Somebody, please help! I need to go to the Dellaholic Anonymous Money Treatment Center. I can't help myself buying more DELL shares when they go down.<g>
Indicators fell, but Garzarelli's bullish
Market strategist sees buying opportunity in further dips
By Elaine Garzarelli, CBS MarketWatch
NEW YORK (CBS.MW) -- At this writing the S&P 500ÿ has corrected 10 percent, and if it is any more, a terrific buying opportunity would be at hand.
Our 14-stock market indicator composite dropped to 47 percent from 50 percent, due to the downgrade of our sentiment indicator.
Our contrary indicator, the number of bullish advisors, increased over a four-week average rate to 66 percent from 58 percent, subtracting about 3 points from the total. Stock market corrections generally occur when this index reaches 70 percent, which was a recent weekly reading.
The preliminary GDP estimate by the Bureau of Economic Analysis for the second-quarter indicated a stronger economy than most economists expected. The GM (GM) strike alone accounted for about 1 percent of lost growth. In addition, the second quarter showed large drags from net trade and inventory accumulation. The slowdown in inventory accumulation was partly due (about one-fifth) to the decline in automotive dealer stocks reflecting abundant incentives -- this decline cut 2.5 percent off GDP growth. Real GDP growth was 1.4 percent for the quarter with final sales at 3.9 percent.
We believe that Greenspan talks tough in order to calm down the surging stock market; however, he does not have enough evidence to justify raising interest rates. There continues to be signs of low inflation as the second-quarter GDP deflator rose only 1ÿ percent year-over-year. The rate of change in the CIBCR leading inflation index, which we believe Greenspan monitors closely, has declined again this month - making it seven consecutive months of decline in the rate of change (normally, five upticks in the index level have been followed by a Fed tightening).
Europe is slowing
Greenspan, in his Humphrey-Hawkins testimony, said he saw no signs that the Asian crisis is stabilizing. The area continues to be mired in a recession/depression scenario with Korean unemployment at a 32-year high. Chinese stock markets are hitting new lows, and Japanese bank stocks relative to the Nikkei are at new lows.
Europe is also feeling the affects of Asia, with the Asian contagion slowing global economic activity. Europe's slowdown is evident with German bond yields at all-time lows, UK real retail sales down -1.2 percent in June, and Spain's PPI deflated for the first time since 1986. As the same time, the European Commission wants to insure that governments reduce their budget deficits ahead of the introduction of the single currency. Although we believe the Asian situation will have a dampening affect on Europe, most of those countries should endure the situation as well as the U.S., we believe.
Yield forecast
We believe interest rates, not earnings, will be the strength of the bull market over the next year. Both top-down and bottom-up analysts are continually lowering their earnings estimates as companies report weakness (partly due to the Asian affects). We continue to look for flat S&P 500 earnings into 1999. Our bond model, however, continues to suggest yields will continue to decline based on low inflation and the budget surplus. As the budget stays in surplus, there is less need for the government to issue more debt which, of course, limits the supply of bonds and causes yields to continue to decline. This should be the fuel for the stock market's continued rise even with the flatness we anticipate in earnings.
When solving our bond model, we assumed inflation as measured by the chain weighted GDP deflator will average about 1.5 percent through the year 2000 -- currently it is running 1ÿ percent year-over-year. If we assume 1.5 percent inflation, and the budget stays near its current small surplus, a bond yield of 4 percent or such is likely by the year 2000. This in turn, of course, improves our valuation indicator for the stock market even in a flat earnings environment, suggesting an S&P 500 of 1500 (an approximate 12,000 Dow).
Sector analysis
In order for an industry to be ranked attractive, two criteria must be met. First, our outlook for the industry's earnings growth must be superior to that of the S&P 500, and second, the group's relative P/E must be below its normal range.
This month we downgraded four industries to neutral. Underlined stocks were on our favorite stock list and are no longer recommended as buys.
Aerospace/Defense -- downgraded due to slower earnings in 1998 based on the recent news of the slowdown in Boeing. This year's earnings slowdown deflates 1999 earnings and causes valuations to be high (-26 percent underperformance potential). The top 3 stocks in the group are: Boeing Company (BA, 57.3 percent of the S&P group), Lockheed Martin Corp. (LMT, 26.3 percent), and Northrop Grumman Corp. (NOC, 8.9 percent).
Household Furnishings -- downgraded due to the -10 percent decline we anticipate in 1999 (compared to flatness for the S&P 500). The stocks in the S&P group are: Maytag Corp. (MYG, 47.2 percent of the S&P group), Whirlpool (WHR, 52.8 percent)
Leisure Time Products -- downgraded also due to the -10 percent decline we anticipate in 1999. The stocks in the S&P group are: Brunswick Corp. (BC, 12.2 percent of the S&P group), Hasbro Inc. (HAS, 26ÿ percent), Mattel, Inc. (MAT, 61.8 percent).
Retail - Drugs -- downgraded due to the group's valuations - it's outperformance potential is a mere 3 percent. The top 3 stocks in the group are: Walgreen Co. (WAG, 44.3 percent), CVS Corp. (32.3 percent), and Rite Aid (RAD, 20.9 percent).
Sector highlights
The following four groups are highlighted this month. Please note the underlined stocks are our favorites in the industries.
Chemicals -- This industry is ranked unattractive because of the -30ÿ percent decline in earnings we forecast next year. Currently the group's relative P/E is at a 10 percent premium. It's normal P/E is a 5 percent discount to 5 percent premium relative to the market suggesting an underperformance potential of 4ÿ percent. The stocks in the S&P group are: The largest 5 stocks in the group are: Du Pont (EI), (DD, 59.6 percent of the group), Dow Chemical (DOW, 15.4 percent,), Air Products (APD, 6.6 percent), Praxair, Inc. (PX, 5.2 percent), and Union carbide (UK, 5.1 percent).
Hardware and Tools -- We rank this industry as unattractive. This group's relative earnings has been declining since the third quarter of 1996 and its relative price has been flat over the same period. The relative P/E normally trades at a 40 percent premium and is currently at a 131ÿ percent premium on our 26 percent earnings decline forecast for 1999. The stocks in the group are Black and Decker (BDK, 61.1 percent of the group) and Stanley Works (SWK, 38.9 percent).
Health Care Diversified -- This group continues to be on our attractive list since we forecast an 8.5 percent gain in 1999 earnings compared to flatness for the S&P 500. Because the group normally trades at a 25 percent premium, and is currently at a 13 percent premium, a 10.5 percent outperformance potential is attainable. The largest 5 stocks in the group are: Bristol-Meyers (BMY, 28.1 percent), Johnson & Johnson (JNJ, 24.4 percent), American Home Products (AHP, 16.7 percent), Abbott Labs (ABT, 15.5 percent), and Warner-Lambert (WLA, 14ÿ percent).
Hospital Supplies -- Since we expect a 6 percent gain in earnings next year (after a 36 percent gain this year), we rank this group as attractive. The group's normal P/E ranges between a 20 percent to 70 percent premium and it is currently trading at a 60 percent premium, suggesting a 6 percent outperformance potential. The largest 5 stocks in the group are Biomet, Inc. (BMET, 39ÿ percent of the group), Medtronic, Inc. (MDT, 31.7 percent), Baxter Int'l (BAX, 16ÿ percent), Boston Scientific (BSX, 14.7 percent), and Guidant Corp. (GDT, 31.7 percent).ÿ
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