Another's view of the past week. . . . . .[from Wall Street's perspective]
April 19, 1999
And Now a Cyclical Rally as the Dow Hits Another High
By Michael Santoli
Vital Signs
Usually, you'd have to wait until July and the Tour de France to see a cyclical rally as spirited as the one staged by Wall Street last week.
The shares of all manner of metal-bending, tree-felling and mine-scraping companies, those that move to the beat of global economic expansion, roared higher in a remarkable stampede away from the previously untouchable growth-stock leaders and toward perceived value. Of the major market indexes, the Dow Jones Industrial Average, thick with manufacturing and commodity names, derived the most strength from the move, rising 320 points to 10,494, a new record.
Much of the cash that fueled the run in economically sensitive names came from the hides of technology stalwarts whose earnings were suddenly in question, and consumer-growth stocks sacrificed at the altar of profit-taking and sector rotation. Those two groups are the bread and butter of the Nasdaq and Standard & Poor's 500, leading those gauges to fall 4% and 2%, respectively.
But even within the Dow, the effect of the cyclical surge was blunted by steep tumbles in its tech and growth names, such as IBM, off 15 15/16 to 170 3/8, Wal-Mart, down 7 3/4 to 95, and Merck, which thudded 5 5/8 to 77 5/8 . The Dow Transports, strongly geared to the economy, took flight, rising 158 points to 3528. A pure measure of the week's stars is the Morgan Stanley Cyclical Index, which vaulted 11% on the week and is now up a whopping 20% on the year.
The sudden shift came as a sort of tacit consensus was coalescing among Wall Street prognosticators that with Asia finding its equilibrium, Europe slashing interest rates and 1999 earnings shaping up far better than last year's depressed results, the time had come to pick up the long-ignored laggards of the market. In an unintended harmony, strategists John Manley of Salomon Smith Barney, Ed Kerschner of PaineWebber and Tom Galvin of Donaldson Lufkin & Jenrette, among others, were telling clients some version of the pitch that earnings growth -- which last year belonged only to the elite -- was broadening out to the masses, meaning a great many more stocks could have enough fuel to go higher this year.
Investors were receptive to the pitch because some favorites like big tech stocks were suddenly suspect after Compaq's dreadful earnings warning and some cautionary words and lower revenue growth from Intel. Internet stocks first shot higher early in the week, performed a rendition of a speculative blowoff and as a group finished down some 8%.
Still, the magnitude and speed of the jump in groups like metals, machinery and chemicals took even those who predicted it by surprise, leading to concern that the run might not have legs. Making these worries more acute is the fact that these sleepy stocks have juked to the upside in the past, only to surrender leadership to the growth convoy again. Ed Hyman's strategy team at ISI noted Friday that never in the 1990s bull market has the S&P Industrial Cyclical group had such a vertical ascent, noting that they're "still doubtful" that this is the real thing. Evidence of Wall Streeters' ambivalence toward the market action was rife in the upgrades by Goldman Sachs Thursday of metals stocks Alcoa, Phelps Dodge and Inco to "trading buy" -- not long-term buy -- after they'd started to run. And does it make sense that the oil stocks ramped in tandem with the Transports?
What's generally agreed to is that if this rally is to have any staying power, it will have to be because of favorable earnings, not merely liquidity flows and portfolio adjustments. Encouragement on that front came last week from the likes of Caterpillar, Boeing, General Motors and Ford. Yet look at what happened to some growth names when the companies reported forecast-topping earnings but offered cautionary outlooks: Sun Microsystems was chopped by 15 5/16 to 54 15/16, Pfizer fell 15 1/16 to 126 15/16 and Guidant -- subject of a skeptical item in Barron's Online's Weekday Trader recently -- dropped 12 5/8 to 52 5/8 .
One stubborn Dow-stock underperformer, Eastman Kodak, got investors excited Friday by reporting better-than-expected first-quarter earnings, complete with revenue growth and not just cost-cutting, something analysts have been waiting for. What's more, the film company had sales growth in the competitive U.S. consumer-film market and showed signs of improving results in the important emerging markets. The stock jumped 6 7/16 Friday alone and on the week was up 10 1/16 to 73.
What might have cheered the market as much as the earnings was Kodak's coming around to Wall Street's two great pleas to management: It announced a new $2 billion stock-buyback plan and released an expanded amount of detailed operating information to analysts, who have long complained that the company doesn't do enough to help them understand its business.
Kodak's chief financial officer, Harry Kavetas, told analysts in a conference call Friday that the company was already in the market buying back stock. He added that "at these price levels, we'll probably stay in buying at the limit the exchange lets us buy," and that the company "will also be buying at materially higher [price] levels."
Two observations fortifying the bearish stance on the market have been that the advance in the major indexes has been too narrow, with only a handful of huge stocks driving the move, and that valuation measures such as price-earnings multiples are untenably high.
But it could be argued that if one of those points is true, then the other isn't, or at least it isn't fully true. That is, if the mega-cap stocks are all that have been powering the indexes to record levels -- rendering them a lousy gauge of an overall market where the majority of stocks are way off their highs -- then market-wide P/Es are equally distorted by the outsize influence of these giants, which tend also to have the heady valuations.
This can be seen neatly by piecing the S&P 500 into two sub-indexes, its 10 largest components and the lower 490. Such a breakdown performed by Donaldson Lufkin & Jenrette at the request of Barron's illustrates that "the market" is significantly more modestly valued than the gaudy multiples on its big bullies would indicate. As of Thursday, the median P/E of the S&P Top 10 -- Microsoft, General Electric, Wal-Mart, AT&T, Intel, Pfizer, Merck, Exxon, Cisco Systems and MCI WorldCom -- was 39 and the average was 42, based on consensus earnings forecasts for the next 12 months. For the other 490, the median P/E was 19 and the average just under 30. But that average multiple for the bottom 490 would be quite a bit lower if not for outliers like America Online, which at the time sported a P/E of 350.
Beaming the market's fundamentals through this prism calls into question the notion that the market is so unwieldy and top-heavy that once the titans at the top falter, an avalanche will be tripped that would take down everything below them. It also sheds light on why investors had so little trouble last week pivoting in one motion away from overloved growth stocks and into those sleepers that had been suffering from neglect, even if the move seemed a bit forced.
An optimist would further argue that the more moderate valuation of the majority of stocks means there's a good deal of dry powder remaining out there that could be ignited by itchy money flowing out of the old favorites, thus keeping the market strong by other means.
The Dow Jones Industrial Average benefited from its heavy exposure to the manufacturing and commodity economy during last week's cyclical rally, edging to a new record close at 10,493, up 320.
One of those optimists is DLJ's Tom Galvin. But aside from the industrial cyclical stocks that were waving from the winner's circle at the end of last week, Galvin's favorite laggard group these days is the financials.
Yes, the major bank indexes are up some 50% from their October 8 low, when they were priced for global meltdown. But the Philadelphia Stock Exchange Bank Index is essentially flat from a year ago, while the S&P has risen 18%. Galvin notes that in terms of year-over-year stock performance relative to the market, money-center and regional banks are now as far behind the indexes as they've been since 1991 -- which was, of course, a wonderful time to have bought the banks. It's not the cleanest comparison, because in '91 the banks had trailed the market for some time, while they were hot-performing leaders in the few years leading up to 1998.
To Galvin, the group's attractive attributes include earnings momentum after the difficulties of late 1998, possible salutary regulatory relief and a steeper yield curve, which acts as a tailwind for finance companies' funding activities. Finally, he figures the banks are a pretty good play on the return of global financial stability, which appears to be taking root, though a prolonged conflict in Central Europe could alter that.
A prelude to this week's parade of bank earnings came last week from J.P. Morgan, which trounced analysts' profit projections and saw its shares rise 4 5/16 to 133 1/16. Wall Street's odds-makers suggest that Morgan's performance offers great hope for other big trading and corporate-finance oriented banks such as Citigroup and Chase Manhattan.
On a squishier patch of the financial-services firmament stand a handful of less-than-sexy institutions that have decided they're tired of two-year-old 'Net companies based out of some kid's dorm room making all the money in this new economy and in the bull market it has spawned. Last week, at least three financial outfits announced an "e-commerce strategy," to the enrichment of their shareholders, at least temporarily
Florida Banks, Atlantic Bank & Trust, Sovereign Bancorp and North Fork Bancorp, all regional or subregional outfits, all whispered the words "Internet banking" and the trigger-happy traders set to work. From the previous week's close to their fleeting peak prices on Wednesday, the gains ranged from 437% for Florida Banks to a mere 23% for North Fork. This despite the fact that there are pure Internet-only banks already plying cyberspace and that outbidding electronic competitors on deposit and loan rates online is just about the definition of a commodity, low-entry-barrier business.
Friedman Billings Ramsey, a small Washington investment bank that had a Roman-candle kind of flash and fizzle in the IPO market last year, pitched in with plans to launch an online underwriting operation, purportedly to give the wired masses dibs on its new-issues pipeline. Considering that the undistinguished, mostly finance-related stocks FBR brought public since late 1997 are almost all down from their offer prices -- some more than 50% -- it's tough to see the appeal in getting in on future deals. Nonetheless, FBR's own stock jumped 6 1/16 to 12 1/2 .
The nearby chart could be captioned "What Are the Kids Doing for Fun These Days?" It could also be inscribed on a tablet for the Church of What's Working Now, as it depicts the past year's dramatic movement in the shares of America Online and AMF Bowling, two companies that would like to make their respective services an integral part of Americans' lives -- only one of which, needless to say, is succeeding.
The AOL story is overly familiar. Having become the Ma Bell of the Internet generation while allowing America's youth to slow the performance of the Web during the after-school rush hours, AOL has now joined the top 20 most valuable companies in the stock market. Unlike its greener progeny among 'Net stocks, AOL does indeed have earnings, every dollar of which has been capitalized with $400 of investors' money. You've Got Mail, a movie about the romantic possibilities of chatting anonymously via AOL, took in some $113 million at the box office.
Such a cultural landscape makes it rather tough on the lesser-known AMF which resides on the other end of the leisure-time economy as the biggest name in bowling, about the farthest thing from "virtual" entertainment conceivable. AMF, which was bought earlier this decade in a leveraged buyout led by Goldman Sachs and then taken public in late 1997, is not profitable, because of its continued high debt load. But it had cash flow of $130 million last year on $714 million in revenue. The market is paying 30 cents for every dollar it collects in sales from rounds played and pizza consumed. At a recent 4 1/8, AMF shares were fetching half its year-end book value -- though cumbersome or unrecoverable things like property and equipment and goodwill make up its bulk. Hollywood's recent contribution to the world's store of bowling-related art, Kingpin, failed to crack $25 million in domestic gross.
AMF is exactly the sort of stock this market hates right now: tiny market value, a company that plies a no-growth industry, its business capital intensive and substantially exposed to Asia (a big market in bowling products). For that reason, it has not a single promoter on Wall Street. Yet not two years ago, it tickled every nerve on the Street with its then-trendy attributes: It was a "roll-up" company seeking to consolidate the fragmented bowling-alley industry, it was looking to invigorate an "underleveraged brand" and it had muscular Wall Street backers in Goldman. It's now basically the same business, valued at a fifth of what Goldman priced it at 17 months ago.
Now, though market veterans will talk about how surging bowling stocks were the 'Net stocks of the early 'Sixties, those two lines on the chart stand virtually no chance of ever crossing. So despite what a patient and grizzled tangible-value seeker might secretly wish, the market will continue rewarding the more dynamic enterprise. After all, the 'Net has vast business and communication potential, has knit together the world. And you don't have to rent ugly shoes to log on.
Copyright © 1999 Dow Jones & Company, Inc. All Rights Reserved.
- - - - - - - - - - -
_ _ _ _ NOTE_ _ _ _ _Please visit the Dow Jones website for this and other stories. |
