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Barron's(9/29) MARKET WEEK -- Stocks: The Trader: There's More To Market's Slide
(From BARRON'S) By Michael Santoli
There's a cute and tidy story going around that the downturn in the dollar last week combined with the OPEC-engineered bounce in oil prices to knock the stock market for substantial losses. Could be. But if so it's a little curious that the sector hit hardest was technology -- the very group that benefits most from a weaker dollar and is perhaps the least energy-intensive industry in the market. The dollar's tumble and oil's uptick were, more likely, "MacGuffins," as Alfred Hitchkock called his convenient, simplistic plot devices. They propelled a drama playing out mostly in the psyches of professional investors. This is hardly trivial, given that investor psychology has been the propellant of the intense rally that had evaded serious pullbacks for months. The tempting conclusion suggested by last week's losses is that portfolio managers' performance anxiety is now manifesting itself in different types of behavior. While the zeal to grab a fair share of the market's upside has for months spurred the pros to chase the highly valued market leaders, last week there were hints that money managers were eager to preserve their gains, sell some winners and pare risk levels. The selling hit the tech-driven Nasdaq hard, driving it down 113 points, or 6%, to 1792, extinguishing a month's worth of gains. The S&P 500 gave up 39 points, or 3.8%, to settle below 1000, at 996. The Dow Jones Industrials lost 331 points, or 3.4%, to reach 9313. There are other possible fundamental items on which to pin the sudden selling impulse. Earnings warnings from Viacom and a few others rattled investors a bit, though the overall preannouncement season isn't shaping up to be a particularly poor one. There were also a couple of economic releases that undershot forecasts and spread concern that the economy's momentum might be flagging. One of the market's weaker days, Thursday, was explained in part by a decline in durable-goods orders during August. But that number had been out for a good seven hours by the time stocks began registering the bulk of their losses in a late-day flop. Merrill Lynch economist David Rosenberg notes that 80% of this month's economic data releases have failed to beat expectations, a reversal from the ratio in August. That couldn't have helped the bulls' cause, but the fact is that investors had for weeks been able to absorb or ignore most negative news as they punched in the buy orders, and last week that changed. Scott Jacobson, a trader and strategist at Jefferies, says, "Getting close to the end of the year, if you're an average portfolio manager and you're at or near your benchmark, you'll start to `closet index' and hug the benchmark." That would imply selling many of the kinds of stocks that have worked especially well for the past six months. High-expectation, low-profitability, fringe-dwelling tech stocks, for example. If this activity continues, it would also suggest that the massive outperformance of small-cap shares could be about to curdle. The valuation gap that once favored smaller, more aggressive, more deeply cyclical stocks is no longer quite so compelling. Vadim Zlotnikov, strategist at Sanford C. Bernstein, told clients last week: "To make a significant bet on small-cap names now, you need to believe in a very strong recovery" in the economy. Jacobson adds that Treasury bonds, which have rallied to knock 10-year yields to 4.02% from 4.60% right after Labor Day, "are telling stocks something again." Namely, bonds might be whispering that the hopes for a galloping economic pickup might've been premature. If indeed investor psychology is beginning to take on a more defensive cast, then larger, more stable stocks might be expected to grab the lead, at least temporarily, from the long-shot, highly leveraged bets that have been rewarded for some time now. Zlotnikov notes that his firm's model for selecting stocks with high-quality earnings and attractive valuations has underperformed the market since its March low. In examining past periods back to 1966 when this quality screen has trailed the market this badly, he found that its laggard behavior tends to last five or six months before rebounding strongly. It's been just over six months this time. He's now favoring health-care-services stocks, as well as energy names. Even stock-market bulls, of course, have been talking about the likelihood of a retreat, albeit a shallow one, in the indexes. Some have professed to be hoping for just that, so they might do a little buying at lower asking prices. And certainly, there's enough liquidity out there to allow for that to play out on a broad scale. Yet a couple of index levels deemed significant by technicians were breached in the latest downdraft. Heretofore invincible momentum champions such as Yahoo were taken down a peg. Short sellers have stopped kicking the dirt and are looking for fat pitches to hit again. And, naturally, the same dynamic that pulled fresh buyers in as stocks surged could begin operating in reverse. It's happened before.
-- The action in Viacom shares had been evidencing deep investor concern for several days before the company finally validated the market's fears on Wednesday, by tempering its revenue and profit outlook for the rest of the year. The media outfit blamed continued softness in local advertising demand for a reduction in its revenue and operating-income projection to "mid-to-high single digit" percentage growth from a prior forecast of double-digit income growth atop single-digit revenue gains. In each of the three trading days before Viacom's announcement, its shares had sold off steadily on roughly twice their normal volume. Hints of a slower-than-hoped rebound in local advertising had emerged from the New York Times and Gannett, and some observers had begun to worry that Viacom's CBS television stations might have a tough time matching last fall's ad performance that was helped disproportionately by political ads. Paramount's weak summer box office showing was another drag. In fact, from Sept. 5 -- the day after Congress voted to preserve many restrictions on media-outlet concentration -- Viacom's heavily traded B shares are down some 17%. This radical underperformance is something new for Viacom, which was a nearly bulletproof stock throughout much of the bear market, consistently afforded a valuation premium by an investor base in the thrall of Chairman Sumner Redstone's grand vision and President Mel Karmazin's vaunted operational acumen. Last week several loyal analysts came to the company's defense, calling the stumble an aberration and, predictably, a buying opportunity. The bullish case always begins with a tribute to the quality of its assets: CBS, Showtime, MTV, Nickelodeon, Paramount, Simon & Schuster, the list goes on. True enough. But AOL Time Warner and Walt Disney and Fox Entertainment each has its own set of enviable media assets, too. What Viacom has that the others don't is significant exposure to radio, through its ownership of the Infinity Broadcasting stations. Radio accounts for only 9% of Viacom's revenues. But because it's such a high-margin business it produces some 19% of earnings before interest, taxes, depreciation and amortization -- the coin of the realm in media. This accounts for much of Viacom's exposure to local ads, which has badly trailed the recovery in national advertising. Spencer Wang of J.P. Morgan published a cautious note a week ago Friday on Infinity's ratings, which have fallen even more than the overall declining listenership rates of the industry among the important 25-to-54 age group. The growth drought in radio has led some investors to question whether there are more worrisome trends to be inferred. Drew Marcus of Deutsche Bank believes it simply means that radio has stopped gaining market share from other media. Meanwhile, he thinks, "The weak pacing of local advertising calls into question the strength of the economic recovery." Others, though, wonder whether there's something more significant happening in radio, whether consumers are being increasingly turned off by the homogenization of radio formats and the aggressive increases in commercials aired per hour. The long-term expected growth rates of radio companies -- no surprise -- hint at none of these concerns, as analysts pencil in three-to-five-year earnings increases of 15%-25% per annum. There has been management shuffling at Infinity in an effort to revive the group, and it seems Viacom is committed to spending money to get ratings higher. One skeptical observer notes that the real story in Viacom's announcement last week was that management effectively said margin expansion wouldn't happen this year. It brought profit-growth guidance in line with revenue growth. So much for those hopes of gaining leverage to an advertising recovery. He also points out that Viacom has effectively had to cut back its guidance three years in a row. Until now, the market has overlooked these hiccups and tuned right back in to the Mel and Sumner show. Yet even with its recent decline, Viacom's stock doesn't appear to be a particular bargain compared with other companies with exposure to the same businesses, such as Time Warner, Fox and Tribune.
-- There was a line of thinking among certain investors, cited here recently, that a drastic dividend cut by Eastman Kodak could lead to a higher stock valuation. The idea was that the company would thereby signal a plan to marshal resources to maximize cash returns from a declining film market while selectively making acquisitions in higher-growth businesses. Well, Kodak's announcement last week that its lavish, $1.80-a-share annual dividend would be hacked down to 50 cents wasn't received quite so well, as the company's shares were knocked down by 6.40 to 21.40. Barron's(9/29) MARKET WEEK -- Stocks: The Trader: -2- [CZBGKVR] The hostile reaction can be traced to a couple of things. Clearly, yield-fixated investors see no reason to stick around. But the nature of Kodak's announced plan -- to pursue some $3 billion in acquisitions and enter the savagely competitive ink-jet- printer business -- spooked even those who thought a dividend cut could be spun positively. The company posited that its plan would lead to $3 a share in earnings in 2006. No one has enough faith in a strategically challenged company's fortune-telling abilities to buy into that, especially given Kodak's mixed record on acquisitions and only tentative success turning a profit from digital photography. Bond analyst Carol Levenson of Gimme Credit calculates that Kodak could achieve even better earnings growth by 2006 by using the same $3 billion to simply buy back stock, with little operational risk. One intriguing element of Kodak's plan is its vow to start making private-label film. This suggests Kodak is indeed looking to pull as much cash out of every available segment of the film business, rather than retain premium pricing and sniff at the mucky business of competing for market share. Once the yield investors and the understandably skeptical former bulls finish selling, Kodak shares should find more stable ground. The best-case scenario might be if Kodak were to pull a McDonald's and answers a disillusioned Wall Street by forgoing delusions of fast growth in favor of retrenchment, cash-maximization and humility. But with such a dramatic makeover in the works, today's Kodak stock buyers won't be able to gauge its prospects for success for quite some time.
-- After three calendar years of eroding stock prices, virtually every powerful constituency in the Washington-New York politico-financial world has an acute interest in stocks riding higher. Brokerage houses and mutual-fund firms have their bottom lines at stake, of course. The Fed wants to forestall asset deflation and to see the market ratify its attempts at goosing economic growth. The Bush administration needs Wall Street to augment re-election prospects. The Treasury and Congress desperately covet capital-gains taxes to help offset some of a soaring deficit. Just about the only people that have a stake in seeing the market decline are a couple thousand hedge-fund managers habitually attached to the short side. The liquidity thrust from tax cuts, higher government outlays and teensy interest rates are widely discussed as contributors to the market's rebound this year. But there's also been a market-friendly effort by Congress to legislate away the bad or inconvenient items that can plague companies' books. One goodie offered to corporate interests by the tax-cut law was the chance to accelerate the depreciation of newly acquired capital goods. This effectively lowered the after-tax cost of these investments and provided a great, temporary incentive for companies to load up on new technology products. Those incremental sales, mostly booked over the summer, have been dutifully incorporated into analysts' run rate of tech demand. Another idea clattering around the halls of Congress would have farther-reaching effects. This is a proposal to allow companies to use a higher discount rate when calculating the present value of their future pension liabilities. If Congress does make such a change, no doubt Wall Street will be happy to bless the cosmetically enhanced earnings numbers. Investors have already been blithely dismissive of the potential earnings-corroding implications of pension shortfalls, and such a legal shift would make the problem that much easier to ignore. The tomorrow-be-damned attitude among investors is perhaps most pronounced in their treatment of airline stocks. As a group, airline shares have more than doubled since the market low in early March. The traditional major airline shares -- AMR, Continental, Delta and Northwest -- have soared from levels implying they were bankruptcy risks. Yet the market might not be taking a full account of the sorry state of the industry's pension situation, according to an extensive new study by Bear Stearns analyst David Strine. Those four carriers have a combined $13.9 billion pension shortfall, against total pension plan assets of $17.8 billion. Strine forecasts that their likely required cash contributions to pension funds will jump from $594 million this year to nearly $1.8 billion in 2004. As a proportion of forecast operating cash flow, the companies' expected 2004 pension contributions amount to 31% for Continental, 37% for AMR, 42% for Delta and 62% for Northwest. For each, operating cash flow is expected to fall short of the airlines' combined net capital expenditures, debt payments and cash pension contributions. Congress may ease the airlines' crushing pension burdens with a little "new math," but as Strine shows, stockholders have little hope of staking a claim to these cash flows any time soon. |
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