WSJ Q Mentioned> (long)
July 1, 1999
Money & Investing
Cyclicals' Rebound in Quarter
May Turn Out to Be Short-Lived
By E.S. BROWNING
Staff Reporter of THE WALL STREET JOURNAL
It was the economy, stupid.
That is how a famous political consultant might have summed up the
just-ended quarter for U.S. stocks: Surprising economic strength in the
U.S. and the rest of the world finally awakened the old-line industrial
stocks. After cruising the backwaters for years, names such as Alcoa Inc.
and International Paper Co. started outgaining the likes of Microsoft Corp.
The question is whether it can continue.
In April, the materials and services sector of
the Standard & Poor's 500-stock index was
up 18.5%, notes Deborah Cashman Ohl, a
portfolio manager who specializes in cyclical
stocks at New York's Ashland Management.
Those suddenly fast-rising stocks include steel, aluminum, construction and
other classic cyclicals that rise and fall with the economy. "They've gotten
ahead of themselves," given that they have been trading on expected
earnings gains, not actual gains, Ms. Cashman Ohl says. "Now I think we
are going to see a period of consolidation as we wait to see whether the
earnings can justify this kind of move. The cyclicals have been very
undervalued and they do trade ahead of their earnings releases, but at this
point I don't consider them a good buy."
Investors have seemed to share her skepticism lately. As worries about
inflation and sharp interest-rate increases have subsided, so has the hunger
for these industrial stocks. Wednesday, the Federal Reserve boosted its
guideline short-term interest rate just a quarter percentage point and
indicated that it isn't inclined to raise it again right away. Money flowed out
of the industrial stocks -- the cyclicals -- and into old favorites such as
technology and banking stocks.
For the quarter, the Dow Jones Industrial Average, heavy in cyclical
stocks, rose 1,184.64 points, or 12.11%, to 10970.80. That left it 1.23%
short of a record. The Nasdaq Composite Index advanced 224.72, or
9.13%, to 2686.12, a record, and the Standard & Poor's 500-stock index
moved up 86.34, or 6.71%, to 1372.71, also a record. The Russell 2000
small-stock index zipped ahead 60.05, or 15.10%, to 457.68.
Fans of the cyclicals point out that they are easing after some impressive
gains, and could easily take off again later.
Market Boxscores
6/30/99
close
% chg.
from
3/31/99
% chg.
from
6/30/98
DJIA
10970.80
+12.11%
+22.55%
DJ U.S. Market
1297.31
+6.33
+20.89
DJ World
220.02
+5.54
+14.39
S&P 500
1372.71
+6.71
+21.07
NYSE Comp.
648.13
+7.38
+11.99
Nasdaq Comp.
2686.12
+9.13
+41.77
Amex
797.93
+12.34
+10.63
Value Line
465.76
+13.81
-2.29
Russell 2000
457.68
+15.10
+0.06
Alcoa, the cyclicals' star performer, has gained about 50% in value since
the start of April, while Microsoft has been virtually flat. The same general
trend has hit a wide variety both of old-style industrial stocks and
new-style, onetime highflying technology stocks.
The reason for the cyclicals' rebound: In the second quarter, the common
wisdom on the economy changed radically. In the first part of the year, a
handful of prominent technology stocks soared amid worries that 1999
would be hobbled by sluggish economic growth, perhaps even a recession.
In that kind of world, investors were willing to pay big premiums for
sterling companies that they thought would deliver strong earnings growth
even in a weak economy.
But as the second quarter progressed, all the economic data suggested a
very different world, with the economy growing as much as 4% a year,
maybe more. Industry reports suggested that manufacturing activity was
booming far ahead of expectations. Suddenly, it looked as if a lot of
companies, not just a handful of market darlings, could be delivering strong
earnings in a surging economy. Why pay 100 times the past year's earnings
for networking company Cisco Systems Inc., when you could buy
farm-equipment maker Deere & Co. for less than 15 times earnings?
And, the thinking went, what if the strong economy produced inflation?
That would mean higher interest rates. Higher rates make investors pull
back from companies with hefty price/earnings ratios, because higher rates
make it more expensive to wait for the big future earnings gains that the
high P/E companies promise. But inflation often is good for old-style
industries, whose sales jump when the economy booms.
Little wonder that, in the second quarter, the stocks posting some of the
biggest gains came from once-lagging industry groups such as metals,
industrial technology, machinery, forest products, basic materials,
chemicals and paper.
Rex Wardlaw, a portfolio manager at Wells Capital Management, the
money-management arm of Wells Fargo & Co., counts himself among the
optimists who think the cyclicals can keep gaining.
"What we are seeing is a real selectiveness among investors, who want the
best of the cyclical names," he says. "People are spending their money on
the large-capitalization cyclical companies, names like DuPont Co. and
Alcoa. I think those stocks really have room to run because they are doing
fundamental things to change their businesses. Alcoa is taking $1 billion in
costs out of its business" by redesigning processes and working more
efficiently.
The Fed's mild rate increase, and its signal that it isn't planning another rate
increase right away, was taken by some investors as a sign that the Fed
won't use interest rates to kill economic growth this year. That is good
news for the cyclicals.
"Higher-quality cyclical stocks will continue to do okay as long as the Fed
doesn't kill economic growth," Mr. Wardlaw says.
For now, however, many investors seem more worried that the cyclicals
have come too far than optimistic about the future.
"Our economy is in convoy with those of the rest of the world -- pulling
them all, actually," says James Griffin, market strategist at
money-management group Aeltus Investment Management of Hartford,
Conn., in a report to clients this week. "A mishap somewhere back down
the line might lead to another flight to quality," meaning a race back into the
handful of big, reliable names such as Microsoft and General Electric Co.
Second-Quarter Stock Performance
Best- and worst-performing large cap stocks in the second quarter.
Large cap denotes stocks with market value of approximately $5 billion
or more on March 31, 1999, adjusted for subsequent changes in shares
outstanding.
Large Cap Winners
Price
6/30/99
% chg.
from
3/31/99
Comments
Broadcom A
$144.56
+134.6%
Produces semiconductors for
booming telecom. business
Qualcomm
143.50
+130.8
Settles intellectual-property
dispute with competitor
Ericsson
AES
58.13
+56.0
Independent power producer
expanding worldwide
Computer Assc.
54.75
+54.0
Financial software group
benefits from surging earnings
Tandy
48.88
+53.2
Its Radio Shack unit booms
Immunex
127.44
+53.1
Biotechnology company
benefits from new arthritis drug
Honeywell
115.88
+52.8
Merging with AlliedSignal
Alcoa
61.88
+50.2
Most prominent of newly
popular industrial stocks
Hewlett-Packard
100.50
+48.2
Beats estimates, expects higher
revenue growth
IBM
129.25
+45.8
Announces surprisingly strong
earnings again
Large Cap Losers
McKesson HBOC
$32.19
-51.2%
Top executives quit or fired
amid accounting scandal
Cadence Designs
12.63
-51.0
Warns 1999 revenue and
earnings to be flat
Excite At Home
53.94
-31.5
At Home completes merger
with Excite
Gillette
41.00
-31.0
Warns second quarter, 1999
profit to miss estimates
Parametric Tech.
13.88
-29.7
In strategic alliance with Origin
BV
Amazon.com
125.13
-27.3
Warns of wider operating
losses this year
Compaq Computer
23.69
-25.2
Warns of second quarter loss
America Online
110.00
-25.2
To invest $1.5 billion in Hughes
Electronics, form alliance
AmSouth Bancorp
23.19
-23.6
To purchase First American
Corp.
Tricon Global
54.13
-23.0
Chief financial officer resigns
Quantitative analyst Edward Keon of Prudential Securities, who as early as
February was urging clients to buy out-of-favor stocks such as cyclicals,
now is suggesting that they go back to large-cap "growth" stocks such as
GE and Cisco Systems. He thinks the economy will avoid inflation, helping
growth stocks and hurting cyclicals.
"By the time that it becomes clear to everyone that the inflation scare is a
phantom menace," he told clients this week, "everyone will be jumping into
the growth-stock pool."
Ms. Cashman Ohl of Ashland Management says that she, like many
investors, has been carrying a big position in such quality cyclical names as
Alcoa, "because it is the leader among the aluminum stocks and has
delivered consistent earnings growth. For the time being I'm willing to give
it a little chance here."
But if Alcoa's earnings, due out in a few days, are disappointing, there are
a lot of people holding onto a stock that already has posted big gains, she
adds. The risk if Alcoa disappoints is that a lot of them could take some
profits and lighten up.
U.S. Industry Group Performance
Best- and worst-performing U.S. industry groups for the second quarter.
Best
Performers
Performance
Worst
Performers
Performance
Aluminum
+ 45.42%
Cosmetics
21.29%
Industrial technology
+ 38.16
Consumer
services
17.32
Other non-ferrous
+ 34.12
Savings & loan
8.98
Electronic components
+ 31.09
Restaurants
8.70
Transportation
equipment
+ 31.09
Drug retailers
8.10
Heavy construction
+ 26.62
Pharmaceuticals
6.46
Industrial, diversified
+ 26.21
Beverages,
distillers
5.84
Heavy machinery
+ 25.87
Biotechnology
5.60
Forest products
+ 24.15
Auto
manufacturers
3.78
Chemical-commodity
+ 22.09
Medical supplies
2.99
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