To OTC Journal Members:
 

How Smart Is the Market?

Market watchers have long agreed that today's market climate is a barometer for both economic and corporate performance three to six months down the road.

Investors who subscribe to this theory should not be surprised as June quarterly earnings reports from many technology companies are pathetic. The NASDAQ told us when it made its low in mid April business would bottom out sometime in September or October.

The NASDAQ has been hovering around 2000 for nearly three months now, which suggest things are not getting any worse, but there is no sign of an economic upturn in the near future.

There is an old Wall Street saying recently employed by Alan Greenspan in testimony before Congress. Paraphrased, it goes like this: "The Market has successfully predicted five of the last two recessions".

While this anecdote amusing, you might wonder if it is true. How good is today's market at predicting future corporate and economic performance? We have some interesting hard evidence which may convince you today's market is a strong precursor for future performance.
 

Boom and Bust Cycles

Over the last eighteen months there have been two opposing boom and bust cycles which are historically unprecedented. The Technology sector, fueled by unlimited capital from Wall Street and a gold rush mentality to create an internet presence for both startups and existing companies experienced an enormous bubble of technology driven economic activity. This bubble burst in a nasty way in March of 2000.

The economic boom of the 90's created significant increases in demand for energy. In 2000 oil and natural gas prices sky rocketed, leading to a gigantic boom cycle for the Energy Sector just as the technology sector was flushing itself down the toilet.

The question and theme for this newsletter: How Efficient Was the Market at Predicting These Two Coincidental and Opposite Boom and Bust Cycles? We'll look at two opposing bellwethers in their respective groups, and evaluate the market's ability to predict these cycles.
 

Intel Corporation (NASDAQ: INTC) vs Shell Canada (TSE: SHC)

We have chosen Intel and Shell Canada for our demonstration. Demand for semiconductors is a perfect proxy for the health of the technology sector, and Intel is the 800 pound gorilla in that arena. Our resource rich Canadian neighbors to the north benefit greatly during boom energy cycles, and Shell Canada is one of the largest companies in that space.

Here is a chart comparing the earnings performance of Shell Canada and Intel over the last four reported quarters. Note the steady increase at Shell Canada, beginning at $.82 in Sept 2000, peaking at $1.28 in March 2001, then retreating a little to $1.13 June 2001, reflecting softening energy commodity prices.

Intel on the other hand has fallen off a cliff. Earnings were $.38 in September of 2000, and have dropped 70% to a low of $.12 in the June quarter of 2000.

This simple comparison of these two profit trends reflects the Boom and Bust cycles both industry groups have experienced in the last eighteen months.
 

Does The Market Predict This Performance Correctly?

After comparing earnings performance, the next step is to compare stock price performance and observe its movement relative to earnings.

Here is a chart comparing the performance of both Intel and and Shell Canada over the last 15 months. Intel's stock price is in red, and Shell Canada is in green. We felt these colors were appropriate choices, reflecting the performance of both stocks.

Note Intel's stock trades nearly to $76 per share in September of 2000 just as the company is finishing a strong quarter. However, the stock gets cut in half over the next two months. Later we learn the company is entering a free fall which will take earnings down 70% over the next three quarters. The market does not learn about the September quarter until well into October, yet the stock craters long before.

On the other hand, Shell Canada comes in with $.82 in September of 2000, and hits a high of $1.28 six months later. The stock trades sideways from June to November, and then begins a run which takes the stock up 40% over the next seven months. The stock peaks in June at $49, and then falls back to $39 in early July.

In the case of Shell Canada, the stock peaked in price after the strongest quarter, which suggests the market did not predict the earnings trend well in advance as it did with Intel. Or, perhaps the market believes Shell Canada's next quarter will be strong as the stock has recently risen from $39 to $42.
 

What Does the Current Market Tell Us About the Future?

If you believe the trend in stock prices today gives us clues about the future, you have to conclude the worst is over in the technology sector. Intel has traded between $28 and $32 since late April, and the NASDAQ looks pretty much the same.

This sideways action indicates the economy has bottomed at a growth rate below 1%. However, stocks are telling us there is no economic rebound in the picture yet.

Once this market starts to improve you can be certain a better economic climate will be close behind. August should be a lackluster month with more sideways trading, but a post Labor day rally is probably in the picture, with improving conditions in October and November.

Microcap stocks are experiencing a capitulation phase, and we are placing a self imposed moratorium on new ideas as the last several trading alerts have been failures. Look for exciting new features during August while we wait for the shake out to end.

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