9/26

Watch Out For Falling Stocks

Paving The Way...On the four lane superhighway of this bull market, a good number of stock boulders have fallen from the cliffs above and struck the pavement.  For the most part,  these castoffs have landed in the slow lane and have really only impeded the progress of the "widows and orphans" of the world.  You know, old economy has-beens like PG, AT&T, DuPont, etc. have put a dent in more than a few trust-baby portfolios.  The fast lanes have pretty much remained free of debris.  And, when an odd stock boulder previously thought incapable of breaking free unexpectedly falls from the sky and rolls toward the fast moving traffic, the speed demons merely hit the accelerator, swerve around the fallen angel, and gun it to a greater level to make up for lost time.

Unfortunately, someone has to examine the facts in any landslide event.  Wouldn't you just know that the Contrary Investor road crew has right now donned their hardhats and is ready to hit the pavement.

And The Meek Shall Inherit The Earth (At Least For A While)...Before yanking the stock boulder specimens off the road and returning them to the lab for structural analysis, we need to lay a little groundwork in how natural landscapes change over time.  The immutable laws of nature dictate change as a guaranteed constant.  As we all know, the financial markets are ruled by the immutable laws of nature - in this case human nature.  It just so happens that the human animal is also governed by change.  Change in temperament.  Change in emotion.  Change in reaction.  Change in beliefs, etc.

The following is an aerial surveillance photograph of the financial market roadbed of the last decade and how change has effected the texture and appearance of the pavement:

Some striking changes over time, don't you agree?  The clear standout is the market's seeming preoccupation with technology.  Ironically, energy stocks held roughly the same position in '80.  (Not 1880.  In 1980.  Just 20 years ago.)  The market voting mechanism never lies regarding displays of financial emotion.

The increase in the finance sector weighting is also no surprise as we have documented to you many a time that credit creation is big business in today's economy.  Remember when Coca-Cola, Philip Morris and the food stocks (consumer staples) were must own issues?  C'mon now, it was only ten years ago.  We know it seems like ancient history.  

What is also clearly striking to us in the table is energy and utilities.  The piece we wrote regarding oil a few weeks back factually documented the decline in refinery and energy production capacity in the US over the last decade.  Sector action is reflective of where capital and consumer spending has been concentrated in the last 10+ years.  The big question of the day is that given the tight supply situation we are experiencing in crude, refined product, natural gas and electrical generation capacity at the current time, have we as a country wildly misallocated capital over the last ten years?  Any now failed dot.com "early retiree" may say no.  Catch a minimum wage worker at the gas pump and they may have a slightly different take on life.  Instead of drilling "dry holes" in dot.com land, wouldn't we have been better off taking care of our energy needs?    

Watch Out For Falling Stocks...Much like the table above, one of the best ways to try to gain some perspective in viewing change is to take an aerial view as opposed to a tick by tick count of activity.  In honor of the Intel news last week and the clear message in the S&P sector table presented, we thought it may be an appropriate time to check in on the tech sector and some of its quite visible poster children.  It's our bet that if energy prices are truly slowing the global economies and corporate profits (margin pressure), softening in technology spending is a sure bet.  Forget currencies.  We are talking about unit demand and price.  Currencies just exacerbate the issue.

It was only a few months ago (7/18) that we showed you the following two charts after the release of INTC's 2Q 00 earnings (where they were seemingly rewarded for "making the numbers" by realizing massive capital gains from their investment portfolio.)

We were simply scratching our heads in that the above chart seemed completely inconsistent with the chart below: 

As you already know, that last bar to your left on the bottom chart has contracted a bit in the last week (well, actually, the top chart also).  The early warning signs have been there all along.  The Intel stock boulder already displayed deep fissures, well beyond hairline cracks.  Now that the boulder has "hit the pavement", it's all of a sudden become obvious?  Only to the speed demons that never look up.

All Together Now...It's not just Intel.  The signs are all around us that broad infatuation with technology stocks is getting long in the tooth.  The Internet explosions are but one of many examples.  Over the past "X" discussions, we have touched on tech many a time.  Overowned, let alone overvalued.  Too heavily concentrated in the behemoth mutual fund portfolios.  The subject of financial media euphoria.  In the first leg down in the NASDAQ during April and May of this year, not a lot of believers got out.  The rally back to July highs validated the complacent choice of the tech crazed masses and lured the mistrusting back in.  Now the stocks look like they are beginning to break again.  

Be prepared.  The next section is nothing but charts.  We present them for your approval.  If we enter the second leg down of what up to now appears to be the beginning of a NASDAQ bear market, the selling could become violent and emotional.  (Think you've already seen violent and emotional selling?  Think again.  You haven't.  The public and the mutual funds are still fully loaded.)  Is it too late to sell or seriously trim the top NASDAQ darlings?  You decide. 

We've shown you a fair amount of longer term parabolic charts here (some do not appear so as many charts only cover the last 24 mos.  Believe us, they are parabolic when viewed over the last 4-5 years.)  Most of these charts look to us like they are resting at critical technical break points.  One well know tech happy newsletter writer/advisor recently advised clients to load up as "rarely are all the major tech issues at or below their 200 day moving averages at the same time."  Yes, rarely indeed.

So, is it too late to sell the former tech kingpins.  Only time will tell, but we contend they are still over owned and still expensive given the strong probability of declining cyclical global spending on tech over the near term.  The following is another example of a parabolic chart that broke two years ago.  Quite unfortunately for holders, the selling continues today and has been the most violent almost 1 1/2 years after the initial break.

Please note that the right "Y" values on this chart are off.  Nonetheless the directional price representation is accurate.

Life In The Fast Lane...It struck us as nothing short of ironic that amidst the market's impounding of the Intel information last week, that momentum drivers in the fast lane chose to hit the gas.  Biotech stocks were flying as was the networking crowd.  Clearly biotech is in the sweet spot.  Since earnings are slim to none, disappointments are hard to come by.  For the networkers, well, as of yet no one has lost their lunch.  That day is probably not far off (especially given the slowing in foreign economies), but until then the boulder above is perceptually intact on the rock face.  It's just too high above the maddening crowd for the cracks to be seen.  Once again, the aerial views can shed perspective on parabolic emotion:

The biotech and networking areas seem about the last bastion of hope for the tech oriented momentum players.  The big mutual fund behemoths, alternatively, are in trouble.  Tech is so over owned in their portfolios that there is simply no orderly way out.  Likewise the market caps of the biotechs and the networkers allow no orderly way in (broadly) during an attempt to swap exposures from mainline tech to these areas.

Where can investment opportunity be found?  From a longer term standpoint (barring a jolting bear market characterized by a lack of overall liquidity), we suggest you consult the S&P sector table we showed you at the beginning of this discussion.  Trust in human nature.  Trust in change as an immutable construct of man and nature as a whole.  The meek shall inherit the earth (for at least 15 minutes, anyway, according to Andy Warhol).