JANUARY 3 – As we start the New Year, I am optimistic that 2005 will ultimately prove to be a good year for the economy and the stock market.
In many ways, 2004 was a very difficult year -- a year of wild swings, in which the greater part of the year the stock market oscillated up and down in a trading channel, making it very difficult to hold positions for any length of time.
Shortly after the elections, the stock market began to shift out of a transitional pattern into a sustainable uptrend. I can't say how long the uptrend will last, but up to this point the trend is still bullish, though beginning to look somewhat lethargic.
I am concerned about the near-term aspects of the market. There are some warning signs.
For example, small traders are buying three times as many calls as puts, with the put/call ratio reaching an extreme. That's a sign that the market may be getting a bit ahead of itself.
Commercial traders, who trade in the full and e-mini contracts of the Standard & Poor's 500 Index, Nasdaq 100 Index and Dow Jones Industrial Average are beginning to take defensive actions, and that concerns me.
-- Dennis Slothower , editor
JUNE 22 -Things look extremely bullish right now....the money supply, as measured by M2 [currency plus most savings, demand deposits, and money-market funds], is growing at a 10.7% annual growth rate. Some would [point to] other factors. But as I see it, these other factors do not make a growing money supply into a negative....
The cost of money is secondary to the availability of money, and the cost of money certainly isn't a threat to the economy when interest rates are at 1%, 1.2% or even 2%. You don't have to look very hard to see plenty of liquidity right now, which will continue to fuel the expansion of the economy. If you have paid attention to the growth in liquidity over the last three months, you should be assured that corporate earnings are going to be extremely strong, come the July reporting period. The economy is in great shape.
Earnings are expected to grow 20% in the second quarter. You may hear that the stock market is overvalued. I don't believe it. The Standard & Poor's 500 trades 21 times the trailing 12-month earnings. The benchmark's average price-earnings ratio the last 18 years is 23. If the economy continues to grow at such a sizzling pace, the P/E ratios will fall fast. Earnings are what justify stock prices. They look very dynamic from my vantage point.
I think July will be an impressive breakout month, once we get past the Federal Open Market Committee meeting and the handover of sovereignty to Iraq. Now is the time, accumulate stocks -- while the odds are stacked in your favor.
-- Dennis Slothower
Nov.- I see the Fed trying to control growth. They really don't want to see the economy overheat before the elections, so they are trying to get a grip on it now, and then expand it again next year so that the economy will look more robust going into the election period. It looks as if the Fed wants to "paint the tape," by suppressing the economy now, only to show better numbers when they count, right before the election.
-- Dennis Slothower
Finding great companies to invest in has never been easy. It was never supposed to be. As the market collapsed - and collapsed and collapsed - over the past two years, smart strategists kept repeating one simple mantra, “There will always be room for good companies and good stocks even in down markets.” The trick would be finding them.
In the roaring late 1990s even a monkey could throw a dart and hit a rising stock. It took much of the homework, and guesswork, out of investing while creating a false sense of certainty that we were all, at heart, born stock-pickers. Have we learned our lesson yet? Apparently so.
Even as the markets have shimmied higher over the past several weeks [with the S&P 500 (^SPX) having risen 22 percent since March 2003], it's still a tough sell for investors to come off the sidelines and have faith in a broad-based bull rally. Bear markets will do that to you. So will accounting scandals and corporate fraud. And so will crooked analysts who acted as shills for their firms' investment banking clients.
But the original mantra still holds true: that good stocks and good companies will always rise regardless of good times or bad. And those investors lucky, smart, and hardworking enough to have found a few small cap stealth stocks that fit this description were handsomely rewarded even as the market cratered around them.
Some of these stocks - Lexar Media (LEXR) and Asta Funding (ASFI)- were featured in this column. Others, like Sonic Solutions (SNIC), were profiled in newsletters such as the Growth Report. And still others, such as Medifast (MED) were highlighted in stealth stock publications such as Dennis Slothower's Stealth Stocks report.
The question now is whether these few stealth stocks can continue to rise even as the broader market takes a breather, collects its winnings and tests the winds economic change going forward? Upon initial reflection, it appears the answer is yes - that there's more upside still to come.
Bankruptcies and Diets
In February 2003, this column also featured another stealth stock, Asta Funding, as a good hedge against a slowing economy. In a nutshell, Asta buys up credit card debt and tries to collect on what's due. If it can collect more than it paid, it makes money. Not a difficult business to figure out, especially given that, despite an economy in the dumper and hundreds of thousands of people out of work, consumer spending has remined strong. Why? Because our level of personal credit card debt has risen to all time highs, and soon some of those cardholders would have to pay the piper. All good news for Asta.
The stock proved common sense right. Continuing its steady rise, shares climbed from near $10 two years ago to just shy of $22 today. Slothower in January 2003 had told investors that Asta would reach $21 by the end of the year; just five months later it's already there. Though some analysts feel that the stock may have gotten ahead of itself, there's no reason why Asta can't continue its march higher. Though it's recent quarter saw a slight decline in revenue and net income, the company continues to carefully select portfolios of debt to purchase - a high-risk business where caution is Asta's most valuable commodity.
Another company which could offer similar gains to Asta is Medifast, recently featured by Slothower as a stealth stock to be carefully considered. Like Asta, Lexar and Sonic, Medifast occupies a market where demand is high - and growing. Medifast makes meal replacement shakes and other diet products which are sold through diet and fitness centers. Is the stock a double or a triple? As of May, Slothower thought so, acknowledging that a large, if not ever increasing portion of Americans are overweight. The financials told the story. Medifast's first-q om $1.8 million to $6.3 million with earnings increasing over the same time frame from $238,000 to $845,000.
The problem, of course, is that since Slothower's column appeared in May 2003, the stock has more than doubled from $7 per share to now trade near $15. Good news for those investors who had already bought up the company's stock - confusing for those still looking for stealth stocks with further bullish potential. Because Slothower mentioned the stock could not only double, but possibly triple, there may yet be upside to be had; it's just here that investors should be careful. Which brings up the central point of this column.
For those investors smart and diligent enough to have invested in some of these stealth stocks, they proved the mantra that even in the worst of markets good companies could be found. Now that they've found them, however, we've reached an inflection point as to what to do with them.
While no one has ever lost money taking profits, there's a strong argument that at least some of these companies will continue to grow for the foreseeable future. If their current prices are not yet too rich, it might still be possible to hang on for future gains. Either way, watching these companies rise has certainly been far more fun than having watched much of the rest of the market collapse prior to this year.
From The Chart Room
Small Stock, Big Chart
Ben Berentson, 01.23.03, 500 PM ET
NEW YORK - In this tough market, it is difficult to find a stock chart where everything looks good. However, Dennis Slothower, the editor of the On the Money and Stealth Stocks newsletters, seems to have done just that. The stock in question is Asta Funding, a company which buys and sells unpaid credit card debt and consumer loans. Right now the stock trades for just under $13 at a price-to-earnings ratio of 5.5.
What's the technical attraction? First Slothower points to a "saucer reversal," where the stock makes a bottom in the shape of a bowl and then begins to rise again. Slothower thinks that this pattern has thrown the stock into an uptrend, as shown by an emerging pattern of higher highs and higher lows.
Slothower's other technical indicators confirm the uptrend. The stock trades above its 50- and 200-day moving averages, has rising relative strength and an RSI level of well above 50. This means that the stock is trading up more than 50% of the time. Asta's (nasdaq: ASFI - news - people ) MACD is also favorable, in a clear uptrend, still flashing a buy signal and is well over the zero line. When all of this is added up, Slothower is predicting Asta could move to at least $21 and might even double in value by the end of the year.
A Sampling of Advisory Opinion
P.O. Box 290708
Brooklyn, N.Y. 11229
E-mail: [email protected]
SEPT. 30 ~ The Federal Reserve will let politics, whether through diplomacy or war, deal with the issue of rising crude-oil prices and save its monetary-punching power to come to the rescue after the crude-oil war premium has been resolved. OPEC is a party to this economic war we are engaged in. Consequently, I see no price relief for crude oil until this war issue is resolved. However, once that happens and crude oil begins to fall, whether in October or sometime next year, I look for a dramatic turnaround in the economy and for stocks to rally in concert. Falling crude-oil prices are extremely bullish for the stock market. Until then we just need to remain patient and out of harm's way.
Q & A
When Dennis Slothower was a young trader at Shearson Lehman Hutton, he received a hands-on education that would serve him well. By trading financial futures and commodities, Slothower learned that volatility risk had to be managed or hedged. While still at Shearson, he developed his own risk management model to manage volatility risk in the trading of financial futures. In 1986, he applied his risk management model to equity and bond mutual funds. A good thing because in September 1987, the model flashed a major sell signal, and Slothower moved his clients completely out of the stock market. That protected them from the October 1987 market crash. In 1989, Slothower founded Strategis Financial, an investment advisory and money management firm in Provo, Utah, and began publishing two newsletters, Stealth Stocks and On the Money. On the Money has been a consistent top performer, according to The Hulbert Financial Digest, with annualized returns of nearly 13% since 1994. Besides Strategis, Slothower also formed a second money management firm called Alpine Capital. Both firms have over $100 million under management.
Forbes: How do you pick stocks and funds?
I use more of a top-down approach in my money management. What I have found is that what causes bull markets and what causes bear markets is primarily the policies of the Federal Reserve. When the Fed is zooming the money supply and expanding rapidly, we know there's going to be a lag time of a quarter to two quarters before it shows up in the economy. In January, the Federal Reserve became concerned about promoting the economy too rapidly. Consequently it began to tighten the money supply, and so here in the second quarter, the stock market is seeing some weak signs on the horizon.
But about six weeks ago, the Fed started changing its policies once again, and we have seen the money supply shoot up $100 billion in the last six weeks. So this suggests that in the third quarter, we're going to see a much stronger-than-expected economy. I think this will carry on to the fourth quarter as well. Once I determine from a fundamental point of view what I see developing there, then I go to the individual stocks of those sectors that I feel make the most sense.
So after you have picked a sector and you drill down to the companies, what do you look for?
I look at everything on a relative basis. I ask, how is this company performing in its sector? I also want to know how the company's stock performance compares to the overall market among the 7,000 to 8,000 stocks I track. For starters, I look at the price/sales ratio. Several studies have shown it's a better determinate on the future price of stocks than the price/earnings ratio. I also look at the PEG ratio (price-to-earnings ratio divided by annual earnings growth). I look at the growth rate of the company. I ask whether the company's growth rate is solid relative to the safety element of the company and its value.
I do use somewhat of a value approach to stock selection rather than just pure momentum play. I like to look at the intrinsic value. This is more of a hypothetical value based on the sum of a company's future earnings. It's hypothetical because it's somewhat subjective as to what it's going to be versus what is happening, but you can get a pretty good idea of the value compared to a stock's current price to determine whether the stock is under or overvalued.
But you incorporate technical analysis, too, right?
Right. You can have a great company, but if its stock is in a downtrend, and I buy it, I'm likely to lose money. So having a company that is displaying solid relative strength is where the technical side of the market comes in. I want to see one that is at least trending above a 20-day moving average. Relative strength of an individual stock against a sector or a market over, say, a nine to 14-week intermediate period, is very revealing as a whole. It's saying that the stock is stronger than its competitors.
What's your impression of the market right now?
First of all, let's talk about the trends. It just looks awful. Every one of the components that I look at to measure risk looks really bad. I look at new lows versus new highs. If there are more than 50 new lows on the NYSE two days in a row and climbing, that's bad. On the Nasdaq, if there are more than 75 new lows two days in a row, that's bad. Right now, we've got something like 130 new lows on the NYSE and 300 on the Nasdaq.
However, with that said, from a fundamental point of view, the Fed is zooming the money supply quite dramatically. All of the fundamental factors are saying we should see a marked improvement. However, the market doesn't want to hear that. It's scared to death because of all of the things happening around the world. However, I do think that that is very close to changing.
A recent AAII sentiment reading showed bearish sentiment is up to 40%. That's only happened six times in the last decade and every time that has produced a dramatic bottom and a major rally coming out of it. The bullish consensus dropped below 30%. Every time it gets into that mid-20 range, that's the bottom of the climatic cycle in the market. What we're seeing here is an important intermediate term bottom, which should be reached in the very near term.
When do you think the bounce will come?
We're pretty close to the bounce. I'm looking for a summer six-week rally, which won't necessarily be a really strong rally. Then there will be another downturn in September and then the market will bottom in October. Even then, there won't be much of a pullback because the Fed really is getting aggressive here. And I just don't see the big boys allowing this thing to crash before the election. If it happens, that would be a very bad sign. So I'm looking for a reversal, but technically, I don't see it yet.
that you like right now?
Any individual stocks you think could perform well?
One company I especially like is Penn Gaming (nasdaq: PENN - news - people ). The thing I like about this company is that it's rapidly growing. It's consolidated here just recently, but it is very well positioned to grow rapidly in the near future. It's my top pick among gaming stocks, which I personally feel that, as the economy gets better, the gaming stocks will benefit. It's a well-diversified company and has excellent fundamentals. I have the intrinsic value at $61 and a growth rate of 24%. It's only trading at $32, but the technicals are kind of weak, so you should wait until the market strengthens before buying. It owns several race tracks and operates casinos in states like Mississippi and Louisiana.
Another company I would look to buy on any kind of a pullback is Engineered Support Systems (nasdaq: EASI - news - people ), which trades around $45 per share. It's a company that is in the defense and aerospace sector, which is a strong sector. The military has changed its strategy to rapid deployment type of basis. Engineered Support provides the support systems for these groups: the radar and surveillance equipment, certain kinds of biological shelters and even latrines and so forth. The company has $1.5 billion backlogged in orders, and the military likes what the company is doing. My target price this year is $65.
Election Cycle Theory Redux
NEW YORK (CBS.MW) -- "Don't vote -- it only encourages them."
But right now the investment letters have a twist on that famous anarchist slogan. Their version: "Let them vote -- it encourages us!"
Reason: after a decade-long absence, the election cycle has suddenly resurfaced in investment Letterland. This is the idea that, as long-time proponent Yale Hirsch of Stock Market Almanac Investor Newsletter put it recently, "each administration usually does everything in its power to juice up the economy so that voters are in a positive mood at election time."
The economy is juiced up -- and the market responds. Until after the election. But that's another story.
OnTheMoney's Dennis Slothower recently summarized the average election year rally like this:
"Hirsch has shown in his classic work that the reliable gains occur from the lows of mid-term election years to the highs of pre-election years. Perhaps you have not seen this study but it is eye popping... A 50 percent average gain from the lows in mid-term election years to the highs in the following year and guess what folks, this is the DOW, not the NASDAQ or the RUSSELL 2000 small cap index which is very likely to outpace."
Here's the percentage change in the Dow Jones Industrials between the mid-term year low and the high in the following year:
"...the Fed has to act now if the voters are going to be in a positive mood come elections and that is exactly what they are doing now... So what's keeping us in cash for most of our portfolios? While the market looks very promising it has not confirmed a buy signal... we need to have the technical side of the market start flashing buy signals. I believe we are very close to seeing that happen again but we need to see the dollar prove to us that it has made a bottom by rallying impressively its approval of the Fed's actions."
Mark Hulbert's 20 years of experience tells him that we're going to see many more letters mentioning the election cycle. This is the sort of unquantifiable intuition his ruthless rating system doesn't pick up.
I regret to report that Mark is cynical about the reasons. He thinks that the letters weren't talking about the election cycle last year, when it would have been bearish, because they just don't like being bearish. In fact, he thinks they didn't mention it much in the last, rip-roaring, decade because they didn't like to skunk the party.
I think that's kind of hard. Expansion of the money supply simply wasn't the game in the disinflationary '90s. (Remember the disiniflationary '90s?)
Hirsch is a long-established service and his annual Stock Traders Almanac is particularly respected. However, Hirsch's Hulbert Financial Digest record is pretty awful. He is interested in small, volatile stocks and pays a price for it. Mark has been unable to glean a consistent pure market timing record from Hirsch's pontification at all. (This happens.)
But Dennis Slothower is emerging as a real force. He's beaten the market over the last six years that Mark has followed him and at various points has been among the top five performers. Click here for profiles of Hirsch and Slothower.
And why, to put it kindly, is one of the "Best" taking instruction from one of the "Rest?" Ah, that's part of the mystery of the market, as manifested in Letterland.
April 1, 2002- Analysts could well be low-balling their forecasts. This way if earnings disappoint, the analysts look better. If earnings do better than expected, the market will react favorably, and this could well be the case once we start to see real numbers. However, auditors are now running scared due to the problems with Enron. It is very likely that most financial statements may reflect a more conservative tone. It is uncertain to what degree this ay affect first-quarter earnings, but investors have been very cautious in the last three weeks as the earnings season approaches.
“When we make a major bottom, technology will lead the charge, not the Dow."
February 18, 2002- Technology remains very weak, and as long as investors are liquidating their OTC stocks, I have to rate the market as still locked in an intermediate down cycle. When we do make a major bottom, technology will lead the charge, not the Dow. At this point, any rally this week just looks like a small rebound in an ongoing intermediate down cycle that is not likely to bottom until later this month or early in March…The fact that the economy is improving is a great sign that the correction shouldnâ€™t be a real long-lasting affair. I look for an important intermediate bottom to be realized in a few weeks and for the next up leg to develop in early spring.