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Add to MSN Stock List Message Board Jubak's Journal Recent articles: • Where, oh where, did the war rally go?, 4/11/2003 • The increasing risk in 'safe' investments, 4/10/2003 • Follow the cash flow to 5 great stocks, 4/8/2003 More... | Jubak's Journal 8 stocks to watch in a wandering market Even as stocks cover the same ground again and again, you're not really lost if you know which companies to follow. By Jim Jubak This is a market thats at a tipping point -- balanced between hope and fear. The problem with this type of market, also known as a range-bound market, is that there isnt enough real information to give either emotion a significant edge. Hope that things are getting better is sufficient to drive stocks up, but fear that things arent as good as they seem works to drive stocks back down. If this market is range-bound, were going to see rallies fail at 1,430 on the Nasdaq Composite ($COMPX) , 8,500 on the Dow Jones Industrial Average ($INDU) and 900 on the Standard & Poors 500 ($INX). And well see the dips contained at 1,270 on the Nasdaq, 7,800 on the Dow, and 800 on the S&P. That wouldnt be a disaster. Building investor confidence that the market isnt about to drop another 20% or 30% is a requirement to ending the bear market -- or at least this stage of it. And stocks need to spend some time building exactly this kind of base to create a foundation for any kind of advance that lasts more than a few months.
But a range-bound market would be a disappointment for those investors who are counting on a strong 20% to 30% rally to finally put an end to the misery of the last three years. And bears betting on an equally big move in the other direction to turn their short positions into big winners wont be very happy with that scenario either. Ambiguous evidence And of course, a range-bound market generates plenty of opportunity for profits and losses even if the indexes finish with a wash. Any investor who buys at one of these temporary tops and then panics into selling at one of these temporary bottoms can be whipsawed into considerable losses. And any investor who can buy low and sell high (or short high and cover low for shorts), maybe even repeating the same modestly profitable trade over and over again, can rack up solid profits in a market thats going nowhere. At the moment I think its impossible to tell with real certainty that this is a range-bound market. The evidence is just too ambiguous. On the one hand, the stock market is retreating for resistance and advancing from support in just the way that a trading-range market would. For example, on April 7, stocks stalled at 1,430 on the Nasdaq Composite and 8,500 on the Dow Jones Industrial Average before fading to a slight gain at the close. Those levels roughly mark the stock markets 2003 highs in January and March. In addition, and stocks dont show an inclination to break above those points. The 1,423-1,430 level on the Nasdaq, for example, was the floor for that index in the aftermath of Sept. 11 and in the market lows of October 1998. It was also the high reached in the August 2002 rally. Now it seems to be acting as a barrier to the technology-dominated Nasdaq Composite. Similarly, the Nasdaq Composite bottomed at 1,271 on March 11 and at 1,279 on Feb. 12. This isnt to say that these levels are guaranteed prices. Instead, think of it this way: On recent experience, when the index is at 1,270 or so, investors can reasonably conclude that stocks are relatively cheap given the lower risk given the market has turned at this level twice before. At 1,270 or so on the Nasdaq Composite, investors have appeared willing to buy. But at 1,430, stocks seem relatively expensive given the markets recent history of selling off at this level. The risk at 1,430 is high enough so that selling in order to take profits makes sense. Defining the range There all kinds of ways to define the range right now. You might define the range as between 1,270 and 1,430 on the Nasdaq. You might define it as something wider, say, 800 to 950 on the Standard & Poors, as J.P. Morgan equity strategist Christopher Wolfe has done, or at 800 to 900, as I would. But the message is pretty much the same: Lacking conviction, investors take profits as soon as they materialize. And they look to re-enter the market when prices sink to a level that shifts the risk/reward ratio back to the side of reward. That lack of conviction is supported by the light-to-moderate trading volume in the market even on big news days. But before you conclude that the case for the trading range is open and shut, you ought to note that some pretty good technicians have come to very different conclusions. Phil Erlanger, editor of Erlanger Squeeze Play and one of my colleague Jon Markmans favorite market timers, for example, has what he calls zero buy confidence in the Nasdaq and not much more confidence in the S&P 500. The market is setting itself up for a decline from current levels because investors are overconfident. He points to the extreme drop in the VIX ($VIX.X), an index that measures fear by looking at price action in the market for stock. The stock market is much more likely to climb when it starts from high levels of fear because as that fear recedes those investors move money back into stocks. The current lack of fear means theres not very much fuel to move the market higher. On the other hand, Dan Sullivan, editor of The Chartist market timing newsletter and one of the top five performing investment newsletters over the last 20 years, according to Hulbert Financial Digest, moved back into the market on April 10, ending his 100% cash position. Sullivans reasons included the strength of the March rally. He noted that most bull markets start with a powerful upward thrust, and the eight-day March rally was the most powerful move upward since 1896, according to Sullivans research. Second, Sullivan cited the behavior of the high-relative strength stocks that have led the market higher. Rather than rolling over as theyve hit 52-week highs, many of these stocks have continued to lead the market, providing the leadership that any market needs in order to rally. It's a precarious balance The convincing cases that can be made for all three points of view point out, to me, how precariously balanced this stock market is. Events -- especially quarterly earnings reports -- will tip it one way or the other in the short term. The key event to watch will be Microsofts Its now widely feared that Microsoft will miss consensus Wall Street estimates, if not on earnings per share, then on revenue. And the companys guidance on the June quarter will set expectations for the rest of the technology sector. Watch what prices do across the stock market if the company does miss. A quick drop on the miss that brings in the buyers will confirm reports that institutions are moving money back into equities from bonds on any dip. Then, if more bad earnings news (and nobody is expecting anything much good out of this war-worried quarter) doesnt take out the bottom of the trading ranges, that will go a long way to turning the trading-range opinion into a market consensus. Dont underestimate the way that a consensus in favor of a trading-range market can become a self-fulfilling prophecy. If everyone thinks its safe to buy at 1,270, then it probably will turn out to be safe to buy at that level because the consensus itself will bring out the buyers. To get more insight into the direction of the market, Id suggest that you take a couple of weeks to see how prices respond to the expected bad earnings news. (And to see if any unexpected bad news emerges that could take the floor out from underneath this market.) And then, if it still looks like this market is holding its recent trading range, you can start dividing stocks into two groups. Look for momentum There will be those, like Sullivans high relative-strength stocks, that seem determined to go climb higher. Watch closely to see if these stocks maintain their momentum through any earnings-season pullback and downgrades analysts slap on stocks near a high in a trading-range market. If they do, its possible that this group will be able to provide the leadership needed to take the stock market back up to the top of the trading range at least. And maybe further. And continue to monitor this group to determine if stocks can push through the higher range. Some high relative-strength stocks to watch as indicators include:
But investors might find a better combination of risk and reward in finding stocks that have retreated from the top of their range but still show solid strength in the recent market. These stocks show the price action thats likely to endear them in the early going to investors who believe this is a range-bound market. These stocks are particularly attractive because they are able to demonstrate earnings, revenue or cash flow growth combined with a strong balance sheet. In this group Id put
But Im going to add PepsiCo to Jubaks Picks here. The company isnt likely to be affected by anything negative that happens in the technology or energy sector and in fact might actually climb as investors interested in increasing their equity exposure opt for relative safety. Next column, Ill move from general strategy for this market to looking for specific stocks that might get a positive pop from negative news on earnings. New developments on past columns Watch the skies to see if stocks will soar On April 10, Moodys Investors Service cut its rating on Continental Airlines 3 food stocks face a leaner, meaner world Moodys was busy last week. Besides downgrading Continental Airlines, the bond rating agency also dinged Smithfield Foods Updates to Jubak's Picks Buy PepsiCo PepsiCos Editor's Note: A new Jubaks Journal is posted every Tuesday, Wednesday and Friday. The Wednesday edition stems from Jim's appearance on CNBCs Business Center most Wednesday nights at approximately 5:45 p.m. ET. Selected CNBC stories can be found in the TV Reports index. At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Continental Airlines, EnCana, PepsiCo, Smithfield Foods and Whole Foods Market. He does not own short positions in any stock mentioned in this column. | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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