Barrons:
After All the Gyrations, Stocks End the Week Flat
By ANDREW BARY
Technology stocks again took center stage in another volatile week of trading.
The techs led the market higher in a strong rally Monday and then contributed
to a late-week selloff that left the Dow Jones Industrial Average and other key
indexes little changed in the five sessions.
The other big issue on investors' minds last week was the bond market, which
suffered a sharp setback amid concerns that a strong U.S. economy may
prompt a credit-tightening move by the Federal Reserve later this year. Bonds
did recoup some losses on Friday, but the yield on the 30-year Treasury bond
still finished the week at 5.57%, up a half-percentage-point since the start of
the year.
For the week, the Dow Jones Industrial Average
fell 33 points, or 0.4%, to 9306. The blue-chip
index surged 212 points Monday in its biggest
gain so far in 1999 before losing ground in each of the next four sessions,
including a 59-point setback Friday. The S&P 500 ended the week at 1238,
down less than a point. The Nasdaq finished at 2288, up just over four points.
So far this year, the Dow is up 1.4%; the S&P is ahead 0.7%, and the
Nasdaq is higher by 4.3%
Compaq Computer was the spark for the tech sector's setback Friday as several Wall Street analysts cut their profit estimates for the leading maker of personal computers. Those earnings reductions came after Compaq indicated that its sales are off to a slower-than-expected start in 1999. Compaq dropped 5 5/8 to 35 3/8 Friday on market-leading volume of 74.5 million shares. Compaq now is off sharply from its late-January peak of 51 1/4 .
"The issue is whether the personal-computer industry is slowing down," says Steve Milunovich, Merrill Lynch analyst, who Friday cut his first-quarter profit estimate for Compaq to 30 cents a share from 35 cents. He also trimmed his 1999 estimate to $1.75 from $1.80. Milunovich's earnings revision admittedly was mild, but it's worth noting that a month ago, there were whispers on Wall Street that Compaq might earn $2 a share this year. The reaction to the Compaq news was severe because so many momentum-oriented investors focus on profit revisions.
Milunovich still sees 15% unit growth in personal computers this year, but
because prices are falling, revenue growth may be just 5%-7%. His view: A
slowdown in revenue growth may make it tough for PC makers to hit their
ambitious profit targets. The Compaq setback came a week after Wall
Street's disappointment with Dell Computer's fourth-quarter revenue growth,
which prompted a sharp decline in Dell's stock.
Some investors believe that Wall Street has overreacted to both the Dell and
Compaq news. "The tech correction has run its course," opined Stephen
Dalton, portfolio manager at First Union's investment management arm. "The
positive trends for the large-cap tech companies are still in place." Dalton
favors Gateway 2000, Oracle, Dell and Sun Microsystems, among others.
For the week, Intel lost 8 1/8 to 119 15/16. Microsoft was up 2 3/8 to 150
1/8 ; Dell was unchanged at 80 1/8, and Gateway was off 3/16 to 72 11/16,
after hitting a record 84 1/2 Tuesday. The Internet stocks finished broadly
higher, with many advancing on Friday despite weakness elsewhere in the
tech group. America Online rose 8 3/4 to 88 15/16; Amazon.com gained 26
1/4 to 128 1/8 ; Yahoo advanced 18 1/4 to 153 1/2, and eBay surged 94 1/2
to a record close of 334, just ahead of its 3-for-1 stock split Monday. It
seems odd that the Internet issues are now considered safe havens despite
their lofty valuations. AOL, for example, trades at almost 300 times projected
profits for its current fiscal year.
Wall Street's bulls say interest rates are unlikely to head any higher given the
low rate of inflation. They also predict that corporate profits this year should
prove surprisingly strong.
Laszlo Birinyi, head of Birinyi Associates, a Greenwich, Connecticut, research
firm, says most investors assume that profits are more important than rates.
But his research shows that quarterly movements in the S&P 500 have little
relationship to quarterly profit trends. He points out that the S&P 500 had its
worst year of the decade in 1994, despite the strongest yearly gain in
corporate profits. It was the sharp rise in rates that hurt. Conversely, stocks
took off in 1991 despite a drop in earnings. The reason: Rates fell.
A sense of optimism that rates will stop rising is based partly on the strong
showing last week among many financial stocks and a slight rise in the Dow
Jones Utility Average. Banks and utilities generally come under pressure if
investors fear significantly higher rates. But last week, Citigroup was up 4 1/2
to 58 3/4 ; Chase Manhattan gained 3 5/8 to 79 5/8; Bank One rose 3 1/2 to
54 3/4, though Fannie Mae did fall 2 1/4 to 70.
Winning industry groups last week included the airlines, drugs and
money-center banks. Merck lately has been reasserting its leadership in the
pharmaceuticals group, and rose 2 1/2 to 81 1/2 last week after hitting a
record 82 on Friday.
The market's technical situation remains unimpressive with more Big Board
stocks falling than rising and many more new 52-week lows being hit than
new highs. Birinyi argues that these technical indicators overstate any
weakness in the market. It's important, he says, to look beyond the absolute
number of new highs to the actual stocks making new highs. Birinyi is
impressed because the admittedly meager new-highs list last week included
such blue-chip stocks as Merck, McDonald's, American Home Products,
AOL, Wal-Mart and Anheuser-Busch. Most of the new lows were smaller
stocks, including a sizable number of energy issues.
The S&P 500 hasn't moved much so far in 1999, but the index's modest
0.7% rise has masked a lot of volatility.
With investor sentiment often swinging markedly from the morning to the
afternoon, the S&P 500 is experiencing some of its greatest intraday volatility
ever. Through Thursday, the benchmark index showed a 1% intraday change
-- from the session's high to its low -- on 36 of the 37 trading sessions in
1999, according to Bear Stearns. The intraday measure arguably is a better
gauge of market volatility than the net daily change in the S&P.
As the accompanying table shows, the S&P has moved 2% or more on 41%
of the trading sessions in 1999, up from 23% in all of 1998. Volatility has
been steadily rising in the past few years, especially compared with the period
from 1992 through 1995, when 2% moves were rare.
What's producing the higher volatility? "With the market so richly valued, it's
more sensitive to changes in interest rates or earnings disappointments," says
Elizabeth Mackay, strategist at Bear Stearns. She also cites the higher
weighting of volatile tech stocks in the S&P and the recent loosening of
trading "collars" on the New York Stock Exchange that limit certain forms of
program trading.
Other factors producing bigger swings include the growing influence of millions
of online traders, many of whom close out positions by the end of the trading
day. Whatever the source, higher volatility probably is here to stay.
The Dow Industrials fell 33 points in the week to 9306 after starting
with a 212-point gain Monday. Winners included Merck, Citigroup,
American Express and Disney. Goodyear, AT&T and 3M declined.
The Dow now is up 1.4% in 1999.
The problem with most mining companies is that their profits hinge on the
vagaries of commodity prices.
Reynolds Metals is different because its sizable consumer packaging
operations, notably Reynolds Wrap aluminum foil, provide stable profits and
help insulate the company's overall earnings from swings in aluminum prices.
The allure of the packaging business lately has attracted some bargain hunters
to Reynolds' depressed stock. The shares have come under pressure because
of the steady drop in aluminum prices, which now stand at 54 cents a pound,
off 17% in the past year.
Reynolds' stock was off 9/16 to 42 3/4 last week, after touching a new
52-week low of 42; the shares hit a high of 68 last April. Reynolds now is
flirting with its 10-year low of 40 set in 1994 and is actually below where it
stood in 1989.
Reynolds, the No.3 global producer of aluminum, has been a perennial asset
play and restructuring story. Many investors simply are tired of waiting for the
story's denouement and have moved on. Yet the capitulation could provide an
opportunity because Reynolds, by some estimates, trades at about half its
asset value of $85 a share.
Some investors say Reynolds' packaging business
alone could be worth $2 billion, or $35 a share.
That $2 billion figure is roughly 10 times
projected 1999 cash flow. Reynolds Wrap is the dominant aluminum foil
brand in the U.S. with an estimated market share of over 50%. If the
packaging operations are worth $35 a share, investors buying Reynolds
effectively are paying little for its aluminum business.
Reynolds last year completed a two-year restructuring program that resulted
in reduced costs and the sale of several businesses. The company used the
proceeds from asset sales to cut debt and repurchase stock.
Operating profits totaled $3.47 a share in 1998, up from $2.91 in 1997.
Barring a recovery in the aluminum market, Reynolds will be lucky to match
last year's profits in 1999. But the company could earn as much as $8 a share
at the top of the aluminum cycle.
Some investors would like to see Reynolds spin off or sell its packaging
operations to highlight the value of that division. But the company wants to
keep the business and expand it.
Reynolds has badly underperformed industry leader Alcoa, whose shares
ended the week at 40 1/2, down a point (Alcoa split its stock 2-for-1 on
Friday). In the past year, Alcoa is up 14%, while Reynolds is down 29%.
Alcoa has benefited from stronger financial performance and from the
large-stock bias among portfolio managers. And its management has near-cult
status on Wall Street.
At its current price, Reynolds would be eminently digestible to an acquirer,
given its market value of just $2.8 billion. Reynolds also has about $1 billion in
debt. Alcoa's market value, by contrast, stands at $15 billion. Reynolds
clearly has been a longtime disappointment, but it may finally be getting too
cheap to ignore.
Amazon Deal Causes Drug-Chain Selloff
Barnes & Noble and Borders Group, the country's top two booksellers, have
been prominent casualties of the Internet's rapid growth and the stock
market's online obsession. Will the drugstore chains be next?
Amazon.com last week caused a splash when it announced plans to buy a
40% stake in Drugstore.com, a fledgling e-commerce venture that aims to sell
prescription drugs and other health-care items over the 'Net at discounts. It
remains to be seen whether many consumers will go online for drug
purchases. But the Amazon announcement was enough to prompt some
late-week selling of the major pharmacy stocks, one of the hottest retailing
groups in recent years.
Walgreen did rise 13/16 to 32 on the week, but it finished below its all-time
high of 34 set Wednesday. CVS was up a point to 53, but ended below its
mid-week peak of 58 3/8 . Rite Aid dropped 3/8, to 41 3/8 .
Wall Street analysts rushed to the defense of the drug chains. Merrill Lynch
analyst Mark Husson called the late-week selloff "irrational," arguing that the
companies aren't as vulnerable as traditional booksellers to the online threat.
One reason: People with the flu aren't going to wait days to receive their
prescriptions.
But the chains, especially Walgreen, could be vulnerable if only because of
their lofty price/earnings multiples. Walgreen trades at a stunning 53 times the
profits projected for its current fiscal year, which ends in August. CVS has a
P/E of 36, and Rite Aid, 24, based on expected 1999 profits.
Walgreen shares are up 75% in the past year and have risen tenfold since
1990. Walgreen's ascent reflects its steady 15% annual profit growth, its
allure as a demographic play on aging Baby Boomers, and investors'
willingness to accord huge P/E multiples to companies with consistent
double-digit profit growth.
Walgreen is well-managed. But should it command a higher multiple than all
the major drug makers except Pfizer? After all, the top drug outfits have
better profit growth, higher margins and less competition.
Walgreen's prescription-drug sales are growing smartly, but the company did
warn in its latest 10-Q filing that its margins are under some pressure from
rising third-party and mail-order sales.
It won't take much penetration by the online companies of pharmacy business
to raise investor fears about the drug chains. Just look at the book business.
Amazon had a 2% market share last year, but its rapid growth has already
hurt both Barnes & Noble and Borders.
Borders fell 1 3/8 to 13 13/16 last week, and now is off 57% in the past year,
shrinking its market value to just $1 billion. Amazon now towers over Borders
with a market value of $20 billion. Reflecting the fears about its future,
Borders trades at just 12 times projected 1999 profits. If you're looking for
an anti-Internet stock, Borders is the one. Barnes & Noble, meanwhile, was
off 5 1/2 last week to 29 5/8 after guiding Wall Street estimates down for its
profits this year. |
