I rarely put much emphasis on technical analysis of individual stocks. Reading charts can work, but only in the absence of material new information. Without meaningful newsflow, technical indicators will often hold up because everybody is looking at the same thing and traders will act similarly, thereby allowing the technical analysis to become a self-fulfilling prophecy.
However, as soon as the company reports earnings, receives an analyst upgrade, or announces a merger (among dozens of other possible catalysts), chart reading goes out the window in favor of a necessary revaluation of the company's shares based on new revelations.
With indexes, however, technical analysis has a bit more merit. Many hedge funds trade the indexes as a whole, as well as individual stocks. Newsflow for an entire index, the S&P 500 for example, doesn't occur. The S&P doesn't report earnings. Wall Street research departments don't have analysts covering indexes. As a result, the double top that formed recently on the S&P 500 could be concerning.
Traders focused on indexes could very well use that formation as a reason to sell, and not only their index ETF's and futures, but their stock holdings as well (based not on company fundamentals but rather index technicals). Despite a nice move higher in February, the market is still down for the year, as January's drop has yet to be fully recouped.
If we can't break the overhead resistance in the 1,212-1,213 area on the S&P, the recent rally might not continue very much longer. Interestingly, the market opened the year at 1,212, which turned out to be the high for this week before we headed south once again.
Examining Changes to the Dow 30 Components
Every few years investors hear of impending changes to the Dow Jones Average, the broad index of 30 industrial stocks created by Charles Dow in 1897, widely used as a stock market barometer. For the majority of the 20th century, changes to the index's components were rare. Only when one of the 30 stocks was acquired by another company would they be replaced, and the new addition would usually be in the same industry as its predecessor.
However, with the bull market of the 1990's, Dow Jones & Company (DJ), the publisher of the index, began changing the group of 30 stocks even without any news of a merger. With stock prices rising at a rapid pace, cheerleaders for stock ownership were everywhere. Dow Jones & Company figured it could boost stock prices even more by replacing underperforming companies with better ones.
Rather than saying they wanted to boost the Dow's performance, those who orchestrated the changes justified such actions be claiming that the new index "better represented the country's ever-changing economy." Basically, even though we still filled up our cars' gas tanks at Chevron stations and wrote on paper made by International Paper, these companies really weren't good gauges of the so-called "new economy." With the advent of the digital camera, somehow Kodak no longer deserved to be in the Dow, despite billions of dollars in annual sales and owner of one of the country's more prominent brands.
Were these changes really necessary? I was never a big fan of them. Companies go through ups and downs. Businesses are cyclical. When oil prices are low, companies like Chevron won't make very much money and their stock prices won't perform very well. Does that mean we should boot them from the Dow? Probably not. Nonetheless, since 1999 exactly 7 of the Dow's 30 stocks have been replaced due to economical irrelevency (read "bad stock performance").
Not being a big proponent of bandwagons as far as stocks are concerned, I am truly excited to have discovered yet another contrarian indicator for stocks. Think about it. Dow Jones boots a poorly performing stock and adds an elite name to the index. Isn't this the perfect contrarian indicator for someone who loves buying out-of-favor stocks? After all, if you get booted from the Dow, your company must really be down in the dumps. And if you are the lucky company to be named a replacement, you really must have done well lately.
So, the next time a change is made to the Dow Jones Industrial Average, I will be trading on the news. I'll short the stock that gets added and pair that trade with the purchase of the company that got the axe. Will this strategy work, you ask? Well, let's take a closer look at how the aforementioned 7 alterations since 1999 have fared after the changes took effect.
On November 1, 1999, four stocks were removed from the Dow; Chevron (CVX), Goodyear Tire (GT), Sears (S), and Union Carbide (UK). Not surprisingly, they were replaced by some bull market high-fliers; Home Depot (HD), Intel (INTC), Microsoft (MSFT), and SBC Communications (SBC).
Less than five years later, in April 2004, more changes were announced. This time 3 companies were replaced. American International Group (AIG), Pfizer (PFE), Verizon (VZ) took over for AT&T (T), Eastman Kodak (EK), and International Paper (IP).
Dow Jones & Company, as well as most investors, were probably thrilled with the decision to replace these "old economy" stocks with newer, faster growing market darlings. The great news (if you're looking for contrarian investment opportunities) is that the performances of the two groups of stocks has been quite a dichotomy, just not in the way many would have expected.
Of the 7 stocks deleted from the Dow since 1999, 3 of them were either acquired or are in the process of being acquired (Dow Chemical bought Union Carbide, Sears is going to be bought by Kmart, and AT&T is going to be purchased by fellow Dow member SBC Communications). All told, on average, the seven deleted stocks have risen by a staggering 227% since their removal. That equates to a return of more than 32% each.
While those returns are impressive, they won't make for much of a contrarian investment strategy unless the ones that replaced them gained less than 32% on average. Amazingly, the 7 stocks added to the Dow haven't gone up at all. In fact, they've lost a combined 155% since they were added to the index, for a loss of 22% each. Only one of the seven has risen in price (Verizon) and its shares are up a meager 2%.
Hopefully more changes to the Dow are coming, for contrarian investors' sake anyway.
Market Struggles Out Of The Gate In '05
It looks like the stock market may fall in each of the first four weeks of the new year, a feat not accomplished in many years. January is supposed to be a seasonally strong time for stock prices, as pension fund and retirement account contributions flood the trading floors. Not so this year. It looks like the huge rally we saw in November and December has run out of steam. Take this morning for example. Blowout earnings from Microsoft (MSFT) and the announcement of yet another promising merger; Gillette (G) to be bought by Proctor and Gamble (PG), and yet the market can't trade up.
Perhaps it's the Iraqi election that is holding us back. If Sunday goes well, maybe the market will rally strong next week. If not, the many optimists who predicted a 10 percent market gain in 2005 may very well be disappointed. We definitely need some kind of catalyst soon, as the short term action looks bleak.
Despite a poor outlook for the broad indexes, don't think you can't make money if you know where to look. This truly is, to use a terrible cliche, a "stock picker's market." Oil prices are near $50 a barrel. Energy stocks like Suncor (SU) are still cheap. There are many financial stocks that carry p/e's under 15 and pay nice dividends. Small caps still fly under the radar most of the time, providing below-market valuations but above-average growth prospects.
And always use overreactions after an earnings report to your advantage. Verisign (VRSN) fell 15% after hitting its Q4 targets and slightly raising its guidance. Wall Street wanted more upside to the numbers and slammed the shares, but that was wrong. Now you can pick up the stock for $25 a share, giving it a p/e of 25 with a 30 percent projected growth rate for 2005.
Taser Shareholders Stunned
Let the class action lawsuits begin. It appears the party for stun gun maker Taser (TASR) is ending. Two years ago, TASR stock traded at $0.35 (split-adjusted). After rising to more than $33 in 2004, the stock fell 30% today, to close at $14 per share. Taser is down 55% so far this year, and it's only January 11th. As a result, lawsuits will be filed, lots of them. And soon, very soon.
Shareholders will scream of being had. Taser didn't adequately update the public about its business, they'll say. They will point to the company's management; a father (Chairman) and two sons (one is CEO, the other is President). The trio sold more than $100 million worth of stock in 2004, all while touting their stun guns' safety and growth potential to any TV station or reporter that would listen.
They will be accused of insider trading because they were selling stock as they were hyping their company's prospects. Class action lawyers will conclude they knew business would fall short of their rosy projections, hence they sold, but didn't tell anyone, leaving shareholders with a 55% loss in 11 days.
Can you blame them? Not the shareholders, they are to blame, but rather Phil, Tom, and Rick Smith. Are they bad people for taking $105 million in profits off the table when their company was being valued at nearly $2 billion, despite only having $68 million in sales? Are they crooks? No. Actually, they are smart. They didn't know ahead of time when orders would be delayed or exactly when competitors would bring new products to market. What they did know was that companies aren't worth 30 times revenues very often, and when they are, it's not for very long.
How about Mark Cuban? Is he a crook? Most people (including myself) think he was a genius when he sold his Internet broadcasting company, Broadcast.com, to Yahoo! for billions of dollars. He got Yahoo! shares in exchange, and even knew to sell those too. Mr. Cuban didn't sell because he lost interest in his business, or because he doubted whether radio signals would be broadcast over the Internet. He sold because he knew Broadcast.com was not really worth the $7 billion the equity market was pricing it at.
It's the world we live in today. We do something stupid, lose money because of it, and we sue. We don't admit we made a mistake and learn from it; vowing never to make the same mistake again. That's what we should do, but not what most of us will do. Taser shareholders who will choose to join the class action suits are a perfect example.
If you paid 30 times sales for an overhyped pipedream company, you probably will lose money. It happens. We all mess up sometimes. But do yourself a favor. Learn from the mistake. Learn how to value companies properly, so as to avoid losing any more money. But please, don''t sue the people who understood concepts you failed to grasp.
The Smiths may be very guilty of overhyping their company. But not once did they hold a gun (no pun intended) to somebody's head and force them to buy Taser stock. When they saw an asset they owned become grossly overvalued, they sold. They did what every good investment manager would have done, and is heralded for doing.
We shouldn't sue people just because they're smarter than us. I'm not against giving every human being their fair day in court. The problem right now, in 2005, is that we don't only sue when somebody breaks the law. We sue when we mess up, to get revenge.
With the S&P Crossing 1200, Gains in '05 Could Be Limited
The S&P 500 closed today at 1203, its highest level since the third quarter of 2001. The market's strong rally in the last five weeks clearly has boosted morale on Wall Street, but can we expect this upward move to continue?
Unfortunately, it doesn't look like the market has a lot more room to run. Earnings are expected to rise about 8 percent in 2005, and the S&P 500 trades at 17.2 times the current $70 earnings estimate for that index, hardly cheap.
If we take an aggressive profit growth forecast of +10 percent for next year, and put a fairly rich 18x multiple on that, we get a 1300 target on the S&P, about 8 percent higher than where the market stands today. Much like 2004, next year should prove to be another solid year for stock-pickers, but an uneventful year for index fund owners.
There are still several issues that could derail continued economic growth in the coming months; sustained $40 per barrel oil, Middle East trouble during the January elections in Iraq, as well as the fear of rising inflation and/or interest rates. All in all, it makes sense to be cautiously optimistic as investors structure their portfolios for the coming year.
Insider Selling Hit 4-Year High in November
Corporate insiders sold $6.6 billion worth of company stock in November, an increase of 187 percent from the prior month. This amount was the highest recorded in a single month since August of 2000 ($7.7 billion). For every $1 of stock purchased by insiders in November, $46.45 worth was sold. The largest group of sellers came from Charles River Labs (CRL), where 14 insiders sold nearly 800,000 shares, netting $36.7 million in the largest round of selling for that company in 5 years.
Historical evidence has shown that insider buying is a much better indication of equity valuations, when compared with insider selling. However, this statistic still indicates to me that stock prices, in general, are likely to be relatively fairly valued at this point in time. It appears that individual stock selection will be crucial in 2005, as the broad market indices aren't likely to appreciate too much from here, given that the S&P 500 is slated to book an 8 percent earnings gain next year and the index trades at a forward P/E of 17.
One notable insider purchase was that of Washington Mutual's CEO, who bought 50,000 shares of WM stock at $39.50, his first open market purchase ever and the largest in the company's history.
History Suggests Strong Market in 2005
If you're a numbers person, a history buff, and an investor, you will most likely find the following numbers very bullish for the coming year on Wall Street. Now, I'll be the first to point out that I really don't think the numbers below will really have an effect on the stock market's direction next year. But, they are interesting and should, at the very least, peak one's curiosity as to whether or not it is simply a coincidence that years ending in a "5" have traditionally been great for investors.
Most of us know that the historical average for stock market returns has been about 10 percent per year. Interestingly, since the Dow Jones Industrial Average was created (1897 by Charles Dow), there has never been a year ending in the number "5" in which the Dow lost value. In fact, no such year has ever failed to beat the historical average of a 10 percent gain. In fact, these years have come and gone 10 times and the Dow has averaged a gain of 34.6 percent. I have not taken the time to investigate why this may be the case, but let's hope the trend continues. Here are the numbers for the Dow:
1905: 38.2%
1915: 81.7%
1925: 30.0%
1935: 38.5%
1945: 26.7%
1955: 20.8%
1965: 10.9%
1975: 38.3%
1985: 27.7%
1995: 33.5%
2005: ???
10-Year Average: 34.6%