The Meehan Notes
May the New Economy Rest in Peace
By Bill Meehan
Special to TheStreet.com
7/9/01 8:53 AM ET
URL: thestreet.com
Bulls were running wild in the streets of Pamplona and running scared on Wall Street. More earnings warnings and a weaker-than-expected jobs report made for a gory session Friday, as hope for a V-shaped economic recovery got trampled. While Pamplona's centuries-old tradition occurs like clockwork every year, that's hardly been the case for a summer rally on Wall Street, although this myth has lived on for years.
Most of the damage done during the thinly traded, holiday-shortened week was confined to the tech sector, as speculation continued to rage. However, selling was widespread heading into the weekend. Utility stocks were the only group to post a decent gain on the horrid week, although energy stocks also managed to rebound from their recent drubbing. Crude futures rose more than $1 a barrel Friday, adding to the market's vicious tone. If there was something to be optimistic about, it was that the market, particularly the Nasdaq, is again now very oversold. And, perhaps, as second-quarter earnings begin to pour in, things won't look as bleak as they have through the treacherous warnings season. Of course, more warnings are probably forthcoming, and earnings visibility isn't likely to be any clearer.
Economic Outlook
Curiously, Labor Secretary Elaine Chao said, "The stable economy is poised to take off" -- after nonfarm payrolls fell 114,000, more than double expectations. While the 113,000 decline in manufacturing jobs was the weakest link, a puny 5,000 increase in the services sector clearly indicated that the economic malaise has spread. Hours worked fell at a 1.5% annual rate, while average hourly earnings rose 4.2% year over year. With productivity in reverse, the cost of benefits rising even faster than earnings and the dollar surging, profit margins are likely to remain under pressure.
It's no surprise that Goldman Sachs chief domestic economist William Dudley sees pretax profits' share of gross domestic product shrinking to 8.4% this year vs. 9.5% in 2000. And it shouldn't come as a great shock that with so many options under water, execs are demanding more of their compensation in cash. Companies won't benefit from the copious tax deductions resulting from options being exercised, as they did during the market mania. Contributions to the bottom line from overfunded pension plans, which increased 60% last year from 1999, might also flag, dragging down operating earnings.
In addition, companies won't likely buy back as much stock as they have over the past several years, eliminating one of the biggest sources of demand. As for investors, Strategic Insight put equity growth fund inflows at only $1 billion year-to-date. Equity value and bond funds have taken in $74 billion, helping to account for the outperformance of value stocks and corporates. However, even as Friday's fiasco lifted Treasuries, high-grade and intermediate-grade bonds rose 7 and 9 basis points, respectively, last week.
The number of QQQ (QQQ:Amex) shares outstanding has grown to 532 million from the year-ago 134 million. While the Qs are sometimes used as long-term holdings, they're now trading so heavily that the shares turn over completely every eight days! For the market as a whole, turnover is running at an annual rate of 188%, with tech stocks at 373%. In the words of Zurich Financial's chief economist, "We are witnessing an unprecedented institutionalization of speculation without any anchor in traditional valuation measures."
Major Market Measures
While Microsoft (MSFT:Nasdaq) has grown bigger as other mega-cap tech stocks have shriveled, the software giant now accounts for 11% of the entire Nasdaq capitalization. Although the company is rid of Judge Thomas Penfield Jackson, it's still been branded a rogue monopolist, and its near-term future still remains tied to PC sales. Given its long-term growth rate, current valuation might be a bit stretched, even if management weren't distracted by an ongoing duel with the government. Plus, its technical picture is deteriorating rapidly. With Microsoft's impact on the Nasdaq Composite and Nasdaq 100, you don't have to be a certified market technician to worry about the Nasdaq should Mister Softee disappoint.
On Thursday, my momentum indicators flashed a sell signal on the Russell 2000, and the downside follow-through Friday gave definitive sell signals on the S&P 500, the Nasdaq Composite and the Nasdaq 100. Also troubling was the breakdown in the Philadelphia Stock Exchange Semiconductor Index, which easily took out support Friday morning. Fundamentally, chip prices remain under pressure due to weak demand and an abundance of supply.
While implied volatility in optionland continued to expand, the Volatility Index and the QQV, which measures the volatility of QQQ options, remain much closer to their lows than to levels that indicate fear. And the weekly polls also showed a perverse lack of concern. Investor's Intelligence showed 50% bulls, while bears slipped to only 25.5%; the Market Vane bullish sentiment increased to 42% from 33% in the prior week; and the American Association of Individual Investors' bearish reading plunged to 18.5% from 32.9%. On a positive note, the Chicago Board Options Exchange put/call ratio rose to 0.90 Friday, although it was only 0.65 for options on the Qs. My near-term targets of 1145 for the S&P 500, 1790 for the Nasdaq Composite and 1520 for the Nasdaq 100 indicate that a long S&P Depositary Receipts (SPY:Amex)-short QQQ spread might be a decent intermediate-term move for less aggressive traders. Aggressive traders should simply consider selling into rally attempts.
Energy stocks and utilities appear to offer the only near-term "safe havens," although some of the other, more traditional defensive names are also apt to hold up better than cyclicals and tech, which is rapidly being seen again as very sensitive to the global economy. So much for the New Economy; may it rest in peace. However, many of the traditional defensive stocks will continue to be hurt by the strong dollar, and most had a great deal of difficulty growing top and bottom lines even during an economic boom. So investors should remain skewed toward value and hold some cash to take advantage of bouts of indiscriminate selling, such as what had been seen in the energy patch. The bulls will be back, but probably no sooner than the fourth quarter, which is the earliest that I expect analysts to begin raising -- rather than chopping -- 2002 estimates.
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Bill Meehan is the chief market analyst for Cantor Fitzgerald, a Manhattan-based institutional trading and research firm, and writes daily for the Cantor Morning News. Before that, he was a market analyst for Prudential Securities. At time of publication, Meehan was long QQQ puts, Microsoft puts and Merrill Lynch Semiconductor Holdrs puts, although holdings can change at any time. He appreciates your feedback at bmeehan@thestreet.com.
Morning News, Copyright, 2001 is a product of Cantor Fitzgerald & Co. ("Cantor Fitzgerald"). The material is based upon information that Cantor Fitzgerald considers reliable, but Cantor Fitzgerald does not represent that it is accurate or complete, and it should not be relied upon as such. Cantor Fitzgerald and its affiliates, officers, directors, partners and employees may, from time to time, have long or short positions in, buy or sell and deal as principal in the securities, or derivatives thereof, of companies mentioned herein and may take positions inconsistent with the views expressed. None of the information contained herein constitutes or is intended to constitute a recommendation by Cantor Fitzgerald of any particular security or trading strategy or a determination by Cantor Fitzgerald that any security or trading strategy is suitable for any specific person. To the extent any of the information contained herein may be deemed to be investment advice, such information is impersonal and not tailored to the investment needs of any specific person. You should consult with and rely upon your own advisers whether and how to use such information in making any investment decision. |
