SuperModels Community
Join the discussion in the MSN Money SuperModels Community.
SuperModels
Recent articles:
• 20 stocks for the beginning of the end, 10/9/2002
• Play both sides of this market to win, 10/2/2002
• It's time to pull the plug on Cablevision, 9/25/2002
More...
| | SuperModels
Your guide to trading the S&P's terrible $2s
Why these $2-or-less stocks aren't being kicked out of the index is anyone's guess, but there's no reason for you to suffer S&P's mistakes lightly.
By Jon D. Markman
Even after one of the largest four-day advances in its history, the market benchmark S&P 500 Index ($INX) still holds 12 stocks priced at $2 or less -- a price level that, in the past, its managers declared low enough to merit a securitys immediate removal from the index.
The fact that the S&P 500 holds so many stocks that cost less than a Happy Meal reflects the epic blunder that its managers made in adding overpriced tech stocks at the height of the bubble in 2000, as well as their remarkable inability both to deal with their mistakes in a timely fashion and to adhere to a strict expulsion regimen.
At the start of this year, as much as $1 trillion in pension and mutual fund money worldwide was tied directly to the performance of the S&P 500 Index. Investors had been led to believe that it was impossible to beat the index -- whose mission is to hold shares of the nations largest companies -- so it was best to simply own it. The theory followed five years in the mid-1990s, 1995 to 1999, in which the indexs specialty, large-cap stocks, soared in value at the expense of all other asset classes.
But investors have been loath to come to grips with the notion that passive big-cap indexing was just another dumb fad. And even after a 29% decline this year, investors have kept the Vanguard 500 Index Fund (VFINX) -- the granddaddy of all S&P 500 index portfolios -- the No. 1 fund, ranked by assets, in the nation. Through the end of September, the fund reported $63 billion in accounts, a tad more than the $60 billion claimed by perennial runner-up Fidelity Magellan (FMAGX).
Mores the pity that even this blind faith has failed to prop up the terrible decision that the S&P 500 Index management committee made in 2000 and 2001 to mirror the mania. And now investors are left with 12 stocks that any responsible fund manager with an IQ higher than a hat size would have dumped long ago -- and, quite obviously, most did.
Most professional fund managers, indeed, are prohibited from owning stocks priced at $5 or less. And yet the S&P 500, the single-largest equity-investment vehicle in the world, owns 34 of these money-losers, most of which were added to the index near their all-time highs. Heres the list, with prices through Friday's close.
| S&P 500s $5-and-under club | | Symbol | Company | 10/11 close | % chg YTD | 12-month income $ | | LU | Lucent Technologies | $0.58 | -90.8 | -17.8 billion | | DYN | Dynegy | $0.86 | -96.6 | 153 million | | MIR | Mirant | $1.27 | -92.1 | 71 million | | ADCT | ADC Telecommunications | $1.29 | -72.0 | -940 million | | AES | AES Corp. | $1.44 | -91.2 | -27 million | | SLR | Solectron | $1.48 | -86.9 | -3.1 billion | | GLW | Corning | $1.48 | -83.4 | -1.3 billion | | AV | Avaya | $1.49 | -87.7 | -450 million | | WMB | Williams Cos . | $1.73 | -93.2 | -1.3 billion | | JDSU | JDS Uniphase | $1.84 | -78.8 | -8.7 billion | | PMTC | Parametric Technology | $1.93 | -75.3 | -68 million | | SANM | Sanmina-SCI | $1.97 | -90.1 | -257 million | | NOVL | Novell | $2.12 | -53.8 | -106 million | | PCS | Sprint PCS Group | $2.22 | -90.9 | -927 million | | Q | Qwest Communications | $2.43 | -82.8 | -2.5 billion | | CPN | Calpine | $2.49 | -85.2 | 409 million | | CIEN | CIENA | $2.65 | -81.5 | -2.6 billion | | SUNW | Sun Microsystems | $2.77 | -77.6 | -587 million | | GTW | Gateway | $3.06 | -61.9 | -696 million | | CPWR | Compuware | $3.23 | -72.6 | -257 million | | AMCC | Applied Micro Circuits | $3.30 | -70.8 | -570 million | | PWER | Power-One | $3.35 | -67.8 | -139 million | | PMCS | PMC-Sierra | $3.36 | -84.2 | -367 million | | MDR | McDermott International | $3.52 | -71.3 | -259 million | | HRC | HealthSouth | $3.60 | -75.7 | 312 million | | AMR | AMR Corp. | $3.70 | -83.4 | -2.3 billion | | AMD | Advanced Micro Devices | $3.76 | -76.3 | -396 million | | AWE | AT&T Wireless Services | $4.06 | -71.7 | -1.1 billion | | LSI | LSI Logic | $4.18 | -73.5 | -882 million | | PVN | Providian Financial | $4.40 | 23.9 | -273 million | | EMC | EMC | $4.61 | -65.7 | -1.1 billion | | PKI | PerkinElmer | $4.70 | -86.6 | -54 million | | AYE | Allegheny Energy | $4.72 | -87.0 | 299 million | | XRX | Xerox | $5.02 | -51.8 | 49 million |
|
The human factor
An eight-person Standard & Poors committee chaired by economist David Blitzer decides which stocks to add and remove from the index. From the time of the indexs inception in the 1950s through the late 1990s, few stocks were removed for reasons other than merger or bankruptcy. But in 1999 and 2000, stung by the success of the Nasdaq Composite ($COMPX) and fearing irrelevancy, the committee launched a misguided campaign to throw out dowdy old value stocks such as auto-parts retailer Pep Boys (PBY, news, msgs) and replace them with exciting new tech stocks like JDS Uniphase (JDSU, news, msgs). (I explained these issues in depth in three previous columns; see them here, here and here.)
The rationale for these summary expulsions was vaguely termed lack of representation, which in S&P argot meant either that the companys industrial sector had lost ground to some other sector -- e.g., retailing was eclipsed by technology -- or that the company itself no longer reflected its sector. Under pressure from critics like myself, the index committee in the middle of 2002 stopped using this indistinct language and began to report in its press releases the precise reason that stocks were removed. And the most common reason given, so far, has been that the stock traded at or below $2 for five consecutive days.
So what explains the bizarre turn of events in which a dozen stocks in the index can still be had for less than a couple of bucks -- a price once considered unimaginably laughable?
Blitzer could not be reached for comment. But in past interviews he has noted that the index is merely supposed to mirror the market, and as such, its ups and down are of no concern to its managers.
A plan for the masses
S&P is a proud organization, and one can be somewhat sure it has a plan to expunge its record of these embarrassments before too much longer. In the meantime, I have an action plan for both bulls and bears.
Bears should assume that some or all of the stocks priced at $1.99 or less will eventually be expelled. A handful of these companies may survive and prosper, but they will spend most of their recovery period from a penalty box outside the index. When $1 trillion worth of index-linked funds have to sell these stocks from their portfolios, their prices will flush south with the roar of Niagara Falls. Following a breakdown from any strength in the next few weeks or months, bears should take short positions in the following stocks: Lucent Technologies (LU, news, msgs), Dynegy (DYN, news, msgs), Mirant (MIR, news, msgs), ADC Telecommunications (ADCT, news, msgs), AES Corp. (AES, news, msgs), Solectron (SLR, news, msgs), Corning (GLW, news, msgs), Avaya (AV, news, msgs), Williams Cos. (WMB, news, msgs), JDS Uniphase (JDSU, news, msgs), Parametric Technology (PMTC, news, msgs) and Sanmina-SCI (SANM, news, msgs).
Bulls and other speculators, on the other hand, will assume that if a great deal of money floods into the market for a seasonal upward push through the rest of the fourth quarter and into January, the lowest-priced stocks in the S&P 500 that are already the most heavily shorted and have the highest betas will rise at a rate much faster than the index. A short squeeze combined with speculative enthusiasm could push the following stocks to double or triple for no other reason than that they are tagging along for the ride as portfolio managers around the world equitize their cash holdings by buying index funds.
Here are the most heavily shorted low-priced, high-beta, low-valuation stocks in the S&P 500 Index. If youre bullish, buy the stocks or call options on any pullback in the overall index.
| S&P 500 short-squeeze candidates | | Symbol | Company | Beta | Price/sales ratio | 10/11 close | Short interest ratio | | XRX | Xerox | 1.68 | 0.22 | $5.02 | 37 | | PCS | Sprint PCS Group | 2.95 | 0.2 | $2.22 | 23 | | AV | Avaya | 3.7 | 0.1 | $1.49 | 22 | | AES | AES Corp. | 2.2 | 0.08 | $1.44 | 18 | | GTW | Gateway | 2.28 | 0.22 | $3.06 | 12 | | AWE | AT&T Wireless Services | 1.55 | 0.76 | $4.06 | 12 | | LU | Lucent Technologies | 2.21 | 0.13 | $0.58 | 11 | | CPN | Calpine | 1.58 | 0.11 | $2.49 | 10 | | PWER | Power-One | 2.84 | 1.3 | $3.35 | 9 | | SLR | Solectron | 2.49 | 0.1 | $1.48 | 8 | | AMR | AMR Corp. | 1.91 | 0.03 | $3.70 | 7 | | MIR | Mirant | 1.95 | 0.02 | $1.27 | 6 | | PMCS | PMC-Sierra | 3.11 | 2.63 | $3.36 | 6 | | AMD | Advanced Micro Devices | 2.54 | 0.4 | $3.76 | 6 |
|
Ill track the results of these two strategies through the end of the year, and report back. In the meantime, if you wish to monitor the S&P 500 committees pronouncements, visit this page after the close of each trading day.
Fine Print
After last week's powerful display of buying interest, the two market-timing analysts mentioned in my last column upgraded the broad indexes to speculative short-term buys. Phil Erlanger, who I reported last Wednesday was already turning mildly bullish, told subscribers Monday that continued short-covering could push the S&P 500 as high as 945 or 960 in coming weeks. Paul Desmond, who thinks a great deal more downside lies ahead, nevertheless told readers that his short-term indicators had turned bullish in a manner similar to the period after July 24. ... Last week, both the New York Stock Exchange Composite ($NYA.X) and the Dow Jones industrials ($INDU) rebounded precisely off their 10-year moving averages. The last time the NYSE Composite kissed its 10-year moving average was August 1982, the start of the last bull market. Write me at jmarkman@microsoft.com if youd like the data and chart; put "NYSE" in the subject field. ... Numerous large, diversified large-cap or mid-cap funds have pummeled the S&P 500s performance not only in the past year, but in the past three-, five- and 10-year periods. Ill send you the top 15 upon request. ... Passive-indexing partisans always complain the majority of managed funds dont beat the indexes over time. But you dont have to own the majority. You only need a few. Favorite no-load large-cap or mid-cap funds with low expense ratios are Ariel (ARGFX), Longleaf Partners (LLPFX), Dodge & Cox (DODGX) and Clipper (CFIMX). ... ISI Group reported on Oct. 10 that the bear market of 1973-74 lasted 651 days, during which the market declined 48.2%. The current bear market, which began with the S&P 500 peak on March 24, 2000, has declined 49% over 929 days. ... ISI said the three-year average total return of the S&P 500 dropped to -11.3% at the end of September, surpassing the -7.4% average annual decline registered in 1974, but falling short of the -25.6% record established in 1931. ... The good news after three years of decline? Its very unlikely to continue in 2003. There's only been one stretch in this century in which the market fell four consecutive years, the Depression period of 1929-1932. And the years following multi-year negative-return cycles have tended to register sharp advances: +54% in 1933, +20% in 1942, +37% in 1975.
While Jon D. Markman cannot provide personalized investment advice or recommendations, he welcomes column critiques, comments and even compliments at jmarkman@microsoft.com.
At the time of publication, Jon D. Markman neither owned nor controlled shares in any stocks mentioned in this column.
|
