"Continued Weakness Through 2004"

That's the forecast of Chris Johnson of Schaeffer's Investment Research, though he still sees potential in some tech stocks

It may not be a bear market, but "we will see continued weakness throughout 2004," predicts Chris Johnson, director of quantitative research for Schaeffer's Investment Research. In his stock selections, Johnson looks for companies that are fundamentally sound but out of favor. For example, he notes that technology stocks have shown some weakness over the past eight weeks and that candidates there could include Advanced Micro Devices (AMD ). Beyond tech, he sees potential in Ford Motor (F ) and DaimlerChrysler (DCX ).

These were a few highlights of an investing chat presented by BusinessWeek Online Mar. 11 on America Online, with Johnson as the guest. He was responding to questions from the audience and from Jack Dierdorff and Karyn McCormack of BW Online. Following are edited excerpts from this chat. A full transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.

Q: What should we start buying?


As we experience this weakness in the market, I believe that you will begin to see the market's tide turn back to some more technology issues. The bottom line is that fund managers and investors alike love to play these stocks, and they've fallen into weakness over the past seven weeks to eight weeks. Factors that I think will begin to take a leadership role out of a short-term bottom include some of the semiconductor stocks and even networking, and some of the auto companies when we look outside of the tech shares.

Q: What are some of the tech stocks that you like now?


Looking at the semiconductor area first, an old favorite has always been Intel (INTC ). Right now, one of the reasons this company has continued to plummet is that everyone loves the stock; everyone is bullish on it. Our research shows that when the public loves a stock as much as they love Intel recently, it's usually a sign of upcoming weakness, or continued weakness.

Following our expectational approach, which involves looking for companies that are technically strong and fundamentally sound, yet not in complete favor with the Street, a company like Advanced Micro Devices pops up on my screen. When I look at AMD, I see a company with a put-call ratio that continues to move higher. This tells me that option investors do not think that the outlook for the company is that bright.

Other tech companies that fall into that category would include Foundry Networks (FDRY ) and Linear Technology (LLTC ). A few out of the tech sectors that meet this criteria would include Ford Motor (F ) and DaimlerChrysler (DCX ).

Q: Besides AMD, are there any other tech stocks or trends that you like now?


I did mention Linear Technology, another company in the semiconductor sector that I continue to like. This is due to the high level of pessimism seen toward the company, and its technical strength. Outside of the semiconductor sector, and looking at one that's beginning to be talked about a bit more, are the telecoms. I think opportunities lie in BellSouth (BLS ) and Alltel (AT ). Again, these are companies that have been performing very strongly technically and continue to show signs of building investor pessimism.

Q: Do you think there are any real safe bets in this market environment?


The only safe bet in any market is your money in a mattress. Not wanting to do that, though, one would find that a well-allocated, diversified portfolio would help an investor weather a market like this. Avoiding too heavy a tech weighting is also important as we go through this year, as these will continue to be the stocks that portfolio managers and institutional traders will continue to dump very quickly at the slightest hint of bad news.

Another tactic, which investors are beginning to embrace, is the use of options to help offset pullbacks in your portfolio. In addition to this, investors are beginning to become more savvy in using mutual funds, which will allow them to profit from declines in the market.

Q: Aren't we looking at some bargain prices today in stocks like General Electric (GE ) and Hasbro (HAS )?


Actually, you are. GE is now trading at $30.42, back to its December levels. At that level, it certainly seems like its a bargain. Reflecting back to the sentiment we use so successfully, this is a company that has a put-call ratio at its highest level in the last one year of trading. This, in addition to the fact that GE is now trading at its 10-month moving average -- which acted as support today -- I think that GE is a short-term outperformer for this market.

Hasbro finds itself in the same position. Last month the company traded to its 10-month moving average and found considerable support. The current put-call ratio is in the top 10% for Hasbro, and given that they have not participated in the dramatic sell-off over the last few weeks to the extent that GE and other peer companies have, Hasbro is emerging as a relative strength leader -- something I always like to see with a pessimistic sentiment. So the two companies you have mentioned look to be short-term outperformers looking forward.

Q: Do you believe this is a bear market rally, and the market will fall a lot farther than people think?


If we want to get technical, when the S&P 500 moved back above its long-term moving averages, the market clawed its way out of bear mode. So the question really becomes, "Do I think we'll move back into another bear market?" To this I'd have to answer, "No," as of right now.

The reason I say this is this market has seen some significant improvements in its fundamentals as well as the technicals. Given this, we have seen investors become more optimistic, which tends to make us believe that we will see continued weakness throughout 2004.

Q: Chris, should I hold my gold or let it go?


Hold onto gold. We continue to do so. Should we see the price of gold again to begin trending above the $400 mark, you'll see many of the mining companies fall back into favor with investors, which will indicate higher prices.

Q: Given your caution, is this a time for investors to hold back on putting much new money into stocks?


We have been advising our subscribers to continue building cash reserves, as we think there will be buying opportunities down the road. One thing that investors were sucked into doing during the bear market that began a few years ago was to throw good money into a bad market. I wouldn't label this market as bad yet, but for the time being, a nice cash reserve will be something that investors will thank themselves for having when the technicals and fundamentals really begin to kick in.

Edited by Jack Dierdorff

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