I'm a sucker for symmetry, in art and life. So as night follows day and surrealism follows realism, I am compelled by the notion of diving into the market with new SuperModels portfolios in March now that the
Nasdaq Composite has for the second time in two months achieved the dubious distinction of plunging an even 50% from its March 2000 high.
I'm not trying to call a bottom by relaunching the SuperModels portfolios after a hiatus of two months. That would be foolish. But I don't think there is a ton of downside from here, and even if there is, the models could outperform modestly even in a weakened market.
Last year, after all, our 20-stock SuperModels year-trader portfolio solidly beat the market until December, when it went permanently south with the collapse of the tech wreck's last holdouts. Reeling heavyweights like
( GTW) dealt the crushing blow to our capital.
That hurt, but you're not supposed to abandon well-tested quantitative investment strategies after they're knocked out in just one year. After two or three years of underperformance, maybe, but not one.
Essentially, the sort of big-cap growth stocks chosen by the SuperModels strategies came to be hated with a vengeance last year after they had become outrageously puffed up in value in the prior three years. A lot of the swelling has now gone down, but those tech growth stocks are looking more bruised today than lean and mean. So our models are now picking stocks that they scoffed at a year ago. Going from one extreme to the other, there's not a tech stock in the bunch, for better or worse.
So how are the names chosen?
In the second edition of my book,
Online Investing: How to Find the Right Stocks at the Right Time,
released at the start of February, I updated the screens used in all of my models and suggested some modest timing methodologies as well.
The reason you haven't yet seen a new SuperModels portfolio based on these new screens is that the timing models haven't yet given a green light long enough for me to write a column about them. As mentioned in previous columns, the signals are based on a system developed by reader
-- a trader in the San Francisco Bay area who declines to be further identified -- and are very simple. If the Nasdaq Composite's 15-day moving average moves above its 50-day moving average, buy the SuperModels stocks in an evenly weighted portfolio. If the 15-day moving average moves below the 50-day moving average, sell the portfolio out. This rule tests very well historically on my benchmark Flare-Out Growth model, yielding huge gains over the past 11 years.
You could have actually begun such portfolios in mid- or late January, when the crossover occurred for the first time since August, but the move didn't last long enough for me to write a column. You would have already sold under the VicLee methodology two weeks ago and would now be sitting on a pile of cash.
While this timing concept is reasonable and responsible, it has also caused some readers to call me a coward and a traitor to the quantitative cause. That's because in the view of many, true model traders aren't supposed to time the market -- they're just supposed to click off a slate of transactions at the turn of the calendar, and check back in a month, or three months or a year, depending on what their tested strategy calls for.
So it's to these hecklers that I am dedicating this new portfolio. If it works out, I'll take credit for bravely stepping into the decline with a round of buys. If it doesn't, I'll just remind you that my timing methods were flashing caution and I launched them kicking and screaming.
Even with all those caveats, I'm still not ready to start yet. I'll wait at least until the close of Feb. 28, and it could take longer. Until then, here are the stocks that would make the cut today:
Flare-Out Growth: Chesapeake Energy , HealthSouth and Dynegy ;
Redwoods: Alza ( AZA), Calpine , Elan and Alcoa ;
MVP Growth: Philip Morris , Tenet Healthcare , Cardinal Health , Anadarko Petroleum , Loews ( LTR) and USA Education ;
MVP Value: Bed Bath & Beyond , TJX Cos and Canadian Pacific .
It's a pretty diverse group with no obvious patterns. It's fairly defensive (tobacco, utilities and health care) for now, but that could change. The final list of names could vary significantly.
Strength in Small-, Mid-Caps
Historic days like Friday offer a lot of information about market strength, if you know where to look. After the close, I checked out the well-hidden
Advances/Declines page at
and discovered that while
New York Stock Exchange down volume outpaced up volume, 67% to 31%, new highs on the exchange beat new lows by a huge margin, 113 to 28. Likewise, at the Nasdaq, up volume beat down volume, 85% to 8% (the rest is neutral), but the new-highs-to-new-lows ratio was virtually even, 62 new highs vs. 67 new lows.
My guess is that this suggests a lot of underlying strength among the small-cap and mid-cap stocks -- that is, the ones that don't trade as many shares. To check that hypothesis, I used the
Stock Screener at MoneyCentral to find the stocks that had made 52-week highs on Friday and set the
market cap criteria to "display only." I then exported that screen to Excel, where calculations revealed that the median market capitalization of the stocks hitting new highs was $875 million. Dominant industries were insurance, retail stores, regional banks, real estate investment trusts, retail and some oil drillers.
Nortel Can Fall Again
Speaking of Friday, the
fiasco that sparked the decline offered one more reminder -- as if we needed another one -- that stocks that get cut in half can get cut in half again ... and again. Nortel first shrank from $86 to $43 in the fall, and it has now plunged to around $20. Can it happen one more time?
Why not? It seems that very few big tech stocks stumble just once with their earnings. Overly high expectations tend to linger in their forecasting systems -- and in the belief sets of the analysts who follow them. So if there's one disappointing quarter, it's generally followed by more. Recent examples are part of the tech-wreck liturgy by now. They include
( CPQ) and
It's all too easy to let your portfolio get washed down the drain in these declines. Without paying any attention to the business fundamentals, it's worthwhile thinking about how that happens psychologically so you can potentially combat it with more rational steps. My guess is that a feeling of goodwill about the stock precedes the first stumble and, as the "availability heuristic" kicks in (a concept covered in a
previous column), our brains are not wired to comprehend that conditions at the company have really changed.
Even after the second stumble, it is hard for investors to believe their old favorite has hit the skids; stubborn complacency rules. And after you've suffered two indignities, a third and fourth seem routine already -- and you're resigned to thinking of your old growth or momentum stock as a fantastic value play. It's just about here that formerly great stocks seem to sink below $20 a share, a magic barrier. Once that level is breached, indifference takes these stocks down to the $12 area or worse, where Lucent is today, and where Xerox was before it fell to, well, $6.
Compaq -- once overloved and now underappreciated -- has been stuck in the range of $14 to $34 since April 1999 and shows no strong signs of breaking out soon.
Recoveries do occur, of course -- just often enough to give false hopes. One recent example was
, which was one of the really great momentum stocks of the mid-1990s (it went from a split-adjusted $2 in May 1994 to $57 in April 1998 as it totally dominated its human resources-software niche).
In July 1998, however, it announced a huge, unexpected shortfall in earnings, and the death spiral began as one poor quarter after another was announced. Volume declined, and even insiders were selling heavily all the way down. The stock bounced around in the low teens for 18 months until suddenly waking up, as if from a nightmare, in July 2000. And even in the bad market of last year, it went almost straight upward, from $14 to $54 at its January 2001 peak.
My guess is that the course ahead for Nortel looks something like Compaq or PeopleSoft. More stumbles as capital expenditures on telecom continue to decline and more disappointments. Eventually, though, telecom spending will resume with great vigor -- let's say, in 2002 -- and Nortel will rise again, just when many have given up hope.
Other big stocks that are in holding patterns within 30% of their five-year lows include
( EK) and
-- all favorites in their day, not unlike Nortel or Compaq.
If you're in Orlando, Fla., this week, stop by and see my presentation on finding great stocks with screening engines and other tools at 8 a.m. Friday.
At the time of publication, Jon Markman did not own or control shares in any of the equities mentioned in this column. He previously owned Nortel but sold after the second disappointment.
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