The Lottery-Ticket StageThe stock market has entered one of those "lottery ticket" periods that come at the closing stages of all big rallies. Calculations of risk and reward that might have restrained stock prices become irrelevant in such a market. And stock prices are driven higher by investors who buy because they fear they'll miss out on the big prize. This kind of investor psychology makes the stock market extremely vulnerable to huge blowoff moves on the upside during lottery periods. And the sudden end to this psychology can leave investors just as vulnerable to big losses on the downside, when the market decides to correct or consolidate.
Three Weeks and CountingImagine that you're the lead manager of the growth stock position of a university endowment, or of a company pension fund, or of a state pension. You're looking at the distinctly unpleasant task of having to explain to your clients why, after losing money for quarter after quarter during the bear market, the portfolio that you run has also trailed the indexes during this sustained rally. Your job could be at stake if the client is unhappy enough to fire your firm as one of its money managers. You've got about three weeks -- until the books close for the quarter on June 30 -- to fix the problem, or at least to make it as manageable as possible. What do you do? You sure don't buy Alcoa ( AA), even though the aluminum company's shares should benefit from any second-half economic recovery. You sure don't buy Microsoft ( MSFT) because the stock is among the cheapest of the technology stocks after sitting out just about the entire rally.
A Place to Pin Your HopesInstead, you buy a lottery ticket. You look at which stocks have been going up the most in recent days, and you pile into them in the hope they'll just keep going up for a few more weeks. So a Genentech ( DNA), which climbed 50% from May 15 to May 30, goes up another 15% last week. An ImClone Systems ( IMCLE), up 16% in the same two weeks, explodes for another 64% in the last week. Or a Talk America Holdings ( TALK) moves up 12% in two weeks and then soars another 36% last week. Or a SCO Group ( SCOX) runs up 32% and then gallops for another 51% in the last week. Notice what these stocks have in common? It's not that they're in the same industry. They are all members of extraordinarily volatile sectors and have histories of making big moves once the momentum buyers catch hold of the stock. SCO Group, for example, has a beta above 5, meaning that its price is about 5 times as volatile as the market as a whole. And you could certainly see the momentum buyers at work in these names last week. Volumes popped in all of these stocks. Talk America, which normally trades an average of 290,000 shares a day, traded 1.2 million on June 6. ImClone hit volume of 19 million shares, way above its average of 2.8 million. Money managers who buy a lottery ticket aren't looking for stocks with modest valuations that are likely to creep up in the months ahead. Genentech already trades with a market capitalization of $37 billion and a multiple of 65 times projected 2003 earnings per share. Talk America is projected to show earnings declines from last year's levels of 24% and 44% in the next two quarters, 34% for all of 2003.