Laszlo Birinyi Jr. : Recovery Under Way

» Kirk - Recovery Under Way

Thu May 22, 6:35 PM ET
By Laszlo Birinyi Jr.
http://news.yahoo.com/news?tmpl=story2&c...

Has the economy turned around? Has the market bottomed? Can we quit worrying so much? As an investment professional, I hear these questions a lot lately. My answers are yes, yes and yes. The economy has seen its low. The strength in the junk bond market is telling us so. This year an index of low-quality bonds that we track is up 13%, not including the additional income from the 10% yield. The strength in the junk bond market is to the economy what robins are to spring. It means that investors' fears about the economy are abating.

The market may not be at a classic bottom--if there is such a thing--but in reality it hit a low last Oct. 9, when the Dow Jones industrial average tumbled to 7286, rallied, corrected and then moved higher beginning Mar. 10. In mid-May we were at 8647.

Here's another sign of budding optimism: The trend these days is bigger upsides and lower downsides. That's a switch from a year ago. If you take the market's reaction to good news versus its reaction to disappointing news, you find it nets to a plus 221 Dow points: In 2003, on the 14 days when the economic reports were positive, the market gained a combined 1,136 points. On 16 bad-news days, the combined loss was 915.

But I am most encouraged by the market's reaction to specific companies. For example, Tyco (NYSE:TYC - News) on Apr. 30 announced it would take a $1.1 billion charge for still more accounting problems. Tyco stock promptly slumped 15%, but by the day's close it was up 1.5% from Apr. 29.

In another case, Wal-Mart Stores (NYSE:WMT - News)' sales figures for April were disappointing. No matter. The next trading day, May 8, the stock dipped just 7 cents and the following day was up 79 cents. In its Apr. 14 issue Barron's warned that key Internet issues such as Ebay (NasdaqNM:EBAY - News) were overvalued. The result was a wave of buying, continuing Ebay's upward march (the stock has gained 50% since November). The buying behavior is faintly reminiscent of--dare I say?--the late, great 1990s bubble.

Such euphoria stems partly from the quick victory in Iraq (news - web sites) and an unleashing of investors' pent-up desire to at long last make some money. The largest catalyst, however, has been a rash of unexpectedly good corporate earnings.

True, no full-scale earnings boom has developed yet. And many of those lauded for their earnings performance have only met Wall Street's (often lowered) expectations. But the feeling is that if, say, one oil company is doing better, then the other oils will follow.

One example is General Electric (NYSE:GE - News). When it met analysts' earnings consensus of 32 cents a share for the first quarter, the stock took off--even though those earnings were down from the year before. In the market, there was a big spillover effect to Honeywell (NYSE:HON - News) and United Technologies (NYSE:UTX - News), whose rises this spring have paralleled GE's. By itself GE has accounted for 5% of the S&P 500's gain since mid-March. Performing the same service for tech stocks, Microsoft (NasdaqNM:MSFT - News) has added nearly another 5% or so of the overall S&P gain.

Now the warning. While the worst is behind us and the outlook more positive, you can't expect that all will be well. For individual investors, the market has become treacherous. Not because of the economy or terrorism, but because of the market's short-term orientation, fed by instant electronic information and rule changes like 2001's decimalization, which narrowed bid/ask spreads. This change allowed sharp Wall Street traders to step in front of individual investors. On in-and-out trading the edge now is with the pros.

In his classic The Money Game Adam Smith listed two great inflection points: the 1975 Erisa, the law bringing regulation to pension investing, and May Day 1975, when fixed brokerage commissions ended. To those I would add decimalization and regulation fair disclosure.

Today's hedge funds illustrate the shift to a trading mentality. George Soros in his heyday made large macro bets on economies and currencies. Nowadays hedge funds would rather cadge pennies from market pricing anomalies. Some Big Board specialists have been criticized lately for front-running, which, if true, is an abuse of their positions. I suspect this game is far more widespread among Nasdaq traders.

The best way to immunize yourself against transaction costs imposed by the system is to avoid in-and-out trading. Follow Warren Buffett (news - web sites)'s example and hold good names for the long term. In technology I like Lexmark (NYSE:LXK - News) (73) and Dell (NasdaqNM:DELL - News) (32). I would consider drug company Bristol-Myers (NYSE:BMY - News) (26), insurer Cigna (NYSE:CI - News) (51), retailer Gap Inc. (NYSE:GPS - News) (17) and commercial/investment bank J.P. Morgan Chase (NYSE:JPM - News) (31).

From Today
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-- posted by Kirk