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Ride out a reversal with down-and-out stocks
With the S&P 500 sending an ominous signal, you might want to abandon big caps for something a little smaller -- or place a bet on dirt-cheap names with nowhere to go but up (maybe).
By Jon D. Markman
They might just be grumpy from the summer heat, but it suddenly seems like large-company stocks are glowering at bulls with their once-famous thousand-mile stare.
From 1965 to 1982, the Dow Jones Industrials ($INDU) bumped up against the 1,000 level five times without punching through, as investors were repelled at the millennium mark in June 66, November 68, December 72, September 76 and April 81.
Now it looks like dj vu all over again, admittedly on a much more abbreviated scale, with the S&P 500 ($INX). Disappointed big-stock bulls were first punched back at the 1,015 level in June, then in July at 1,015 again and at 1,011 on Friday. (Meanwhile, the Russell 2000 ($RUT.X), which tracks small-company stocks, hit a new two-year high last week.)
A trivial, short-term phenomenon? Perhaps, but bears and worried bulls will point out that the S&P 500 Index recorded its first outside reversal day since Jan. 15 on Friday. Thats a technical pattern, you may recall, in which the days high is higher than the previous days high, the days low is lower than the previous days low, and the close is at the extreme of the range, which amounts to a reversal of a strong prior trend.
Whats it all mean?
As I noted in a Dec. 4 column last year Ready for a nasty reversal of fortune?) and in my book, Swing Trading, this is a rare event that often plays out like this: If the stock or index was trending down during the weeks prior to the outside bar, then an outside reversal bar that closes at or near the top of the day tends to be bullish. It means that sellers gave it their best shot that day, but were swamped by buying pressure and laid down their arms. In contrast, if the stock or index was trending up during the prior weeks, an outside reversal bar that closes near the bottom of the day is bearish. It suggests that buyers gave stocks a final hard push but were overwhelmed by selling pressure.
The Jan. 15, 2003, outside reversal led to an immediate 11% decline through mid-February. The prior occurrence, on Dec. 2, 2002, led immediately to a 6% decline in the S&P 500 through the end of that month. (Upside reversals are equally rare, and have likewise worked out well for traders in the past year. One on Oct. 10, 2002, led to a trend reversal and a 19% gain over the next month. One on July 24, 2002, led to a trend reversal and 21% gain over the ensuing month.)
An outside days initial spike upward or downward typically occurs on unexpected news. On Friday, the news was a bullish mid-quarter update from Intel (INTC, news, msgs), which gapped up from a $26.39 close on Thursday to a $29 high on Friday before fading badly to close at the bottom of its range at $27.39. In December last year, it was a highly bullish report on Best Buy (BBY, news, msgs) earnings; the stock gapped from a $27.68 close on Nov. 29 to a $30.45 high on Dec. 2, but closed the day near the bottom of its range at $28.05. It then sank to $22 by the end of the month.
So does the outside reversal signal the end of this summers rally? Not so fast.
How to play the reversal
The market has a way of tricking us with neat historical comparisons. And there is one odd thing about Friday, which, if used as a clue in one of the mystery novels you may have read at the beach this summer, might have seemed just a little too cute. And that is that the same date, Aug. 22, proved to be a significant top for the market last year: The S&P 500 reversed and plunged 19% from that Thursday into its Oct. 9 low. The threat of an anniversary fade to darkness strikes many observers as just the clever sort of ploy that the market would employ to fake us out.
So if youre considering how to put cash to work at this confusing juncture, split the difference: Fade the big-cap growth stocks that dominate the S&P 500 and focus instead on small-cap growth stocks. Or, if youre patient and have a contrary streak, consider beaten-up big-cap value stocks.
This makes sense in the context of the larger economic climate today, after all, as away from the equity action -- in the obscure but critically important world of currency traders -- the U.S. dollar has just completed one of its most epic shows of strength in history. Since its low of 0.8432 against the euro on June 16, the buck has shot up to 0.9217, a gain of 9.3%. (For those who like to see the euro in dollars, the euro has weakened from $1.186 to $1.0874.) Either way, thats a huge move in the world of currency trade, nearly equaling the shock value and size of the June-July moon shot in the price of U.S. Treasurys.
The implication of the currency move for stocks could be significant, for as the dollar rises, the cost of U.S. goods in Europe and Asia soars. This makes the products of big U.S. conglomerates such as General Electric (GE, news, msgs), Procter & Gamble (PG, news, msgs) much more expensive, trimming sales prospects. Likewise, currency conversions from those sales will put large U.S. exporters, those big-cap growth companies, at a disadvantage in the third quarter. In contrast, small companies generally dont export much as they focus on the domestic U.S. market; their sales are, for the most part, unaffected by currency fluctuations.
To find annihilated big-caps that could be sold out and ready for accumulation by patient, early value buyers, screen the MSN Money database for stocks that are down in the past year and in 2003, sport fat dividend yields and are rated Hold or Sell by most brokerages. These down-and-out, much-hated stocks are largely the sort of defensive names that falter when the market rallies but can hold their own in a widespread decline. On Wall Street, its valuable to note that every dog has his day. Without picking just one, I would bet a small sum that, as a group, the stocks in this table outperform the broad market by the end of the year.
Drug maker Schering-Plough (SGP, news, msgs), which was obliterated for the umpteenth time this year on Friday after it cut its dividend and growth forecast, seems particularly interesting. One shell-shocked owner, John LaForge, co-manager at Phoenix-Hollister Value Equity (PVEAX), says his analysis suggests that at $14, the price is ridiculous, but if it were to sink to $12 it becomes hilarious. Believing that the companys break-up value is at least $17, and probably much higher, he adds: If you dont buy Schering at $12, you will be the laughingstock of the investment world.
| Down & out in the S&P 500 | | Company | % Chg YTD | % Above yr low | Price/sales | Div. yield | Last price | | Newell Rubbermaid (NWL, news, msgs) | -22.5 | 6 | 0.84 | 3.60 | $23.40 | | Winn-Dixie Stores (WIN, news, msgs) | -34.8 | 7 | 0.12 | 2.00 | $9.97 | | Schering-Plough (SGP, news, msgs) | -32.6 | 7 | 2.39 | 4.50 | $14.96 | | Great Lakes Chemical (GLK, news, msgs) | -9.8 | 10 | 0.76 | 1.70 | $21.54 | | H.J. Heinz (HNZ, news, msgs) | -2.3 | 11 | 1.38 | 3.40 | $32.11 | | Transocean (RIG, news, msgs) | -12.8 | 12 | 2.51 | 0.00 | $20.22 | | Amerada Hess (AHC, news, msgs) | -15.9 | 13 | 0.31 | 2.60 | $46.31 | | Eastman Kodak (EK, news, msgs) | -19.6 | 17 | 0.63 | 6.40 | $28.17 | | Coca-Cola (KO, news, msgs) | -1.3 | 17 | 5.24 | 2.00 | $43.28 |
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Somewhat less compelling at this time are consumer stocks such as Newell Rubbermaid (NWL, news, msgs), which owns a fantastic portfolio of brand names -- such as Sharpie, Waterman and Parker pens, Rubbermaid containers, Calphalon cookware, Little Tikes toys and Levolor blinds -- but cannot seem to wring significant growth out of any of them. The companys relatively new chief executive, Joseph Galli, showed confidence in the stock by buying $580,000 worth of shares in the open market this month. But he also recently lowered earnings guidance, in part because of weakness in a segment as seemingly inconsequential as its picture-frame business.
As for growth stocks, one industry that seems to have its customers by the neck is software security. It doesnt take a genius to see that Symantec (SYMC, news, msgs) and Network Associates (NET, news, msgs) have nailed down annuity-like businesses of selling consumers and enterprises anti-virus software packages that need to be updated every few weeks to knock down the latest threats. I enhanced Symantecs bottom line by buying three new licenses myself last week for my work and home desktops, plus my work laptop. The stocks arent cheap, but Symantec is one of the few companies for which the bear market basically did not exist. Every so often, it gets hammered for a few days or weeks, though, so try to buy it under $45 in the fall, once the Sobig and Blaster furor dies down.
Fine Print
To learn more about Schering-Plough, visit its Web site. The companys Coppertone division makes two of my favorite summer 2003 products: Bug & Sun, which combines sunscreen and insect repellent, and Kids Sport Lotion Spray, which is by far the easiest way to get sunscreen on children, since theres no rubbing required. Its possible that my family is the worlds largest single user of permanent-ink Sharpie pens, a division of sad-sack stock Newell Rubbermaid. Did you know it comes in silver? Mail sent to me in the last two weeks to my jdm@oddpost.com address has been obliterated by the Sobig virus. Ive started a new address, as shown below.
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 jmarkman@oddpost.com. At the time of publication, he had no positions in stocks mentioned in this column.
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