Trader's Edge: Reading Road Maps
04-Jan-01 09:29 ET
[BRIEFING.COM - Jim Schroeder] It was widely called for by the market participants, advertised by the Fed and assumed to be in the offing over the short term but the 50 bp rate cut on Wednesday took the market by surprise. The response was swift and dramatic with the Nasdaq Composite establishing several new records. We will take a look at some of the history of the Fed switching gears, Nasdaq records and potential barometers for indications of the strength of the anticipated follow through.
A Little History
A quick look at what the Fed has done and the market reaction to the switch. The 50 bp move is the first intermeeting rate cut since October 1998 and it is the first time since July 1992 that the Fed moved to ease by as much as 50 bp. As far as the potential timing and size of the next move, that is for others to debate. However, while they have said they are prepared to lower rates further, over the last 12 years the Fed has not eased 50 bp two times in a row. There is precedence for moves of this size in the other direction as rate were increased by at least 50 bp 4 meetings in a row from May 1994 to February 1995. The last two times that the Fed switched from a tightening cycle, not just a 1 time hike, in June 1989 and July 1995 the Nasdaq extended the initial reaction move by just 2 days and 7 days, respectively before staging a substantial percentage correction.
Top Ten Moves
Back on December 7 a brief*(article follows) was written that discussed the top ten moves on a percentage basis that had occurred in the year 2000. What the brief highlights is that although the Nasdaq has put together the largest percentage gain, point gain and record volume, it has not necessarily proven to be a recipe for sustained gains. Initially after one of the top ten point gains last year the market moved roughly 5%-6% in a run that lasted approximately 2 days. Interestingly, the market fell during this initial move 6 out of 9 times as profit takers held sway. Each of the subsequent reversals, however, surpassed the initial reaction in terms of percent.
What Was Missing
Based on the previous switches from a tightening cycle to an easing and the follow through on a top ten percentage gain, there does not appear to be a clear case for a sustained run. However, this time it is indeed different. Unlike the negative action in the market that preceded this switch to an easing, in both the 1989 and 1995 changes the market had rallied strongly for months prior to the Fed actually cutting rates. As far as the market being unable to build on the numerous top ten advances last year, which is typical in a bear market, we finally have the Fed on the side of the bulls and prepared to move again.
Barometers
There are several different things that can be looked at as a way to gauge the strength of the advance. On an individual stock basis, watch the reaction to neutral or even negative news. As an example, Corning (GLW) was hit hard despite indicating that they would be able to meet expectations. As a potential way of determining how much of the bad news related to the slowdown in IT spending is now factored into the market we would watch how Inktomi (INKT) reacts over the next few sessions or so to its Q1 profit warning. On the data front, the market has reacted poorly to weak economic news. An indication that the perception is now changed would be if there was limited downside or even a positive reactions (bad is good as the Fed will ease further) in the wake of additional weaker data. In terms of the strength of the economy and the market, the trading pattern that develops in the dollar could provide some clues. The perception of a strong economy and strong stock market (or at least improving) relative to the rest of the world, could result in a stable or rising dollar.
Technicals
Clearly the dramatic advance is encouraging from a technical perspective. Also in the bullish camp is the fact that the pattern of the move was impulsive and that daily (and potentially weekly readings) have formed bullish divergences. A divergence merely means that an index moves to minor new low while the indicators do not. This situation produces a more convincing buy signal. The fact that the trendline off the December highs was also breached on a closing basis adds to the bull case. While some corrective action is possible, as shorter term indicators are a bit overextended, as long as breadth readings (A/D line, up vol vs down vol) remain strong, the stage is set for gains with the next resistance of significance not found until the index reaches the 3000 area.
Where Out Where In
The sectors that performed exceptionally well during 2000 are the ones that could underperform if indeed this is a lasting turnaround. This includes defensive plays such as gold, tobacco, utility, drug, insurance and healthcare. On the upside, some of the beaten down tech stocks that we highlighted in a brief**(article follows) last week as issues to nibble in based on a valuation/growth comparison to the drug sector include AMAT, INTC, CSCO, ORCL and SUNW. There is also potential for the fiber optic and telecom equipment issues to recover amid hope that the IT spending slowdown will be reversed later in the year.
*Trader's Edge: Top Ten Follow Through
07-Dec-00 09:28 ET
[BRIEFING.COM - Jim Schroeder] The wave of euphoria that swept over investors, due to the largest percentage gain in Nasdaq history, was followed up with a dud. Despite the high volume, broad based surge, the market was unable to develop much buying interest with the high for Wednesday established in the first 20 minutes. In part because of the somewhat disappointing performance, we thought it a good opportunity to take a look at what the Nasdaq has done in the past following massive percentage gains.
In the Dec 6 WSJ they were kind enough to provide the top 10 percentage gainers for the Nasdaq. An interesting aspect to the list is that 8 out of 10 occurred this year while the index was in the process of trimming 50% of its value. While tech investors have been hurt, the list shows that there have been a number of trading opportunities for those nimble enough and with a strong enough stomach to stand all the volatility. What we looked at was the short term initial reaction of the Nasdaq following one of the year 2000 top 10 gains based on the close the next day and what the market was able to accomplish thereafter. The first column is the date of the move from the largest gain to the smallest within the top 10, the second is the length of the initial move and the percent change on an intraday basis and the third is the time and length, also on an intraday basis, of the secondary move.
Date . . . . . .Initial Move . . . Secondary Move
Dec 5, 2000.
May 30, 2000. . 1 day, -1.7% . . . 4 days +14.2%
Oct 13, 2000. . 3 days, -8.7%. . . 2 days +16.8%
Oct 19, 2000. . 1 day, +3.4% . . . 4 days, -12.8%
April 18, 2000. 3 days -11.8%. . . 5 days +19%
April 25, 2000. 2 days -5.3% . . . 2 days +13.3%
April 17, 2000. 2 days +8.8% . . . 2 days, -13.1%
June 02, 2000 . 5 days +2.1% . . . 2 days -5%
As an example, within 3 days of the Oct 13, 2000 surge the index had fallen 8.7% on an intraday basis within two sessions it had rallied 16.8% off the low of the initial move.
That's all well and good, but what does this tell us? Is there some type of pattern? Well, despite the dramatic advance, the market has actually shown a propensity to decline following the move. Including the Dec 5 rally in this camp, the initial move following has been to the downside five times out of eight. A more important pattern, which has thus far taken place in each and every instance, is a reversal of the initial move. Not only that, each and every reversal no matter what the direction has easily exceeded the initial move. Given that the index closed lower on Dec 6, based on the averages, it could fall to approximately 2725 (5.97%) on an intraday basis within 2.4 days and then rally to 3090 (13.45%) over the next 3 sessions.
Other factors that support the positive reversal scenario include a friendly outlook for the Fed, the recent ability of some issues (ALTR, XLNX) to rally despite negative news, still heavy cash position on the sidelines, reports of massive margin liquidation, the market's ability to bounce after 3 negative months in a row (Sep-Nov), a turnaround in the deeply oversold technical indicators and the aggressive pattern of the push off the Nov 30 low.
However, as we have seen each and every occasion this year, large percentage moves to the upside obviously do not mean that the bottom has formed. A major obstacle to sustaining the run off the Nov 30 low is the upcoming earnings warning season. While this has yet to even get into full swing, 226 companies have already issued warnings. This is not far behind the total for all of Q4 1999 (263) and Q4 1998 (272). Technical confirmation of an important bottom comes on breach of the steep downtrend that has been intact for the last three months amid strong volume. This has been lacking during previous recovery attempts reflecting the strength of the underlying negative bias.
**Trader's Edge: Chase, Rattle or Slow
21-Dec-00 11:03 ET
[BRIEFING.COM - Jim Schroeder] It has obviously been a very difficult year for the tech sector to say the least and given all the negative developments it is hard to envision an immediate end to the bleeding. If you were fortunate enough to move into the boring sectors like healthcare, insurance, utility, Treasury bonds and drugs early in the year and close your eyes you have put together an excellent performance. Alas, this group of investors is in the minority with most scrambling to cut losses and look for the next short term investment opportunity. Three possible themes going forward are to chase the hot sectors, rattle into the old economy cyclicals or look to pick your spots and slowly move into some of the tech stocks.
Chase
This theme is logical from the standpoint that momentum is clearly in your favor with no end yet in sight for a turnaround in the beaten down sectors. The question, however, is how aggressive do you want to be when these groups have already put together spectacular gains. The performance thus far this year is as follows; utility +41%, healthcare +31%, insurance +30%, drug +26% with a 30-yr Treasury index up 16%. The table below gives some of the current data on a few of the drug stocks which we use as a representation of the performance of the hot sectors. The last column shows how much they have soared just over the last two months (PFE is off the Sep low).
. . . . . . . . . . . . . . . . . . . . Next Year . . . . . . . L/T . . . . . . %Gain
Stock . Current . . . . . . Earnings and . . . . . Growth . . . . . . . off
Symbol . Price. . . . . . . % Gain . . . . PE . . . Rate . PEG . . Oct Low
MRK . . 93 3/8 . . . $3.19(+10.6%) . 29.3x . . 12.1% . 2.4 . 48%
BMY . . 71 9/16. . . $2.59(+10.7%) . 27.6x . . 11.9% . 2.3 . 49%
PFE . . 46 3/8. . . . $1.29 (26.7%) . 35.9x . . 21.3% . 1.7 . 19% (Sep)
Rattle
A strong case can be made for the cyclical stocks based on three factors. The first is the decline in oil prices as the lead oil futures contract has dropped roughly $10 from the October peak. The second is the anticipated easing of interest rates. While the timing has disappointed the marketplace, cuts are in the offing. The third reason for those with a strong overseas presence is related to the value of the dollar. As the dollar weakens it allows a company with overseas earnings to benefit from the conversion to dollars from stronger foreign currencies. The table below lists the current info on a number of these issues.
. . . . . . . . . . . . . . . . . . . . Next Year . . . . . . . L/T . . . . . . %Gain
Stock . Current . . . . . . Earnings and . . . . . Growth . . . . . . . off
Symbol . Price. . . . . . . % Gain . . . . PE . . . Rate . PEG . . Oct Low
IP. . 37 5/8 . . . $2.87 (+20.3%). . 13x . . 7% . . 1.87 54%
DOW . 33 1/8 . . . $2.27 (+1.6%) . . 14.6x . 9.4% . 1.55 44%
PD. . 54 . . . . . $2.98 (226%) . . 18x . . 7.5% . 2.4 35%
DD. . 44 1/2 . . . $3.11 (+10.9%). . 14.3x . 10.8%. 1.32 12%
NUE . 36 11/16 $3.45 (-3.8%). . 36.7x . 14.2 . 2.6 24%
Slow
The final theme of moving back into the technology arena clearly has drawbacks. And, given that the concerns that triggered the breakdown (slowing corporate IT spending and slowing demand) have yet to be resolved it is difficult to make a case for a strong move in back into these issues just yet. However, the meltdown has trimmed much the excess valuation achieved early this year. From a longer term perspective we would prefer to own some of the tech stock bellwethers than the slower moving cyclicals based on the growth rates and PEG ratios.
. . . . . . . . . . . . . . . . . . . . Next Year . . . . . . . L/T . . . . . . %Gain
Stock . Current . . . . . . Earnings and . . . . . Growth . . . . . . . % off
Symbol . Price. . . . . . . % Gain . . . . PE . . . Rate . PEG . . High
AMAT . 37 13/16 . . . $3.38 (+18.1%) . 11.2x . 25% . . 0.44 -67%
INTC . 31 15/16 . . . $1.59 (-3.2%). . 20x . . 20.4% . 0.98 -58%
CSCO . 36 1/2 . . . . $1.00 (28%). . . 36.5x . 33.9. . 1.07 -55%
ORCL . 28 1/2 . . . . $0.62 (+22.6%) . 45.9x . 26.4. . 1.74 -38%
SUNW . 27 7/16. . . . $0.88 (+26%) . . 31.2x . 23.5. . 1.32 -57%
Conclusion
Decisions on asset allocation in this type of environment are difficult but latching on to just one theme going forward could prove hazardous to your portfolio. A solid case can be made for chasing some of the hot sectors on a short term basis, rattling into the old economy cyclicals with intermediate term money and looking for opportunities to slowly move into some of the tech stocks over the next few months in anticipation of a potential second half turnaround.
Jim Schroeder
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