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Hey, Modelman, answer me this
Markman tackles the big issues: What's your secret source Mr. P thinking? Is that strategy about buying the S&P 500's castoffs still any good? And what do those experts you quote all the time think will happen now?
By Jon D. Markman
Youve got questions, weve got answers. Today we bring you a new SuperModels feature called Hey Modelman! (Submit your own questions here.)
Hey Modelman, whatever happened to your idea about buying stocks kicked out of the S&P 500 -- does that still work?
Modelman: Its still flying high. The concept worked beautifully just last month when AMR Corp. (AMR, news, msgs), the parent of American Airlines, got the boot. Standard & Poors will stand behind the big-cap stocks in its standard-bearing S&P 500 Index ($INX) for just about any crime against shareholders except bankruptcy. When it looked like AMR was going banko just before the start of the Iraq war, S&P showed the deft timing touch for which it is revered in Americas poorhouses by forcing it out of the 500 on March 15. Since then, the stock has taken off, rising more than 200% through April 28 to $4.75 from $1.50. Its replacement, Apartment Investment and Management (AIV, news, msgs) was up just 5% over that time, half the advance of the index itself.
Hey Modelman, last week you said things were looking up for the economy, and then we get zinged with a GDP report showing annualized growth in the first quarter of 1.6%. What gives?
Modelman: New weekly data from Economic Cycle Research Institute, as well as government reports, continue to suggest that a new recession is not imminent. The data are providing fodder for both bulls and bears, but the bottom line is that the economy in 2003 so far looks a lot like 2002: Were getting positive growth in gross domestic product, but not enough to add jobs or to make businesses confident about investing. So you end up with an economy that is limping forward on one leg, in the words of analyst Lakshman Achuthan. That one leg is the consumer, who continues to hang in there. To be sure, consumer debt is rising, but interest rates are so low that people have the cash flow to cover payments. The good news is that while the recovery from the 2001 recession is subpar, it looks like well avoid the global economic meltdown that appeared possible when oil prices were rising and worldwide consumer confidence was falling. The bad news is that business spending continues to appear anemic as the overcapacity built during the bubble years continues to repress decision-makers. Figure on something like 2.9% growth in GDP for the year: Not terrible, but nothing to write home about. It may not even feel that strong to the investor class, because of the unusually high number of well-paying white-collar jobs that are being cut in the latest round of corporate layoffs.
Hey Modelman, I know its crass to think this way, but do you think the SARS crisis will have any impact on my tech stocks?
Modelman: China accounts for about 10% of all personal computer sales worldwide, and most of the sectors growth. ((Intel (INTC, news, msgs) alone has said that the Pacific Rim accounts for 39% of its revenues.) That means 10%-plus of all the stuff like disk drives, memory chips, CPUs and power supplies made by U.S., European and Asian companies depends on healthy sales in that single country. Now consider that retail sales in China have plunged since severe acute respiratory syndrome has hit, as few consumers want to venture into public places such as shopping malls to buy stuff. One source told me that the largest Chinese PC manufacturer, Legend, has reported it is at 60% of its plan for the quarter. Motherboard manufacturers say orders from China are way off. And this news comes at a time when retail sales in South Korea, another major market for PC and other electronic products, are decelerating. Even if the SARS crisis is resolved tomorrow, a month of sales in China is probably lost. Since few stock analysts have adjusted their revenue and earnings models to adjust for the loss, it seems logical that the second quarter will be unusually challenging for the shares of companies that sell into the PC complex, such as large caps Intel, Micron Technology (MU, news, msgs), Rambus (RMBS, news, msgs) and Integrated Circuit Systems (ICST, news, msgs).
Hey Modelman, in mid-February you wrote about newsletter publisher Robert Drach and his system of buying into market declines and selling into rallies (Its not about war, its about prices). Is he still wildly bullish?
Modelman: No, quite the contrary. Back on Feb. 19, when stocks were falling like dumb bombs all across Wall Street, Drach said in an interview: Were buying now when sentiment is negative, and well sell 'em back to the masses when theyre happy campers again. Its all about buying inventory at wholesale and selling it at retail. Apparently, its retail time again as Drach said Sunday that his investment model had just turned negative -- shifting to an exposure of 70% cash, 30% stocks. In March, his exposure to the market crested at 82% stocks, 18% cash. He believes that the final spurt of buying in mid-April resulted from the investigation of specialists at the New York Stock Exchange, as the specialists covered shorts to clean up their books. We sold stocks profitably into that move -- it completed the advance we expected, so we took the money, he said. As for the future, Drach said he believes the next market move will be an unsustainable 6% rise or fall that will reverse back to the current level. If its a 6% move up, then he expects to become even more bearish and reduce exposure to stocks further. If its a 6% move down, then hell increase exposure to stocks. I think itll be sloppy and choppy, he said in his usual dry, world-weary way. Most interesting names at this time are three in the insurance industry that were whacked last week: American International Group (AIG, news, msgs), Aflac (AFL, news, msgs) and Arthur J. Gallagher (AJG, news, msgs).
Hey Modelman, whatever happened to Tony Kolton, the market historian you used to write about? Whats he think about war, peace and stocks?
Modelman: I found Kolton on his cell phone on Friday afternoon as he was shopping in Chicago. To refresh your memory, hes the brains behind the Market Information Machine -- a workstation that is used widely on Wall Street stock and commodity desks, as well as those of U.S. spymasters, to find meaningful patterns in historical data of any kind. He said 2003 is playing out just like every other year in the past that followed three consecutive down years: Up in January, down into mid-March, then higher into April. He said the pattern calls for increasing strength throughout the rest of the year, with the broad averages up as much as 25% by the end of December. He particularly likes highly speculative little biotech stocks like Paradigm Genetics (PDGM, news, msgs), Millennium Pharmaceuticals (MLNM, news, msgs) and Geron (GERN, news, msgs).
Hey Modelman, last question: I noticed that your source, the anonymous hedge-fund manager Mr. P., is described in Vic Niederhoffer and Laurel Kenners book, Practical Speculations as one of the greatest speculators of our era. What are his latest views?
Modelman: We last heard from Mr. P. in columns on March 19 and Feb. 12, when he accurately predicted that the market would bounce hard off levels just above the October lows -- bedeviling investors who planned to wait for those levels to be breached. He continues to believe that investors are generally too bearish. Although he expects regular corrections this spring and summer, he calls himself, with a bit of wistfulness, long and happy. This bout of positivism is tempered by the fact that, professionally, he prefers to be bearish because that is the stance most likely to be outside the mainstream. Mr. P believes that success as a trader stems from determining which large groups of stock or commodity holders have the greatest false belief -- and trading against them. At the moment, he thinks investors overestimate geopolitical threats and believes that the president will win large tax cuts in Congress, providing stimulus for the economy and a psychological lift for investors.
Fine Print
To keep track of S&Ps index moves, regularly visit its Web site. Achuthan publishes ECRIs weekly leading index on Fridays at ECRIs Web site. A minimalist view of Drachs market-timing and stock work can be monitored at the Web site of public televisions Nightly Business Report. Drach is a regular on the program. The strategy of buying shares of cheap, low-priced, heavily shorted S&P 500 companies that I recommended in my column last week, Stocks with a peace dividend, as well as in several other past columns, paid off handsomely last week with big gains in Mirant (MIR, news, msgs) and Avaya (AV, news, msgs). They were up 41% and 32%, respectively. Of course, not all my ideas have turned out so well. In a column on Nov. 30, I recommended General Dynamics (GD, news, msgs) long and Millennium Pharmaceuticals short. Since then, GenDyn has fallen 21% and Millennium has risen 46%. My S&P 500 Peace Dividend Portfolio rose 17.4% in the past week, lead by advances of Mirant (MIR, news, msgs), Dynegy (DYN, news, msgs), Avaya (AV, news, msgs), AES Corp. (AES, news, msgs), Calpine (CPN, news, msgs) and Lucent (LU, news, msgs), of 54%, 43%, 38%, 30%, 25% and 15%, respectively.
Jon D. Markman is senior investment strategist and portfolio manager at Pinnacle Investment Advisors. While he cannot provide personalized investment advice or recommendations, he welcomes column critiques and comments at supermodels@jonmark.com. At the time of publication, his fund was not long or short any stocks mentioned in this column, but positions can change at any time.
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