Growth Stock Guru Says Risks Are Too Great
When William O’Neil talks about the stock market today, the disappointment in his voice is palpable. He’s not having much fun.
The veteran West Los Angeles money manager and publisher of Investor’s Business Daily newspaper believes this bull market is dying a slow death. “The market is just rotating (among stock groups),” he says. “I don’t think anybody has made much headway in the last few months.”
So in mid-November, O’Neil sent his clients a letter warning that the risk of staying in the highest-flying growth stocks--the issues he has traditionally championed--has simply become too great. Time to sell, he said.
Coming from the 60-year-old O’Neil, that advice carries weight: Hundreds of thousands of investors large and small subscribe to his newspaper, own his book (“How to Make Money in Stocks”) or have attended one of his stock seminars over the years.
Indeed, O’Neil’s change of heart on growth stocks such as computer chip giant Intel, golf club maker Callaway Golf and iced tea phenom Snapple Beverage has coincided with a vicious selloff of those issues in recent weeks.
But some of O’Neil’s devotees worry that his caution is being forced, or at least magnified, by his obligation to his 18-month-old New USA mutual fund--a burden he didn’t have between 1975 and 1992, when his prowess as a stock picker brought him national fame.
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Before New USA was born, O’Neil and protege David Ryan basically managed their own money. While they shared their stock-picking formula with other investors via the newspaper, book, workshops and O’Neil’s widely circulated market research (the lifeblood of his empire), they did not handle public money.
Now, with thousands of investors having entrusted $275 million to O’Neil and Ryan in New USA, the big question is whether the two have become overly conservative--a potentially dangerous mode in the high risk, high payoff world of growth stock investing.
So far this year, New USA’s first full year of existence, the fund is up about 7.5%. In contrast, the average growth stock mutual fund is up about 8.9%, according to fund-tracker Lipper Analytical Services.
Have O’Neil and Ryan played this market too timidly? “We’re probably being more careful and cautious than most” growth stock investors, O’Neil concedes. But he says that has far more to do with the age of the bull market than with concerns about preserving his new shareholders’ capital.
The recent breakdown of stocks that have tripled or quadrupled over the bull’s 38-month run suggests that investors are growing cautious and that they are becoming unwilling to bid market-leading stocks higher, O’Neil says.
His stock-picking formula, which he developed in the late ‘70s, uses a computer to rate stocks according to seven variables, including their current earnings growth, extent of institutional ownership, and “relative strength,” or how the stocks perform compared with the market.
What he sees increasingly, O’Neil says, is that “the highest-rated stocks aren’t acting like leaders anymore. There’s a smaller and smaller list of leaders to shift into.” That’s a classic sign of a market that’s topping out, O’Neil says.
Technology stocks, which historically are among the market’s most volatile issues--and the most lucrative, if played correctly when they boom--are particularly vulnerable now, O’Neil says. He and Ryan have sold New USA’s stakes in such names as Intel, Motorola, Sybase and Cisco Systems.
Motorola has tumbled from a 1993 peak of $107.50 to $88.875 now. But some of the tech issues are still showing strength. Sybase, a leader in database management software, is at $40.75 now, off just 6% from its ’93 high of $43.50.
Nonetheless, the 33-year-old Ryan, who manages New USA day to day, insists that “a lot of these stocks are not coming back” in this bull market. “When a stock hits a peak, it sometimes takes three to six months before it really starts down,” he says.
The risk for New USA is that this latest setback for growth stocks is merely a “correction”--a short-term selloff that will soon be followed by a surge of new buying, sending prices to higher highs.
O’Neil and Ryan admit that they misjudged previous selloffs in some growth stocks over the past 18 months; had they loaded up on selected stocks when they were down, New USA could be up much more than 7.5% this year.
But the strategy of buying on dips is a fool’s game late in a bull market, O’Neil says. “One of these days that will no longer work,” he says--when a stock that’s down 10% suddenly falls 20%, then 50%.
He learned that lesson the hard way in the 1960s, when he managed the now-defunct O’Neil Fund, his first mutual fund. Like many growth funds of its era, it crashed in the horrendous bear market of 1969. O’Neil sold the fund in 1975.
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How severe a bear cycle does O’Neil expect this time? He sees the broad market falling 15% to 20%, and new growth stocks down 30% or more. That will be the signal to begin moving aggressively back into equities, he says.
Ryan says he needs a bear market of that magnitude to pick up stocks cheap enough for New USA to produce the kind of 30% annual returns that O’Neil boasted in his private account in the ‘80s. Naturally, the promise of such high returns is what drew investors to New USA in the first place.
Until the bear comes, Ryan says the fund will continue to play it relatively safe. Fully 25% of the fund’s assets are in cash; that could go as high as 50%, Ryan says.
Moreover, while O’Neil has always touted young growth firms as the key to successful long-term investing, the stocks in New USA now include some industrials that are very un-O’Neil, at first glance: issues such as Chrysler and Ford, and gold stocks such as Placer Dome and American Barrick.
Ryan insists that the fund remains true to O’Neil’s growth stock orientation. “This is a growth fund,” he says, “but if opportunities come up in other areas, we can take advantage of them.”
In the ‘90s market, Ryan says, “You have to have an open mind.”
