Reactions to this week's earnings results were volatile, as I discussed Thursday. Smart investors will evaluate these reactions so they can make better investment and trading decisions overall. I'll show you how this works for big-name tech stocks
It's a tough discipline, but to improve your success, learn how to buy on pullbacks and sell into strength. This way, you can use market volatility to benefit from shorter-term trading opportunities, while maintaining core holdings in technology companies you have chosen for the longer term.
Why and How
I developed my stock valuation models with an eye to do exactly that. When a stock declines, it becomes less overvalued or more undervalued, which makes its fundamental screens even more important. When a stock rallies, its weekly chart profile outweighs the fundamentals. Paying close attention to the weekly chart profile can help you decide to stay long until you see a signal to book profits. A weekly close below the stock's five-week modified moving average would be one such signal. Entry and exit levels, which I call value levels (buy) and risky levels (sell), can be used to trade around core portfolio holdings.
Learning to trade around a core holding should help you outperform by capturing bigger gains as stocks trade back and forth between value and risky levels while they make longer-term moves higher. Investors need to shift away from the "buy and hold" strategy that worked for 20 years, because it hasn't worked as well over the past six years. By having an exit strategy and the discipline to trade with shorter-term horizons, you can minimize the pits of the 2000-02 market demise. The strategy in the new millennium is "buy and trade." The key discipline for executing this strategy successfully is reducing the emotions that can adversely affect investment and trading decisions. Again, I developed my models to help do exactly that, a process I describe at the end of this column.
Applying the System
For example, according to my model, Apple was 77.0% overvalued when it traded at $44.50 at the beginning of March. That was a clear warning that shares were vulnerable in the event of a negative reaction to earnings. In April and May, with shares testing my annual value level at $34.22, my model showed Apple had become 12.5% undervalued. Investors looking to buy Apple could have done so on that pullback to $34.22.
At its Thursday close of $43.29, Apple was 4.4% overvalued, with fair value at $41.45. Because Apple has been rallying, the weekly chart profile is the one to consider, and it currently is positive, which means it is not giving us a clear signal to book profits. Investors who are looking to make short-term trading adjustments should know that my monthly value level -- at which to buy -- is $42.79 and my monthly risky level -- to sell -- is $43.90.
Why is Apple only 4.4% overvalued now vs. 77.0% overvalued in March, even though its Thursday closing price isn't much lower than the early March price? Because Apple earnings have been better than expected, which has increased trailing 12-month EPS. This in turn caused analysts to raise forward 12-month EPS estimates. Both of these factors have raised Apple's fair value, making shares significantly less overvalued.
Take a look at eBay, which became 40% undervalued at its $32.75 low on July 5. At Thursday's close of $42.10, eBay was 23.7% undervalued, with a positive weekly chart profile. Longs in the name will probably want to stay long until it reaches my quarterly risky level at $51.15. My monthly value level -- again, that's for buys -- for eBay is $39.96 for those looking to trade around a core position, and my semiannual risky level is at $44.56.
How do you value Google? That's been a big question since it reported earnings after the close Thursday. Google shares have traded all over the map this session. Google reported EPS of $1.36, higher than the raised consensus of $1.21. The company gives no guidance, but I heard one analyst say the firm's fourth quarter will be a monster, whatever that means. Another analyst raised annual EPS to $5.73, and estimated $9.00 for 2006. These figures make Google's fair value $376.62, which justifies those $350/$360 price targets seen in the media -- if these projections prove to be correct. With the weekly chart profile overbought, and with the stock too new to calculate value and risky levels, I cannot suggest levels at which to buy and sell at this time.
My final example is Yahoo!, which declined from $37.73 to $32.75 following Tuesday's earnings disappointment. When I
screened Yahoo! in the Tech Trading Diary on Tuesday, I showed the stock 26% undervalued. Trading at $37.73 at that point, it was trading between my semiannual risky level of $37.28 and my monthly risky level of $38.19. That suggested Yahoo! had to beat consensus earnings estimates significantly and offer raised guidance in order to sustain gains. At Thursday's closing price of $32.94, Yahoo! is 34.9% undervalued, with a negative weekly chart profile. Given how undervalued shares are, I would not use the negative technical signal as a reason to sell. From a fundamental perspective, I would consider buying Yahoo! at 40% undervalued, should it trade there. For short-term trading adjustments, my weekly value level for Yahoo! is $30.40, and my semiannual risky level is at $37.28.
Again, the goal here is to learn how to use market volatility to benefit from shorter-term trading opportunities, while maintaining those core holdings in technology companies for the longer term. Please
your questions on this topic over the weekend, and I will include my response in next Tuesday's Tech Trading Diary.
In 1984, I developed proprietary forecasting models that help me evaluate the risk/reward for markets over a rolling six-month horizon. My models are based on a matrix of the past nine closes in various time horizons: daily, weekly, monthly, quarterly, semiannual and annual. In my judgment, the evaluation of nine years of closes builds in the summation of all bullish and bearish events, which is necessary to project future volatility including supports, pivots and resistances. Bearish fundamentals may cause weakness to support. Bullish fundamentals may cause strength to resistance. Pivots tend to act as magnets, having an 85% chance of being tested during their time horizon.
The underlying theory of my models is that nine years of monthly, quarterly, semiannual and annual closes are enough to assume that volatility among all of these closes is the summation of all possible bullish or bearish events.
My long-term view is thus a rolling six-month horizon, in which each monthly close may lower or raise the risk/reward for the market. The standard tools of technical analysis that I use were established in the fourth quarter of 1987. My goal was to establish a weekly measure of positive, neutral or negative technicals with a method that resulted in the fewest false signals.
Following weeks of "brute force" back-testing data for bond futures, I decided to use a weekly 12x3 slow stochastic reading for momentum, and the five-week modified moving average as the trigger, given a weekly close above or below that level.
The 12x3 weekly slow stochastic reading is between 00.0 and 100.0, in which a rising trend above 20.0 is positive and a declining reading below 80.0 is negative. Under 20.0 is oversold. Above 80.0 is overbought.
The five-week modified moving average starts with a five-week simple moving average. The five-week MMA is then calculated as ((Prior five-week MMA * 4) + (Latest Close))/5.
The 200-week simple moving average is considered a support or resistance and an indication of the longer-term trend.
A market with a positive weekly chart profile has a rising or overbought 12x3 weekly slow stochastic reading with a weekly close above its five-week modified moving average.
A market with a negative weekly chart profile has a declining or oversold 12x3 weekly slow stochastic reading with a weekly close below its five-week modified moving average.
Richard Suttmeier is president of Global Market Consultants, Ltd., chief market strategist for Joseph Stevens & Co., a full service brokerage firm located in Lower Manhattan, and the author of
newsletter. At the time of publication, he had no positions in any of the securities mentioned in this column, but holdings can change at any time. Early in his career, Suttmeier became the first U.S. Treasury Bond Trader at Bache. He later began the government bond division at L. F. Rothschild. Suttmeier went on to form Global Market Consultants as an independent third-party research provider, producing reports covering the technicals of the U.S. capital markets. He also has been U.S. Treasury Strategist for Smith Barney and chief financial strategist for William R. Hough. Suttmeier holds a bachelor's degree from the Georgia Institute of Technology and a master's degree from Polytechnic University. Under no circumstances does the information in this commentary represent a recommendation to buy or sell stocks. While he cannot provide investment advice or recommendations, he invites you to send your feedback --
to send him an email.