Look for Stocks to Keep Idling

Chris Johnson of Schaeffer's Investment Research sees a flat market into 2005, although he thinks FedEx and Qualcomm are good bets

The market will be stuck in a narrow pattern through the Presidential election, possibly until yearend. So says Chris Johnson, director of quantitative research for Schaeffer's Investment Research, who blames "technical trend lines, oil prices, and the possibility that earnings aren't going to pan out the way investors thought they might."

Johnson, who relies heavily on technical analysis, sees oil service, energy, and gold as sectors in favor now, even as investors sour on favorites such as semiconductors and networking companies. However, if you are willing to sell short or go for a speculative put, he considers some tech stocks as opportunities, including Intel (INTC ), Cisco (CSCO ), and Foundry Networks (FDRY ).

In other areas, Johnson is high on FedEx (FDX ) due to investor sentiment, fundamental factors, and technical readings. For the same reasons he likes Harley-Davidson (HDI ), Amerada Hess (AHC ), and Qualcomm (QCOM ).

These were among the points Johnson made in an investing chat presented Sept. 30 by BusinessWeek Online on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff and Karyn McCormack. Edited excerpts follow. A complete transcript is available from BW Online on AOL, at keyword: BW Talk.

Q: Chris, the stock market seems stuck in that all-too-familiar pattern. What's your prognosis?


As it stands right now, I believe the market's trying to break the chains of a few issues, which include technical trend lines, oil prices, and the possibility that earnings aren't going to pan out the way investors thought they might. Unfortunately for now, I think the best-case prospect is that things will stay in this trading range. We are in a market that continues to trend in a downward walk vs. the upward pattern that investors would prefer.

Q: So what's your outlook for the S&P 500-stock index and Nasdaq through yearend? Will we remain stuck as the election nears?


I do think that we'll be stuck through the election. As you know, the S&P 500 has been in a very tight range, from January through now. It has tended to have a slight downward bias. I think that bias is going to continue through yearend, and you're more likely to have an S&P 500 that's south of the 1,100 mark, come Dec. 31, rather than north.

Q: Can the runaway price of oil sink the Dow and send it back to the 7,500 level?


In the larger scope of things, I do believe that should oil continue to trend as strongly as it has, it will have a very negative effect on Dow stocks. Investors have not yet seen the results of the increase in crude-oil prices in the bottom line of companies' earnings. We should begin seeing that, though, in the next few quarters, and these results could lead the major indexes to new lows for the year.

Q: Are you seeing any major shifts by investors in or out of any sectors lately?


Obviously, the sectors that have begun to fall into favor include oil- service companies and energy companies, and now gold is beginning to come back into favor again. At the same time, these sectors are becoming darlings of investors' portfolios, and we're beginning to see some of the more time-honored favorites fall out of favor. These sectors include semiconductors and networking companies. While these sectors have been under fundamental and technical pressure for some time, we're now finally seeing indications that investors are moving from them, such as the numbers of analysts dropping their recommendations on semiconductor stocks from buys to holds or sells.

Q: Do you monitor moves in bonds, and does it affect your market outlook? Any thoughts on the recent rally in long-term Treasuries?


We do monitor the moves in bonds and have considered the trend in bonds very bullish. We do expect to see these trends continue, especially as there's a good sentiment backdrop to keep the trend in place. The way we track the sentiment on bonds is by looking at put/call ratios and other tools on the iShares 20-year Treasuries (TLT ). The trend we're seeing here is one of growing pessimism, as the put/call ratio for the TLT continues to trend higher. From our perspective at Schaeffer's, it shows us that there has been a good deal of pessimism that continues to build toward bonds, which is bullish for their outlook.

Q: What do you think of the troubles at Fannie Mae (FNM ) and of its stock now?


Fannie Mae has obviously taken a hit recently, [with share prices] moving from the mid-70s to the mid-60s, upon the announcement of the investigation. Were I a holder of the stock, I would take a hold-and-wait position. As somebody who's not holding the stock, I would take a wait-and-see position before jumping in..... Should the investigations not be too damning of Fannie Mae, I would expect that you'll see some buying opportunities in the short term. But again, if I didn't own the stock right now, I wouldn't be rushing out to buy it.

Q: Going back to tech stocks, as you mentioned earlier, some industries are falling out of favor. Are you steering clear or finding opportunity in the rubble?


There are opportunities for those who are willing to step outside of conventional-investment means. When I say that, I'm referring to either shorting a stock or buying speculative puts. In either of those cases, there have been some fantastic opportunities in some very mainstream names, such as Intel (INTC ), Cisco (CSCO ), Foundry Networks (FDRY ), and I believe there will be others. The few companies that continue to hold in there are Dell (DELL ) and Microsoft (MSFT ). As I see it, should the stronghold on their current price levels (Microsoft, 27.5; Dell, 35) fall off, you're likely to see another round of selling in the tech arena that will reward those investors who are either short or holding speculative puts.

Q: Beyond tech, can you give us any stocks where you see buying opportunities now?


One company that remains a favorite of mine throughout this year is FedEx (FDX ). This is a company that has strongly outpaced the market and has recently given a strong buying opportunity when it dropped from $89 to $84. Taking a look at FedEx, at the beginning of the year they began an overhaul of their assets to position themselves as a strong performer in their business field. In addition, they've demonstrated strong fundamental growth and strong price activity, and we're seeing the signature of a bullish kick, according to our expectational analysis approach, of negative sentiment on the part of investors....I expect this combination of sentiment, fundamentals, and technicals, to continue to propel FedEx above not only their competition, but the rest of the market. A few other companies that fit the same criteria include Harley-Davidson (HDI ), Amerada Hess (AHC ), and Qualcomm (QCOM ).

Q: Merck (MRK ) took a beating today. Do any of the pharmaceutical stocks look promising?


Well, certainly Merck did take a hit today, which also affected the sector overall. Looking outside today's price activity, we see a sector that has followed along with the market in its downward walk throughout the year. One thing that does set the pharmaceuticals aside from many other sectors is that its put/call ratio has actually trended to extremely high readings....A high reading indicates pessimism toward a sector, which one would expect to see, given the fundamentals and price activity in the drug companies.

For now, I would continue to hold on buying in the sector as an overall,and wait until those fundamentals and technicals improve, at which time the sector would be a very good value, and at which point the sector would outpace the market. If I had to look at a few companies in the sector to buy right now, a couple of candidates in terms of extreme pessimism would be Wyeth (WYE ) and Forest Labs (FRX ). But again, I wouldn't go out and buy these blindly today.

Q: How do the financial stocks stack up?


Very good sector to pick on right now. As you know, the financials were hot until March of this year, and then they followed suit with the rest of the market and trended sideways, with somewhat of a more harsh downward trend from March to May. Taking a look at some of the sentiment for the financials right now tends to have me again holding on the sidelines, as optimism toward these companies has grown to an extreme, with the put/call ratio for the S&P Financial Trust (XLF ) shares trading at extremely low levels. Recent activity has seen these shares trade from the $30 range to the $28 range amid this building optimism, with a large number of companies beginning to report earnings...For now I'd be a "hold" at best on the sector.

Q: What are some good stocks that pay high dividends?


Being a short-term trader, I normally don't concern myself with the level of a dividend, as I'm usually not in the stock long enough to get it. Keeping that in mind, I'll give you a quick list. Let me throw out some tickers for you: 10% yields or higher -- Anthracite Capital (AHR ), Vector Group (VGR ), Enerplus Resources Fund (ERF ), Nordic American Tanker Shipping (NAT ), Allete (ALE ), Enterra Energy Trust (EENC ), Pengrowth Energy Trust (PGH ), Petrofund Energy Trust (PTF ), and Annaly Mortgage Management (NLY ). Now for the shameless self-promotion: A long list of stocks with high dividend yields can be obtained by visiting our Web site, and accessing Schaeffer's Gold Filters area.

Q: How heavily do you weight the fundamentals vs. your technical analysis? It would seem factors such as Iraq and terror fears loom especially large these days.


Very good question. Depending upon my outlook, I weigh my fundamental analysis differently. For stocks that I'm looking to hold less than two to six months, fundamental analysis takes the back seat, with perhaps only 10% to 15% of my final answer weighing on the fundamentals and the remainder of that being split between technical and sentiment analysis. It's when I hold a stock longer than six months that I begin to scrutinize the fundamentals very heavily. For example, my FedEx pick earlier was actually a stock-of-the-year pick in January of this year. In that case, I weigh fundamentals as an equal share with technical analysis to get to my bottom-line buy rating on the stock. As a review, if I'm holding a stock longer than six months, I'll share the weighting. Anything shorter, and the technical side takes center stage.

Edited by Jack Dierdorff

    Before it's here, it's on the Bloomberg Terminal. LEARN MORE