Here’s the situation. A big credit problem emerged many months ago, which caused a temporary market decline. After a new bull run, those credit problems intensified, causing the market to endure a sickening slide and many individual stocks to crater.
Then the Fed cut interest rates a couple of times, coming to the rescue of the bulls. The market rallied for a couple of months … though it wasn’t a broad advance. In fact, the majority of stocks were meandering, with hundreds still hitting new yearly lows. But a relatively few leading stocks - those with top-notch sales and earnings growth, expanding margins, and huge prospects - were soaring, as institutional investors piled in.
Here’s the funny thing: I’m not describing 2007. I’m talking about 1998, a year that’s paralleling this one so closely I believe it’s prudent to look back before looking ahead.
Just FYI, we at Cabot are students of the market - always studying and remembering history, because in the market, there really is nothing new. Sure, there are new sectors, new stocks, new forces at work … but in the end, it’s the same greed-fear battle that takes place each day. Remembering history and applying it (dubbed precedent analysis) has helped us many times in the past.
And it looks like it’s going to be a help this time around, too. Back in late-1997, the market was shocked by the Thailand currency debacle, which caused world markets to plunge on October 27. That was similar to this February’s sharp-but-short decline, caused by Shanghai’s issues, as well as some festering sub-prime fears. (Most sub-prime mortgage stocks topped out even before February.)
Then we enjoyed a nice bull run for a few months (during the spring of 1998, and the spring of 2007). And then the credit crunch arrived; in 1998, even the giant hedge fund Long Term Capital Management was crushed, causing a market panic. Interestingly, at its worst point, a huge 1,190 stocks hit new lows on the NYSE in 1998. This year? While the indexes didn’t slide as much, the August 16 low saw … 1,132 stocks reaching new lows. Pretty close!
Then the Fed started to cut rates (both instances featured, first, a surprise rate cut, and then another a few weeks later) and the market rallied. But the broad market didn’t participate in a big way back in 1998 - it was the Internet and telecom stocks that took off; if you weren’t invested there, you didn’t make money
We see a similar thing happening today - one look at Washington Mutual, Citigroup, Merrill Lynch, Countrywide Financial and now AIG will tell you financial stocks are in the toilet. (Most are hitting new lows!) But most growth stocks, particularly China, telecom, smartphone and gaming industries, look great.
The dichotomy that started in 1998 lasted about eighteen months. What about this time? I’m not in the business of predicting … but I can envision something similar taking place for the rest of this year and into 2008.
Let me be clear - I’m not predicting another huge melt-up bubble like we had in 1999 and 2000, so please don’t throw a bunch of money at some extended market leaders. But I can easily see today’s top stocks continuing to move higher, despite a poor showing from the broad market.
Historically, a narrow advance is unusual. And, actually, it almost always ends badly, either in a bear market or a severe correction. Most often, such narrowness doesn’t last long - maybe a few weeks - before the bears take control. But every so often, it can last for months, and you shouldn’t be surprised if that’s happening now.
So how do you take advantage of it? Let me share a couple of stock ideas; the first is a turnaround that’s going to benefit from the Fed rate cuts, and the second is a stock that was actually a leader back in 1998 … and is so again today.
The first stock (drum roll, please) is Toll Brothers (TOL), the leading builder of high-end homes. You really couldn’t pick a worse area to be in the past couple of years; the housing market, of course, topped out months ago, and the sub-prime mess has only worsened the bust, and more important for investors, worsened perceptions of the housing group.
Interestingly, that’s one of the reasons for my recommendation. After a 68% decline from July ‘05 to August ‘07, TOL has now found support around 20 for the past three months. More important, the volume patterns have been excellent; there have been 15 days of big-volume buying the past few months, with tame volume on the sell side. And the stock has bested its 50-day moving average for the first time in a few months, another positive.
Yes, yes, I know of all the reasons housing could (should) worsen in the months to come. But the thing is, so does everyone else. So what value do I place on that knowledge? Little! What is well known on Wall Street (and on Main Street) is of little use. I happen to believe the Fed rate cuts, combined with the current purge in the housing market, could easily lead to improving building activity looking out six or nine months. Apparently, some investors are coming to a similar conclusion, placing a few bets on TOL.
Of course, I could be wrong, and if this stock plunges below 19 1/2, I’ll change my opinion. But given the severity of the decline over the past two years, and the recent signs of accumulation, I think TOL could move up strongly in the coming months should the housing market simply stabilize.
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As for my second recommendation, it’s Nokia (NOK), the dominant cell phone manufacturer in the world with a 39% market share (although in the U.S. it trails a few competitors). Back in 1998 and 1999 it was a big winner, leading the “wireless revolution.” Today, wireless is so mainstream it’s no revolution, but this big firm is up to some new tricks.
First of all, the company is moving into the low-end of the cell phone market, especially internationally. That’s no big news … but what is exciting is that Nokia is making big money doing it! In the third quarter, in fact, the firm’s after-tax profit margins expanded to 12.1%, up from 9.2% a year ago - a 31% improvement! It seems that the firm’s scale and manufacturing expertise is allowing it to dominate in areas where many others fear to tread.
Second, Nokia isn’t resting on its laurels. Here’s what I wrote about its new endeavors in Cabot Top Ten back on September 10:
“Despite its big name, Nokia is making its first-ever Top Ten appearance, as both business and investor perceptions are on sharp uptrends. The stock came back to life after the company reported great first quarter earnings in mid-January, and it’s followed that up with two great reports since then; the second quarter results, released in early August, were superb, revealing the fastest quarterly sales and earnings growth rates in years thanks to new handset models and a growing (now 38%) market share. But even bigger news was announced a couple of weeks ago - management is looking to become more like Apple, offering not just hardware but also web services like maps, music, games, and eventually allowing users to swap pictures, video and audio. Called Ovi (Finnish for “door”), the new web service could result in faster growth (more than 200 million Nokia phones are already in the marketplace, ready to use the service) and higher margins. The market likes the news, and so do we - this could be another big, dominant firm that’s re-inventing itself into a growth company.”
I like that the company’s sales (up 14%, 36% and 44%) and earnings (17%, 48%, 97%) growth are both accelerating, that the aforementioned profit margins are expanding, and that the stock is big and liquid; it’s just the kind of stock that institutions have confidence piling into, and supporting on pullbacks.
The stock is currently in the fourth week of a rest period, but after a blowout quarterly report (earnings topped estimates by 27%!), I believe the path of least resistance is up.
Until next time, all the best.
For Cabot Wealth Advisory
Editors Note: Mike Cintolo is Vice President of Investments for Cabot Heritage Corp., as well as Editor of Cabot Top Ten. Mike’s OptiMo proprietary stock screening system, used in Top Ten, uncovers the market’s strongest stocks - the stocks the institutions are accumulating day in and day out. But he doesn’t just give you a list of ten strong stocks; you’ll also find out the ruling reason behind the stock’s strength, what price you should buy each stock, and sage market commentary, letting you know which trends are emerging (or submerging). As Mike would say, “If you fish in the pool of Top Ten stocks, you’re guaranteed to be invested in the leaders of any market advance.” It’s all delivered to your e-mail inbox every Monday evening. Interested? Click the link below to receive our special charter rate.