkei hit its peak. And while deflation is now engrained in Japan and has been for the last few years, it doesn’t mean that the USA is now poised to follow Japan’s lead.

Fortunately there are healthy differences in the economies. The first being a startling ruthlessness employed when dealing with failing companies in this part of the world, which although myopic exceptions might be made in the case of the steel industry and a few others, generally is quite unforgiving in the severity of ridding itself of these businesses.

Another difference is the speed at which monetary policies are adjusted to deal with the situation. Once it was established that a recession was likely, the Federal Reserve responded rapidly with cuts in the overnight rates, which in turn drove down the cost of borrowing for consumers. The injection of liquidity supported consumers in their propensity to spend and triggered a round of mortgage refinancing. The hope was that business investment would be given time to digest the over-investment of the previous few years.

Are these differences helping the situation and leading to a different outcome than the Japanese experience? Probably. For while the main beneficiaries of the Fed’s action have been the housing and auto sectors, the latest figures demonstrate that business investment moved up 0.6% in the third quarter – the first increase since 2000. And a look at the breakdown of these numbers shows that civil aviation was the main drag while investment growth was close to 5% and equipment spending reached 12%. Again the jury is still out, but these steps do show a remarkable difference in the results attained so far.

Telecom

In the ongoing saga of the rise and fall and rise of Lucent and Nortel, we have the unlikely arrival of fellow telecom fallen angel, France’s Alcatel, telling investors that its ship has docked in the land of milk and honey once more. There is the little matter of a $225 million operating loss in the latest quarter (and a total loss which is more than double this figure), but naturally that is seen to be behind them and brighter days are ahead. Seems we’ve heard this story before.

Furthermore, on Friday, Lucent and Nortel were subjected to cuts by Moody’s bond rating service. Nortel’s debt was lowered 3 notches to the sixth lowest level of junk grade bonds out of 11 levels. Meanwhile its biggest competitor, Lucent, was assigned the fifth lowest level of junk just below Nortel. To Nortel’s credit, Moody’s stated that Nortel has managed to generate a much stronger gross profit margin than Lucent. It also has a wider selection of products because it provides enterprise networks as well as carrier network equipment and its business covers a wider territory with much less dependence on North America. They finished by adding that they expect sales to continue to shrink.

Knowing that the telecom marketplace suffers from an acute case of over-investment and overcapacity, this sector is ripe for consolidation. Is it that farfetched to ponder a combination of Nortel and Lucent or, if not those two, why not a combination such as Alcatel and Nortel, which actually would have more merit due to the complementary nature of its products?

Equity Rally?

In general, market indexes appear poised to start a new stage upward with stochastics having moved away from their overbought territory and with the Microsoft settlement announced on Friday being a catalyst for a new stage. The market psychology has changed dramatically where even the Purchasing Managers figures released on Friday showing an overall score of 48.5% (representing contraction in the economy) was greeted with a yawn as most analysts tended to look at the orders part which showed expansion at 50.9%. This is a bullish scenario for us and although this could still be just another bear market rally, it is a tradable rally.

On Wednesday of this week, the Federal Reserve meets once again and the general perception is that the Fed will move to cut rates once more to boost the economy, which is seen as slowing down considerably.

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 as Canadian content in Canadian RSP funds. Otherwise there is a 30 percent restriction on foreign stocks held in these accounts.