COMMENTS WEEK OF 4/19/99-4/23/99
|NO COLUMN PUBLISHED DUE TO
|The return to old
leadership gained momentum yesterday as investors piled into technology stocks following
Microsoft's better than expected earnings report. Internet stocks continued their 2
day rebound from the past week's temporary lull in irrational exuberance, and the drug
stocks rallied after being given a dose of feelgood by Bristol-Myers Squibb and Johnson
The bull market sensitive
stocks, the brokerages and retail stocks, also joined in the rally. The Russell 2000
rallied almost 3%, but as we've said before take this index with a grain of salt because
the top of this "small cap" index includes such mega cap names as CMGI, E*Trade,
and Real Networks. Strip these 3 stocks out of the index and the Russell's
performance yesterday becomes just ho-hum.
Left out of yesterday's rally were the fear sensitive gold
and utility stocks which had rallied over the past week during the market's temporary
Significant this week has been the ability of the S&P
500, NASDAQ, and the Transports to flirt with disaster and bounce up off support levels.
The 3 indexes are likely to move higher in the short term. The inability of the 3 indexes
to join the Dow in record territory this week is a negative for the intermediate term
The short term is what will matter today however as the
market will likely attempt to rally strongly following IBM's blowout numbers. The
tech sector's recent bad case of earnings jitters will likely be completely erased by
IBM's better than expected numbers and rosy outlook for the future. "Strong"
earnings from Internet companies CNET and Go2Net (and did we mention a pair of stock
splits) after yesterday's bell will ignite the feeding frenzy in Internet stocks once
Today will feature another full slate of earnings
announcements for the market to digest, or cheer as has been the case recently. This
earnings period has left investors feeling upbeat as expectations have been met or
exceeded. This earnings period, and the increase in bullish sentiment it has
spawned, is likely setting the market up for a rude awakening down the road.
We wonder how long the focus will stay on the beating of
(in many cases diminished) expectations, rather than the actual numbers. Yesterday's
numbers from Coca Cola were a case in point as the stock rallied after the company
exceeded expectations. Overlooked was the 11% drop in earnings. Coca Cola's
ability to rally on what essentially are bad numbers is not an isolated event however.
The S&P 500 staged a healthy rally in 1998 even as corporate profits declined
for the year. How long the smoke screen of the beating of diminished expectations
will be able to both drive stock prices higher while covering the declining quality of
corporate earnings is a question that will likely determine how long the current run
Stay tuned for second quarter earnings.
|Deja Vu. Graham and Dodd,
not to mention their student Buffett, will have to wait for another day. Yesterday seemed
like old times, as bargain hunters stepped in to pick up shares in the market's recently
deposed leaders: the brokerages, drugs, PC makers, retail stocks, and the short on
earnings but long on dreams Internet sector.
stock split announcement from Citigroup helped steady the financial sector yesterday and
helped the brokerage stocks step back from the brink (of breaking below support).
The S&P 500 also held its own (in this case support at 1286) and rallied to
1306.17. We would watch 1286 on the downside and 1318 on the upside in today's
The Internet sector rallied strongly yesterday after an
astute analyst found value in a trio of stocks trading at 41, 42, and 108 times sales.
A second quarter operating loss (to be fair it was lower than expected) and a
forecast of future losses from E*Trade added fuel to the Internet rebound and helped spark
NASDAQ to a 64 point gain. NASDAQ finished at 2409.65, a point below its 55 day
moving average. The index has not spent more than 2 days below its 55 day moving
average since October, and a third close below the average today would be bearish and
would likely result in a retest of support around 2313.
NASDAQ will likely end its 2 day stay below the 55 day
moving average today. Internet stocks will likely lead the index higher today following
the announcements of (better than expected) losses from Xoom.com and RealNetworks (who
threw in a 2 for 1 stock split for good measure).
With money moving into the old favorites yesterday, the
cyclical were banished to the doghouse from which they recently emerged. The Dow
Transports tumbled 72.79 and at this point they appear more likely to break below the 3461
support level than to rally to new highs.
The recent optimism that fueled the sharp rise in the
transports and other cyclicals may have been a bit premature. The Commerce
Department reported yesterday that the trade deficit grew to a record $19.4 billion.
The report showed exports falling for a fourth straight month. Until demand
picks up in the global economy, any hopes for a sustained rebound in cyclical stocks
remains on hold. The report also showed a $1 billion increase in imports of consumer
goods. A U.S. consumer with a negative savings rate and a strong demand for consumer goods
remains the driving force (and some would say the only) behind the U.S. economy's
continued strong showing.
The ability of the cyclicals to rally further will also be
sorely tested following the release of the IMF's semi-annual global outlook which forecast
a continued slowdown in Europe and a 1.4% contraction in the Japanese economy.
Japan's Ministry of Finance stepped in to douse the recent ardor for the cyclicals
even further overnight with a gloomy economic forecast. Unless U.S. consumers
suddenly start buying earth moving equipment and steel at their local shopping mall,
investors who rushed to the cyclical stocks will likely have a long wait before earnings
match premature hopes.
|Party's Over. The signs of
a shakeout on the horizon were ominous before trading began yesterday, with the S&P
sitting precariously on support at 1318 while the Dow entered the day at yet another new
high. Yesterday's early 271 point runup in the Dow looked and smelled like the
market's last hurrah from the outset, with herd mentality alone driving the index to new
heights. The market's afternoon reversal to the downside on heavy volume likely
signalled a short term top for the market, and a final peak in the speculative frenzy that
has gripped many investors.
ingrained buy on the dip mentality that has built up since 1987 did not end with
yesterday's tech stock blood bath, and we will likely see an attempt by bargain hunters to
steady the averages this morning, but the belief that making money in the markets is easy
was likely severely damaged by yesterday's action.
More than a few of the new breed of "traders"
who have approached the markets as a game of easy money were probably rudely awakened
yesterday to the fact that trading is not a sport, or a one way ticket to the easy life,
it is in fact a business that needs to be approached like a business if one hopes to
succeed in it over the long term.
The bubble of speculative excess and of its principal
vehicle, the Internet stocks, was pricked yesterday, and the days ahead will likely see a
continued shrinking of the bubble of excess as reason slowly but surely supplants emotion
as the basis for trading decisions. We do not expect every newly declared "master of
the markets" to learn the names Graham and Dodd overnight, but the day is coming.
While the market has made a short term top, there will
likely be one final attempt at new highs before a long term top is put in place. A
long term top is likely already in place among many Internet stocks, including the online
brokers and the Internet banking issues where speculation rather than fundamentals has
been the driving force.
In today's trading we would keep an eye on Merrill Lynch,
which is sitting on support and 20% off its July 1998 highs. We said 2 weeks ago
that the stock tended to be a leading indicator of future market action, and we would take
its recent plight as a warning that the final top might not be here, but it is fast
|The market's game of
sector rotation gained steam on Friday, with the new darlings, the cyclicals, powering the
Dow Industrials to yet another record and lifting the Dow Transports over the 3461
resistance level to a close of 3528.70.
move into cyclicals will likely continue in the early part of this week as the combined
forces of jump-on-the-bandwagon momentum and money managers trying to find a final resting
place for last week's pre-deadline inflow of retirement funds continue to push the
The ability of the cyclicals to sustain their rally past
this week remains in question however. A large part of last week's upward spike was
due to a recent malady suffered by many fund managers, namely
"fear-a-da-tech-earnings". Figures released by AMG Data Services on Thursday showed a continued inflow of funds into large cap equity
funds ($1.9 billion), and out of small caps ($866 million). Fund managers, faced
with a river of cash flowing into large cap funds and a need to stay fully invested,
needed to find a large cap sector replacement for their old favorites (the tech stocks).
With hopes for a global economic recovery dancing in the heads of many a
pundit, the beaten down large cap cyclicals beckoned.
As the market enters a seasonally slow period for
retirement fund inflows, fundamentals will have to take up the slack in order to drive the
cyclicals higher. The fundamentals of recovery continue to be long on hope and short
In Japan, near zero interest rates and massive public
works spending has stopped the slide, but there is no sign of recovery in sight.
Capital spending continues to decline, and consumer spending is being dragged down with
it. With sectors that account for 75% of the Japanese economy locked in a downward spiral,
there is little hope for recovery.
Europe, too, is long on hope but short on reality.
Recent interest rate cuts will do little to solve Germany's high cost basis. Any
positive effects of recent rate cuts could also be negated if the war in Kosovo drags on
and European NATO member nations are forced to add to their already high debt burdens to
finance a protracted, intensified war.
In the U.S., the economy remains strong, but it is a
consumer led economy. The manufacturing economy remains weak and is showing few
signs of improvement. Friday's industrial production and capacity utilization reports
pointed to continued weakness in the manufacturing sector. First quarter industrial
production figures were the weakest since 1991, and March capacity utilization hit a 7
year low. Without a pickup in the manufacturing sector the cyclical stocks can not
sustain their rally.
The immediate benefits to U.S. cyclical stocks from the
economic recoveries underway in South Korea, the Philippines, Singapore, and Thailand are
also overstated. There continues to be a surplus of capital equipment in much of
Asia, and the early beneficiaries of any pickup will likely not be the capital equipment
makers. At this stage in Asia's recovery, a Foster Wheeler or a Fluor is more likely
to benefit than a Caterpillar or a Deere, likewise a Cathay Pacific is more likely to
benefit than a Boeing.
The indiscriminate herd like stampede into anything with a
cyclical label attached remains one where hope outweighs the underlying fundamentals.