Barrons Week in Review
Saturday, January 18,1997
For the week of Jan 13-17
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Another Week, Another Record; Will a
Five-Figure Dow Arrive by '98?
Jay Palmer
Table: Vital Signs | The Dow Jones Averages
Above 11,000 at year-end 1997? Ridiculous? Perhaps so, but that's where
the Dow Industrials are headed if the market continues the blistering pace of the
year's opening weeks. Last week, the Big Board's blue-chip index put on another
scorching 129 points, or 1.9%, notching new record highs in four of the five sessions
(Wednesday was the one down day) to close Friday above 6800 for the first time
ever. It was the third ``century'' mark crossed this year, and it brought the market's
1997 advance to 384 points, or just under 6%. Trading was brisk throughout the
week, though volume of 2.57 billion shares didn't match the previous week's record
2.72 billion.
Unlike in prior weeks, economics had little serious impact on trading momentum.
Key news from Washington came Tuesday with the release of the December
consumer price index. Here the rise of 0.3% was in line with expectations, though the
so-called core CPI (the number excluding the volatile food and oil readings) was up
just 0.1%, less than the predicted 0.2%.
Ironically, the same strong economy that has so long been a drag on stocks proved a
positive this past week, with shares moving higher amid a steady stream of strong
fourth-quarter profit reports, most of them well ahead of analysts' targets. First off
the block were the banks, with the likes of J.P. Morgan, Wachovia and First
Chicago all reporting gains from higher revenues. The week's winners include
BankAmerica, which rose nearly 9, to 106 7/8, and Citicorp, up 7 5/8, to 107
7/8.
But from then on, the focus turned in a big way toward the technology sector, with
most stocks heading higher. Intel was one that had an especially chopped
week-long ride, rallying strongly on Monday and Tuesday ahead of much-better-
than-expected earnings, only to plunge amid profit-taking Wednesday. Over the
week, the stock did virtually nothing, closing a few cents lower at 144 1/8.
Advanced Micro Devices gained 7 1/8, to 34 7/8, on a smaller-than-expected
loss, while IBM rose to a new 52-week high of 167 before falling a tad to close the
week at 165 1/8. Earnings news helped boost Sun Microsystems 4, to 31 1/4, and
lift Microsoft more than 2 1/2, to 84 1/2.
But not all tech stocks were up: Apple Computer lost 1 1/2, to 16 3/4, following
grim earnings results.
In other sectors, strong earnings added 5 1/8 to Honeywell, which closed at 71.
Record profits at General Electric helped lift that stock 2 1/4, to 103 5/8.
As ever, special situations continued to affect individual stocks. Dow Jones,
publisher of Barron's and The Wall Street Journal, rose 5 1/8 on the week, to 40
7/8, on a Fortune magazine story saying some members of the family that controls
the company want action taken to boost the stock's performance. Zurich
Reinsurance gained 7, to 37 3/4, on news that the Zurich Group will buy the 33%
stake in the company it doesn't already own. Eastman Kodak put on 2 7/8, to 85
1/4, on better- than-anticipated profits and news that it would begin another
restructuring, with a 10% dividend increase thrown in for good measure.
PaineWebber rose 3 5/8, to 31 3/8, following a (quickly denied) report that
BankAmerica was musing about a takeover.
On the downside, Netscape Communications lost 2 3/4, to 43, following an
analyst's report that the company had pushed to close business in the final quarter of
1996, improving that return but hurting the likely return in the current three months.
onventional wisdom has it that increased volatility in the equity market is bad
news, because it often foreshadows major downturns in stock prices. If that's true -
and the high volatility spikes that occurred before both the 1987 Crash and the 1990
selloff suggest it might be - there are certainly grounds for worry right now. Volatility
ratios, which in essence measure the market's gyrations, have risen quite sharply in
just the past few weeks, climbing above 1996 levels, which, in turn, were well up on
those of 1995.
Current volatility readings are about 18%, as measured by Eric Sorensen, the head
of quantitative research at Salomon Brothers. That's low by the standards of '87 and
'89 (see the accompanying chart) when, ahead of selloffs, volatility spiked to levels
well above 30%. But it's still quite a jump from the 12% seen just last November,
and the single-digit numbers posted at the start of 1996, and in '94 and '95. Over the
longer term, volatility, after trending generally lower in 1991 and '92, stayed pretty
stagnant throughout 1993, '94 and '95, but appears to have been rising ever since.
Other measures also indicate that volatility is on the rise. Over the first 13 trading
days of this year, the NYSE's 50-point collar rule (which snaps into effect to restrict
program trading when the market swings more than 50 points from the previous
day's close) was applied 12 times on 10 days. Statistically, that's quite a jump from
the pace set in 1996, when, over the full year's 250-odd trading days, the collar was
triggered only 119 times on 101 days.
Add in the fact that trading volume has been high of late, setting records on several
days this year, and worrywarts and doomsayers agree that the recent rise in volatility
raises a red flag.
But should it?
The short answer is no, insists Abby Joseph Cohen, Goldman Sachs's
well-respected and uncannily prescient market strategist. Her first point is that
volatility, though moving higher, is not high. ``Volatility has been abnormally low for
some time,'' she argues, talking not months but years. ``There were a number of
reasons for that, including the fact that it was a cheap market and the basic economic
cycle itself was a lot less volatile. Now the market is approving a fuller valuation and
we are seeing a surge in volatility back to more normal levels.''
Cohen does agree that
if the bull market turns,
20-20 hindsight will
most probably reveal a
spike in volatility, but
she remains convinced
that the time has not yet
come. What we are
seeing now in higher
volatility is not the sort
of trading choppiness
that precedes a fall but
rather itchy and impatient investors awaiting the market's next move up. ``You have
to look at the underlying fundamentals behind the volatility,'' she argues. ``Those
fundamentals remain good. Investors are chopping around until they feel comfortable
with current trading levels. When they get comfortable, this market is going to go
higher, not lower.''
Though perhaps not quite as bullish, Sorensen wouldn't quarrel too much with
Cohen's arguments. ``If you think about it, investors get jittery on bad news, so
historically higher volatility has been associated with the beginning of market
sell-offs,'' he says.
``But this new higher volatility is not connected to bad news, but rather with just the
sort of uncertainty that comes after a strong market run-up. What we are seeing now
is not unlike the higher volatility that came last July. The market sold off 100 points or
so, but then the uncertainty went away and the market came on back up.''
In Sorensen's view, some two-thirds of volatility spikes are associated with market
downturns. But the current upturn in volatility, he figures, is the sort associated with a
rally, not a decline. ``As the volatility levels fall back from the current levels of 18%
to something closer to 12%,'' he argues, ``that's when the market will restart its
climb, perhaps putting on a further 5%-10% before any further refreshing pauses.''
Still, like Cohen, Sorensen cautions that volatility is a red warning flag that can't be
ignored. ``When the market peaks, and peak it must eventually, it will be signaled by
high volatility.''
he PC market got a boost this past week when Salomon Brothers' analyst
David Childe reported especially strong January sales at CompUSA, a welcome
shot of good news (after the punk sales performance of prior months) that sent the
computer retailer's stock soaring 20% in one day. But will the good times last
through 1997?
Certainly, it's not as if there isn't a lot going on that may in one way or another attract
PC buyers to stores. Intel has just started selling a new, more powerful
multimedia-savvy version of its Pentium microprocessor, and past evidence suggests
that the introduction of such new systems can fuel a lot of upgrade demand. This
spring Sony and others plan to start selling the new high-capacity Digital Versatile
Disc (DVD) systems, a sort-of CD-ROM lookalike that stores much more data and
will ultimately lead to more interesting and powerful PC software.
Most important, perhaps, Microsoft just last week launched its new version of
Office 97, which bundles new and improved versions of Word and Excel. Sometime
later this year, Microsoft will bring out its long-awaited new operating system
software, now code-named Memphis but most probably soon to be known as
Windows 97. That, as with the launch of Windows 95 two years ago, is expected to
foster a boom in PC demand.
With all these happenings, '97 should be a good PC year, right? Well, not
necessarily, suggests Bret Rekas, computer analyst at Donaldson Lufkin & Jenrette.
He points to a recent report that U.S. household PC penetration, widely considered
to be around 35%, is probably a lot closer to a rather more saturated 50% when you
look at the realistic potential market. The corporate PC market is a lot healthier, he
agrees, but even there, nothing's going on that will greatly accelerate purchases.
Though new technologies are coming this year, especially Intel's MMX and the
DVD, there is a dearth of software to utilize the new products, and they are unlikely
to fuel any new hardware upgrade cycle.
``We believe the growth of the consumer PC will slow in 1997 because many people
still cannot afford a PC, or justify the expense, because they see no compelling
reason to own one,'' Rekas wrote in a recent report. He expects worldwide PC unit
growth this year of just 15%, a figure at the low end of all expectations and a sharp
slowdown from the historic norms of well over 20%. Worse still, he says, ``in 1997,
unlike in 1996, slowing growth and pricing pressure is unlikely to be offset by
plunging component costs and rising gross margins.''
As a backdrop to all this, Rekas sees a continuing consolidation in the industry, with
the big getting bigger and the small falling by the wayside. ``If you are not among the
top 10 producers, you have a major problem,'' Rekas told Barron's. ``To survive
you need high volume and brand recognition.'' Rekas doesn't quarrel with the
widespread perception that industry winners in the coming shakeout will include
Compaq, Dell and Hewlett-Packard. He is far less upbeat about the outlook for
Apple Computer, Packard Bell and Digital Equipment, each of which he figures
is in for some very lean times. Gateway is on the fence and could go either way.
o stock had a better 1996 than that of Billerica, Mass.-based Centennial
Technologies. The shares jumped an eye-popping 447%, easily the NYSE's best
performance. Since the end of the year, however, investors have taken some profits.
Centennial closed Friday at 34 5/8, down 4 3/4 for the week, and off 17 3/8 from its
year-end close of 52.
The reversal has been accompanied by a lack of news, but a huge surge in trading.
The company has 18.7 million shares outstanding, and total volume so far this year
has topped 11 million shares - more than changed hands in the first seven months of
1996.
In part, Centennial's mammoth 1996 rise resulted from expectations of continued fast
growth. The sole Wall Street analyst tracking the company, John McManus of
Needham & Co., projects earnings of 77 cents a share for the June 1997 fiscal year,
on revenues of $143 million, versus fiscal '96's 33 cents, on $37.8 million in
revenues.
In recent quarters, most of Centennial's business has come from manufacturing PC
cards, credit-card-size devices that plug into electronic equipment to provide data
storage, communications and other functions. Their most familiar applications are as
PCMCIA devices, which plug into laptop computers.
A significant slice of Centennial's growth this year, however, will come from its recent
move into contract manufacturing. Centennial recently acquired contract
manufacturers in both the U.S. and the U.K., and this month expects to begin
operations in Thailand.
Neither business lacks for competition. In PC-card manufacturing, where Centennial
has focused on flash-memory devices for non-PC applications, its rivals include
Smart Modular Technologies, Sandisk, and several big Japanese electronics
firms. In contract manufacturing, the competitors range from mom-and-pop outfits to
larger rivals like SCI Systems and Solectron. None of Centennial's competitors, in
either business, has gotten the same heartwarming valuation from the market. At
Friday's closing price, Centennial had a market cap around $666 million (down from
about $1 billion at the stock's peak), trading at about 45 times expected current
fiscal-year earnings. This, even though the move into contract manufacturing will
mean serious margin contraction.
Centennial founder and CEO Emanuel Pinez concedes that the expanded contract
manufacturing business will mean a gross-margin decline from 31.8% in the
September quarter to 26%-27% over the next two quarters, though he expects an
upturn after that.
Centennial's astounding run has attracted momentum investors and short-sellers alike
- short-interest recently totaled 1,333,389 shares - and its run has spurred
increasingly heated debate on cyberspace bulletin boards. A lot of the chatter has
focused on rumors of a mega-contract from AT&T for Centennial's new Nomad line
of on-board computing and communications gear for the transportation industry.
The theory is that AT&T would buy the systems and then sell them, bundled with
communications services, to truckers. The rumors surfaced after Centennial and
AT&T co-hosted a booth at a trucking conference in October. But, so far,
Centennial has no orders for Nomad, from AT&T or anyone else. Pinez declined to
comment on the rumors, noting only that Centennial expects to begin seriously testing
the Nomad system in this quarter.
The shorts contend that widely repeated rumors of a $300 million AT&T pact are
ridiculous; time will tell if they're right. They also assert that Pinez misrepresented his
academic credentials in Centennial's SEC filings. The prospectus for its April 1994
initial public offering said Pinez holds a B.S. in chemistry from Hebrew University in
Jerusalem, and a master's in business administration from the London School of
Economics.
In a written response to an inquiry from Barron's, an official in the graduate registry
office of the London School of Economics said a check of ``computer records,
paper files, archives and microfiche'' for every year since 1957 turned up ``no trace
of Mr. Pinez having been awarded a master's.'' (Hebrew University officials couldn't
be reached by press time.) Asked about his academic credentials, Pinez declined to
comment.
- Eric J. Savitz
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