Playing a Nervous Market: What to Watch
Don’t be fooled by the latest rebound in stock prices. This is still a very nervous market.
Last week’s rally that carried the Dow Jones industrials up 4.5% and the Nasdaq composite up 3.1% may owe more to temporary giddiness over some strong corporate earnings (such as Microsoft’s) than to a sustainable shift back to bull-market mode.
What’s dogging this market, after all, are deep worries about the outlook for inflation and interest rates--the stock market’s greatest enemies in the long run.
Some Wall Street analysts fear that the summer pullback in stock prices may resume when third-quarter corporate earnings season winds down next week and markets are once again left to focus almost solely on bond yields--now at two-year highs--and the possibility that the worst is to come.
Perhaps the most serious problem for stock investors in a market this high-strung is that any disappointment can cause individual share prices to plunge 20%, 30% or more in no time. Owners of such big names as IBM, Xerox and Mattel, to mention a few, have already found out just how brutal a frenzied sell-off can be.
But volatile markets like this one also provide opportunities for aggressive and fleet-footed investors who know what to buy, and when. Case in point: Internet software company Vignette Corp., which shot up 66% in four days last week thanks to an explosive earnings report.
If the challenge in this dicey market is as much to avoid dramatic short-term losses as to cash in on any big movers, many investors may need to employ different strategies than they would in an ever-rising bull market.
Here are some factors to consider, and “technical” market indicators to learn to watch, as you mull buy and sell decisions:
Earnings Reports: Patience is a Virtue
Earnings season, the quarterly ritual during which companies report their results for the previous three months, can be a buyer’s paradise in a bull market as companies report glowing results and stocks generally rise in appreciation.
In a weak market, however, buyers must be cautious.
“The first thing is to use your head, and I don’t mean that facetiously,” said Greg Kuhn, a hedge-fund manager in Easton, Pa. “You’ve got to go in small and slow because the market is in a whipsaw mood.”
Investors should keep a list of companies that they expect to report solid earnings. But in this environment, it’s often better to wait to buy those stocks until after earnings data are released and companies have conducted conference calls with analysts.
Of course, investors are sure to forfeit some gains by waiting for the actual reports instead of buying the stocks in advance of expected good earnings, Kuhn said. Vignette, for example, bolted 20% in the two days before its profit release as word of mouth spread on Wall Street that the company would show a blowout quarter.
Also, once profits are reported (often after the market has closed, but while after-hours trading still is going on), professional investors can act faster than individuals to grab shares, pushing up prices.
But by waiting for the actual results--and, more important, by waiting to hear that the company sounds optimistic about the near future in its conference call or its earnings statement--investors can insulate themselves from what can be large stock drops if there’s a hint of disappointment. Case in point: IBM’s plunge last week, post earnings.
Kuhn waited to pick up America Online and cellular phone firm Nokia last Thursday after each company had announced earnings, and after the market had begun to react favorably to their reports.
In similar fashion, Kuhn waited on Net software firm Inktomi. And he’s glad he did: The company reported a slightly smaller loss than expected, but the shares plunged almost 15% on Friday after Merrill Lynch & Co. downgraded the stock.
“You’re going to be giving up gains to be sure” that results satisfy expectations, Kuhn said. “You have to let the market tell you where to be and what to do, especially in this environment.”
Relative Strength: Stock vs. Market
One of the best ways to keep an eye on stocks is to study their price and volume patterns on charts--so-called technical indicators. Some believe that stocks can send clear signals about their near-term direction to investors who know how to read charts.
The idea behind technical analysis is that a visual representation of a stock’s trading history yields insights that can’t be gleaned from a financial statement.
Relative strength is one of the most widely used technical indicators among professionals. Relative strength gauges the performance of a stock price compared to the broad market over a specific time period, typically one year.
Relative strength is normally expressed on a scale of 1 to 100. A high number, such as 90, means the stock has done better than 90% of all others in the last year. A 20, on the other hand, depicts a laggard.
You can find relative strength data on many investment sites on the Internet, including https://www.stocktables.com.
The value in studying relative strength is that a stock that has outperformed the market in the past often will continue to do so. In other words, good stocks often remain good stocks. Frequently, some experts say, relative strength is high in advance of a big jump in price.
Relative strength can be high even in a falling market. A stock that goes sideways during a market downdraft is outperforming, a sign that it may rise strongly when the correction ends.
Nokia, for example, weakened in midsummer as the market topped out, but it had performed well since early August. Its relative strength was an impressive 88 when the company released earnings last week--and the stock zoomed from $95.75 to $105.
Conversely, a stock that goes sideways during a bull run could be setting itself up for trouble.
One caveat: Be careful about chasing a stock that has already surged dramatically, such as after a good earnings report.
“Don’t chase anything here,” said Doug Fairclough, chief investment strategist at ClearStation.com, a technical-analysis Web site.
Regardless of market conditions, stocks that lunge forward for several days often backtrack in the next few days. Vignette, for example, followed its breakout last week by giving back 11% on Monday.
Trading Volume: Watch for Surges
A stock’s volume trend may be a more important indicator of where it’s headed than the near-term price action itself.
Heavy volume demonstrates urgency on the part of investors. They’re anxious to buy or sell. It follows, then, that it’s a positive sign for a stock’s outlook when the price rises on heavy volume and falls on low volume.
Conversely, it’s negative when stocks drop on heavy volume and generally unimpressive when they rise on lackluster activity.
However, volume can be more subtle. What if volume is rising but a stock is going sideways?
That’s a phenomenon known as churning, or “distribution,” and it’s considered a warning sign that the price is vulnerable.
When churning occurs, new buyers are coming in, a force that would normally power the stock higher. But they’re offset by an equal number of sellers. Eventually, the thinking goes, buying pressure will dry up and sellers will take control.
“You want to see more money going in on up days and the converse of that on down days,” Fairclough said.
Highs vs. Lows: Track the Trend
When a stock falls these days, especially if it’s a highflier, many individuals are tempted to “buy the dip” on the expectation that the price will shoot right back up. The danger, of course, is that the stock won’t come back, at least not right away.
How can an investor know when to jump in? There’s no sure-fire way. But before buying, check to see if the stock has been notching lower lows and lower highs during its trading in recent weeks or months.
Consider the accompanying chart of America Online. The stock peaked above $175 in early April but slid to $77 four months later.
Few stocks go straight down, and AOL was no exception. It rallied several times during its downdraft. Each time, however, it hit a lower peak than the previous try. In other words, it was notching lower highs, a clear warning sign. And after each rally, it subsequently fell to lower lows.
But the trend reversed course in late September when the stock fell again--but remained above the level of the previous sell-off in early August. That was an early indication that the worst of the selling was over.
A more bullish sign came a couple of weeks later, when AOL rose above its most recent high, signaling increasing buying pressure. Indeed, AOL has jumped from $77 in early August to $121.25 now.
Intraday Trading: Watch the Close
Tracking where a stock finishes each day in relation to its intraday range--its highest and lowest intraday prices--can be telling.
Does the stock frequently end at the bottom of its daily range? In other words, does it frequently trade higher early on but sell off late in the day? Or does a final burst of buying carry the stock near its daily high?
Obviously, it’s positive to close at or near the daily peak, and negative to finish near the low.
“If the stock habitually trades at the low end of its intraday range . . . the internal strength of the stock is starting to weaken,” Fairclough said. “It’s a pretty important and reliable indicator to look at.”
The indicator is important in part because it yields insight into the actions of institutional investors. Pros often are most active late in the day after they’ve surmised daily trading patterns and digested news. That stands in contrast to individuals, who are most active in the morning.
Understanding institutional thinking is critical because the clout of mutual funds and hedge funds normally influence a stock’s price far more than individuals.
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Times staff writer Walter Hamilton discusses the day’s market action regularly on the KFWB-Los Angeles Times Noon Business Hour on KFWB-AM (980). He can be reached at walter.hamilton@latimes.com.
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Stock Market Barometers
Fundamental and technical indicators of the market’s health
Key indexes vs. their 200-day moving averages: A stock index’s 200-day moving average indicates the basic trend, up or down. It is generally bullish if the index stays above the average.
Price-to-earnings ratio of Standard & Poor’s 500: 26.09*
Based on estimated operating earnings per share for 1999; average since 1923: 13.5
Dividend yield of the Standard & Poor’s 500: 1.28%
Average dividend yield of blue-chip stocks; average since 1923: 4.5%
Weekly new highs vs. new lows on the NYSE: 83/895
Data for the week ended Friday. More highs indicate a bullish trend.
Investment newsletter sentiment:
Stocks’ near-term trend as predicted by 135 independent investment newsletters, weekly survey by Investors Intelligence.
The data are often viewed as a contrarian indicator: A rising percentage of bulls can signal a topping market.
Put-call ratio: 0.37
The ratio of stock put options to call options traded last week on the Chicago Board Options Exchange. Ironically, a low put-call ratio--under 0.40--can be construed as bearish because it indicates a high level of optimism, leaving a lot of room for disappointment.
* Now calculated based on operating earnings, which exclude one-time charges--so P/E is lower than if actual earnings were used.
Source: A.G. Edwards & Sons. More information can be found at https://www.agedwards.com.
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Peaks and Valleys
America Online’s stock gave an indication that its deep, four-month slide was turning around when the shares notched a “higher low” in late September. The “higher high” reached a couple of weeks later was stronger proof. Daily performance and latest:
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Source: Bridge Information Systems
