KORNER REPORT / Investing & Market Kommentary - 3
New York
Investing
Throw Out The Rulebook
No investment rule book, no history lesson could possibly prepare investors for today's markets. This week, as President Clinton's impeachment trial began and Brazil's currency collapsed, the Dow dove. But then, like some Hollywood hero, it recovered. Somehow, against a backdrop of tremendous turmoil, optimism prevails. Record consumer confidence, tiny inflation, insignificant unemployment, low interest rates, strong profits. Gravity defied, yet again.
Value Lie Manager Alan Hoffman's view seemed to sum up the late-week mood: “We're probably setting up a pretty good base for rational expansion in 1999,” he told CNBC.
Indeed, the Dow shot up more than 220 points on Friday after falling more than 500 points in the first four days of the week.
Regarding Brazil, a sense of been-there-done-that has taken hold, at least for the moment. No matter how dire the economic situation appears — with its implications for the rest of South America and the developing world — investors remain determined to take solace in stock market resiliency. Notably, Brazil's stock market soared an unheard-of 33 percent on Friday.
Art Cashin, director of floor operations for PaineWebber at the New York Stock Exchange, noted this week on CNBC that investors see the Brazilian situation as nothing more than a rerun of last summer's Asian/Russian currency crisis — an event that sent U.S. shares plummeting at first, only to return to new highs. He sums up the common view this way: “Wait a minute, I've seen this movie before, back in August. Nobody dies at the end. I think I'll buy everything.”
The Internet — Just a Craze or History in the Making
Once upon a time, railroads were the “next big thing.” Will the Internet prove as profitable?
“Every invention doesn't create the same ripples in the economy,” write Michael Cox and Richard Alm in their new book Myths of Rich and Poor: Why We're Better Off Than We Think.
While the parachute was useful, for instance, it wasn't an earth-shattering invention. The Internet, on the other hand, just may be.
Why? What makes the Internet an invention for the ages — and not just the latest fad?
Internet's Rapid Entry
For one thing, people have adopted the Internet faster than most any other information-age invention.
The first mass-produced automobiles chugged down American roads in the early 1900s, but it took 55 years for even a quarter of U.S. households to buy an auto. The personal computer fared better; within 16 years of its introduction, a quarter of U.S. households owned one. Adoption time for the cellular telephone, introduced in 1984, shrank to 13 years.
In 1991, the World Wide Web made the Internet accessible to anyone with a computer and a browser, and in less than ten years the 'Net has reached 25% of the population, says Cox, also a senior economist with the Dallas Federal Reserve Bank.
Creating New Industry
For another, the Internet has spawned another industry: E-commerce. The Internet is changing the way people spend their money, says William Sterling, global strategist for Credit Suisse Asset Management and the co-author of Boomernomics.
According to Jupiter Communications, nearly 10 million American households will have high-speed Internet connections by the year 2001, and coupled with advances in payments and securities technologies, “will in all likelihood put on-line commerce into hyperdrive.” The value of electronic commerce is expected to reach a staggering $223 billion over the next four years, up from just over $11 billion in 1997, he adds.
Still, the Internet interest has the smell of a “mania,” says Joseph Aaron, a San Francisco-based investor in technology hedge funds. The behavior of investors bears a suspicious resemblance to those who bought into the Dutch tulip bulb craze in the 1700s, when speculators — and later, the man on the street — paid enormous sums for rare bulbs, then lost fortunes when the flower bulbs went out of style and bottom fell out of the market.
21st Century Radio?
On Wall Street, many have compared Internet stocks of today to radio stocks circa 1929. Not only did the stock market rocket to new highs before crashing that year, but radio, the newest craze, and broadcast industry-related stocks, started a slow decline that ended with the death of empires such as RCA.
Internet stocks are similarly volatile. TheStreet.com Internet Sector index lost 35.73, or 6.6 percent, to 506.34, in a single day this week. And 'Net stocks themselves yo-yo seemingly uncontrollably. For example, Yahoo! tumbled as low as 332, then rebounded as high as 406 before closing off 8 percent at $368 a share in one recent trading session.
So do Internet stocks — and the frenzy surrounding them — signal a peak in the 'Netizen craze and a future downfall for the industry? Assuming the Internet joins the lexicon of American inventions, and isn't just a fad, some think most of the money may have already been made.
“Investors [in Internet stocks] are not out there buying Amazon.com because they can make a case for sound fundamentals of the companies, most of which are losing money. It could end badly at some point,” says Aaron.
Analyzing Wall Street's Analysts
A Stanford study finds the pros are often too bullish, and slow
to downgrade. But their advice can lead to strong returns
Wall Street analysts help investors navigate among a sea of stocks in a fast-moving marketplace. However, a series of groundbreaking studies from Stanford's Graduate School of Business gives the analysts mixed ratings. The research found these market-watchers are often overly optimistic, biased and slow to report negative findings. But the good news is that investors who carefully follow analysts' recommendations are likely to see strong returns
Aanalysts track companies' performances, judge businesses against their competitors and offer earnings and stock performance projections. But in this age of market frenzy, many analysts — such as Mary Meeker of Morgan Stanley Dean Witter, who backed America Online when it was having troubles, and Henry Blodget of CIBC Oppenheimer, who made an exceptionally bullish call on Amazon.com late last year — have achieved minor celebrity status.
As a group this reputation is not well-deserved, said money manger Bill Fleckenstein.
“People think analysts are objective and really they are not. There is a tremendous bias against their ever being negative in the first place. Secondarily, there is tremendous pressure from corporate finance and from [analysts'] management to be biased toward the positive,” said Fleckenstein, president of Fleckenstein Capital.
The studies, by Stanford professor Maureen McNichols and London Business School researcher Patricia O'Brien, concluded that while analysts may not be trying to mislead investors deliberately, as a group analysts are “persistently over-optimistic.”
(The major brokerage firms declined to comment on the study's findings.)
Process Of Self-Selection
What leads an analyst to pick certain stocks while ignoring others? To find out, the two accounting researchers analyzed the analysts — 523 individuals at 129 brokerage houses, covering 3,774 companies.
The study found that analysts are less likely to report bad news than good because they self-select what they cover. In other words, they add coverage when their information is favorable and drop coverage when it's not. The bad news rarely shows up in their forecast reports.
That doesn't surprise professional money mangers. “If you think about human beings, rather than analysts, humans are optimistic creatures. They like to deal with the fascinating side of things and to avoid the dark side,” said John Bollinger, who runs a capital management firm and the Equity Trader Web site, which rates and tracks stocks.
This bias shows up in a number of ways. According to the Stanford study, return on equity was greater for stocks the analysts had recently added to their coverage than stocks with previous coverage. Returns were even lower for stocks that were dropped from coverage altogether. Stocks that weren't covered by any of the analysts studied showed the lowest return on equity.
Accentuate The Positive
Why the emphasis on the positive? The study speculates that analysts prefer to maintain good relationships with the corporate management of the firms they follow. The parent company for many analysts is an investment bank, and the businesses analysts follow may be potential or current clients.
“Analysts clearly have two conflicts of interest. Their primary clients are large institutional investors. They owe the most immediate information to them. At the investment banks, many of the firms they cover are also clients. They have some reservations about publishing bad news about corporate clients,” said Bollinger.
This may explain why analysts are slow to make bad news public. The study found that the median number of days between an upgrade of a stock was 98, but the number of days between downgrades was 127.
The study found that large fund managers may get preferential treatment by analysts who tip the managers off about upcoming corporate trends that may be negative. The fund managers can then re-arrange their portfolios before the bad news hits Wall Street in official earnings announcements.
But despite these concerns, one of the most important questions is how helpful analysts' ratings are to investors. The study found that, of the analysts surveyed, if their recommendations were followed to the letter, investors' yearly returns would average 12 percent higher than a benchmark index similar to the S&P 500.
However, that's unlikely to happen. The study found that analysts often recommend buying stocks in undervalued small- and medium-sized companies. But investors are often slow to act on stocks they don't know and the analysts' advice often goes unheeded.
Garzarelli Says Market Made A Healthy Correction
The Brazilian devaluation this week caused more volatility in the stock and bond markets. Overall, the S&P 500 corrected 4.9 percent and the Nasdaq 5.4 percent. The bond market, however, rallied.
This slight correction in the stock market along with the rally in bond prices caused our valuation indicator to look healthier.
We believe the impact from Brazil will be significant for some particular stocks that derive a substantial amount of their revenue from Latin America.
However, the overall stock market should see limited damage. We would use any price decline as a buying opportunity.
Our positive forecast for the S&P 500 and Dow is based on our low interest rate outlook.
Based on a 10-year bond yield of 4.0 percent and our 1999 S&P 500 down -1.0 percent earnings estimate of 43.45, our model indicates a level of 1400 for the S&P 500 and 11,000 for the Dow over the next 6 to 12 months.
Interest Rates & Bonds
Bond prices rose this week as the Brazilian crisis sent funds towards the safety and liquidity of the Treasury market.
We expect bond yields to continue to decline through the next few years as inflation is very low and the federal budget remains in surplus.
We feel the Fed is carefully watching the U.S. economy and will not to let it slow to any dangerous levels.
We believe Greenspan would act again as soon as there is a possibility the global economic problems are affecting the U.S. economy.
Elaine Garzarelli is a columnist for CBS MarketWatch. You can get more information at her site -- garzarelli.com.
Market Kommentary
Stocks rallied back after two days of bruising losses, bolstered by news that Brazil's central bank would allow the real to float freely in the foreign-exchange market. Treasury bonds slumped in a shortened pre-holiday session, and the dollar rose. On Monday, the Martin Luther King Jr. holiday, all U.S. financial markets will be closed.
The Dow Jones Industrial Average soared 219.62, or 2.4%, to 9,340.55 regaining nearly all of Thursday's 228.63-point loss. Despite the rally, the industrials still ended a difficult week down with a total loss of 302.77, or 3.14%, after hitting a record 9,632.32 a week ago. The average now stands up 1.73% for the year.
The Standard & Poor's 500-stock index climbed 31.07 to 1,243.26 and the New York Stock Exchange Composite Index gained 12.32 to 593.39.
The Nasdaq Composite Index jumped 71.38, or 3.1%, to 2,348.20, propelled by the rocket-fueled performance of its dominant technology sector. The Morgan Stanley high-technology index jumped 37.77, or 4%, to 969.15.
Tech stocks shot higher as investors embraced the market's first Internet-related initial public offering of the year. Shares of MarketWatch.com (MKTW), a San Francisco online financial-news service, closed at 97 1/2, up from their IPO price of $17 a share. The American Stock Exchange Internet index advanced 21.06 to 714.92.
Stocks surged to their highest levels of the day in the last half-hour of trading, as volume soared amid the monthly expiration of stock and stock-index options -- a so-called double-witching -- and position-covering ahead of Monday's Martin Luther King Jr. holiday, when all U.S. financial markets will be closed.
Wall Street snapped out of its two-day slump on news that Brazil's central bank said its currency, the real, would trade unhindered against other major foreign currencies. Brazil didn't say that it was abandoning the real's trading band altogether, but said it wouldn't intervene on the foreign-exchange market Friday to keep the currency within the band.
The news was viewed favorably by international financial markets, which have been roiled this week by the South American country's escalating financial crisis. Brazilian investors cheered the central bank's move, with the benchmark Bovespa stock index soaring 33%, its second biggest percentage-gain on record.
In allowing the real to float freely, Brazil's central bank revoked the new trading band it had set Wednesday. That move, which widened the band, resulting in an effective devaluation of about 8%, and sent stocks reeling world-wide.
Meanwhile, the Brazilian central bank's director responsible for supervising the country's banking system, Claudio Mauch, early Friday rescinded his decision to resign. The announcement of Mr. Mauch's resignation had added to anxiety gripping international markets about Brazil's financial woes.
Joseph Battipaglia, chief investment strategist at Gruntal & Co., said that while the problems facing the Brazilian economy are far from resolved, the country has begun addressing the issues at the core of the crisis -- the need to work at bringing interest rates down and to restore confidence among international investors in its markets. He cautioned, however, that the impact on the U.S. financial markets will continue to be felt as turmoil churns the emerging markets.
"Emerging markets have been in a bottoming process, starting with the Asian crisis, and we're about 70% there. Now we're focusing on Latin America, but soon the attention will turn back to China, which has been propping up its currency and may soon seek some relief," he said. Mr. Battipaglia said he expects to see more of the type of reactionary response Wall Street has shown this week to news of Brazil's problems.
Treasury prices slumped in an abbreviated pre-holiday session as fears of an imminent economic meltdown in Latin America subsided. Some investors, who put funds in the bond market for safe-keeping this week, shifted back to equities. The bellwether 30-year bond sank more than 1 point, or $10 per $1,000, to yield 5.12%.
U.S.-listed shares of Brazilian companies rose after Brazil abandoned government support of its currency, the real. Unibanco (UBB) shares jumped 2 1/8 to 12 1/16, Companhia Cervejaria Brah (BRH) rose 3/8 to 7 5/8 and Companhia Brasileira de Distribucao (CBD) rose 2 to 13. See related story.
Technology Stocks
Cree Research (CREE) shares fell 4 7/8 to 42 1/2 after the company said it plans a secondary offering of 1.3 million shares. The decline came even after the company earned 21 cents a share in the second quarter, a penny above analysts' estimates. Cree makes semiconductor materials and electronic devices from silicon carbide.
Shares of eBay (EBAY) fell 1 15/16 to 223 3/8 after rising as high as 242 earlier in the day. The online auctioneer announced initiatives to combat fraud, misrepresentation and bidding irregularities by people using its services. An analyst at Warburg Dillon Read initiated coverage of eBay, Amazon.com (AMZN), Beyond.com (BYND), Onsale (ONSL) and Preview Travel (PTVL) at "hold." Amazon shares rose 2 3/8 to 140 3/8, Beyond.com was up 1/2 to 28 1/4 and Onsale gained 8 7/8 to 58 7/16, while Preview Travel shares fell 15/16 to 22 1/2.
Platinum Technology International (PLAT) plunged 5 5/16, or 28%, to 13 3/8 after the software company warned that its fourth-quarter earnings will be significantly below analysts' expectations.
RealNetworks (RNWK) shares soared 4 15/16 to close at 55 Friday. Lehman Brothers initiated coverage of the company's stock at "buy." RealNetworks, a developer of Internet multimedia software, inked a deal with AtHome Corp. (ATHM) to create a new broadband streaming-media platform.
AtHome (ATHM) slipped 5/8 to 102, both on Nasdaq. AtHome said it will deliver video clips at nearly television quality to subscribers of its high-speed Internet service, using streaming media technology from RealNetworks.
Shares of IDT (IDTC), a Hackensack, N.J., provider of telecommunications services, shed 3 15/32, or 25.9%, to 9 29/32. The company late Thursday said earnings for the second quarter ending Jan. 31 will be 10 cents below analysts' projections of about 16 cents a share. IDT also said earnings will be below analysts' views through December 1999.
Motorola (MOT) rose 2 3/8 to 68 7/8 on the New York Stock Exchange. Gruntal & Co. upgraded the stock to "strong buy" from "buy," a source at the firm said. The firm increased its 12-month price target on the shares to $85 from $65. Also, BT Alex. Brown raised its rating on the stock to "buy" from "market perform."
Visual Networks (VNWK) shares rose 3 7/8 to 43 1/2 after the company posted pro forma earnings of 10 cents a share in the fourth quarter, 2 cents above the First Call consensus estimate. Revenue in the quarter rose 64 percent to $15.1 million from $9.2 million in the same period a year before. In the quarter, both AT&T and GTE agreed to use Visual Networks' Visual UpTime system. Visual makes WAN service-level management systems.
Xoom.com (XMCM) zoomed higher for a second straight day, moving up 9 1/16 to 57, after the Internet direct marketer inked a strategic deal with Web content provider InfoSpace.com (INSP). InfoSpace is to provide Xoom with online white and yellow pages and classifieds. InfoSpace shares added 2 5/8 to 55 1/2. See full story. In an interview broadcast by CNBC, the chief executive of the San Francisco provider of Internet services said that it can collect behavioral information about its users that can help predict trends in consumer demand. Xoom.com can enter the user's name and postal address, if it's in the U.S., into six databases to find out what he or she has purchased in the last two years, Chris Kitze said.
Intuit (INTU) rose 6 1/2 to 85 3/16 on Nasdaq. Credit Suisse First Boston raised its rating on the stock of the tax-software firm to "strong buy" from "buy."
ASE Test's (ASTSF) U.S.-listed shares rose 8 1/2 to close at 41 3/8 after Taiwan's Securities and Futures Commission approved the company's secondary issuance of stock in that country. ASE is an integrated-circuit packaging subsidiary of Taiwan-based Advanced Semiconductor Engineering Inc.
BMC Software (BMCS) rose 2 5/16 to 40 1/16 on Nasdaq. Prudential Securities raised its rating on the stock of the software firm to "strong buy" from "accumulate."
Shares of Microchip Technology (MCHP), a Chandler, Ariz., semiconductor concern, posted fiscal third-quarter profits late Thursday that fell short of analysts' projections. Several analysts Friday cut their ratings on the stock. Shares fell 4 5/8 to 35 1/8.
Rambus (RMBS) shares wilted 8 1/2 to 89 1/2 after the semiconductor maker warned of trouble ahead in the next six months. First-quarter income matched analyst's consensus earnings estimate of $2.1 million, or 8 cents a share, vs. $1.6 million, or 6 cents. But Rambus, a Mountain View, Calif manufacturer of chip-to-chip interface technology, said it sees flat earnings in its next two or three quarters.
Still, other technology stocks managed big gains. Microsoft (MSFT) shares finished with a flourish, closing 8 points higher at 149 3/4 on Nasdaq. Cisco Systems (CSCO) added 5 5/16 to 101 11/16. Sun Microsystems (SUNW) rose 5 15/16 to 100 7/16.
Atlantic Data (ADSC) soared 3 3/4 to 12 1/16. Adams Harkness & Hill raised its recommendation on the Quincy, Mass., company to "strong buy" from "accumulate." Atlantic Data Services provides information technology strategy consulting and systems integration services to customers exclusively in the financial services industry, primarily banks.
Pinnacle Systems (PCLE) shares surged 4 3/8 to 38 1/2 after the company posted net income of 44 cents a share for the second quarter. Analysts were looking for earnings of 41 cents.
MarketWatch.com (MKTW) , the first Internet IPO of 1999, soared to 97 1/2 after pricing 2.75 million shares at $17 each. The online financial news publication is based in San Francisco.
Active Issues
Shares of Eastman Kodak (EK), which fell sharply Thursday after reporting disappointing fourth-quarter results, extended its slide Friday, losing 1 1/2 to 69.
Fifth Third Bancorp (FITB) shares rose 5 3/8 to 70 1/8 after the Cincinnati banking concern company reported fourth-quarter net income of $150.1 million, or 55 cents a share, compared with $120.1 million, or 45 cents a share, in the year-ago period. Results were a penny ahead of the consensus estimate, according to First Call.
Consolidated Papers (CDP) gained 15/16 to 26 1/8. The Wisconsin Rapids, Wis., paper producer beat analysts' earnings projections with fourth-quarter profits.
Johnson Controls (JCI) , a Milwaukee, maker of automotive systems and controls, added 7/8 to 61 7/16. The company's fiscal first-quarter earnings were better than analysts predicted.
Reader's Digest Association (RDA) gained 2 9/16 to 28 5/8. The company declined comment on press reports that Time Warner is considering the exchange of some of its assets for a stake in the Pleasantville, N.Y., publisher. Time Warner (TWX), which also made no comment, advanced 2 1/4 to 61 13/16.
AirTouch Communications (ATI) moved up 4 9/16 to 83 3/8. Bell Atlantic Thursday received preliminary indications from the Securities and Exchange Commission to use a favorable accounting method in its bid for the wireless services giant. Bell Atlantic (BEL) fell 11/16 to 53 1/8, while Vodafone Group, the British telecommunications concern that has put up a competing bid for AirTouch, gained 1 7/16 to 176.
Delta Air Lines (DAL) moved up 1 3/8 to 56, while Alaska Air Group (ALK) gained 2 5/16 to 49 5/16, after Merrill Lynch raised its ratings on the stock of the air carrier. Continental Airlines' (CAIB) Class B shares added 1 5/16 to 35. Merrill also raised its rating on the stock. The firm also boosted its earnings estimates for the group.
General Mills (GIS) rose 15/16 to 82 3/4. Goldman Sachs raised its rating to the Minneapolis packaged foods maker, adding the stock to the firm's recommended list.
Briggs & Stratton (BGG) shares rose 3 1/2 to 50 3/16 after the engine maker said second-quarter net income more than doubled to $1.06 a share, compared with 41 cents a share in the year-ago period. Results were well ahead of the consensus estimate of 65 cents a share, according to First Call.
Warner-Lambert (WLA) fell 1 5/16 to 69 13/16. The Morris Plains, N.J., pharmaceuticals maker said a Food and Drug Administration panel will review the safety of its diabetes drug, Rezulin, which has been linked to liver damage that caused some patients' deaths.
IMS Health (RX) added 1 11/16 to 69 15/16. CIBC Oppenheimer started coverage of the Westport, Conn., provider of market research services for drug makers.
Uniphase (UNPH) gained 8 3/4 to 78 5/8 on Nasdaq. Salomon Smith Barney raised its rating on the stock of the San Jose, Calif., developer of fiber-optic telecommunications equipment.
Biogen (BGEN) rose 5 3/4 to 96 on Nasdaq. Warburg Dillon Read raised its rating on the stock of the Cambridge, Mass., drug developer.
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