Breaking Away from 'Over Loved' Stocks

Chris Johnson of Schaeffer's Investment Research tells why he's down on large tech stocks such as Apple, but high on AT&T

With the Federal Reserve seemingly out of the picture when it comes to raising interest rates, investors can still find a few stocks to profit from—even after the recent run-up, says Chris Johnson, director of quantitative research at Schaeffer's Investment Research. While he's "cautiously optimistic" on the market overall, he sees opportunities for gains in telecom stocks given that they have bullish technical, fundamental, and sentiment signals.

On the other hand, Johnson continues to be wary of many large-cap tech stocks. He places Microsoft (MSFT), Intel (INTC), and Apple (AAPL) on his "warning list" of tech companies that are not showing much fundamental spark from new products, and are also still "over loved" by Wall Street.

"I'm not seeing what I saw a couple of years ago where they're innovating and moving forward," says Johnson about Apple. "I'm worried that their earnings will start to show that."

He's also starting to see worrisome signs for energy stocks from a technical standpoint. Johnson shared his views with Karyn McCormack of this week in New York City. Edited excerpts of their conversation follow.

What's your market outlook? The market has rallied since we last met (in early August).

We've had a great rally. The S&P 500, and not so much the Nasdaq, which took more of a beating, but certainly the Dow Jones industrial average found that intermediate- and long-term technical support, and rallied from it. Now obviously those interest rate fears have subsided as investors have back-shelved the idea that we're going to see interest rate hikes. As a result, we've seen investors willing to bring money from the sidelines.

As of right now, we're seeing somewhat of an overbought market. When we look at the short-term perspective, some of the pullbacks could be short-term buying opportunities.

Do you think this rally will hold?

I'm cautiously optimistic. Our sentiment indicators, such as the equity put-call ratio and the VIX, are all sending mixed messages right now. Even the investor polls are kind of dicey in their day-to-day and week-to-week activity. So there's no clear-cut long-term or intermediate-term bullish signal that's saying go out there and start buying stocks. But you're getting short-term buying opportunities. That's why I'm cautiously optimistic.

On the other side of that, a lot of fundamental analysts and economists are pointing to a slowdown in the economic outlook. That's another one of those potholes that you really have to look at in terms of factoring into current prices. I still think we're in a technically-driven market. A lot of that long-term support rides below current levels. So I think there are some opportunities throughout the year, and some sectors will be favored more than others. But investors would be wise to be cautious on the market overall.

What's your firm's view of the economy? Goldilocks or hard landing?

We're not economists by trade. That's the message you've seen: the Goldilocks economy, where it's not too hot and not too cold. Any surprise interest rate hike would knock this market back on its heels and cause sellers to take action. But over the long term, we continue to see this Goldilocks market. The problem is, if inflation heats up, investors are going to be pretty quick to react.

Where are the opportunities that you see?

The last time I was with you we talked about telecom, and I still think that's a great area (see, 8/2/06, "Anxiety Hits the Market: What Now?"). That has been performing very well, not only over the last year but also for the last couple of years. Companies like AT&T (T), they have been fundamentally rebuilding as the market was softer or weak.

Telecom has been strong from a technical perspective, and now the fundamentals are kicking in; they're doing great on earnings. At the same time, analysts and investors have not become over-infatuated with the stocks. So there are still opportunities there. From a technical perspective, some of the technology sectors—networking, but not so much semiconductors—are offering a bullish opportunity for short-term traders.

So is AT&T still your favorite stock?

AT&T is the darling of the group. It was my stock pick last year, and I kept it this year. It's steady. It gives a yield. It has a number of different things that make it attractive. But at the same time, the sentiment, technicals, and fundamentals of the company are all lined up to continue outperforming the market, which it has done. Many people don't consider it a technology stock, but with all the networking they're doing—the Network Solutions business has really ramped up—it is a technology stock.

You also like networkers?

I wrote a piece a few weeks ago, when the networking index on Amex was around 200, saying they're lined up for not only a bounce, but also that I think they're going to take over from a leadership perspective. And they've done exactly that. Companies like Cisco Systems (CSCO) have to some degree, curiously, jumped out and taken a leadership role.

Clearly, with Intel falling out of favor, a lot of people are looking for that tech stock that will be the icon or leader of the group. It's not going to be Microsoft, they're still stuck in that lack of innovation phase.

What about Apple?

Two or three years ago we talked about how Apple was the only company innovating. They're not doing it any longer. Now they're resting on their heels. I was watching TV with my wife during a football game and they had commercials about the color iPods that are coming out. They've gone through the video, the colors now, and they're pushing the max again. To see them doing that instead of saying, here's what we're going after next, is a concern.

It's one stock that I'm putting on what I'd call my warning screen right now. It's kind of like Microsoft, with their different versions of Windows. It's nothing really substantial that causes me to say, I gotta have it.

Are you wary of any other group?

Right now you have to have a big question mark over energy. Has that become one of the areas that has become over-loved? We're starting to reach the point when everybody is talking about a sector. That's the time when the caution light should be [coming on]. That situation is building in the energy area. The fundamentals are still good, but the technicals are starting to drop off and the sentiment has had a lot of optimism. So two out of three to the downside makes a very cautious, or tenuous, sector right now.

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