By Gene Marcial Investment pro Bernie Schaeffer is one unrelenting bear who remains convinced that the stock market is in for a long-term decline. But he has turned bullish on one sector: Technology. Yes, the techs. More specifically, he favors the small-cap variety. "My bullishness on smaller-cap techs has been building since early November," says Shaeffer, who heads Schaeffer Investment Research and is the editor of the Option Advisor newsletter.
He says investors should be in the tech-dominated Nasdaq, which he believes has "far greater upside potential than the blue chips." Schaeffer concedes that the broad market will continue to be strong for the next month or two. It has been absorbing bad news with aplomb -- and rallying vigorously on good news, he notes.
Where's the buying coming from? Money-market funds have soared in the past couple of years, as investors fled the stock market and switched into such funds, thus setting up some nice potential buying power to further stoke the rally. But an even stronger source comes from the tendency of big investors to bail out of bonds when stocks start to move in order to catch up with the equities rally. The "we can't afford to miss the new bull market" mentality kicks in further, he says.
EVEN KEEL. Schaeffer believes more strongly than ever that the blue chips and the Dow Jones industrial average -- which has climbed back to the 9,000 level recently -- will "bear the lion's share of the brunt of the next leg down." He says the the small-cap tech sector has sufficient strength to keep the Nasdaq composite index, around 1,450 in midday trading on Dec. 3, on a relatively even keel, even if the blue chips implode.
What impresses Scaheffer about the Nasdaq? "It has outperformed the Dow -- much more so during the rally off the July bottom," he notes. The market gains in the 1990s occurred in the context of a strong Nasdaq, he says.
Also impressive is the breakdown in the CBOE Market Volatility Index, which closed on Nov. 29 and Dec. 2 below the 30 level. Weakness in this index is another factor, says Schaeffer, that has been consistent with a strong market. Also bullish is the accelerating surge in put activity on the Nasdaq 100 Trust (QQQ). "When option speculators bet against the prevailing price trend, that trend is likely to have stong legs" says Schaeffer.
FOUR FAVORITES. He favors the small techs because many of them have become true values, with very much improved technical strength. Yet investors remain bearish on them, he adds, saying the Nasdaq has the potential of rallying to between 1,650 and 1,750 before topping out. On the other hand, some of the stocks trading in the single-digit zone could gain 50% over this period.
Among Schaeffer's top tech picks: Lexmark (LXK), the No. 2 printing and imaging company behind Hewlett-Packard (HPQ); disk-drive maker Western Digital (WDC); Qualcomm (QCOM), a wireless telecom products and services company; and mobile-phone company AT&T Wireless (AWE).
Lexmark, trading at $66.25 a share, has beaten consensus estimates in the past 28 quarters, notes Schaeffer. He says the stock's price-earnings ratio of 20 based on fiscal 2003 estimates is two-thirds of Intel's (INTC) 30 p-e and one-half of Applied Materials' (AMAT) 40 multiple.
UP FROM THE LOWS. Western Digital, trading at $8.49 a share, has outperformed the Nasdaq index by 600% since December, 2000. It also beat analysts' forecasts when it reported September-quarter earnings of 11 cents a share, vs. estimates of 6 cents. Its p-e of 10 is based on earnings estimates of 44 cents a share for 2003, vs. 25 cents in fiscal 2002.
Qualcomm, which bases its wireless products on its CDMA technology, is trading at $40.83 a share, way up from its low of $23.75 in early August. It traded as high as $61.99 a year ago. Second-quarter earnings of 31 cents a share beat estimates of 27 cents. Qualcomm also announced that it expects 2003 earnings of $1.15 to $1.20 a share on estimated sales growth of 19% to 23%.
AT&T Wireless beat expectations for a breakeven September quarter by posting earnings of 4 cents a share. It has also managed to increase its customer base when other large national wireless carriers were experiencing reductions, says Schaeffer. Trading at $7.60 a share, the stock is far above its low of $3.25 in early October, and has outscored the Nasdaq by nearly 100% since the October, 2002, market lows.
EXHAUSTED RALLY. Schaeffer notes that widespread skepticism has dogged the stocks on his buy list. And outside of certain tech shares, he advises that long-term investors "should remain out of the stock market, and traders should look at the potential short-term gains."
His sense is that by mid-January, the rally should end as the sidelined money that was waiting for such a bull move will have exhausted itself. That will result in another overvaluation in stocks -- without any significant upturn in corporate earnings.
"And the external risks -- war, terrorism, dollar implosion, budget deficits, rising debt, falling real estate prices, and deflation, will not have disappeared," says Schaeffer. He suspects that any one or two of these negative events wlll occur sometime next year. Marcial is BusinessWeek's Inside Wall Street columnist