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us stock market, top stock pick
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10/25/03 Investment House Alerts Report
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IH Alert Subscribers:
MARKET ALERTS
Targets hit alerts issued Friday: None issued
Buy alerts issued: ESPR; IDT; GNSC; TXN; GBH; NTES; SINA; SOHU
Trailing stops issued: BKHM
Stop alerts issued: OSIS; PRSFD; LF
MARKET SUMMARY
Market loses ground thanks to MSFT, but there was underlying resilience.
Earnings have been up 20%+ this quarter, driving the market higher in anticipation of results. Investors scrutinize each new report from the big names, looking for clues to the future. As we have discussed, however, while companies are very upbeat regarding Q4, they are reluctant to be ebullient about 2004. Shareholder lawsuits, regulation FD, Sarbanes-Oxley combine to keep management cautious regardless of conditions. About the only companies that show no fear regarding the future are those growing gangbusters, and those are the new leaders (SINA, SOHU, NTES were on fire Friday).
For the indexes and analysts, however, it was all MSFT Friday after its deferred revenues failed to placate ravenous investors demanding solid confirmation of burgeoning future results. MSFT is now in the category of GE, i.e., no longer a growth company but a cash cow because of its installed base that will produce roughly 10% annual gains. Yet, because of the market cap weighting system for the big indexes, it has a hugely disproportionate impact on the major indexes. 70% of Nasdaq's 20 point loss (14 points) was caused by MSFT. 56% of DJ-30's 30 point loss was MSFT. When MSFT gapped down and sold off even more to close at its low, that was a tremendous drag on the indexes.
As for individual stocks, however, the action was much different though masked somewhat by MSFT. The indexes also gapped lower and sold off through the morning, but after a full 50 day MVA test, they found legs and rallied back nicely. But for MSFT, Nasdaq would have ended positive on stronger volume. That means a lot of stocks tested lower and rebounded to close positive on rising trade. After a few sessions where buyers went totally sidelines, the past two sessions saw them stepping in and testing the waters on the low. Indeed, the solid recovery off of the 50 day MVA on volume is a very good sign for the market. Despite the MSFT miss, investors were back in buying the new leaders as well as staples such as TXN that are showing strong earnings growth once again.
This second straight session where stocks recovered off the lows shows those buyers with some money ready to again put it to work. On top of that there were leaders being rewarded for their good results (SOHU revenues up 194%) as investors still plow money into the winning stocks, and winning stocks are those that grow sales, earnings, and revenues the most. Thus the outlook is positive once the market gets through this most recent correction. The question is whether the Friday 50 day MVA test is enough to send stocks on the next bounce up in the channel or if they need more rest this time around.
THE ECONOMY
Money supply still slowing, but it is not all the Fed though the Fed will need to act.
The Fed is still prosecuting a very easy money policy as it, much as the Clinton administration and its leader, is primarily concerned with maintaining what is left of the legacy of Greenspan. It wants the pedal to the floor to get the economy back and humming as rapidly as possible to Greenspan can finally head off into the vault at the Federal Reserve with reputation somewhat intact. Thus we hear comments from Fed governors about how the tax cuts were in fact very well timed despite Greenspan's remarks in Congressional testimony that they would not be timely enough to help the economy. Amazingly the Fed is actually willing to admit that something else other than its own management of monetary policy has had an impact. In any event, the Fed has not changed its policy of easy money.
The money 'crunch' and thus some resulting interest rate increases as we have seen of late is due not to the Fed pulling money from the economy as it did in early 2000, but a shift from money to other assets. The money supply is made up of more than cash. There are savings accounts, checking accounts, money funds, and a multitude of forms it can take. What is happening as the economy recovers is that a lot of that money that was sitting idle is being redirected into other asset classes and thus causing the contraction in money supply the past few weeks.
Overall this is a good trend because it is another example of how businesses are starting to invest in business once again. Thus despite the continued subdued outlooks businesses provide, there continues to be empirical evidence that things are improving much more than they are letting on. After three years of dormancy, that is exactly what the economy needs.
There is always a 'but', of course. The Fed has got to make sure that rates don't rise too much too early to cut off a supply of funds. The stock market has rebounded nicely and that helps company's ability to finance, but for the hundreds of thousands of privately held companies that make up the backbone of the economy, money is the source of financing, and it needs to remain cheap for now. Thus while Treasury Secretary Snow was correct in noting that higher interest rates would be a good thing because it would mean the economy is recovering, you don't want them too high too early and act as a governor on growth when things are just starting to pick up. Thus the Fed needs to be as vigilant as it says it is and step in with liquidity if needed.
Tunnel vision on deficits.
Put together a politician and a microphone today and you hear some lament about the deficit. It's the largest of all time, it will raise interest rates, it will cause capital to flee the country. The Fed even buys off on the interest rate increase argument. None of the claims, however, has any historical, empirical evidence as support. Politicians and the average citizen seem to view the federal deficit as they would a household deficit and conclude that running deficits is bad. They are told this is the largest deficit in history but without any apples to apples historical comparisons. They are told the deficit is increasing when the latest data put out by the OMB that predicted larger deficits shows it is already decreasing. More and more there is an unfounded call to repeal the tax cuts as a means to reduce the deficit. Little do they realize (or more likely refuse to acknowledge the facts) that without the tax cuts to spur growth the deficit would be much larger. We are hard pressed to think of other subjects that receive so much attention and print, so little of which is accurate.
First, this is not the largest deficit of all time though many like to trumpet this half-lie. At current levels the deficit is 3.5% of GDP, a hair over the long-term average. Though the dollars may be more, as a part of the economy it is not. In other words, while the deficit has increased during a recession, something that is entirely normal as economic activity dies off, the deficit is right in line with what we have averaged for decades and is NOT the highest in percentage terms. For example, as a family grows and the breadwinners make more money, they buy a bigger house where the monthly payments are larger. Because their income has grown, however, the higher payments still represent the same or even less of their income and are still easily paid even though they went up in actual dollars. Thus you cannot look at the absolute dollars and make any rational conclusions about what is acceptable or not. If that was the case, no one would ever qualify for a home loan if the payments would increase over the prior payments.
Moreover, federal deficits are not state or household deficits. The feds can make money either literally by printing it or by various incentives in the economy. The trick is not to go overboard and cause inflation or some other pernicious side effect. The data today shows this is not happening. Indeed, the data already shows that the budding growth engendered by the tax cuts is increasing tax revenues and reducing deficit projections. The most recent data show that $12B in additional revenues from taxes due to increased economic activity. Spending was also reduced by $55B. Thus the July estimate of a $455B deficit has been reduced to $374B at the end of September, the end of the fiscal year. Moreover, that $455B projected deficit was lowered to $401B in September. Even with this economy just getting its feet under it, the economic activity is already generating revenues and reducing the deficit that was created by an economy that was in decline in early 2000 as noted in these very reports. With a little spending restraint coupled with the economic growth, deficits will be well under control as the economy continues to expand.
Still many clamor to repeal the tax cuts that allow businesses and individuals to decide where best to invest money in the economy and instead use the money for more federal spending programs that are somehow supposed to create lasting jobs. Spending money on one shot projects does not create jobs. Creating more federal bureaucracy does not add to economic strength as the USSR demonstrated. This movement to remove the very stimulus that has awakened the economy is akin to draining the gas out of the tank after you have just managed to restart the car after the tank ran dry. It ignores that tax cuts are investments in America because they get individuals and companies to invest in our economy when it needs it the most. Dollars that never make it to the federal revenue coffers are invested in the economy and the return is greater than the dollars taken out as jobs are created, wages rise, goods and services are consumed. Tax revenues jump because of new wages being taxed, new sales, excise, and other taxes. As the numbers show, that is already happening.
Ask any economist and he or she will tell you that to overcome a recession and economic slump you run deficits. That is precisely what we are doing. But only 23% of the deficit is due to the tax cuts while 77% is due to the spending and the slower economy. We are already seeing the dramatic results a bit of economic growth and some spending cuts can have on the deficit in just three months with a still weak economy. Remove the tax cuts and you remove a big part of the stimulus that is helping restart the economy. Then we really will see the economy fade as the critics have predicted claiming the stimulus is a one-time event. It is not transient because the tax cuts put more money in pockets each month in addition to the ongoing business stimulus in the form of deductions for investing in your business. Moreover, this stimulus snowballs; as more money is put into the economy more activity and more spending result. The economy is getting to a point where it will be self-sustaining and will generate enough revenues as long as spending is reasonable. Not only would it be unwise to repeal the tax cuts before that happens, it will also be the case that there will be no need to repeal the cuts because a strong economy with some spending restraint will generate all the tax revenue Congress wants.
In sum, deficits during economic recovery efforts are nothing unusual and are not that important as the deficits are created by the economic downturn. Once the economy recovers, deficits shrink as we are already seeing. Those obsessed with deficits so early in an economic recovery ignore the historical impact of deficits as well as the historically proven positive impacts of tax cuts. They are trying to whip up a political controversy where economics and history show there should be no controversy. Tax cuts and stimulus create business, jobs and revenues when they are needed the most. Removing them would stall the progress and put us right back where we were without investment in the US.
THE MARKET
The market is going pretty much to script right now, selling down to test the 50 day MVA on Friday in a continued pullback form the upper channel. After a strong move in anticipation of earnings, the actual news is being used as a point to take some gains over the past 8 sessions. Friday was no different though the indexes hit the 50 day MVA and started to rebound, showing signs they want to hold that level.
There was some higher volume on SP500, DJ30 and even Nasdaq, but that has to be tempered with the action itself. A test of the 50 day led to solid rebounds on solid volume. A higher volume test of the 50 day MVA, even if it results in a loss for the session, can be a good sign if stocks or the index rallies back up. That shows that big buyers stepped in at that point and drove prices higher. That is exactly what happened on Friday.
The key is whether the Friday bounce translates into a resumption of the trend higher or if it needs some more time. The earnings rush has peaked with the MSFT earnings. Still a lot yet to come, but the mad rush last week was the zenith. Eight days of coming back to test the uptrend and 50 day could be enough to set it up for the next move. Even with the MSFT drag on Nasdaq and DJ-30, the losses were trimmed as the indexes made dramatic recoveries off the lows. Thus despite the hype surrounding the MSFT earnings, the market showed underlying strength that again emerged on Thursday after being dormant for a few sessions.
It seems that investors are coming to a consensus that even though 2004 guidance is not what they wanted, it is understood that most companies are not going to give glowing guidance at this stage of the recovery. The disappointing guidance injected some uncertainty back into the picture and stocks sold off on the uncertainty. Now many question if the recovery will last because CEO's remain cautious. CEO's were cautious when the market bottomed, when it broke out in March, during the summer consolidation, and the fall run. The political climate is not one where companies are willing to go out on a limb. Remember, the market started rallying a year ago when there were very few signals of an economic upturn. It broke out again in April when many were still saying the economy had peaked because of higher oil prices, the war, etc. Now that there is once again concern about the viability of the recovery in 2004 (the market looks ahead, not just to Q4 of this year), the market has backed down. Amidst the uncertainty for the future is when stocks tend to rally. It may take a few more sessions to regroup here, but we found the Friday action in the indexes and some leadership stocks encouraging after over a week of losses.
Market Sentiment
Hardly any movement in the sentiment indicators that would suggest an imminent upturn. The put/call ratio spiked to 0.98 last week but declined the following two sessions.
VIX: 17.71; +0.03
VXN: 25.45; -0.64
Put/Call Ratio (CBOE): 0.79; -0.06
NASDAQ
Again gapped lower on earnings news from a big player, but again rallied back to the close. More impressive action because it tapped the 50 day MVA and then made the move.
Stats: -19.92 points (-1.06%) to close at 1865.59
Volume: 1.96B (+1.14%). Volume edged higher, technically a distribution session as Nasdaq posted a loss. The tap of the 50 day MVA and intraday recovery along with the doji on the candlestick pattern, however, all indicate more positive price/volume action than merely the loss on a slight volume increase.
Up Volume: 535M (-82M)
Down Volume: 1.379B (+86M)
A/D and Hi/Lo: Decliners led 1.51 to 1. Not really pernicious selling.
Previous Session: Decliners led 1.37 to 1
New Highs: 105 (-14)
New Lows: 10 (-1)
The Chart: http://www.investmenthouse.com/cd/^ixq.html
Gap and tap of the 50 day MVA (1848), then the rally back on continued strong, above average volume. The high volume test of the 50 day and the sharp jump up off of that level show that buyers were there to pick up stocks as they made similar tests. The low actually took Nasdaq below the 50 day and to the up trendline. All the better, as that shows the uptrend is still very much in place. Nasdaq has made 3 full tests of the 50 day MVA and to other times it undercut the 18 day MVA and came close. That many rotations often needs a more sustained rest in the form of another base. Given that October is almost up and stocks typically perform well into the end of the year, however, there may be simply a session or two more of testing the 50 day before a bounce. It was very good news to see some of the leaders off and running Friday, e.g., internet stocks.
S&P 500/NYSE
A slight 50 day MVA undercut brought in the buyers and a nice rebound.
Stats: -4.86 points (-0.47%) to close at 1028.91
NYSE Volume: 1.416B (-11.22%). Volume remained above average but backed off as the large caps tested the 50 day MVA and bounced. The rebound volume was disappointing given MSFT made up a portion of the surge.
Up Volume: 483M (-321M)
Down Volume: 921M (+140M)
A/D and Hi/Lo: Decliners led 1.34 to 1. As with Nasdaq, modest downside breadth.
Previous Session: Decliners led 1.09 to 1
New Highs: 107 (-8)
New Lows: 10 (-1)
The Chart: http://www.investmenthouse.com/cd/^spx.html
Undercut the 50 day MVA (1021) and other price support at 1020 on the low (1018) and then as is often the case, after the undercut shook out the last sellers it started to rally back. On the high it reached toward the 18 day MVA (1034) but fell back to close. Nice recovery of course, but the lower volume on the rebound relative to Nasdaq indicates SP500 may have to re-test the 50 day MVA over the first part of the week to truly set that level as support to work off of for the next move higher. The action was good in that it tapped just over the highs in the summer range (1015) and kept that consolidation range in tact. That was the nice lateral 3 month move that has set the foundation for SP500 to rally further. It has not taken advantage of that as of yet, however.
DJ30:
Stats: -30.67 points (-0.32%) to close at 9582.46
Surging volume as DJ30 tapped just below the 50 day MVA (9516), held support at 9500, and then rebounded for a very modest loss. MSFT was half of the point loss and much of the volume gain (297M versus average 198M on Thursday). A good test of the 50 day MVA but still below the September highs (9686) and the short term MVA (9665 is 10 day, 9646 is 18 day) as near resistance. As with SP500, it may come back again to test the 50 day MVA, taking another session or two to plant that as support for the next move higher.
THIS WEEK
Earnings will continue though at a lesser pace, economic data returns with Q3 GDP looming big, and the FOMC meeting on Tuesday. GDP is important as 5.8% expected, but many are saying anywhere from 6% to 7% is possible. As with earnings, a number that does not beat expectations may disappoint. That is out Thursday, so the market will have some time to test the 50 day MVA a bit more and then be set to move up of the GDP number is well up into the 6% range.
That remains the biggest question right now for us, i.e., when the market will make a move up from this level. It could still roll over and tank, but Thursday and Friday showed buyers still willing to step into the breach even when companies were offering lower to little or no 2004 guidance. While some will argue that indicates future economic weakness, to us that only means companies are being conservative and that this pullback based on that conservative approach after testing the upper end of the range is an opportunity for leading stocks that have come back. Friday we issued some alerts to take advantage of that pullback and rebound when some internet leaders started to take off. After the rest of the market finds its footing here the overall market may be ready to advance once again as well.
End part 1 of 2
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