Tech investing--MSN: "Jubak's Journal, How to hedge your high-tech bets", posted 8/4/00...
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How to hedge your high-tech bets
Even if you're convinced that tech will soar again in the fall, adding oil drillers and financials is good insurance.
By Jim Jubak
I tried, I really did. But I couldn't get a single non-technology stock into the Future Fantastic 50. The one non-tech stock that I nominated to fill one of the six open slots on the list -- retailer Target (TGT, news, msgs) -- garnered a rather pathetic 6% when followers of this column cast their ballots. It finished ninth out of a list of 10 nominees. In fact, only two non-technology stocks, Target and Mexican cement-maker Cemex (CX, news, msgs), made the list of 36 semifinalists. (For more on the nominees and the vote, see my July 21 column, "Help Jim pick 6 for his Fantastic 50.")
And it wasn't just that my voters ignored non-technology stocks. They scorned them. The inclusion of Target got comments such as "Target? Where's the growth there?" and "That is the sorriest bunch of nominations I've ever seen. Target, the department store, is going to outperform Nortel Networks (NT, news, msgs) or Applied Micro Circuits (AMCC, news, msgs) over the next five years? Are you kidding me?" (For the full text check out the "Trash Jim's Nominees" thread in the Market Talk with Jim Jubak Community.)
I find this both surprising and intriguing.
Still swinging for the fences
Surprising, because I would have thought that, given how badly many fast-growth, high-price-to-earnings stocks have been punished since March -- including examples in Jubak's Picks -- more investors would have voted for slower growth with less risk. I wouldn't have been surprised if the vote had shown a massive shift away from high-risk high tech. But despite the punishment, it seems like a lot of us are still swinging for the fences. Target, which analysts project will grow earnings by 16% in the fiscal year that ends in January 2001, is just not as attractive a proposition to us as Applied Micro Circuits, which analysts expect to grow earnings by 133% in the fiscal year that ends in March 2001. And that's even though Target trades at a trailing 12-month P/E ratio of just 22, while Applied Micro Circuits trades at a multiple of 383.
Intriguing, because I think this reaction bodes well for a fall recovery in many of the highfliers that have taken a pounding this summer. Investors are likely to be somewhat more cautious, asking for real earnings and plausible plans to ramp growth. But it appears from this vote that the core of technology investors, whose support is critical for this group going forward, aren't about to abandon potential winning stocks from the revolutions in wireless communications, optical networking and electronic commerce that are reshaping the economy. The fundamental belief in those trends appears unshaken, and these investors appear willing to pay up to be part of those trends.
Good news for tech sector
That's an important indictor to me. Add in the record river of cash that flowed into equity mutual funds in the second quarter -- at $73.4 billion, the highest ever for the period -- and sentiment seems positive to me for the rest of the year. Fundamentals point the same way. Analysts are forecasting earnings-per-share growth of 10% or more for the rest of 2000, and we're about to enter what is traditionally the strongest part of the year for technology revenues and earnings. All in all, I think the battered technology sector is positioned to do much, much better in the last three to four months of the year.
That's good news for Jubak's Picks. My entire strategy this year has been built on sticking it out with many of the high-growth, high-multiple stocks in the portfolio until the fall -- and even adding a few names like BroadVision (BVSN, news, msgs) and Atmel (ATML, news, msgs). This will work out quite well for me if these stocks come roaring back the way they did in this same period in 1999. If everything works out, stocks like RF Micro Devices (RFMD, news, msgs) and PMC-Sierra (PMCS, news, msgs) will leave the slower-growing Targets of the stock market in the dust.
If this scenario is correct, I think it's pretty clear what an investor ought to be doing. Hold onto those high-growth, high-multiple technology stocks that have shown good relative strength during the technology crunch. Add new positions from among the technology stocks with the best relative strength, using cash raised by selling stocks that didn't come through the downturn in very good shape. (If you'd like to see a more-detailed explanation of this strategy, see Jon Markman's Aug. 2 column, "Stick with strength to beat August heat.") I don't think you need to rush right out to apply this strategy -- August and possibly September are likely to have a few nasty surprises still in store for us. In fact, I think it's a good time to use some stop-loss orders. See my update on Cisco Systems (CSCO, news, msgs) below for an example. Over the next month or so, however, I'll be gradually implementing this strategy.
But that said, I also think it's important to understand that just because I want this to happen (and very badly, indeed) -- and just because I believe it will happen -- doesn't mean that it has to happen. While I think a late September rally that extends for the rest of 2000 is the most likely market scenario, it's not the only possible outcome. And anyone who invests as if it is takes a high-risk gamble. So even though I think it makes sense to build a portfolio on this favorable scenario for technology stocks, I also think it makes sense to plan for a future that's unfavorable for those stocks.
Which brings me back to where I started -- with the scorn heaped on my nomination of Target.
Let me connect the two problems -- macro market call and micro stock pick -- this way. I think it's true that Applied Micro Circuits will outperform Target if everything goes right at both companies. Similarly, a portfolio loaded with high-growth, high-multiple technology stocks will outperform one that more closely mirrors the Standard & Poor's 500 ($INX) -- if everything goes right for the technology sector over the next six months. The difference is that it is much more likely that something material will go wrong for Applied Micro Circuits than for Target, simply because it is harder to grow earnings at 133% than it is to grow earnings at 16%. (Similarly, I think there's a lot more that can go wrong with the technology sector than with the broader market.)
Fine-tune your side bets
It's hard to figure this "probability of error" into investment decisions. Most of us deal with this issue by a seat-of-the-pants method that we call "hedging our bets." To a portfolio of high-growth, high-multiple technology stocks, we'll add a drip of retailers, a drop of financials, a dab of drugs. These sectors have tended to do well in the past when technology stocks have done badly.
We can fine-tune this sector selection by studying the recent past performance of the market. In the last week or so, for example, when technology stocks have been down, sectors such as regional banks, oil drilling and services, and drugs have been up.
And comparing a stock's (or a portfolio's) performance in an up market with its performance in a down market is also a useful tool. (I did a form of this when I reported on the performance of Jubak's Picks for the second quarter of this year in my column, "Ouch! What the second quarter taught me.")
But I'd like to suggest a way to take this hedging strategy a step further by using a rough "what could go wrong" analysis to see which sectors actually work best as hedges on a technology-heavy portfolio.
What could go wrong?
OK, so what could go wrong with the technology sector? Let's take two major possibilities. Interest rates could resume their climb after the November election. And the economy could slow enough to hurt earnings.
How do those alternate scenarios play out with the sectors we're considering as hedges? Higher interest rates wouldn't be good for any stocks, of course, but they'd be particularly tough on financials. Slow growth in the economy, on the other hand, would probably help financials, since it would mean no more interest rate hikes. I'd give financials a "minus one, plus one" rating.
Drugs? Higher interest rates would probably work to the sector's benefit -- as long as the hikes weren't too aggressive -- since investors tend to buy drug stocks as safe havens when the market as a whole gets rocky. If economic growth slows, but again, not too much, the sector could go either way. Traditionally, drug stocks are a haven when growth comes into question. But the drug stocks are so high-priced themselves -- and Pfizer (PFE, news, msgs) recently threw a scare into the sector by posting anemic growth -- that slower growth in the economy is likely to hurt the sector. I'd give financials a "plus one, minus one."
Oil? Higher interest rates are not an issue, except for the most leveraged of companies. Slower growth? Not an issue either, as long as we're not talking recession. The price of a barrel of oil is high enough that it could fall substantially without forcing any cutbacks in drilling and exploration schedules. I'd give drilling and services stocks a "plus two."
So to hedge a technology-heavy portfolio now, my first choice would be oil drilling and service stocks. I dropped Schlumberger (SLB, news, msgs) from Jubak's Picks on July 28 in the belief that we were far enough along in the recovery cycle for this sector to pick a more aggressive stock than this industry leader. My two picks at this point in the cycle would be Ensco International (ESV, news, msgs) and Marine Drilling (MRL, news, msgs). Both are highly leveraged to activity in the Gulf of Mexico, an area that has gone from cold to hot in recent months. I think the potential return from either of these picks is about 35% in a year -- Schlumberger by my calculations was likely to return 15%. Since I've only got one empty slot in Jubak's Picks right now, I'm going to add Marine Drilling, with a target price of $34 in August 2001.
My second choice as a hedge would be financial stocks, especially since I think there's a good likelihood that the Federal Reserve will not raise rates in August. My picks here would be Golden State Bancorp (GSB, news, msgs) and Providian Financial (PVN, news, msgs). I'll write more about those and other financial stocks later in the month when I've got a slot for another hedging stock in Jubak's Picks.
Over the next month of so, then, I'll be pursuing two different buying strategies. As in this column, I'll be looking for stocks with strong profit potential that are also a hedge in case the technology sector doesn't behave as I think it will in the fall. And, as in my next column, I'll be looking for the strongest technology stocks -- and weeding out the weakest in Jubak's Picks -- so that I can get the maximum return if technology stocks do rally.
That means I'll be looking to buy two very different kinds of stocks, but all as part of a single strategy.
Changes to Jubak's Picks
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Buy Marine Drilling
To hedge a technology heavy portfolio now, my first choice would be oil drilling and service stocks. Marine Drilling (MRL, news, msgs) is highly leveraged to activity in the Gulf of Mexico, an area that has gone from cold to hot in recent months. During the second quarter of this year, day rates on the company's jackup rigs in the Gulf of Mexico jumped to an average of $27,100, up from $21,000 per day in the first quarter and $15,300 in the fourth quarter of 1999. Analysts are projecting $30,000 a day for the third quarter of 2000. I think the potential return from this pick is about 35% in a year, compared to a likely 15% for industry leader Schlumberger, by my calculations. Since I've only got one empty slot in Jubak's Picks right now, I'm going to add Marine Drilling with a target price of $34 in August 2001.
Updates on past columns
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Catching the Cisco Express
The price action on Cisco Systems (CSCO, news, msgs) has been particularly worrisome lately. The stock failed to move above its June peak in the July rally for technology stocks and has looked extremely weak over the last week. This concerns me because Cisco is due to report earnings on Aug. 8, after the market closes, and the stock usually runs up before earnings and then declines afterwards. The price action so far seems to show a high level of concern about the report. There is definitely the possibility that Cisco could disappoint -- if not on earnings per se, then on margins or inventory. Long-term investors are probably best served by ignoring this entire issue and sticking with this core technology stock. Aggressive short-term investors should consider putting in a stop-loss order at $59, just below the 200-day moving average for the stock. I'll revisit this issue in my next update on the morning of Aug. 8.
Blue-chip chip stocks
Credit Suisse First Boston reiterated its "buy" rating on Atmel (ATML, news, msgs) on July 31, citing the company's release of its 64 megabit Data Flash memory chip. The single-chip solution will give Atmel a product to sell into the high-density digital storage market made up of such fast-growing products as MP3 players, digital cameras and WAP Internet wireless phones, the firm said. In addition, the company's existing core business remains strong with demand outpacing supply. (Full disclosure: I recently purchased an initial position in Atmel for my personal account.)
5 stocks to 'disrupt' a lagging portfolio
Wedbush Morgan initiated coverage of Puma Technology (PUMA, news, msgs) with a "strong buy" on Aug. 2. The firm set a 12-month target price of $38. The company will report earnings on Aug. 24.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Atmel, Cisco Systems and Puma Technology.<<< |
