Recovery May Not Be as Expected

Monday, May 06, 2002

The North American markets continue to trade on a negative bias. The NASDAQ continues to weaken far greater than the other indices on the basis of weak economic evidence of a recovery.

It remains difficult to forecast a recovery in business spending for I.T. Corporations continue to monitor expenses very carefully. As a result, technology companies are having difficulty growing revenue. At best, the sector can hope for stable to slightly declining growth. From a market perspective, the largest tech firms (IBM, Microsoft, Oracle, Intel, and Sun Microsystems) are trading at or making new 52-week lows. Emerging bell-weathers (SAP, Peoplesoft, Veritas Software, Brocade Communications) are faring much worse.

If we take a step back from the trading action to evaluate the prospects of the Nasdaq, it is clear that the risk/reward for investors remains very poor. In addition, the tech firms continue to trade with a substantial growth premium, even though we cannot expect such rates to continue – at least in the short term. Therefore, as economic evidence continues to border on muted growth, making money on trading Nasdaq stocks will be a strategy based on selective and short-term positioning.

Another ominous cloud looming for tech stocks is the push by Alan Greenspan to include stock options as expenses. Greenspan pointed out that profits over the past few years would be reduced by about 2.5% if options were included. While the Enron accounting fiasco has fueled an eye for scrutiny regarding options, the issues will most likely continue to add to negative pressure on expensive stocks.

Pharmaceutical stocks, once perceived as “safe havens” in times of uncertainty, are also trading as poorly as tech stocks. Fundamental issues are likely to keep the big cap stocks down. Big-name patents, which are the bread and butter for stable revenue growth for firms, are expiring for Merck and Brystol Myers. In addition, competitive pressures are or will be eating away at profits for Pfizer’s Viagra. With such negative news continually pushing pharmaceutical stocks down, it may be highly profitable to look for an entry point for stocks getting hit by association.

From a valuation perspective, I like Pfizer if it is in the range of $31-$34. Despite competitive pressures for some of its products, Pfizer has a broader portfolio of products and the company therefore deserves to trade at a higher premium than its peers. Brystol Myers and Schering-Plough Corporation ( are at or near 52-week lows. From a “value” perspective, these stocks represent short-term trading opportunities. They are likely to rebound at greater rates than the sector and broader indices.

The big firms are also undergoing pricing pressure from the government, who feel that insurance companies should receive volume discounts. Therefore, “smaller”-cap pharmaceuticals (relative to the market leaders) might be better investments for the long term because they do not face the same deterioration in pricing. They also represent good trading opportunities. ICOS and QLT Phototherapeutics are potential trading stocks, although the risk remains high.

Of the stocks listed above, BMY, MRK SGP, and QLT have been in a bear trend for quite some time. Therefore, a long-term trading position may actually be riskier than trading on short-term bounces. Unless there are fundamental improvements for these companies, the trading time horizon should remain short.

The telecom sector takes by far the biggest piece of the bear-market sentiment. Equipment makers such as Lucent and Nortel continue to live up to “write-off.” Their customers, Worldcom, BCE (Teleglobe), SBC, AT&T and Verizon have cut off CapEx (capital expenditures) for 2002. Bankrupt firms (Global Crossing, Williams Communication and 360 Networks), even though they have restructured, have much less to spend. One could list the customers who themselves are having a tough time growing revenue in a space where prices are declining. The list would be pretty much all telecom providers. It is clear that consolidation must take place among these firms. Until that happens, it is best to avoid all telecom and telecom-related firms.

It appears the only area holding up well is resource sector. While oil, metal, and gold prices have increased (for the most part), it is a sector that investors should be accumulating aggressively. During the late 1990’s as metal prices fell, these firms reduced their operating costs substantially. Many firms also merged to realize cost savings and to control output (and therefore reduce pressure on prices). These actions have yet to occur in the sectors outlined above. My picks are Alcan Aluminum, Inco Ltd, and Barrick Gold.