Where now Dow Jones Industrials?
Two long-term investors have two very different ideas
By Don Scott, CBS MarketWatch
Last Update: 3:42 PM ET Dec 28, 1998
NEW YORK (CBS.MW) -- As investors look ahead to 1999, the last
investment year of this century, the big question is: Can the market post yet
another double-digit gain?
Two savvy, long-time investors, come to startlingly different conclusions,
though they share some common concerns.
Keep in mind that the S&P 500, despite one heck of
a roller coaster ride, was up 26.4 percent heading into
the week, looking ready to post the fourth year in a
row of double-digit gains.
John Murphy, who specializes in inter-market
technical analysis, is worried. He thinks the Santa
Claus rally this year is being driven by money
managers who've under performed the market and are
now window dressing their portfolio.
"These portfolio managers who don't want to look too
bad are buying these few leaders so that it'll maybe
boost their performance the last few weeks of the
year, but also so they can show them on their
balance sheets," he said.
Murphy notes a recent Merrill Lynch study that found
just a dozen stocks responsible for half the S&P
500's gain for the year: Cisco (CSCO), Dell Computer
(DELL), General Electric (GE), Home Depot (HD),
Intel (INTC), International Business Machine (IBM),
Lucent Technology (LU), MCI Worldcom (WCOM), Merck (MRK), Microsoft
(MSFT), Pfizer (PFE), Wal-Mart (WMT).
Two concerns
Murphy's got two main concerns. One is the lack of breadth behind the
current rally and the other is that commodity prices are tumbling again.
"It's very similar in some ways to the situation we had back in the summer
when we had the Dow and some of these big cap averages hitting new
highs," he says. "And some of us technical people were pointing out that the
small stocks were weak, the transportation stocks were weak, the advance
decline line was flat, the new highs, new lows were weakening and then the
market had that big tumble, and now were back up near the old highs again,
yet the breadth figures are worse now than they were last summer."
Murphy thinks the market is underestimating the deflationary threat posed by
falling commodity prices despite a strong positive correlation between
commodity and earnings prices.
Yet if interest rates continue to fall it would be a positive for stocks. "You've
got a trade off, so the decline in earnings may prevent the stock market from
going up, but the decline in interest rates as a result of the weakening
economy and a Fed easing may prevent the stock market from going
down…it's going to be a sideways market, we'll start the year strong and
then maybe run into some problems in the spring."
Bonds may do well
Murphy thinks a lot of money can be made in the markets in 1999, if you
pick the right sectors and the right securities. "With the deflationary trends of
next year, we think bonds are going to do quite well," says Murphy who
cautions investors to stick with Treasuries and stay away from corporates.
For money committed to the stock market, Murphy says mutual fund
investors should think about conservative growth and income funds, equity
income funds and utility funds. When it comes to individual stocks, he says
the consumer staples like Proctor and Gamble (PG), Clorox (CLX),
Colgate-Palmolive (CL) and Philip Morris (MO) are all candidates to check
out, as are the drug stocks, like Pfizer.
If you've just got to have some technology, he says go with Ascend
Communications (ASND), Compaq Computers (CPQ), Dell Computers
(DELL), Micron Technology (MU) or Apple (AAPL).
"Micron has been in a basing pattern for about 2 years," says Murphy, "It
recently set a 52 week high. It's backing off here a little bit, but if it can
break through, and we think it will, we could see it move up to 90."
On AAPL: "It came right down to its 200 day moving average and all kinds of
important technical areas, and it just popped beautifully…if you're looking for
a technology stock that's just kind of a sleeper, this looks like one…if it
takes out the old high of 44 it could move up towards 60."
Options outlook
Price Headley of Schaefer's Investment Research agrees with Murphy on
Apple. But his firm will play it in stages. SIR started recommending Apple
when it was 37 15/16th and Headley says "we're targeting a move to 42."
They also recommend options and note that the Apple January 35 Calls were
trading at 5 1/8th when they said the stock looked bullish. If Apple does go
to 42 by the time that Call approaches expiration in January, the option
contract should be worth about 7. But Headley notes: "if it happens in the
next week or so, it should be trading more like about 8 1/2 because of the
time value of the option contract."
Headley also likes Novell (NOVL). "You've seen the stock finally have a good
turn around on the longer term chart, the 10 month average crossing above
the 20 month average. That hasn't happened since the early 90s when the
stock went from about 5 up to 30 in about a year and a half." He notes the
company has posted two good quarterly earnings surprises and they'll next
report in mid to late February. So he says you could buy the May 20 Call
options contract now for about 1 9/16ths. "30 is our target later into '99 on
Novell, but our first target is at 22 1/2, which, if we had a fairly quick 5 point
move, you'd be looking at the May 20 Call options worth in the neighborhood
of 3 to 3 1/2."
On the broad market, Headley is also cautious in the near term. "I think short
term some sort of a consolidation is probably soon to be upon us here. I'm
thinking it's close to hitting now. …I wouldn't be selling based on that, but I'd
be saying as an options trader you have to be a little cautious of the market
maybe flattening out after the big rally it's had in the short term."
Bullish on '99
Headley differs with Murphy on where the market's headed in 1999.
Headley's very bullish. "You've got the third year of the election cycle, where
if you look back, in third-year election cycles, it's been a double digit gain all
the way back to 1963 every time but once, and that was in 87, where you
had the crash in October, but you still finished up that year."
He says every other year going back to 63 has been a double digit positive:
"'95 was up 34.1 percent and '91 up 26.3, so we've really turned up the heat
here in the last couple of third year cycles."
Headley points out that the election cycle usually tacks on 50 percent from
the Dow's low in the second Presidential mid-term year, to the high of the
third year. That would take the market from last summer's 7400 to 11,100.
"My gut is that when we get through 10,000 the run up to 11,000 could be
potentially pretty quick," he says, but warns, "at some point we will get
pretty close to the 11,000 level and I think at that point you probably want to
take chips off the table because I think we'll have come too far too fast and
then probably be due for a settling."
Don Scott writes for CBS MarketWatch from New York.
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