Stockscom Report for Sunday Nov 2 2003

Publisher: Colin Alexander     Editor: Ken Wilson

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

 

• Buy the rumor – sell the news
• Is high GDP sustainable?

 

Market Synopsis

 

Looking at price action for the second half of the past week, we are convinced that stock indexes have hit a virtual wall and are now searching for a catalyst to power any new swing higher. Stock market results contrasted sharply with the economic news foretelling rosy days ahead. More specifically, the economic data left us with a vision of an American public enjoying the fruits of the strong recovery, however the market indexes led us to believe that this utopia might be postponed.

 

As with previous weeks, we are left with a sense of ambiguity when looking for a market direction. Certainly it has oscillated around some close ranges in the past few weeks, but now with earnings announcements wrapping up and third quarter data freely available, speculative notions are now history. Here is a classic case of, buy the rumor – sell the news. Absent a strong catalyst for growth, the overpriced stock market is ripe for some retracements.

 

Why now after approximately a year of rallying must the stock markets take a breather? What makes this time any different from other moments over the past 12 months? (In fact, the rise was not entirely uninterrupted, there have been some dips, but they have tended to be relatively minor.)

 

In case our readers were out of the country or otherwise indisposed, we mention the fact that third quarter GDP clocked in at 7.2%, well above expectations of something north of 6% and, which incidentally, is the highest level reached since 1984. Delving deeper into the numbers, we find that the $13.7 billion in child benefit tax refunds sent out in July and August was the fuel that prompted consumers to increase spending in July by a full 1% and in August by an even greater 1.1%. Moreover, the permanent tax cuts championed by President Bush meant lower withholding taxes from the standard paycheck. The final month of the quarter, September, was vastly different with consumer spending dropping 0.3%, a reflection of the significant drop in durable goods sold, and after-tax income slid 1.0% with most of the tax refunds now complete. Because September was considerably slower and reversed some of the phenomenal action seen in July and August, the likelihood is that revisions to this third quarter will have a negative bias.

 

Looking beyond the third quarter is more important however, and while it is universally recognized that the fourth quarter will be slower than the last, investors are left wondering which economists to believe. There are basically two camps – the first believes that we are witnessing a global recovery and with small indications of growth in the key economies of Germany and Japan, there is cause for celebration. The latest indications demonstrate that production is increasing, purchasing managers' surveys remain bullish and demand is strengthening. The second camp believes that the recovery looks suspicious, demand is fleeting, consumer-powered borrowings are offensive and stock market valuations have become outrageous.

 

We opt always for the low risk, more cautious approach and perhaps as a consequence, we find ourselves more closely aligned with the second camp.

 

With the fiscal stimulus of a tax refund no longer helping, consumers must now deal with budget deficits at the state end. There are potentially $100 billion in state deficits this year and state legislators must now decide between severe cuts in service or raising taxes to cover this shortfall. Either way, the cost of servicing this funding hole will counteract the stimulative effects of federal largesse.

 

Falling interest rates have financed this boom to a certain degree as mortgage refinancing has caused household debt to rise about $879 billion in the past year albeit at a lower cost of servicing this debt. Much of this new debt found its way into durable goods, those items lasting 3 years or more, such as automobiles. However, the boom that triggered this activity has largely dried up as interest rates rebounded to the current 4.3% range. And with the probability of new bond sales to service the national debt an absolute certainty, there will be considerable pressure on bond prices keeping interest rates at these levels, if not higher. Reducing this refinancing activity means that the debt-driven growth is a thing of the past and future durable goods figures will reflect this new reality.

 

Capital spending has been seriously lacking and is not representative of strong, sustainable growth. Often in normal cyclical expansion, industrial production increases on the order of 8% per annum once capacity utilization reaches 80% yet we are now at 74.7% and there has been little increase in that figure for the past several months. With no pressure coming from utilization of capacity, businesses have no need to increase spending. One must also not forget that the capacity to build also exists in the Far East and usually this route is much more cost effective so a company needing to increase spending to fill a need has the option as well of contracting offshore companies to do the necessary work.

 

Finally it should be noted that the third year of the presidential cycle is often characterized by a improving economy as fiscal policy initiatives aim to start the election year on a favorable note, especially for a first term president. Evidently, this year is no exception to that rule. President Bush absolutely needs a domestic economy on the mend insomuch as daily media reports from Iraq tend to be negative.

 

Warning: We must mention that our recommendation, BGO, is experiencing some difficulty due to the tense situation in Russia where the head of Yukos, the large oil firm, has been arrested and jailed. Moreover the Russian government has moved now to freeze his shares of Yukos thereby effectively nationalizing this company. Western firms are feeling threatened by this new move and BGO has to be concerned both for the operating mine that they have in Eastern Russia as well as their very promising gold find which is still in the evaluation stage. At this point, we would put a stop loss at $3.00 on a closing basis to avoid any unnecessary loss of profit.

 

New Buy Recommendations:

 

WHT # – Wheaton Resources is a gold mining company that has, through acquisitions, quickly become the fifth largest producer in Canada. Chart action is very bullish and with gaps up on Thursday and Friday this week, it's signaling its intention to keep on rising.

 

IVAN # – Ivanhoe Energy is a small energy company exploring and developing oil and gas fields in China. This week they announced the start of a project in the Sichuan Basin where seismic surveys indicate a resource of 5 trillion cubic feet.

 

New Short Sales

None.

 

Stock Positions to Sell/Exit:

 

New stops have been added to the list while others have been modified. Those that have blanks, are being carried unstopped for now. Please see our complete list of stops in the table below.

 

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	Stop	Action Rating
09/29/03	AES	AES	7.50	8.75	unstopped	B
10/06/03	Align Tech	ALGN	13.46	15.41	12.00	H
08/25/03	Bema Gold	BGO #	2.15	3.15	3.00 *	H
09/29/03	China Unicom	CHU	8.18	9.16	7.60	H
10/06/03	Citrix	CTXS	24.31	25.17	23.17 *	H
05/12/03	Cott Corp	COT #	20.02	26.05	22.98	H
10/06/03	CP Ships	TEU #	21.49	20.97	20.00	SOLD
09/08/03	Sapient	SAPE	3.72	5.38	4.75	H
04/28/03	TransCanada Pipe	TRP #	15.85	20.39	19.42	B

 

* Stop on a closing basis