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Jubak's Journal
Recent articles:
• Indiscriminate selling creates 3 bargains, 6/16/2004
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3 techs that could buck the market tide
Low expectations may be techs big break. While the market as a whole muddles along, with consensus views already priced in, any surprises here could deliver outsized gains.
By Jim Jubak
Its time to start nibbling (and I do mean small bites) at a few technology stocks. Im not basing this on a hunch. Instead, Im listening to the Wall Street consensus.
The consensus on the five big-picture, macro trends -- oil prices, inflation, interest rates, earnings growth and the war on terrorism -- is by and large already baked into stock prices. News confirming the consensus opinion, therefore, doesnt significantly move prices. Instead, the likeliest big moves are all on the downside.
On the other hand, there is room for good-news surprises to move individual stocks up, especially in sectors where the Wall Street consensus is decidedly negative.
Right now, one place where I see good odds for the near term (thats the next month to three months) is in the technology sector. Not across the sector, mind you, but quite possibly for individual stocks. Its a risk, sure, but one that has a good chance of paying off.
5 macro trends
Look how little room there is for upside news surprises on the macro level right now.- Interest rates. The Wall Street consensus is that the Federal Reserve will raise interest rates by just 25 basis points (thats one-quarter of a percentage point) when it meets on June 29-30. Worries about a 50-basis point hike just about vanished on June 15 after the Consumer Price Index showed a very modest 0.2% jump in core inflation in May. After the price report, the Fed Fund Futures market was pricing in just a 14% chance of a 50-basis-point hike; before the report, the market had been pricing in a 35% chance. The shift from 35% worry to 14% worry was largely responsible for the June 15 rally in stock and bond prices. But the current consensus doesnt leave much room for further good news surprises. The consensus is likely to be right on interest rates, but that means only a limited pop to stock and bond prices from the actual confirmation of the consensus at the end of the month.
- Oil prices. Theyre headed lower, according to consensus, probably to around $34 a barrel by year end. This consensus is built on two elements. First, a belief that oil-producing countries, in particular Saudi Arabia, will be able to deliver on promises to increase production. Last week, for example, Merrill Lynch projected that Saudi Arabia could increase production by nearly 8% within four months and by 18% within 10 months to 16 months. Second, a belief that recent increases in oil inventories confirm this promised increase in production. In May, U.S. crude oil inventories climbed 2.4 million barrels to 302 million barrels, the highest end-of-the-month level in nearly two years, according to the American Petroleum Institute. U.S. crude oil stocks are up 34 million barrels since the end of 2003. However, the consensus is extremely fragile: There are a lot of dissenters in the markets. And it doesnt take much to bring them out. For example, the 800,000-barrel increase in inventories for the week ended June 11 took oil prices higher when it was announced on June 16, because the consensus had been expecting an increase of 2 million barrels. The lower inventory number raised doubts about how much extra supply might actually be available on world markets. If next week or next month delivers news that upsets the consensus, were likely to swing back to the consensus that prevailed just a few weeks ago, when everyone was worried about oil prices moving up from $42 a barrel. (Which would be good for oil stocks, in all likelihood.)
- Inflation. The current consensus has shifted from a fear that inflation was in danger of getting away from the Fed to a belief that inflation is running at a moderate annual rate of 2% or less. The May core inflation rate of 1.7% year-to-year is a key building block in this consensus because it is a slight decline from the 1.8% year-to-year increase in April. The big risk is on the downside if bad news on the inflation front leads to a return to the earlier fear consensus.
- War and terrorism. The financial markets increasingly (and, to me, amazingly) seem to shrug off a convoy ambush in Iraq that results in a dozen deaths or the kidnapping or murder of an American in Saudi Arabia. It is the changes in the levels of violence that produce moves in stock and bond prices. Odds are that well see more violence as the end-of-June deadline for transferring sovereignty to the Iraqis approaches.
- Earnings growth. The consensus here is very optimistic. Wall Streets industry analysts are currently projecting earnings per share growth of 20% for the second quarter of 2004, according to First Call, for the stocks in the Standard & Poors 500 ($INX), 14% growth for the third quarter and 15% for the fourth quarter. For earnings growth to drive stock prices higher from here, it will have to come in stronger than those estimates. Thats possible with the economy running at a solid 4.4% growth rate in the first quarter of 2004. But the consensus is still a high hurdle for earnings to jump for the market as a whole.
Shift your focus
The consensus on these five macro trends doesnt leave much room for positive news to drive stocks as a whole higher. The market is more likely to muddle higher, say 8% on the upside from here, for the rest of the year, but with periods of downside volatility as the more fragile of these consensus positions are upset by the news flow. (For more on that 8% projection for 2004 see my earlier column, written when the market was about 2% lower, 5 keys for a big finish to 2004.)
That leaves investors who want to do more than muddle through 2004 looking at the micro level for individual stocks that can deliver positive earnings news that isnt reflected in the current consensus. I have found such micro earnings potential in sectors such as oil and oil transportation, manufacturing and natural resources -- and added stocks to Jubaks Picks from those sectors in recent months.
Recently, the technology sector has started to show this same kind of promise for two reasons. First, because the technology sector doesnt get much respect from investors these days. And, second, because technology stocks have the earnings leverage to produce big upside earnings surprises. When the news is surprisingly good, its often really, really surprisingly good.
Take a look at a recent negative bit of technology news to see what I mean about the negative consensus on these stocks. After the close on June 15, Oracle (ORCL, news, msgs) delivered bad news. Although the company reported earnings for the fourth quarter of fiscal 2004 of 19 cents a share, a penny above estimates, it disappointed investors again on growth in its applications software business. Take away the effect of the weak dollar and this key part of the companys business showed a drop of 9% in the sales of new licenses. And that is a big disappointment to investors who have been waiting for Oracle to get its applications business growing for years now.
But thanks to the low opinion of the technology sector, the damage to Oracles price was limited -- the stock fell just 3% the day after its earnings report.
3 techs that may surprise to the upside
That negative consensus on the sector also sets up the possibility of big moves from stocks that deliver good news that goes against the dominant market opinion. And with the earnings reporting season now just about a month away, its a good time to look for potential earnings surprise stories in the sector that might strongly move individual stocks.
Ive got three candidates in mind.
Electronic Arts (ERTS, news, msgs), which took a hit when competitor Take-Two Interactive Software (TTWO, news, msgs) missed earnings projections, but where sales of the new "Harry Potter" game have started off strongly. The company stands a good chance of beating the consensus of 5 cents a share for the June quarter.
Analog Devices (ADI, news, msgs) raised its earnings estimates for the quarter that ends in July to 43-45 cents a share from 39 cents a share. I dont think the company is done, though. Analog Devices is picking up market share and looks to be growing 5% to 10% faster than its industry. The company has shown the ability to raise margins in recent quarters, and I think theres more of that ahead.
Marvell Technology Group (MRVL, news, msgs) has seen Wall Street earnings projections for the quarter that ends in July go to 36 cents a share from 33 cents in the last 30 days. But, as is the case with Analog Devices, I think the actual earnings report will supply even more good news. The company has introduced new products that are just now ramping up in new markets and continues to gain share in its bread-and-butter storage-device market.
Im going to add just one of these, Analog Devices, to Jubaks Picks right now. The next few weeks hold a lot of risk that bad news could disrupt the consensus on one of the big five macro trends, so Im staying cautious. Just nibbling at technology.
Changes to Jubak's Picks
Buy Analog Devices
Analog Devices (ADI, news, msgs) never gets as cheap as Id like, but the company is at a place in its growth cycle that to my mind justifies the price. The shares currently trade at about 23 times projected fiscal 2005 earnings per share; thats well under the 33 times forward earnings the stock commanded at the midpoint in the last cycle. The silicon content of just about everything is increasing, and that plays to the companys strengths. Its analog chips show up in wireless handsets, PCs, cars, wireless phone base stations, industrial machinery, airplanes, CAT scanners, smart bombs, digital cameras and DVD players. But Analog Devices isnt just along for the ride: the company is growing revenues faster than its industry and expanding margins in the process. Gross margins, recently 57%, will edge toward 60% in 2005, in my opinion. Im adding Analog Devices to Jubaks Picks with a target price of $60 a share by December 2004.
New developments on past columns
Its time to buy oil stocks, not sell them
The great debate on oil reserves goes on. A new study from Deutsche Bank reports that the major oil companies replaced only 75% of the reserves they pumped from 2001-2003, even though their Securities & Exchange Commission filings claim the companies replaced 116% of what they pumped. The discrepancy, says Deutsche Bank, is a result of companies booking older discoveries as new finds, and it blames the lower replacement rate on a cut of nearly a third in exploration budgets during these years. A Goldman Sachs report, however, may do the best job of getting at the really important issue: After a decade of underinvesting, oil-producing countries will have to spend $2.4 trillion over the next 10 years on finding, producing and delivering oil. Thats roughly three times what these countries spent in the 1990s. To support that kind of outlay, West Texas Intermediate Crude would have to sell for a minimum of $30 a barrel, Goldman Sachs calculates. That grade of oil sold for about $20 a barrel in the 1990s. Without the extra spending, Goldman reports, supply disruptions are likely to become more frequent and more severe in the years ahead.
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak did not own shares in any of the equities mentioned in this column. He does not own short positions in any stock mentioned in this column.
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