December 2000 Newsletter

Has The Tide Turned Against the Bull Market?

By Chris Lau
Written on December 5th 2000

As if October was not bad enough, November was worse for the markets! If history was any indication, the US presidential election was supposed to be the year that stocks did well. What were the ODDS of a near-tie?! The market was not expecting the potential lawsuits building from both parties. In Wall Street lingo, the market was not expecting to face uncertainty. The market HATES uncertainty! That is one of the major factors pulling the markets down. Compounding the problem is a fear that overall economic growth is slowing.

Question: what the key driver of the bull market was over the last ten years? Answer: consumer demand. So far, consumer demand appears strong. What looms are the effects of a tightening monetary policy (i.e. raising interest rates), which usually takes time to make its way in the economy.

Back to 1998?

In late 1998, the stock market was stumbling because of concerns in the debt market in Russia and Asia. Banks were "tight" with lending money, as they often ended up "burned" from bad bonds that would never be paid back. Consequently, some major banks had to make major write-offs. 2 years later, it is becoming more apparent that we are in a similar situation. The only difference is that the bad debt is coming from telecommunication start-ups and other telecom-related companies. That is why bank stocks are falling from the sky.

As of November 22nd, Citicorp was $47 1/6US down from a high of $59 1/8 (all figures in US dollars), Bank of America was $38 9/16 (its p/e is 8!), and Morgan Stanley Dean Witter was $64 3/8 (falling from a recent high of 110!). Interestingly enough, some compelling value is being created in the financial markets. In the dotcom-like brokerage side, E*Trade is a paltry $10 1/8! At current prices, one should wonder if the company will soon become subject of a takeover later on down the road.

Pure Madness?
The mood is far too pessimistic, and I do not think the market is on a continued downtrend. What I think could happen is that the markets will remain at oversold levels, and value investors will start to come in and buy great stocks at good prices. Stocks such as Macromedia Inc., Rational Software, Open Text, Intel, Avaya Inc., C-Mac Industries, and Celestica are great companies with pretty good prices (considering their growth rates and leadership positions in the market). I don't think the market is entirely "cleansed".

Starbucks and Krispy Kreme Donuts are stocks that are VERY expensive relative to their realistic growth rates. While they are well run companies, the stock is priced to perfection, leaving little room for management to err on executing its growth strategy. It is ironic that the market cleaned out solid dotcom plays like Yahoo Inc, and AOL, but kept the premiums on companies that are vulnerable to changes in consumer taste, as well as competition.

What does one buy now?
Simple answer: TransCanada pipelines. The Market Analysis site traditionally focused on technology stocks, not slow moving, "boring" stocks like TransCanada. In times like these, especially over the next 6 - 18 months, it is going to be very rough on Wall Street. It is a good idea to have some defensive stocks like TransCanada Pipelines, a company that is a story in itself.

Why TransCanada?!
The pipeline stock sports a 5.4% dividend but more importantly, I believe it is a turnaround story. About 2 years ago, the company merged with Nova Corp. to form an ultra-fat pipeline company. It was realizing huge competition, huge costs in servicing debt, and the "synergies" of the two companies was not as great as the market expected. Since then, a new management and more importantly, a new CEO sold off the non-core assets. The company is thinner, and in the past two quarters, showed impressive earnings growth. As a near "rule of thumb," the success of a company turning itself around is indicated by at least two consecutive quarters of improving earnings. That is the case with TransCanada Pipelines. Keep an eye on the company as it continues to show fundamental improvements. (Click here to read my TRP Report!)

What about Nortel?
Given market conditions, it is always a good idea to look beyond the Nasdaq markets and to wait for economic data to come in. It is crucial that we get evidence that the economy isn't stalling significantly, and that a tight debt market isn't justified. In the mean time, take small steps. Getting into Nortel a bit at a time might not be a bad idea, but that comes with a word of advice: large telecom companies were inclined to scale back spending in the last quarter. The telecom companies are under pressure with their own investors to show some return on investments. Therefore, current and potential investors in Nortel need evidence that such reduced spending will not carry in 2001 and beyond. From a technical charting analysis Nortel may have trouble breaking past $60 Cdn. If it can trade beyond that level on high volume, the stock makes a good short-term profit candidate. But watch out if the stock fails (on several occasions) to rally past $60. From a "fair valuation" perspective (comparing P/E to the expected growth rate), Nortel could fall to $49 Cdn.

Your point being…
360 networks looks like it is starting to have good value. Although the company warned revenue would not be as high as anticipated, it is moving into the higher margin business of carrying the fibres for data networking. And JDS Uniphase? It is the same story as Nortel. An expensive stock, but if growth rates can be confirmed for the next year and beyond, JDS would prove to be a good long-term holding.

What about "traditional" bricks n' mortar?
Allocation and diversification will always be the key to successful investing. It doesn't matter if you scored big on one big tech stock, it DOES matter if you put much of your assets in the best performing sectors. If the negative sentiment for technology stocks continues, it might be a good idea to invest in retail stocks. You are correct to assume that a slowing economy means bad news for retail, but remember - the market is filled with fear. It is assuming that the economy is slowing down. From the Canadian side, I like Hudson's Bay (because of all the "back-end" efficiencies the company is implementing). I like Wal-Mart on the U.S. side. Both companies are solid, with Hudson's Bay a better value play than the well-run (and therefore more expensive) Wal-Mart. By January the market should have some economic figures confirming or negating a deteriorating economy. It should prove to make or break portfolio, at least in the short-term.

(c) 2000 Market Analysis Canada

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