Bottom-Fishing? The Current Pickings Don't Look Like Keepers

Last week, I wrote about the dangers facing investors as we head into the fourth quarter's pre-announcement season. Monday, we got a bitter taste of what the coming bad news can mean. We saw several sell-side analysts marking down some of the hottest tech stocks and sectors in order to get out ahead of the coming wave of preannouncements. The market swooned. But the market action wasn't particularly awful; it didn't even make the Nasdaq's top-10 worst day list on either a percentage or point basis.

On down days like Monday, you always hear the sell-side strategists on CNBC and elsewhere suggesting that now is the time to buy beaten up tech. Is it really? In attempting to give a preliminary answer to that question, my piece last week said, "Be ready to pounce when there is panic in the air, and before reasoned calm returns to the market. You still have time. Use it wisely to find leading companies in sectors you like for the next three to five years."

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This suggestion still makes sense to me today, even after the 151-point decline that took the comp down to 2875.64. Let me explain why now may not be the time to bottom-fish if you plan on holding your stocks for more than a few days.

First off, the tech downgrades we saw Monday are by no means the last. (See this column by Jim Cramer on why this will be the case.) The bullish analysts are still defending stocks under attack from the bears. At some point, the defenders will raise the white flags. That has yet to occur. Even the day's mea culpa from Lehman strategist Jeffrey Applegate was positively soothing if you forgot for a moment how wrong he has been this year by being a relentless bull on tech.

Second, the tech profit slowdown already under way could cause the entire economy to slow, which in turn would cause profits to slow even more. Goldman Sachs' economist Ed McKelvey noted the possible economic slowing that could be caused by a profit slump. In a report issued late last week, McKelvey wrote: "Weaker profit growth has several implications for the economic outlook. First, it represents a reduction in the rate of return on capital and therefore makes capital spending more vulnerable. Second, it could aggravate the anticipated weakness in the dollar to the extent that foreign investors conclude that U.S. assets no longer have a return advantage relative to other assets. Third, it could weigh on the stock market, leading to further slowing in corporate profits. In short, a lot is riding on profits."

Third, I don't smell panic in the air. Complacency is more like it. Helene Meisler provided a concise summary of just how smug investors still are. I can feel the complacency in tech investors simply by watching the tape. Stocks open. They go down. But they trade. There is liquidity. In a panic, trading dries up, and prices gap down. There's not a lot of fear out there in tech land. There should be before you go bottom-fishing.

Fourth, tech stocks are carrying a lot of downward price momentum that is unlikely to reverse right away. Technology stocks have been the worst performing sector in the past ten weeks, according to Merrill Lynch strategist Christine Callies in a report issued Monday. The tech slide is picking up momentum.

Fifth, the Fed is unlikely to bail you out. Remember months ago when bullish tech investors scoffed at the significance of a slowing economy on their stock prices? They argued that tech companies' earnings were not dependent on GDP growth. Now that even the fast-growers are suffering earnings- and revenue-growth hits, the tech bulls are singing a slightly different tune. They seem today to be pinning their hopes on the Fed cutting rates to get the economy racing again.

Don't bet on it.

There are two problems with waiting for the Fed to bail you out, according to a recent report by independent market analyst James Bianco. First, Bianco says, technology stocks are not the ones that do best when the market expects the Fed to ease. The groups that do better when the Fed is expected to cut rates are apparel, drugs, food, specialty retail and footwear, notes Bianco. "If the Fed is easing, they are trying to 'prime the pump' and get the economy going," he writes. "When this happens, the retailers should be among the first to benefit from an easier monetary policy."

There is another, larger problem with waiting for the Fed, according to Bianco. Until the Fed starts to ease aggressively, the overall stock market tends not to react at all. Using the S&P 500 as his proxy, Bianco saw that stock prices historically do not get much of a pop until after an easing. Obviously, we have yet to see one.

Finally, we may well see more tax-loss selling before year-end. And banks, worried about their own profits and balance sheets, continue to clamp down on credit no matter what the Fed does or doesn't do. We may see more days ahead when the market closes down 3%, and the bulls interpret that as good news because the market was down 6% intra-day. We may see a breathtaking drop that makes the Nasdaq top ten list and makes the front page of the newspaper.

At that point, you might find even more, attractive bottom-fishing opportunities than today.

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