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BARRON'S:
The Trader
Rally Rolls On,
Helped By The Fed And Tech Stocks
By Michael Santoli
It's almost summertime
and the Fed is easy, the chips are jumping and animal
spirits are high. That, in the cadences of George Gershwin, is the tune
accompanying the latest swinging stock market rally, which paused last
week but
failed to give up any ground.
With ample liquidity provided by central bankers concerned about deflation,
and a rediscovered willingness by traders to treat most any news as
a reason to
buy the Nasdaq titans, stocks displayed some resilience last week.
Confounding attempts by sellers to pare back some of the 15% broad-market
rally that began two months ago, the major indexes held firm and ended
the week
within a rounding error of where they started. The Dow Jones Industrials
added
21 points to 8604; the Standard & Poor's 500 edged up 2-and-change
to 933 and
the Nasdaq climbed 17 to 1520. For now, the steady action has to stand
as a
victory for the bulls, even if the November high of about 940 on the
S&P is
looking tough to surmount.
Intel helped tech believers get bolder in betting on a rising tide of
computer
buying, when its operating chief told a German newspaper that there
are some
signs of better chip demand evident.
It says plenty about the inclination of investors to seek reasons to
buy that
those comments, and Nvidia's improved sales outlook, pedaled the Philadelphia
Semiconductor Index to a 3.8% gain Friday. Intel climbed 55 cents to
19.58 on
the week, as Nvidia screamed higher by 5.47 to 21.37, a move likely
augmented by
the pained buying of the plentiful short sellers betting against the
stock.
Wall Street seems to transition from a wake to a party faster and more
often
than a VFW hall, and right now a celebration is roaring pretty good.
Investor
sentiment, as measured by surveys and the pricing of protective options,
is
suggesting that a large segment of the public has caught a case of the
giggles.
There's a line of thinking that a lot of investment professionals have
adopted
that goes something like this: First-quarter earnings came in stronger
than
forecast, and expectations for the current quarter seem undemanding.
This, say
the optimists, should buoy the market until mid-year, at which point
-- What do
you know? -- the Street will start to focus on happy 2004 profit forecasts.
That leaves aside the risk that the more aggressive earnings targets
for the
second half of the year will be tough to meet, barring a brisk pickup
in the
economy. Last week, stubbornly high unemployment claims and soft chain-store
sales retarded the indexes climb a bit, though the service sector performed
better than believed in April, according to data released Monday.
Chris Johnson, strategist at Schaeffer's Investment Research, points
to the
latest Investor's Intelligence poll of financial professionals, which
showed
that the ratio of bulls to bears topped 2:1, a level that "has
been indicative
of near-term weakness for the market." He adds that since 2000,
"the average
performance of the S&P 500 4-5 weeks after similar readings sees
the index down
over 5%. From a sentiment standpoint, this market may be ready to take
a rest."
A rest wouldn't be so bad, and might even seduce some more chart
readers who
would like to see an orderly digestion of the recent gains. Yet without
too many
more important earnings reports to revel in and the market's seasonally
weaker
period at hand, there may not be enough convenient reasons presented
for
investors to do much more buying, absent a turn for the better in the
broader
economic numbers.
-- The market has, for the moment, rendered the verdict that first-quarter
earnings were worth applause. But that hasn't stopped the vigorous debate
about
just how strong the latest profit numbers were, or whether they augur
still-quicker earnings growth later this year.
With nearly 90% of the S&P 500 membership having clocked in with
results, the
year-over-year rise in earnings stands at 14.7%, according to ISI Group.
That
compares to an expectation of a 13% increase as of May 1 and 8.5% on
April 1.
Overall, 63% of companies exceeded analyst forecasts, with 17% falling
short --
a fairly typical distribution of surprises.
By those measures alone, the upbeat take on corporate fundamentals seems
reasonable, with the reported numbers supporting, at least, a so-far-so-good
attitude among investors.
Peeling away more layers, the sectors that have led the market's 15%
two-month
advance -- consumer discretionary names, financials, technology and
healthcare
-- have delivered some of the stronger results. So, the sometimes-tenuous
relationship between earnings and stock prices endures, to the great
relief of
logicians and writers of finance textbooks.
There's another noteworthy pattern at work, which is also helping to
stiffen
the spines of some bullish observers. The earnings offered up in
the reporting
season now coming to an end were quite clean by today's standards. That
is,
there have been few huge writeoffs and restructuring charges so far,
which has
brought operating earnings and "official" reported earnings
into close
alignment. Through Thursday, operating earnings and official bottom-line
results
were within 1% of each other, says ISI.
It's unclear whether this trend indicates that companies simply wiped
an awful
lot of bad assets and downsizing costs off the books last year, or that
CFOs
have (don't laugh) gotten accounting religion. Whichever is closer to
the truth,
keeping profit statements free of "one-time charges" and too
much prevarication
and obfuscation is crucially important for stocks to retain their recent
strength.
In 2002, companies subjected investors to the widest disparity between
reported and operating results in recorded market history, with generally
accepted accounting principles placing S&P 500 profits some 40%
below operating
numbers. A major element of the bulls' articles of faith for this
year is for
that gap to close.
If it does, and the second-half earnings expectations are attained,
then the
market truly does sit a lot closer to the 17 times 2003 earnings implied
by the
consensus forecasts, rather than the 34 price-earnings multiple on trailing
12-month reported profits. Even at a P/E of 17, stocks are well above
the level
from which bull markets historically have been staged. But the market's
in the
realm of fair value, provided a lot of the current hopefulness about
the economy
and corporate performance is redeemed by reality.
But when the sunny-siders cede the floor to the skeptics, the profit
picture
dims a bit. The first common complaint about the latest earnings slate
is that
the overall S&P 500 numbers got a big boost from energy companies,
whose profits
swelled by more than 200% over the prior year, thanks to the ramps in
oil and
natural-gas prices, which have already subsided.
The second "finger on the scale," if you will, was the salutary
impact of the
sinking dollar on the books of multinational companies. By some estimates,
the
benefit of translating euros and yen into dollars at a favorable exchange
rate
was responsible for virtually all of the top-line growth evidenced by
large
companies so far this year.
That doesn't hurt (yet), and right now the dollar shows few signs of
rebounding very far. But it hardly represents the kind of fundamental
improvement that investors should pay higher prices for.
-- This season's vogue for tech has fixed attention on the stuff in
network
switching closets and semiconductor clean rooms, not medicine cabinets
and
refrigerators. Consumer staples stocks, good performers for so much
of the bear
market, have been set aside as most every Wall Street strategist advises
a focus
on those cyclical and "high-beta" stocks that move fastest
and farthest.
Some are using this as an opportunity to ease into some prestige consumer
names. Gillette and Coca-Cola, to name a couple, received some cheerful
notices
from a few analysts last week.
Neither stock is exactly a bargain, trading well above 20 times 2003
expected
earnings. Their fans will tell you the market doesn't often offer the
chance to
buy their kind of predictability very cheaply. Both companies get high
marks on
the corporate governance front, even as they face up to their unique
competitive
challenges.
Gillette, whose earnings last week outdid forecasts, is dealing with
a price
war in batteries, making its defense of Duracell's leading position
an expensive
one. And, inviting satire, competitor Schick is about to launch a four-bladed
razor to battle Gillette.
Yet CEO James Kilts has impressed with his straight-shooting manner
and the
Street is confident in his ability to deliver an 11% gain in 2003 earnings.
A
couple of brokerage houses last week got more aggressive in talking
up the
stock. At 31.53, Gillette has a 2% dividend yield -- not too bad for
a classic
growth name but hardly a big cushion.
Morgan Stanley analyst Bill Pecoriello Wednesday upgraded Coke, urging
clients
to buy after he stayed cautious on the stock for two years, during which
the
shares have dropped slightly. He's more positive on Coke's pricing stance
with
bottlers, believes margins in noncarbonated drinks and water will pleasantly
surprise and points to constructive management changes. Bear Stearns
followed
Friday with an upgrade of its own.
Arguing Coke is inexpensive,
at 24 times this year's earnings, requires some
creativity. Picoriello notes that Coke's P/E relative to all consumer
staples
stocks is well below its historical level. His call got some traction,
bumping
the stock up 2.99 to 43.99, leaving a bit less headroom below the analyst's
price target of $52. Coke's yield is also tickling the 2% level.
If the fashionable tech trade is just a one-season phenomenon, these
stocks
might gain back a bid on their haven status. But beyond growing investor
fancy
it's not easy to come up with catalysts for higher prices.
-- Quitting while you're ahead isn't a very sporting move when competing
in a
friendly video game. But when investment dollars are in the balance,
it can be a
wise tactic. Those investors who were lucky or shrewd enough to grab
hold of
Activision shares near their lows early this year might want to consider
doing
just that.
Barron's featured a bullish profile of Activision, the No. 3 video game
software producer, in late January ("Split Screen," Jan. 27).
At the time, a
disappointing holiday selling season and a reduction in fiscal 2004
earnings
guidance had clipped the shares back to 13.68, 36% below their value
of early
December. Investors were fretting that the company's product array was
weak and
sales would have a hard time matching last year's results, which were
boosted by
the Spider-Man movie tie-in.
But the market was overlooking a few things. As noted then, Activision
has an
ironclad balance sheet, with $7.50 a share in cash at the time; insiders
were
buying the stock aggressively, and management was finally coming to
grips with
the need to cull and improve its game lineup.
Since then, Activision and other game stocks, such as Electronic Arts,
have
performed rather well, with industry sales staying firm and enthusiasm
spreading
about the demand for game consoles as their prices are due to be slashed.
Activision has won back investor confidence, too, with sales tracking
nicely
with newly conservative projections from management.
Activision shares got a boost last week, first on the fat box-office
take for
the Marvel Comics movie sequel X-2, for which Activision has a game
title.
Thursday night Activision reported fourth fiscal quarter earnings that
easily
met forecasts, and raised its sights for the present quarter. The stock
ticked
higher by 81 cents to 16.90 on the week, and is up more than 20% since
the
article appeared, compared to 13% for the Nasdaq and 23% for the larger
Electronic Arts.
With that kind of performance in the books, the stock is starting to
reflect
some gathering optimism about the company's ability to score big sales
gains
with its coming 2003 releases, which include Shrek 2, Spider-Man 2 and
a new
version of its crucial Tony Hawk skateboarder series. For a few reasons,
though,
it might be wise for investors who were along for the ride to step aside
and
harvest some profits.
With the company sticking to fiscal 2004 earnings projections of 70
cents a
share, the stock is hardly cheap at a price/earnings multiple of 24.
Deduct the
cash holdings -- down to about $6 a share after a sizable share buyback
expenditure -- and the stock is still above 15-times fiscal `04 profit
forecasts, a little pricey for a pretty unpredictable, hit-driven business.
John Piccard, a portfolio manager at J.P. Morgan Fleming Asset Management,
has
owned Activision for several months, but says he took some money off
the table
last week. He thinks the stock is a bit richly valued for a cyclical
business
and the company's ongoing product revamp represents a risk to the outlook.
"Not
much has changed [in recent months] except that the market psychology
has gotten
more bullish," says Piccard.
The sales performance for the balance of this year is far from a sure
thing,
with the important peak period of the year still ahead. And one analyst
notes
that the game stocks tend to behave according to some seasonal habits,
often
topping out at the time of the industry's annual conference, which is
happening
this week.
What's more, there's still the prospect that Activision will make an
expensive
acquisition with all its cash. Somewhat worrisome, too, is the growing
affection
of once-skeptical sell-side analysts. In fact, US Bancorp Piper Jaffray
last
week upgraded the stock to an Outperform rating with the shares just
above 16.
This is the same firm that downgraded Activision in late January with
the stock
near 14, after previously having boosted its rating in July at a price
of 24.
No doubt, with sentiment improving, Activision and its peers could continue
to
be bid higher. But in the current market, locking in a 23% move over
three and a
half months would appear to be the better part of valor.
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