Stockscom Report for Sunday June 22 2003

Publisher: Colin Alexander     Editor: Ken Wilson

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

 

 

Stockscom will not be published next Sunday – June 29^th.

 

Market Synopsis

 

Within the next few days, we'll be over the hump for 2003 – the first half will be history. Not only will we await corporate report cards for the once finished second quarter, but also some evidence of a more general nature to either prove or disprove the existence of an economic recovery.

 

Looking back at the first six months, we know that the US has identified deflation as the number one threat to the global economic system and fortunately, there are people in key areas of the financial system that have the ability to recognize that fact and are willing to do whatever is necessary to try to solve it. (Germany and Japan could take notes). Having said that the question then becomes, have they responded in the proper fashion in order to deal effectively with the threat of deflation? Undoubtedly, they will always be second-guessed no matter what they do and we must keep in mind that they are working their way through a region that has few maps. The Fed's choice of action has been to flood the system with liquidity and induce inflation through monetary means while the government has initiated a fiscal policy of reducing the tax burden to free up cash in the hands of the consumer. Noticeably, one of the results of these actions has been the marked decline in the value of the US dollar.

 

Will it work?

 

We're seeing one result of that action is that people have shifted money from money markets into equity markets as interest rates fell on those deposits and investors searched for a better return. If we take the current month as an example, some $11 billion was moved from various fund families to equity funds and consequently equities all across the spectrum gained under the buying pressure.

 

Anecdotal evidence abounds that institutions that have enjoyed the fruits of the rally will begin rationalizing these investments in order to book profits while other institutions that have missed this boat in the second quarter have and will continue to perform window-dressing up to the June 30^th deadline. These funds will want to ensure that their corporate reports illustrate their uncanny ability to invest in those stocks that have risen the most in the past several weeks.

 

But is this expansionary policy going to change anything? This week we saw that durable manufacturing rose from April to May though it remained lower year-over-year. This gain from month-to-month was interestingly, the first since January. The carefully watched industrial capacity figure stayed at the same low 74.3% however, making any judgment on a trend impossible to identify. Similarly small increases month-to-month were recorded in manufacturing, non-durable manufacturing and industrial output with equally similar drops year-over-year. Given these statistics, it is fair to say that the consumer, upon whom much depends, has, in the past year, not pushed demand terribly far. Despite the unified efforts of the US government and the Federal Reserve, we have not yet seen a pattern suggesting that consumers are ramping up demand as we move into the third quarter.

 

Perhaps one of the biggest obstacles to a recovery is China. Imports from China have grown remarkably these past few years and are unlikely to diminish even with a devalued US dollar for the value of the Chinese yuan is directly tied to the US currency. As the US dollar has declined in nominal terms, so too has the Chinese yuan resulting in no exchange rate effect. If the goal of the US administration has been to lower imports as a means to balance the current account, the strategy will probably fail. Assuming that China resists floating their currency, an act that would surely be met by an unwanted appreciation of the yuan, there is little likelihood of a broad change in prices and consequently no incentive nor disincentive on the part of the American consumer to purchase goods. 

 

As for corporate quarterly results, it could be argued that the first quarter's improvement in earnings benefited from extreme cost cutting and restructurings. Subsequent quarters might not see those benefits as much and we are seeing the end result, which is more negative earnings warnings than positive forecasts – the ratio is currently in the neighborhood of 2:1 according to First Call. But profits are truly important in these trying times as the onerous burden of pension underfunding and skyrocketing medical costs become the norm. After paying the necessary amounts of these costs, little remains for capital investment. This week GM attempted to come to grips with these quickly rising costs by issuing $13 billion in bonds for the express purpose of paying down the underfunded portion of their pension and topping up the budgeted amount for health care costs. While the action is perhaps laudable, it will naturally increase their annual interest expenses even as production and sales continue to fall further limiting their margin of flexibility.

 

Inevitably, we would be looking for a trend to develop in the monthly economic data before pronouncing ourselves on whether this extreme case of expansionary policy is working. It is worth noting that some analysts describe this action as delaying the day of reckoning since here is a case of a bloated budget deficit and a runaway current account deficit being treated to a diet of easy money.

 

For the third quarter, there is a reasonable expectation that equity markets will not exhibit the same strong performance as they did in the second quarter. Too, we are fast approaching summer vacation and this is a period where markets historically slow down and take a break. Stock markets around the world have already priced in a terrific recovery and perhaps in cases such as the Far East, there is reason to believe that the worst is behind them. For us, the jury is still out.

 

New Buy Recommendations:

 

None.

 

New Short Sales

None.

 

Stock Positions to Sell/Exit:

 

We're applying some stops to some of our holdings this week in anticipation of increased volatility.

AES – This stock dropped on news that they would have a secondary offering of 40 million shares, but they announced as well that their earnings per share for the current quarter would still be 50 cents per share. While we thought that $7.00 would hold in the stock price, Friday's action proved to us that more downside is possible. We put a stop on at $6.75 in order to bank most of the profit.

 

LCI – This stock has been an excellent trade and now it is coming off its parabolic turn up from the week before. It has had a history of making retracements that are more than a little significant and as such we apply a stop of $18.74 – the previous low.

 

TRP – Its share price has been on a tear in comparison to previous months' price action, but this one too suffered a setback during the past week. As a matter of security, we put the stop on this at $17.40.

 

 

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.

Date of Entry	Name	Symbol	Entry Price	Current Price	Action Rating
04/21/03	AES	AES	4.43	6.93	H
05/12/03	Cott Corp	COT #	20.02	20.97	H
03/05/05	Encana	ECA #	33.66	37.34	H
03/04/03	Energen Corp.	EGN	30.68	33.65	H
03/04/03	Firstfed Fin. Corp.	FED	30.55	34.45	B
03/05/05	First Niagara Fin G	FNFG	12.59	13.78	B+
06/02/03	IMAX	IMAX #	7.74	8.43	B
04/21/03	LCI	LCI	13.60	20.50	H
04/28/03	TransCanada Pipe	TRP #	15.85	18.33	H