Tech stock summer fun might not last
Commentary: Key volatility indicator hints of danger
By Mike Tarsala, CBS.MarketWatch.com
Last Update: 12:08 AM ET July 30, 2003
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SAN FRANCISCO (CBS.MW) - Tech stock investors who feel like they're on a summer picnic right now could soon face the consequences of gorging on too many spare ribs, baked beans and helpings of potato salad.
The tech-heavy Nasdaq rose again in July, after a 21-percent second-quarter gain, prompting a lot of money managers to pile more tech stocks on their plates. They've taken second helpings on Intel (INTC: news, chart, profile), KLA-Tencor (KLAC: news, chart, profile), Veritas Software (VRTS: news, chart, profile) and other big-name stocks that are up 50 percent or more in the past six months.
Money managers don't seem worried about getting indigestion. Funds keep flowing in, as many customers are acting on sketchy signs of economic improvement, rather than sinking consumer confidence, cautious executive projections and the possibility that the market's bounce is due only to fleeting economic stimulus and the end of major fighting in Iraq.
Yet a few analysts are truly worried about the latest market warning sign -- a steep drop in the CBOE Volatility Index ($VIX: news, chart, profile), a measure of put-to-call options that serves as the market's fear gauge. It's now at a 16-month low, and near a level that forewarned of three other big tech market sell-offs in recent years.
"Anything could trigger a sell-off from these currently high stock prices, and the volatility index could be warning of that," said George Muzea, president of his own Reno, Nev.-based market sentiment consulting service, which advises firms with a combined $1 trillion under management. "When the volatility index gets below 20, it's often a pretty unfavorable sign for the market - especially tech."
Cases in point:
The Vix, as the volatility index is known, dropped to a low of 18.13 the week of August 25, 2000. The Nasdaq fell 18 percent in the following six weeks.
The Vix fell to about 20 the week of July 3, 2001. The Nasdaq fell 29 percent in the following 11 weeks.
The Vix dropped just below 20 the week of April 10, 2002. The Nasdaq fell 31 percent in the following 14 weeks.
When the market is panicked, and the Vix heads to an abnormally high level -- say above 40, it's often a good time to be buying stocks. And the opposite is also true -- when the market is bullish and the Vix dips, it can be a sell signal.
Now that the Vix is hovering at about 20, traders and other technical analysts will be paying attention to key levels on the Nasdaq ($COMPQ: news, chart, profile) in coming weeks to help them gauge the tech stock market's future direction.
We're heading into the dog days of summer with the Nasdaq near 1,730. If the market continues to climb, some technical analysts say it could be difficult for the index to break its next resistance point at the 1,780 level. Conversely, there seems to be a level of technical support at about 1,680, but not another one until about 1,600, should the Nasdaq head lower.
A drop in the Vix isn't necessarily terrible news. Going back to the less volatile market periods before 1998, it often didn't mean much when the index dipped below 20. It's possible that the low volatility right now could simply mean that the market will trade in a narrow range in coming months, as investors react indifferently to the market heading into the summer's lazy, hazy days.
David Briggs, head equity trader at Federated Investors in Pittsburgh, adds that a high Vix number is a better stock market predictor than a low Vix number, which can sometimes be misleading.
But even assuming the most benign technical case, there seem to be some significant fundamental problems with the tech stock market, as well. It should make some shareholders think about selling off at least a portion of the tech stocks that have performed particularly well for them so far this year.
Perhaps the biggest fundamental problem is that tech companies are meeting or even beating earnings targets with sales that stay all but flat. Adjusting for currency effects and letting companies exclude one-time charges, second quarter, earnings among the 80 tech companies that trade on the S& P 500 ($SPX: news, chart, profile) rose 15 percent, while sales were unchanged from last year, according to research by Thomson First Call.
It was about the same in the first quarter: Earnings rose 19 percent, on average, while sales for the group increased 2 percent.
"The tech results so far are based on nothing but cost cutting, and that can only go on for so long," says Chuck Hill, research director at Thomson First Call. "It's more of the same -- we're not really seeing any demand pick-up -- just companies that are doing better by gaining market share."
Still, Wall Street analysts continue to raise third-quarter earnings expectations Hill says. They now assume an average of 56-percent earnings growth for the S&P tech stocks, vs. 29-percent earnings growth in the same quarter last year. That's up from 54 percent at the end of the second quarter.
Even when you adjust for year-ago earnings from Lucent (LU: news, chart, profile) that skew the overall third-quarter earnings expectation higher, Hill says it's a "pretty high estimate".
It's too hard to predict precisely when the market is going to fall, but it's clear that stock prices remain hefty on a price-to-earnings basis, says Rich Williams, analyst with Summit Analytic Partners in Summit, N.J. Investor confidence, he says, has "soared beyond the ability of the underlying fundamentals to explain or support it," while many investors expecting the good times in the second quarter to continue.
Before that happens, we may be due for another market correction -- something the Vix may be trying to tell us.
Mike Tarsala is a San Francisco-based reporter for CBS.MarketWatch.com. |
