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Jon Markman received the Gerald Loeb Award for Distinguished Business
and Financial Journalism
in 2003.
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Don't pick winners -- avoid losers
Use our Stock Screener and StockScouter to weed through an index like the Dow or S&P 500. Keep the best, trash the rest, and you'll be beating the market.
By Jon D. Markman
If you drop an anvil off a skyscraper, it will pretty much fall in a straight line. But equities rarely fall straight down, even in a bear market. They flutter around much like paper airplanes tossed out of a 40th-story window -- mostly heading down, but abruptly interrupting their glide path from time to time with an unexpected upward zoom before inverting and resuming their death spiral.
With both stocks and paper airplanes, the steepest short-term descents often precede the most spectacular short-term ascents. In the market, technical analysts call the downward leg of this dynamic an deeply oversold condition, a term that no one can explain well but essentially means that stocks are down so much they just have to go up a little as short-sellers take their profits by buying some shares back. (Short-sellers borrow stock and then sell it, hoping to replace the borrowed shares with stock purchased at a lower price.)
After virtually seven consecutive weeks of substantial decline, almost every measurer of the market suggests that stocks are in that condition now. And if they are, what can we do about it, particularly if the condition yields just a temporary lift in a broad move down? Heres a two-part answer.
Inclusion or exclusion?
Normally, investing is a process of inclusion. You start with a few of your favorite stocks and add one after another until you have a portfolio of 10 to 100 names. If your goal is to achieve 10% to 12% annual growth -- a bit better than the market historically -- then you have to take on some risk. To get 12% growth, you probably have to risk at least a 5% decline, or worse.
But if you're a professional manager, or aspire to be one, your sole goal might be to beat a broad market benchmark, such as the performance of the Standard & Poor's 500 Index ($INX) or the Dow Jones Industrial Average ($INDU). In a bearish climate, such as the one prevailing now, you dont have to achieve an absolute, or positive, return, just a return thats better than your target.
One unusual method to achieve the bogey-beating goal is through process of elimination: Rather than picking stocks to buy, pick the ones to avoid. Then you can buy an exchange-traded fund representing the index and short the expected losers. Or if you dont wish to short, then just delete the stocks in the index that dont meet your criteria for success and buy the rest.
Picking an index
The easiest index to do this with is the Dow Jones industrials, since there are only 30 instead of 100 (in the case of the Nasdaq 100 ($NDX)) or 500 in the case of the S&P 500. We can go through the exercise first by using StockScouter ratings, then by layering those results with technical criteria.
For the former, visit the Deluxe Screener tool at MSN Money. In the first field name, choose Company Basics and click on Dow Jones industrials. In the Operator field, choose the equals sign. And in the Value field, choose DJ industrials. Then move down to the second row, choose StockScouter Rating and click on Rating. In the operator field, choose the greater than sign (>/=). And in the Value field, choose the number 8. You can then add any other criteria you like, such as Stock Price History / Last Price, with display only as the operator; or Price Ratios / Current P/E with display only as the operator. Here is the screen, and here were the results on Monday, Aug. 16:
| StockScouters Dow 11 | | Company | SS rating | 8/16 price | P/E | Sector | Market cap | | Citigroup (C, news, msgs) | 9 | $44.75 | 14.6 | Finance | $231 billion | | Johnson & Johnson (JNJ, news, msgs) | 9 | $56.08 | 18.9 | Health care | $166 billion | | Altria (MO, news, msgs) | 9 | $47.55 | 10.3 | Consumer non-durables | $97 billion | | Exxon Mobil (XOM, news, msgs) | 9 | $45.02 | 13.8 | Energy | $292 billion | | General Electric (GE, news, msgs) | 8 | $32.18 | 20.8 | Capital goods | $339 billion | | Honeywell (HON, news, msgs) | 8 | $35.35 | 21.9 | Capital goods | $30 billion | | McDonald's (MCD, news, msgs) | 8 | $25.87 | 18.8 | Consumer services | $32 billion | | Microsoft (MSFT, news, msgs) | 8 | $27.16 | 36.5 | Technology | $295 billion | | Pfizer (PFE, news, msgs) | 8 | $31.33 | 30.3 | Health care | $236 billion | | Procter & Gamble (PG, news, msgs) | 8 | $54.86 | 23.6 | Consumer non-durables | $142 billion | | SBC (SBC, news, msgs) | 8 | $25.47 | 15.9 | Public utilities | $84 billion |
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Its nice to see that StockScouter has eliminated almost two-thirds of the Dow stocks from our consideration. As you can see, there are no Dow stocks rated 10, but since we're only eliminating the stocks that StockScouter deems inferior (rated 7 or less), it doesnt matter. The 11 names on our list cover almost every market sector.
StockScouter, you may recall, attempts to highlight stocks that should outperform their peers over the next six months with a minimum of volatility. The rating compacts sub-ratings for each companys valuation, growth, price advancement and insider buying into a single number, then balances its return expectation against the risk an investor needs to take on to achieve that return. Ratings of 1 to 10 are given on a bell curve, with 10 being best and given to the fewest stocks. Companies rated 8, 9 or 10 are all expected to be good performers. In the past three years, the system has achieved sterling results, beating the pants off all the indexes.
Breaking it down
Purists would simply take the names on the list and buy them as a basket without further review. Many investors would look at the charts as well, though, ignoring the fact that theyre adding a level of subjectivity that may detract from results. Half of the names on our list are in modest uptrends or sideways patterns with a positive bias: Exxon Mobil (XOM, news, msgs), Johnson & Johnson (JNJ, news, msgs), General Electric (GE, news, msgs), Honeywell (HON, news, msgs), Procter & Gamble (PG, news, msgs), SBC Communications (SBC, news, msgs) and Microsoft (MSFT, news, msgs). (Microsoft owns MSN Money.) A couple that are in downtrends look potentially primed to rebound from recent basing patterns, such as Citigroup (C, news, msgs) and Altria (MO, news, msgs). Two others, Pfizer (PFE, news, msgs) and McDonalds (MCD, news, msgs), look pretty ugly, but they could surprise people. The nice mix of chart patterns in the group shows that StockScouter isn't biased toward any particular type of trend.
Wish to narrow the list down further? Pfizer is in a long-term downtrend, as measured by a weekly chart of its performance over the past five years. It should recover, but perhaps not within six months. Same for SBC Communications, General Electric and Microsoft. That leaves us with the following, ranked by their technical action over the past four- and one-year periods.
| Supermodels Dow 7 | | SS rating | 8/16 price | Daily chart | Weekly chart | | Honeywell Intl | 8 | $35.35 | Positive | Very positive | | Citigroup | 9 | $44.75 | Basing | Barely positive | | Procter & Gamble | 8 | $54.86 | Mildly positive | Positive | | Johnson & Johnson | 9 | $56.08 | Basing | Positive | | Altria | 9 | $47.55 | Basing | Barely positive | | Exxon Mobil | 9 | $45.02 | Positive | Positive | | McDonald's | 8 | $25.87 | Negative | Barely positive |
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If the bear continues to growl at our door, these stocks may not actually provide positive returns as a group over the next six months. But with any luck, they should outperform their 23 peers in the index with lower volatility -- and perhaps the broader market as well.
Fine Print
Thanks to the scores of readers who responded to my series of columns on Saudi Arabia and peak oil. There will be several more columns to come this year on the subject focused on conservation and alternative energy sources. . . . I received several e-mails from readers in Somalia, of all places. Nice to know MSN is read in Africa. Wrote Amed G. Farah: It was in early 1988 when Chevron started the exploration and rigging our wells and then blocked the deal after the civil war started in my country, formerly Somalia and presently Somaliland. As a chemical engineer with flashing hopes of my resources, it seems to me it is the right time for Chevron and any American oil company to seek such a golden opportunity and forget the new challenges of the oil shortages. I always walk the oil fields known for Chevron, and we dream to see Chevron come by and start shipping the crude oil. For your information, our country has regained its independence from the old brutal regime that has fallen 10 years ago. We enjoy peace and stability with some developmental progress, but very unfortunately, the world ignores us, including your Uncle Sam.
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 ExxonMobil, Citigroup, General Electric, Microsoft, Honeywell.
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