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Why the market's pivot point is . . . right now
This week could make all the difference, so hold on to your hats and focus on the sectors in favor. And those aren't going to include the tech sector.
By Jon D. Markman
Stocks are at a real crossroads this week, as a trifecta of market, political and economic and events conspire to make this potentially the most pivotal period of the year. The outcome could determine the next several months.
If stocks end this week down, conservative growth investors may wish to sit the next couple of months out in cash, as an increase in downward volatility could sap their willingness to wait out the severe downdrafts that may lie ahead. More aggressive private investors may wish to use the StockScouter ratings as a guide to acquire portfolios that could provide buoyancy, and perhaps even an absolute lift, in difficult seas. (See suggestions below.)
The problem is that this year is shaping up to look much more like 1997-1999 or 2000-2002 than 2003. In those earlier periods, there were distinct groups of stocks that went up most of the time and distinct groups of stocks that went down most of the time. In contrast, in 2003 almost everything went up -- an unusual circumstance that lulled many investors into complacency.
Dont look back
To stay on the positive side of the ledger this year, investors need to focus their attention on the sectors and market-capitalization segments that are in favor, and not pine for the past or hope for the best. That means a locked-in attention to small- and mid-sized names in energy, steel, real-estate investment trusts, defense and utilities, and blinders when it comes to the formerly go-go technology, retail and biotech sectors, except for occasional trades.
Whats going on? After slopping around the flat line for months, the Dow Jones industrials ($INDU) took a turn for the worse last week and slipped to a -3% return for the year, while the Nasdaq Composite ($COMPX) sank to the -6% level. Even small-cap and mid-cap stocks, the last refuge of the past three years, ended the week slightly down for the year. When you consider that the Nasdaq was up as much as 7% this year, thats a tremendous descent. The last person to buy into the Nasdaq 100 (QQQ) exchange-traded fund in January is in a world of hurt, and hes got a lot of company.
The recent declines have pushed big-cap stocks below levels that have provided support in the past: Their 200-day moving averages -- or the average price paid over the past 50 weeks. While investors who strictly pay attention to business fundamentals consider these levels little more than squiggly lines on a price chart, many sophisticated trading systems at hedge funds and brokerages are geared to sell stocks aggressively when the indexes sink beneath these levels.
The trouble with the bullish view
The optimistic point of view on the recent erosion is that stocks have simply gone back to their lows of the year for the third time after already being near their highs of the year three times. According to world-weary bulls, that is the very definition of a good, old-fashioned trading range -- and nothing to worry about. The fact that the top of the range, at around 1,150 for the S&P 500 Index ($INX), has gotten progressively lower (although only slightly) is not pretty, the bulls admit. But they say its more important that the size of the corrective phases has fallen well within historic norms. Their mantra: Quit your whining. Buy stocks at the bottom of the range (i.e., right now) and sell them at the top of the range (i.e. perhaps in a few weeks), and all will be fine.
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Whats wrong with this broadly bullish view is that the market always operates on the two axes of time and price. Sometimes time is important, and sometimes price. Big-cap bulls are focused on price at the moment, but after a long period of slop it often turns out that time is more critical. Thats because the longer it takes for an expected positive event to occur (e.g., a sharp rebound from the bottom of a range), the more impatient potential buyers become. The 200-day moving averages, which had been rising, plateau and begin to decline. At some point, shareholders decide to stop waiting for reinforcements to arrive and simply liquidate their positions on the next kerchunk of bad news. If this happens en masse, the bottom can drop out of a quiescent range-trading market, resulting in a sharp, fast collapse.
Love that perverse diversity
Will such a collapse occur? It could happen for many popular stocks, while others cruise along just fine. The market is perversely diverse. The late 1990s are best remembered for the dramatic rise in large technology stocks, but you may recall that large value stocks, as well as non-tech small-cap stocks, were systematically ruined. Similarly, in the 2000-2002 period, tech and energy stocks were trashed but small and medium-sized regional banks, home-builders and real estate investment trusts all advanced to new highs as if they hadnt a care in the world.
Paul Desmond, head honcho at the institutional research firm Lowry's Reports in Florida, says that this sort of complexity probably has always existed in the market but statistical measures were not set up to capture it. Today, the market is sliced and diced a million different ways via a variety of indexes that let us understand micro-climates within the big market ecosystem. He believes that big-cap Nasdaq stocks may be headed back to their 2002 lows while relatively cheap makers of steel, oil and gas drillers, coal miners and munitions makers gun to new highs.
Indeed, he notes that if investors would stop fixating on the Nasdaq or market-cap weighted S&P 500 Index and look at a broader range of stocks, theyd feel a lot more comfortable. He says his firms unweighted index of New York Stock Exchange domestic operating companies -- that is, the NYSE Composite minus closed-end funds, preferred shares and foreign companies -- hit a new high in late June and is only slightly off that level now. On the Big Board you have the majority of stocks still going up, he said.
'Weapons of mass delusion'
As for those pesky tech stocks, well, it could get ugly. Michael Belkin, the dour independent analyst who is virtually alone in having predicted the absolute rout of the semiconductor group this year, has the hot hand in this arena. In an interview on Friday, he said he was sticking to his May and October comments that defensive consumer products companies will outperform their peers in 2004 and that tech stocks are headed straight back to their 2002 lows. (See details in my columns "Prepare for the worst, market seer warns" and "Market prophet is battening the hatches.")
He chided mainstream Wall Street analysts for having suffered an intelligence failure on par with CIA and FBI analysts for hyping such weapons of mass delusion as the notion that the 2003 rally meant the world was experiencing a lasting industrial economic recovery. As investor sentiment shifts toward an understanding that 2003 was merely a cyclical bull rally within a big bear market, he believes, sustained liquidation of mutual funds a la 2001-2002 should ensue. He points out that the Nasdaq, S&P 500 and European indexes are all stuck at their declining 200-week averages, which is the distinguishing characteristic of a long-term downtrend.
| StockScouter Picks for Summer-Fall 2004 | | Company name | July 20 price | Market cap | Industry | | Valero Energy (VLO, news, msgs) | $77.20 | $10 B | Oil & Gas Refining & Marketing | | Nucor (NUE, news, msgs) | $79.00 | $6 B | Steel & Iron | | Burlington Resources (BR, news, msgs) | $37.85 | $15 B | Independent Oil & Gas | | Lone Star Technologies (LSS, news, msgs) | $33.68 | $956 M | Oil & Gas Equipment | | Amerada Hess (AHC, news, msgs) | $83.19 | $7 B | Oil & Gas Refining & Marketing | | Starbucks (SBUX, news, msgs) | $46.43 | $18 B | Specialty Eateries | | Chesapeake Energy (CHK, news, msgs) | $15.57 | $3.8 B | Independent Oil & Gas | | Edison International (EIX, news, msgs) | $26.44 | $8.8 B | Electric Utilities | | Williams Companies (WMB, news, msgs) | $12.33 | $6.5 B | Oil & Gas Pipelines | | EOG Resources (EOG, news, msgs) | $62.80 | $7.3 B | Independent Oil & Gas | | Ultra Petroleum (UPL, news, msgs) | $43.23 | $3.2 B | Independent Oil & Gas | | Oregon Steel Mills (OS, news, msgs) | $15.49 | $397 M | Steel & Iron | | Peabody Energy (BTU, news, msgs) | $58.00 | $3.6 B | Industrial Metals & Minerals | | NS Group (NSS, news, msgs) | $19.00 | $400 M | Steel & Iron |
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The two big factors
My own view is that the improvement of energy and steel stocks has not anticipated a worldwide economic rally, as most economists seem to believe, but rather two separate phenomena:- Its possible that energy is up in anticipation of weakening supply (lower production of oil from the Middle East) and rising demand (the prospect of a colder-than-usual winter in Europe and the United States).
- Its possible that steel, copper and coal are rising because central banking authorities in China have not succeeded in dampening growth in the provinces, and world basic-material exports are rising again to fill its massive industrial maw.
By the same token, its possible that most other stocks are sinking in anticipation of a slowdown in economic growth and consumer demand in the United States and Europe, as well as the prospect of higher taxes in a Kerry-Edwards administration. If the broad indexes close near their low at the end of this week, just prior to the Democratic Convention, watch out below.
Fine Print
Heres a link to the StockScouter screen that I used for todays piece. . . . Desmond at Lowry's made a very timely call on the market rebound last year. As noted in my April 23, 2003 column, he announced to subscribers on March 17 that the great bear market of 2000-2003 had come to an end and that stocks had entered a "primary buying zone." He stuck with that call all last year.
Jon D. Markman is publisher of StockTactics Advisor, an independent weekly investment newsletter, as well as senior strategist and portfolio manager at Pinnacle Investment Advisors. While he cannot provide personalized investment advice or recommendations, he welcomes column critiques and comments at jon.markman@gmail.com; put COMMENT in the subject line. At the time of publication, Markman had positions in the following stocks mentioned in this column: Starbucks, Edison International.
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