Market Conditions

Pull down the yellow flag and run up a small pale green one!

We came through last week remarkably well under the circumstances. Most of our stocks were down on the week but there were some outstanding exceptions. Even among those that were down, very little technical damage has occurred. Curiously, petroleum al service stocks look as if they may be taking a rest and overall our stocks in the group are not making any money. Some are up a bit, some down a bit. It is our view that oil prices are likely to stay somewhere in the $20 range even if they do not stay up near $25, the recent price. At that level for oil prices, the industry should be coining money. Oil companies were compelled to become lean when the price was half the current level. While the gratification may be slower in coming than we originally expected, history shows a long-term record of growing profits and advancing stock prices. Although the ride may be bumpy on the way, we expect an overall doubling in stock prices in this sector within a year or two. That may not be dramatic compared with the performance of some high tech stocks, but we really like the expected reward versus the risk in owning these stocks. In the meantime, the charts still look extremely good for the longer term.

Last week the NASDAQ 100 index completed a strong Lindahl buy signal and finished the week with a record high close. Bellwether stock Microsoft, which had been giving off ambiguous signals, has come through with a strong weekly Lindahl buy signal, suggesting that it may be finally ready to come out of its almost nine-month-long trading range with an upside breakout. Then the minimum target should be about $120 from current $95. There are stocks that we prefer, mainly because of MSFT's sky-high P/E, but we now see the technical case for owning the stock coming on side. In the past it has mattered little when you bought MSFT or how much you paid for it. The company always grew into its stock market valuation. We see the same thing happening now, along with many other high tech stocks, even ones we like but fear to own at current valuations, like Yahoo.

Last week, Fed Chairman Alan Greenspan told us that there will be plenty of liquidity to get us through any potential glitches over the Year 2000 rollover. Easy money means money to go into stocks. So there could be the regular seasonal surge into January, with a potential target for the ND 100 index of between 2850 and 3000, from current 2536. Incidentally, Greenspan seemed to suggest that he expects Y2K to be a non-event. Even granted that he has a vested interest in calming people, our reading is the same. In addition, last week we noticed that Market Vane found the lowest level of advisors for the past year to be bullish on Treasury Bonds. At extremes this Bullish Consensus often indicates the potential for a trend reversal. We are not bullish on bonds, although it seems quite likely that the line of least resistance from here could be upward rather than continuing down. On the other hand, Bullish Consensus for petroleum was at a 52-week high. Although we do not expect a major decline in oil prices, they may have gone up enough and could stabilize around current levels or a little below.

Rating our stocks now

We have lowered our action ratings on the oils to Hold and have raised many of our ratings on high tech stocks to Buy and Buy+. After a bad week, it is often a great time to buy stocks that have done well. They are likely to keep on going up the most when the general level of stock prices stabilizes. For example, it was an incredible week for Applied Microcircuits, up on the week from $52.81 to 64.31, and up from our entry price in April at 22.19. Despite the almost tripling in price, technical action suggests this is still one of the best stocks to buy here. Analog Devices and Applied Materials also look great. Cisco, Nortel and Sun Microsystems look as if they could take off and run, although it takes guts to buy them here. The remedy is just to buy a little of these must-own stocks if you do not already own them. On the other hand, Lucent and EMC look great and are not so vulnerable to a significant setback. They are apparently coming out of a major consolidation. One stock we really want to own is PMC Sierra and strongly recommend buy it on dips as and when they occur. We have several stocks under pressure, including Electronic Data Systems and
Novell. Our assessment of the fundamentals for these companies continues to make us believe that their stocks are merely consolidating. The technical picture justifies holding to see what happens. Many of our best stocks today, like EMC and Flextronics, could easily have been sold out at the bottom of a retracement where, in fact, they were really a buy not a sell.

A Tale of Two Stocks

Everyone knows that many people regard stocks as absurdly high and therefore vulnerable to a severe decline, and perhaps a major stock market crash. Is that true? And, if true, what should one do about it?
Our view is that some sectors are already in a severe bear market, and one that could go down very much farther. The average stock with a value of $150 million or more and listed on the New York Stock Exchange or on NASDAQ is down by 24 percent from its 52-week high. On the other hand, the bull market remains intact for some very carefully selected stocks, mostly high tech, but by no means exclusively. As you can readily see from our list of selected stocks, you could find ones to buy and make money from owning. In our view there are indeed many absurdly overpriced stocks, and many are still absurdly overpriced. However, the market has already been correcting that overvaluation. In doing so, it has generated a bear market destination for a wide range of group indexes and individual stocks. Most prominent among the group indexes is the Dow Transport Index, but there are many others. There are stocks like Coca-Cola, Sears, Gillette and (dare we say it?) Berkshire Hathaway. Take Gillette, for example. The stock is at $41.50, down from its high of $64 in June. You might think this a big enough decline to warrant buying the stock in this great company at a great price. Let's look at its earnings, however. For the latest quarter Gillette is expected to earn 32 cents versus 30 cents for the same quarter last year, for a gain of about 7 percent. We add the comment: if it makes it. Multiply 32 cents by 4 to obtain its apparent rate of annual earnings and you get $1.28. Divide $1.28 into the stock price and you get a Price/Earnings ratio of 31. For our money, Gillette should have a P/E of perhaps 15 or so in the current good times. Even at that level, we allow 5 percentage points for the stock of a great company that has a great history. In the event of a recession, G's profits might halve and the general level of P/E ratios in the market could decline severely. At a time of recession combined with a major stock market decline, we could see Gillette earning perhaps 60 cents for a full year and the stock sporting a P/E of 10. That would make G a $6 stock compared with its current price of $41. Down for a high of 64, such a decline would leave the stock more than 90 percent down from its high. If you think this projection unduly pessimistic, you have only look, for example, at what happened to Cendant during the good times. It sustained a decline of 84 percent from top to bottom when accounting irregularities became known and, in addition, the overall market took a slide. We are not saying the Gillette is necessarily heading for $6 but we certainly regard the stock as extremely pricey. On a technical basis the stock looks like a short sale. On a fundamental basis we don't think a value analysts would be interested in owning the stock at a price much above $20, giving it
a P/E# of about 15.

Now look at Solectron, one of our recommended stocks, arriving on our list at the beginning of April. In the meantime the stock has advanced from $49.63 to $74.63. It was actually down a little on the week despite reporting wonderful earnings. For the quarter the company earned $1.13 per share compared with 86 cents last year, for an increase of 31 percent. Assuming the company's ability to continue earning at that rate and disregarding the potential for further profit gains, the stock has a P/E of just 16.5. For the stock to sell with a P/E approximately equal to its apparent growth rate, the stock could double in price from here even without any multiple expansion. Given an apparent growth rate of 31 percent, profits should double in less than three years. Expand the multiple to its growth rate and you have a stock worth four times its current price within three years. Most important is that the chart for the stock suggests that this could happen. We dare not say it will, for things could change adversely at any time. However, we live by the saying that a trend in force is likely to remain in force until something happens to change it. We now see Berkshire-Hathaway type stocks going out of the sun but we see a few high tech stocks like Solectron carrying on. Berkshire-Hathaway, owner of stocks like
Gillette and Coca-Cola, is itself down by almost a third from its high in July last year. Let's say it again: Our work suggests that it is indeed 'Game Over' for many stocks like that, but there is still reason to own stocks like Solectron and, moreover, it is still not to late to buy them.

It is worth saying again that we have a two-tier market, as we have had now for a long time. Some people say that narrowing breadth may be a harbinger of a general bear market. We have to acknowledge the possibility of this happening. Our preferred interpretation is that the downward bias in stocks like the airlines and General Motors will flatten out and possibly reverse. In that case, growth stocks should continue ratcheting erratically upward. However, stocks like the Gillette, Coca-Cola and similarly expensive non-growth stocks could go down quite a lot more. Looking out a few months, while we tentatively target 2850 to 3000 for the ND 100 index, it looks as if 2000 might be a rocky year for all stocks. We could see the worst of all worlds as easy money is reined in after Y2K arrives. We could also see a slowing in the US economy. This may already be starting to happen as sectors such as housing and retail, including auto sales.

New Recommendations

None

Action Ratings

The following is the legend for designating immediate action for our stock recommendations. The first code is B, meaning that 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.

Current Recommendations:
(Entry Date, Entry Price, Last Close, Code, Name)

Stocks marked # are eligible for Canadian RSP funds. Otherwise there is a 20pc restriction on foreign stocks held in these accounts.

B+ 99/05/12 39.75 60.44 ADI Analog Devices
B+ 99/09/07 76.88 84.81 AMAT Applied Material
B+ 99/04/06 49.00 64.31 AMCC Applied Micro Circuits
(split on 99/09/10 2:1)
H 99/08/06 78.50 83.13 AMGN Amgen Co
H 99/06/14 30.63 30.25 AOG Alberta Energy Corp #
H 99/06/14 38.28 43.75 APA Apache
B+ 99/04/06 92.13 115.53 ASCND Ascend Communications
(acquired by Lucent 1.65 shares to 1)
B 99/09/07 84.94 86.44 BGEN Biogen
H 99/06/14 109.78 107.28 BPA BP Amoco Plc
H 99/09/07 57.69 56.94 BVF Biovail Corp
B+ 99/08/06 26.38 36.00 CHIR Chiron Co
B+ 99/05/14 40.69 45.94 CLS Celestica #
B 99/05/12 117.50 73.50 CSCO Cisco (split on 99/06/21 2:1)
B 99/06/14 14.59 19.73 CXY Canadian Occidental Petroleum #
H 99/05/12 54.61 55.27 EDS Electronic Data System
B+ 99/04/06 132.13 71.00 EMC EMC (split on 99/05/28 2:1)
B 99/08/09 86.31 42.13 ENE Enron Corp (split on 99/06/21 2:1)
H 99/06/14 31.13 30.75 ERICY Erickson
B 99/04/06 51.50 58.44 FLEX Flextronics
H 99/09/07 60/19 55.38 GENZ Genzyme
B 99/06/14 60.14 67.63 GLW Corning
H 99/08/09 48.75 47.38 HAL Halliburton Co
H 99/05/14 84.52 100.48 HWP Hewlett-Packard
H 99/05/12 220.77 125.13 IBM IBM (split on 99/05/26 2:1)
H 99/08/19 77.44 84.56 INTC Intel Corp
B 99/09/07 113.75 110.50 JDSU JDS Uniphase Cp
B+ 99/04/06 60.83 68.48 LLTC Linear Tech Corp
B 99/04/06 32.75 59.06 LSI LSI Logic
H 99/05/12 25.06 22.19 NOVL Novell
H 99/04/06 163.19 86.63 NOK Nokia (split on 99/04/09 2:1)
B+ 99/04/06 65.66 49.70 NT Nortel Networks # (split on 99/08/19 2:1)
H 99/06/14 93.56 104.25 PHG Phillips Electronics
B 99/05/12 106.06 102.75 PMCS PMC Sierra (split on 99/05/14 2:1)
H 99/05/12 49.88 77.13 QLTI QTLI Phototherapeutics #
H 99/06/14 21.39 24.98 SDC Santa Fe International
B 99/06/14 35.97 56.48 SFA Scientific Atlanta
B++ 99/04/06 53.75 74.63 SLR Solectron
B 99/08/19 129.02 146.95 SNE Sony
B+ 99/04/06 130.94 88.69 SUNW Sun Microsystems (split on 99/04/08 2:1)
B 99/08/06 31.00 32.31 TLM Talisman Energy Inc
B+ 99/04/06 109.48 89.78 TXN Texas Instruments (split on 99/08/16 2:1)

In addition we recommend the following Closed End Funds, based on the assumption that Third World economic downturns are not going to last forever and that their stocks are now showing superb technical strength

B 99/04/06 6.63 9.38 FAK Fidelity Adv Korea
B 99/04/06 8.88 11.38 IFN India Fund
B 99/04/06 8.05 13.61 JOF Japan OTC Equity Fund
B 99/04/06 11.00 13.75 KF Korea Fund