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Black eye for the blue chips
From insurance scams and recalled drugs to simply weak planning, so many stocks in the Dow Jones Industrial Average are struggling that the index is trailing the market.
By Jon D. Markman
How now, cowed Dow?
For the first time since the start of the bear market in 2000, the Dow Jones Industrial Average ($INDU) is the worst performing and most scandalized major market proxy over a calendar-year period. And its 5% decline so far in 2004 -- capped by a 100-point slide last week when giant insurer American International Group (AIG, news, msgs) was accused of bid-rigging -- has left it straggling behind the Standard & Poors 500 Index ($INX), down 0.5%, the Nasdaq 100 ($NDX), down 2.5%, and even the Nasdaq Composite ($COMPX), down 3.1%. The Amex Composite ($XAX.X), which is loaded with oil companies, is up 10%.
Its not just AIG. This stunning state of affairs has resulted from months of intense attacks on several of the worlds largest companies for failures financial, strategic and moral. Where two years ago fans of the very large companies that comprise the Dow Jones industrials could lord their superiority over the brash upstarts at the S&P and Nasdaq, they have now been forced to face up to a woeful record of long-ignored shortcomings. The Dow is suddenly a lion in winter.
Cut down in broad daylight
The humbling of the mega-cap index is not trivial. It is emblematic of an economy that has lost its leadership. Imagine an army with no generals or a major-league team without a coach. It was one thing when billions of dollars were lost as overvalued Internet stocks slammed the Nasdaq Composite four years ago; it was easy to say that an unknowledgeable class of retail investors got what was coming to them. But it is quite another when stocks in the mainstream of American life -- brand names, all -- are cut down in broad daylight due to their own mistakes.
Its hard to believe that these self-inflicted wounds will heal quickly or well -- a development that sets a worrisome tone as stocks head into the time of year that typically delivers the best returns. Yet some names in related Dow Jones indexes may find favor instead, as Ill note in a moment.
The latest blow for the Dow came last Thursday when two executives at AIG pleaded guilty to charges of price-fixing and collusion in the insurance industry. AIG was, ironically, added to the index just a few months ago, in part due to its reputation for probity as the nations largest insurance company. The revelation whacked AIGs value by 10%, obliterating $18 billion worth of shareholder wealth.
Prior Dow downers in this season of sanction were Merck (MRK, news, msgs), which lost a third of its value after recalling a highly profitable analgesic linked to heart disease; Coca-Cola (KO, news, msgs), which lost a fifth of its value after warning investors that its worldwide product pricing strategy had failed; and General Motors (GM, news, msgs), which has lost 27% of its value in 2004 amid confessions that it cannot find enough buyers for its cars, even while offering interest-free loans.
Many of the rest of the stocks in the Dow are not much better off. The rogues gallery includes Intel (INTC, news, msgs) and Hewlett-Packard (HPQ, news, msgs), which cant find enough buyers for their semiconductors and computers; cigarette maker Altria (MO, news, msgs), whose future remains a haze of smoker lawsuits; aluminum producer Alcoa (AA, news, msgs), which is so messed up it cant make money even when aluminum prices are at all-time highs; and banker Citigroup (C, news, msgs), which is mixed up in scandals ranging from its role in the Enron debacle to its links to the Saudi terror underworld. Meanwhile, Wal-Mart Stores (WMT, news, msgs) shares are flat as management ponders what comes next after becoming the largest and most disliked retailer in the world.
In August, I proposed that investors could prosper this year not by overtly buying the best of the large-cap stocks in the Dow Jones industrials, but by avoiding the worst. (Read Dont pick winners -- avoid losers.) I used the StockScouter system to choose seven of the 30 names, and they have indeed outperformed so far: up 2.5% over a span that has seen the full index decline by 1%. The method has so far nicely sideswiped the recent Merck, AIG, General Motors and Coca-Cola fiascos -- focusing instead on better-acting components like McDonalds (MCD, news, msgs), +12%, and Exxon Mobil (XOM, news, msgs), +8%
Where theres opportunity: Transports and utilities
As the third-quarter earnings season continues in earnest this week, Id like to propose another alternative to blind Dow indexing for the large-cap segment of your portfolio. Consider leaders among the companies that make up the less-celebrated Dow Jones Transportation Average ($TRAN) and the Dow Jones Utilities Average ($UTIL). Theyve done exceedingly well this year as a group -- both are up more than 12% -- and appear poised for further success after recent pullbacks.
| 11 top-rated Dow transports and utilities | | % chng. YTD | Recent price | Dividend
yield | P/E ratio | StockScouter
rating | | Dow Jones transports | | | | | | | Ryder System (R, news, msgs) | 39.5 | $47.64 | 1.3 | 17.4 | 9 | | Norfolk Southern (NSC, news, msgs) | 32.2 | $31.27 | 1.3 | 22 | 9 | | Burlington Northern (BNI, news, msgs) | 22.8 | $39.72 | 1.7 | 16.9 | 9 | | Yellow Roadway (YELL, news, msgs) | 33.7 | $48.35 | 0 | 25.9 | 8 | | CNF (CNF, news, msgs) | 38.8 | $47.05 | 0.9 | 23.1 | 8 | | USF (USFC, news, msgs) | 10.4 | $37.74 | 1 | 28.2 | 8 | | Expeditors Int'l (EXPD, news, msgs) | 44.7 | $54.50 | 0.4 | 43.3 | 8 | | Dow Jones utilities | | | | | | | Duke Energy (DUK, news, msgs) | 16.1 | $23.74 | 4.6 | N.A. | 9 | | FirstEnergy (FE, news, msgs) | 18.4 | $41.67 | 3.6 | 20.6 | 9 | | PG&E (PCG, news, msgs) | 11.3 | $30.91 | 0 | 3.3 | 9 | | TXU (TXU, news, msgs) | 108.6 | $49.49 | 1 | 20.5 | 8 |
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Its interesting to note that many of these had a turn in the stockade a couple of years ago and are now in the middle of recoveries.
Among the utilities, FirstEnergy went from $38 to $25 in a couple of weeks in the summer of 2003 after being implicated in a big East Coast power blackout; PG&E went from $32 to $6 as it filed for Chapter 11 protection amid Californias energy crisis in 2000-2001; TXU went from $56 to $10 in a matter of weeks in mid-2002 after suffering guilt-by-association in the Enron affair and big losses in its European operations.
Among the transports, Ryder shares sank steadily for five years from 1998 to 2001, before bottoming out and going on to triple; same with Norfolk Southern. Most of the others on the list, especially Yellow Roadway and Expeditors International, have done very well for many years, through all kinds of market climates.
Theres little doubt that Merck, Coke, GM and AIG -- the wounded big caps of the Dow Jones industrials -- will experience their own rebounds in the fullness of time. But for now, and probably the next three to 12 months, they are under house arrest. Leave them there until they can prove they no longer deserve their punishment -- not just with promises that theyll do better, but with deeds.
Fine Print
Thanks for the scores of e-mails on the market views of Mr. P. Quick calming word to those of you who were freaked out by his call for a resumption of the bear market. Although he is quite certain of his forecast, he would be the first to admit that he is not always right. . . . Said reader Brock Nagy: I agree with Mr. P. Why? Because the last recession was caused by Alan Greenspan raising interest rates at the same time oil prices and the euro were rising. When will this guy learn? Here we go again. . . . Brad Brooks, a portfolio manager at Value Line, wrote to say, in part: Recession by late 2004 would seem to be a 50% chance -- and of course the question is when does the equity market price that in? Probably the first half of next year. . . . Energy is clearly the place to be since even at $35 to $40 oil next year, most companies will have higher earnings than in 2004, which the Street hasnt figured out yet for some reason. Of course, if oil goes to $60 and only falls back to $50, it is a home run.
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, he held positions in the following stocks mentioned: Expeditors International, Yellow Roadway, Exxon Mobil, Coca-Cola.
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