Inspiration Is Hard to Find in 2005

In Heaven, everything is fine. You've got your good things. And I've got mine. -- Eraserhead

In the tough market of 2005, bulls have been scraping for every sign of good news to proclaim a bottom. A third straight up day for the S&P 500 and Nasdaq Composite generated some excitement Thursday, as did news after the bell from Microsoft ( MSFT), Procter & Gamble ( PG), Novellus Systems ( NVLS) and SanDisk ( SNDK).

But amid some good signs on Thursday, including a late-afternoon rally instead of the usual '05 fade pattern, plenty of signals are still flashing caution. Not the least of which was the diminished gains and reduced volume on Thursday, indicating a diminished vs. raised appetite for stocks after the initial two-day rally. Volume also declined on the Big Board although breadth there was slightly positive.

The Nasdaq Composite rose just 1 point Thursday to 2047.15 on lower volume vs. the prior day and negative breadth. The S&P 500 added less than half of a point to 1174.55. The Dow Jones Industrial Average fell 31 points to 10,467.40 but would have eked out a third positive day if not for Caterpillar's ( CAT) earnings disappointment.

Some pundits had pointed to the spike up in the CBOE's Volatility Index on Monday to levels not seen since early November as reason that a bottom might be forming. When the level of fear expressed in options prices rises, selling reaches a climax and the market is poised to bounce -- or so the theory goes. Well, bounce it did, but the VIX then declined for three straight days, suggesting renewed complacency.

Part of the problem is that after the fourth-quarter rally, good earnings results aren't enough to generate further share gains. Instead, investors are looking further out and need to see upside surprises in forward guidance as well. As noted here, BCA Research found that analysts' estimates are being revised downward more frequently this month, a bearish signal for the next few months.

Examples were all over the tape on Thursday. Industries that were strong on Tuesday and Wednesday, including biotech, homebuilding and machinery making, were sliders on Thursday on disappointing guidance from the likes of Amgen ( AMGN), Beazer ( BZH) and Caterpillar. Amgen lost 3%, Beazer fell 3% and CAT shed 5%.

The reverse -- good 2005 guidance helping shares -- was also evident but less frequently. Amid a blizzard of semiconductor earnings reports this week, the Philadelphia exchange's semiconductor index climbed for three days in a row for the first time this year. The SOX was up 1% on Thursday as LSI Logic ( LSI) gained 10% on its improved guidance.

Whether Microsoft's increase in fiscal '05 guidance will be enough to do the trick for the software patch (much less the broader market) remains to be seen. The Redmond behemoth raised its outlook for the second quarter in a row, saying it would earn as much as $1.11 a share and generate $40 billion in revenue. That's up from $1.09 a share and $39.2 billion three months ago. Neither a blowout nor a blowup, it would appear.

Microsoft gained 10 cents before the report to $26.11 and tacked on another 41 cents, or almost 2%, after hours.

Novellus' postclose report will be another test for the "guidance is key" theory. The semiconductor-equipment maker beat earnings estimates by a few cents and, while saying future bookings looked "choppy," raised first-quarter EPS and revenue guidance above analysts' estimates. Similarly, Procter & Gamble raised its full-year guidance, explaining that price increases are sticking without cutting into sales growth.

Telecom Tumult

There was turmoil in the telecom patch Thursday as AT&T ( T) became the subject of a rumored $16 billion takeover by local carrier SBC Communications ( SBC). AT&T jumped 6% and MCI ( MCIP), another possible takeover candidate, rose 3%. SBC, which has a market cap more than three times as big as AT&T and MCI combined, lost 4%.

The draw for SBC and its sister "Baby Bells" is not the shrinking consumer long-distance business of either AT&T or MCI, but the more lucrative, fast-growing corporate telecom services franchises along with nationwide infrastructure to serve that market. SBC, Verizon ( VZ) and BellSouth ( BLS) have made strong inroads into consumer long distance, each in the footprint of their prior local service offerings. But they've had less success cracking the corporate market, which has national, or even global, reach.

Blair Levin, formerly chief of staff to Federal Communications Commission Chairman Reed Hundt, says an AT&T-SBC combination is doable but probably not desirable. Levin, now an analyst at Legg Mason, predicts regulatory hurdles could be surmounted, but it could take 15 to 20 months for the deal to be approved, possibly with costly and complicated divestitures. Verizon's GTE acquisition was beset by such problems even though it was ultimately approved.

"We think AT&T would be an interested seller at the rumored price but remain unconvinced the transaction, while doable from a regulatory perspective, would create significant value for SBC shareholders," Levin wrote on Thursday.

Don't forget that former FCC chairman Hundt's quip that a merger of SBC and AT&T was "unthinkable" was made back when a combo would have been de facto illegal. The 1996 Telecommunications Act barred SBC from offering any long-distance service in its region until the company met certain competition guidelines. It hadn't met them back then but has passed that hurdle now.

Plus, with SBC's own successful long-distance service now in place, the carrier might not have any reason to change AT&T's plan announced last summer to dump its consumer long-distance business in a sale or spinoff. That could help finance any deal.

Talk of the deal pushed aside any interest in Verizon's earnings, which came in roughly as expected after various charges were backed out. CEO Ivan Seidenberg turned aside most questions about the rumored deal, saying only that company executives have "an interest in keeping our eyes on everything that's going on."

Verizon, worth almost five times MCI plus AT&T, lost 2% on Thursday.

In keeping with TSC's editorial policy, Pressman doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback.

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