Theorizing a Bullish Trend

Richard Moroney of Dow Theory Forecasts thinks the outlook for stocks is brightening and names some small- and mid-cap favorites

Richard Moroney sees reasons for optimism about the stock market. The editor of the Dow Theory Forecasts newsletter and portfolio manager for Horizon Investment Services says the plus signs include a broadening of the market and the return of money to technology stocks. He's also encouraged that investors seem to be looking beyond the current softness in corporate earnings.

Under the Dow theory, if the industrial average breaks out as the transportation average has and exceeds 11,310, the bulls would be back in charge. At the moment, Moroney says he's looking for "reasonably valued growth stocks," many of them in the small- and mid-cap sectors.

Some of the names he likes include CTS, Dymo Industries, Vishay, and Tellabs in technology; Elan and Medicis Pharmaceutical in specialty drugs; and Questar as a play on natural gas.

Moroney's comments came in a chat presented Jan. 18 by Business Week Online on America Online. He was replying to questions from the audience and from BW Online's Jack Dierdorff and Amey Stone. Following are edited excerpts of the chat. A complete transcript of this chat is available from BW Online on AOL, keyword: BW Talk.

Q: In the last days, the market has looked a bit healthier. Have we turned a corner?


I'm getting more optimistic about the market. Part of the reason for that is the fact that market breadth has improved even as money has flowed back into technology stocks. From a Dow theory perspective, what we would like to see would be for the industrials to confirm the recent breakout in the Dow transports by moving above 11,310.

Q: Pardon my ignorance, but what's Dow theory?


The Dow theory was developed around 1900 by Charles Dow and William Hamilton, the first two editors of The Wall Street Journal. In a nutshell, the Dow theory looks at the action of the Dow industrials and Dow transports to see whether the stock market is in gear. If both averages are reaching significant highs, the Dow is presumed to be in the bullish camp. If both averages are reaching significant lows, the primary trend is considered bearish.

The last major signal under the Dow theory was a bearish signal in October, 1999. The question now is whether the March lows in the industrials and transports represent a bear-market bottom. For a return to the bullish camp, the Dow industrials need to close above 11,310.64. That would confirm the recent breakout we have seen in the Dow transports.

Q: Rich, why is the market improving when so many companies are turning in downbeat results? The market seems to be shrugging off the bad news. It's nice for now, but will it come back to haunt us?


Time will tell whether it will come back to haunt us. However, in my view, it's the market's reaction to news that's most important. The fact that Wall Street seems to be looking past the current slowdown in earnings growth is a big positive, in my view. Still, I think you want your portfolio position in companies with solid sales and earnings momentum.

Q: Do you expect the S&P, Dow, and Nasdaq to return over 20% this year?


I think the market is in a trading range. I am optimistic that that range can be penetrated to the upside, but I always like to let the averages tell the story. In my opinion, the proper course for current conditions is to maintain 15% to 20% cash positions as a hedge while emphasizing reasonably valued growth stocks.... For selective investors, I think 20% growth is a reasonable target.

Q: Can you give us any specific names in your category of "reasonably valued growth stocks"?

A: Sure. In the technology sector, we like CTS, Dycom Industries (DY ), Tellabs (TLAB ), and Vishay Intertechnology (VSH ). Outside technology, we are finding attractive picks in the specialty-drug area. Top names in that group include Elan (ELN ), Medicis Pharmaceutical (MRX ), and Syncor International (SCOR ). One attractive play on the natural-gas price is Questar (STR ), a company I feel will post very strong results in the first half of 2001.

Q: What's your outlook for the contract manufacturer Flextronics (FLEX )?


Flextronics is a quality holding. I think this industry group in general was unduly punished in late 2000. I think Flextronics has above-average prospects. However, my favorite in the group is Solectron (SLR ), a company that has done an outstanding job of growing through acquisitions while earning high returns on capital.

Q: I own a lot of GE stock and am in it for at least another 15 years. What's the long-term forecast on GE?

A: I think the long-term forecast for GE is still solid. The company holds rock-solid market positions in some attractive areas. In particular, GE's finance unit has earned among the best returns in the sector. GE is not particularly cheap at current prices, so I would not be surprised to see it lag in the near term. Over the long haul, I would expect double-digit growth for both earnings and share-price appreciation.

Q: In your portfolio management for Horizon, what's your strategy? Is it related to Dow theory analysis?


Horizon Investment Services emphasizes the top picks of the newsletters I edit, Dow Theory Forecasts and The Low Priced Stock Survey. We use a proprietary rating system to screen for stocks with sales and earnings momentum, improving profit expectations, and strong balance sheets. The overriding objective is to find stocks we feel can exceed Wall Street expectations. Right now, we are finding many of our best picks among small-company and mid-capitalization stocks.

Q: And what are some of those?

A: Well, in addition to the ones I mentioned earlier, we like Golden West Financial (GDW ), a California thrift. We remain very bullish on Southwest Airlines (LUV ). Among smaller companies, we are bullish on Dendrite International (DRTE ), a provider of software to the drug industry. We're also bullish on Metro One Telecommunications (MTON ), a company that provides directory assistance for many of the leading wireless carriers.

Q: I have a lot of AT&T (T ) -- should I dump?


No. I would be inclined to hold your AT&T. In my estimation, AT&T is still undervalued relative to the sum of its four parts. We recently estimated the value of these four parts in a Dow Theory Forecasts article. Our estimated value was $35, using fairly conservative assumptions. With the stock still below $25, my advice would be to sit tight.

Q: Just bought 1,000 shares of Yahoo! (YHOO ) today -- what do you think?


The way we look at stocks, Yahoo still seems overvalued. However, as a near-term trade, I think Yahoo has some appeal. I would not be surprised to see the Nasdaq add to its recent gains over the next two weeks, and Yahoo is a stock that will benefit from any turn in investor sentiment.

Q: Given the recent IBM (IBM ) results, do you see it going even higher than its close today of $108?

A: Yes, I think IBM is a stock that can move higher. What I like about IBM is their computer-services division. Several other computer-service companies have posted decent results, suggesting this area is holding up well in the tech slowdown. IBM is not my favorite tech stock, but I would expect it to beat the market over the next year.

Q: What is your opinion on the semiconductor-equipment sector? And favorites?


Intel's (INTC ) recent announcement that it would boost capital spending this year was a big positive for this group.... My favorite is industry leader Applied Materials (AMAT ). I think this company represents the best way to play the shift toward next-generation manufacturing technology by Intel and other semiconductor makers. We also have a buy rating on Agilent Technologies (A ), a diversified technology company that provides testing equipment to semiconductor companies.

Q: What's your outlook on the biotech stocks?

A: I think most biotech stocks are too risky. I would prefer to put my money into fast-growing specialty drug stocks. One very attractive small drugmaker is SICOR (SCRI ), which is enjoying outstanding sales and earnings growth because of new-product introductions. I also see Elan as a biotechnology play.

Edited by Jack Dierdorff

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