Market Wrapup(05/27/04): Revisiting the Technology Generals

Financial Sense Online ^ | 05/27/04 | Martin F. Goldberg

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Revisiting the Technology Generals

A look at the Technology Generals, posted on October 9, 2003 included my fundamental overview of Intel Corp., and technical analyses of the large capitalization technology leaders of the rally from the October 2002 “bottom.?At that time Intel and Dell Computer were looking technically strong, while Cisco was facing technical resistance, which it subsequently broke to the upside. Microsoft and Oracle were weak; however, with the backdrop of a strong Nasdaq continuing into mid January of 2004, each of the five stocks posted significant gains, before topping with the broader market. Tonight I will revisit the technical charts of these former Nasdaq leaders, as well as present some fundamental thoughts about Oracle. A technical review of the “Technology Generals?indicates three stocks ?Oracle, Cisco, and Intel sit near the necklines of  bearish head and shoulders reversal patterns. These necklines have not been broken decisively. Oracle sits at the neckline both a short- and long-term head and shoulders patterns. A break of the long-term neckline would suggest that the stock would trade down to the low single digits. Dell and Microsoft are showing manic trading patterns that are generally bearish. It’s not a pretty picture for the technology generals.

Oracle

Not since Roger Maris has anyone gotten as much mileage out of little more than one good year as Oracle Corporation. In the bubble top technology year of 2000, Oracle posted record sales and earnings that capped off a decade of fairly consistent growth. In 2000 Oracle posted GAP earnings of $6.3 billion dollars, nearly increasing yearly earnings 5-fold from 1999. The company appeared to be a money making machine at that time! They picked a good time for this performance as a smitten and intoxicated Wall Street bid the company’s value up to about $250 billion dollars. In today’s stock market, this would have made Oracle one of the largest companies by market capitalization in the US! Of course nobody must have noticed at that time, their record sales and earnings were being partially driven by IPO customers that would not exist in a few short months. Since that time, Oracle seems to have stabilized its business, remaining relatively debt-free, and has shown positive, if not spectacular earnings since the bubble top. However, the table below also clearly indicates a company that has matured and is no longer in a rapid growth phase. Oracle is a $50 plus billion company by market capitalization, yet people purchasing the stock are paying a growth price to earnings multiple of over 23 for shares of Oracle. (This is not including the expenses of stock options that have sheared the shareholders of any gain of shareholder equity over the last 3 years, as described below.)

A review of the data plotted above suggests that while Oracle may be a viable and successful business, it provided very little in the way of shareholder value. While the company has made over $11billion over the last three years, shareholder equity has actually dropped over that same time. Where has all the money gone? Not to dividends, as Oracle has never in its history paid any dividends. As you can see, Oracle purchased their own stock for a large part of that money. So has the money gone to shareholder’s coffers via less shares? Not exactly. The share count has changed very little over that time frame. So where’s the money? In the hands of employees and officers of the company by way of stock options. The bottom line for outside shareholders is that Oracle has broken even over the last three years. For their investment in Oracle, they received three years of  happy headlines, but no tangible increase in shareholder equity. Some “investment!"

You would think that the owners of the company (shareholders) would be livid over this apparent theft of wealth that appears to be so obvious. Yet Oracle trades at an expensive P/E of about 23.5. This is in spite of perpetually optimistic Wall Street analyst’s 5-year earnings growth estimates of only 10%. So who are these shareholders who are “A-Okay?with paying up for a stock which only “breaks even?on their behalf? The following lists the seven largest shareholders of Oracle company stock (data from Lionshares.com).

• Vanguard 500 Index Fund

• NASDAQ 100 Index Tracking Stock Fund

• CREF Stock Account

• SPDR Series-SPDR Trust Series 1

• Putnam Voyager Fund

• Vanguard Institutional Index Fund

• Vanguard Total Stock Market Index Fund

As you can see, the largest holders of Oracle stock tend to add no brains or thinking to their investment decisions because they tend to be index funds. (The next tier of shareholders is predominated by large “closet index funds?like Fidelity Blue Chip Growth and Magellan.) They buy (or sell) Oracle because it is part of the S&P 500 or another index. They simply don’t care in the least about Oracle’s fundamentals! Since these indices are capitalization weighted, a higher proportion of Oracle would be purchased as Oracle gained valuation in proportion to the rest of the S&P 500 index members. In addition, as popularity of index funds has generally grown as a result of paid advertisements and stock market gurus such as CNBC’s Susie Orman, this has benefited Oracle for no other reason than it was highly market capitalized. In short, it’s up because it’s up! This is in effect, a form of stock market leverage, which benefits highly capitalized companies such as Oracles and General Electrics during bull markets. But as with all forms of leverage, what is leveraged “to the good?on the way up is leveraged “to the bad?on the way down. Unsuspecting long-term holders of Oracle stock are at risk of a tremendous drop in shareholder wealth if there is a precipitous stock market drop or even a crash. In addition, they also face company-specific risks from a severely competitive business environment with formidable and well-capitalized competitors such as IBM and Microsoft.

If you like the risk to reward ratio of Oracle as an investment (or a short) please read on. The next section includes technical analyses of the Technology Generals.

Technical Analysis

Oracle

The following is a long-term monthly chart of Oracle.

The stock is in a long-term uptrend; but the massive head and shoulders pattern looks ominous. It is also notable that Oracle has posted stock losses in each of the months in 2004, including a high volume drop in February of 2004. The head and shoulders measurement principle suggests that if the neckline is decisively broken, Oracle may trade in the low single digits. The following is an 18-month, weekly chart of Oracle.

The chart above is showing some key technical weakness. The most operative technical pattern is a large head and shoulders pattern. There are bearish tendencies that can be seen in the high weekly volume selloffs that have occurred over the last few months. The stock now sits at the neckline at about $11/share. If it breaks the neckline decisively, classic technical analysis (head-and-shoulders measurement) suggests that Oracle will drop to $7/share or less. This is consistent with the longer term head and shoulders reversal pattern above. Note also that after having dropped from over $15 to just above $11/share, the retracement only reached the minimum Fibonacci retracement level of 38.2% - a sign of weakness. The money flow and accumulation/distribution indicates that the thinking money is heading for the exit. If you need additional advice on whether or what position to take with Oracle, consider what Oracle CEO, Larry Ellision is doing (see).

The last chart of Oracle presents a timing tool. Note how the various weekly moving averages are converging. This suggests that demand for Oracle stock is in balance at the moment, and that it will likely make a move shortly, once the balance is tipped one way or the other. With the stock approaching a short- and long-term its head-and-shoulders neckline, the money flow indicators suggesting that the stock is under heavy distribution, and the Nasdaq showing technical weakness, it seems as if there is a good risk to reward ratio in a bearish position in Oracle if the neckline is broken. Holding a bearish position through the quarterly earnings announcement may not be prudent unless the neckline is broken decisively by that time. Someone on the short side of Oracle could get hurt by a barrage of happy “Wall Street speak.?span style="mso-spacerun:yes">  This has happened with Microsoft after their latest quarterly earnings announcement.

Intel

Below is a weekly chart of Intel.

The stock has completed a double top in January, and is about 1.5 points above the neckline of a complex head and shoulders pattern. The stock is under distribution. A decisive downside break of the neckline at 26 would suggest a drop to about 19 or less.

Cisco

Cisco is in a downtrend and is under distribution. There is a complex head and shoulders pattern which, if broken downside, could take the stock to $13/share or less based on the measurement principle of the head and shoulders pattern. Converging moving averages suggest that a break of the current equilibrium may occur soon. It is interesting how the stock turned tail after it tried to close above the converging moving averages. The other technical indicators described above, suggest that if (when) that break occurs, it will be to the downside.

Dell

Below is a long term monthly chart of Dell. Note that the stock has held up well from the top of the March 2000 bubble to the present time. It is notable that its volume has gradually and consistently decreased from the top to the present. If the stock is to make a upward move, it will take increased volume to take it there.

The short term daily chart indicates that Dell has completed a triple top pattern. It has also formed two separate broadening patterns, typical of an overactive public that occurs near market tops. While it would be difficult to short a consistent long-term performer such as Dell, there is not a compelling technical reason to take a bullish position at this time in my view.

Microsoft

The long-term monthly chart of Microsoft indicates a triangle pattern forming. As with Oracle, the long-term moving averages are converging suggesting equilibrium between buyers and sellers. This suggests that a breakout move may occur soon.

The triangle pattern is shown more clearly on a 4-year weekly chart. Patterns of this nature are apt to “peter out?as they get closer to the apex of the triangle.

The one-year daily chart is a mess, and would suggest that no long position be taken at this time because there is no strategic pattern worth trading. However, the manic trading is bearish for the intermediate term trader or investor.

Summary and Conclusion

Revisiting the technical position of the Nasdaq “Technology Generals?indicates three stocks ?Oracle, Cisco, and Intel that sit at the necklines of bearish head and shoulders reversal patterns. These necklines have not yet been decisively broken. The Oracle chart sits at the neckline both a short- and long-term head and shoulders pattern. A break of the long-term neckline would suggest that the stock would trade to the low single digits. Dell and Microsoft are showing manic trading patterns that are generally bearish. It’s not a pretty picture for the Technology Generals.

Nasdaq Complex Head and Shoulders Bearish Reversal ?Update

Below is a daily chart of the Nasdaq indicating in my opinion, a complex (or multiple) head and shoulders reversal pattern where the neckline does not appear to have been broken to the downside decisively.

While at the time it appeared that the neckline might have been broken about 3 weeks ago, the downtrend has yet to “get going?to the downside. A matching phenomenon that seems to fit the current Nasdaq action is described in Technical Analysis of Stock Trends, 8^th edition by Edwards and Magee, in a subsection that describes the behavior of complex head and shoulders patterns, entitled ?/font>A Leisurely Pattern? (page 78, italics insert by Martin):

“There is something about Multiple Head-and-Shoulders patterns especially pleasing to technical chart followers. Because of their symmetrical tendencies, it is fascinating to watch them evolve to completion. Once completed, however they may try your patience (!!) by their seeming reluctance to “get going?with a new trend. On that account, it becomes easy at times to jump to the conclusion that they have “blown out? i.e., produced a false signal. Actually, except in the matter of extent of move (see below), which we have already discussed, they are fully as reliable as the plain Head-and-Shoulders. False moves are relatively rare with both. And in those extraordinary cases when a Complex Formation does go wrong, it still stands, like the plain Head-and-Shoulders, as a warning that the final Reversal is near.?/span>

Edwards and Magee describe the reduced “power?of a complex (many shoulders) versus simple (1 head, 2 shoulders) head-and-shoulder pattern (page 77):

Curiously enough, the “power?of a Multiple Head-and-Shoulders Pattern is more apt to be over- than underestimated. One might think, in view of the length of time and amount of trading entering into its construction, that it would signal a move (in reverse direction to the trend preceding it) of greater extent than the simple Head-and-Shoulders. Yet, in its immediate consequences, at least, the Complex shows consistently less power. Minimum measuring rules for the two types of formations are the same and are applied in the same manner. The difference between the patterns appears in the price action after the minimum has been reached. The first downswing out of a plain Head-and-Shoulders Top, not counting any early Pullback pattern will frequently carry out of the minimum measuring implications of that pattern quickly and run well beyond it. From a Multiple Top, the first downswing is often more leisurely, and very seldom does it exceed the bare minimum ?a probability well worth remembering when you are dealing with an Intermediate rather than a Primary Top. Of course, if the Complex does develop at a turn of a Primary Trend, prices will eventually go much farther, but even then there is usually a strong recovery from the “minimum?rule.

In my view the authors are suggesting that once the reversal of the multiple head-and-shoulders pattern “gets going? it will probably reach the minimum measuring level of about 1,650 at a more leisurely pace than that of a simple head-and-shoulders. From that point, a “strong recovery?from the ~1,650 minimum rule level would be likely. Whether there would be additional downside potential after the strong recovery would depend on whether we have a Primary or an Intermediate Nasdaq Top. If this “top?is the second leg of a secular bear market, then there should be much more downside potential for the Nasdaq, after the pattern “gets going.?span style="mso-spacerun:yes"> 

Has Anyone Noticed?

Yahoo is back to August 1999 levels. One of the following must be true:

1.       1.  In August 1999 we were not in a stock market bubble.
    2.  Today, we are in a stock market bubble.
    3.  Yahoo has the potential future sales and earnings to make it worth its current stock market valuation of over $40 Billion. For ready reference Yahoo has a price to earnings ratio of 138, not including costs for expensing stock options. (Source: Yahoo Finance.)

Today’s Market

Philadelphia Phillies Hall of Fame 3^rd Baseman Mike Schmidt once said after a hitting slump that lasted several weeks, “Playing in Philadelphia has given me the thrill of victory, and the agony of reading about it in the newspapers the next day.?Today I feel much like Mike Schmidt must have felt at that time. Writing my bearish intermediate views of the Nasdaq has given me the thrill of victory and the agony of writing about it the next day! The Nasdaq posted its 5th straight positive day, but has yet to trade an average day’s worth of volume. You could have seen this one coming because over the last decade, when head-and-shoulders patterns whipsaw, they do so fast and tradable. Still as I referenced above, “in those extraordinary cases when a Complex Formation does go wrong, it still stands, like the plain Head-and-Shoulders, as a warning that the final Reversal is near.?/span>

In technical analysis, volume generally precedes price, so any logical person would conclude that this most recent wonder-rally is not sustainable. Oh, of course today’s volume was greater than yesterday's, so you can expect the momentum Investors Business Daily (IBD) to suggest that this is “just what you would like to see.?I’ll have more discussion on IBD and their momentum/technical analysis-based “CANSLIM?in a future article. Does it (will it) work all of the time?

In the intermediate term, the downtrend of the multiple head-and-shoulders reversal is still intact. The lack of any conviction indicated by the relatively low volume, suggests that the latest Nasdaq rally is but one more shoulder in the intact complex head and shoulders bearish reversal pattern. The only successful people that I have talked to over the last few weeks are those trading into and out of stocks using momentum indicators. A couple of points here and there and taking what the market gives them. It’s been a pretty good way to take money out of the market over the last few months, but does not make for much thought provoking discussion. Here is a daily chart of the Russell 2000. I’m not quite sure why it is rallying; but the best explanation I can give is that the black line on the MACD has crossed above the blue line. Today the Nasdaq made a doji! Isn’t that thought provoking?

For now, I’ll stick to the intermediate term. Tomorrow is a pre-holiday trading session, so you may see Alfred Ameritrade out there buying the QQQ’s for one more day.

I’ve talked to a few intelligent people and read some articles suggesting that between now and November; the market will do okay for political reasons. Although I no longer dismiss that as preposterous, count me in the camp that looks at the chart and only sees a lazy bearish reversal pattern that has yet to “get going.?But if you believe that the “presidential election levitation?is in effect, then please consider how you would feel on Wednesday, November 3^rd if the Nasdaq trades down 200 points by 10am.

After it tried to rally, the dollar is now firmly back in its downtrend where it belongs.

Here is a candlestick chart of the 10-year note yield. By what the charts are telling us, it appears that there is more bond market rally in store and lower interest rates. This, and a bullish Barron’s article are resulting in one more rally from the homebuilders! As Mike Hartman pointed out yesterday, the economic data in the most recent past all seems to support higher bond prices. How convenient!

Gold was up $7/ounce ($395/ounce), silver up 0.14 ($6.19/ounce), the XAU was up 1.4%, and the HUI was up 1.2%. Stocks were up marginally in light trading on the Nasdaq and heavy on the NYSE.

Have a great Memorial Day holiday!

Martin Goldberg

Copyright ? 2004 All rights reserved.

Martin F. Goldberg, MS, P.E.
Market Analyst

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