MKSI And A Double Dip Recession?

• February 19, 2002
• Peter Navarro

Market
Trend: Unclear (Bias downward)

Worst
Sectors: Telecom, Fiber Optics

Best
Sectors: Retailing, housing and semiconductor manufacturing (if trend turns upward)

Stock
of the Week: MKS Instruments (MKSI)

The market remains
primarily a daytrader’s market. There
is money to be made in each day’s volatility, but the risk of holding
positions overnight for successful swing or position trading remains very high. 

A key source of this risk is
Enron-itis — we may wake up any morning to yet another company being accused
of some slippery accounting practices. That’s
all it takes — an accusation — and off the stock price goes over a cliff. 

The problem is that it’s
difficult to short such a stock on the news because of the uptick rule and
deadly to be long. Witness the
alleged shenanigans of that paragon of virtue last week — Big Blue.IBM
(
IBM |
Quote |
Chart |
News |
PowerRating) was accused of booking the sale of a business to
JDS
Uniphase
(
JDSU |
Quote |
Chart |
News |
PowerRating) in a way to disguise operating costs and took a very big hit. Is nothing sacred?

The Broad Market Outlook

Three forces continue to bear down
on the market that will make it difficult for a new bull market to emerge any
time soon: (1) Enron-itis, (2) Falling consumer confidence and (3) Overhead
resistance.

(1) Enron-itis

The effect of Enron-itis is both company- and
sector-specific and also puts strong pressures on the overall market.
Last week, companies like Nvidia
(
NVDA |
Quote |
Chart |
News |
PowerRating) and Big Blue joined Global Crossing, Qualcomm
(
QCOM |
Quote |
Chart |
News |
PowerRating), PNC Financial
(
PNC |
Quote |
Chart |
News |
PowerRating), Take Two
Interactive
(
TTWO |
Quote |
Chart |
News |
PowerRating), and others in having Wall
Street’s Scarlet “A” branded on their chests. Sectors from energy and telecom to electronic gaming and broader tech are
most susceptible. 

The overall market suffers because
stock prices are nothing more than a reflection of a future stream of earnings.
Draw a larger band of uncertainty around those earnings because of
increasingly imperfect information and the only way investors can discount the
increased risk is through lower stock prices.

(2) Falling Consumer Confidence and the Double Dip

The biggest macrowave news last
week was the not-so-surprising, but nonetheless, very disappointing fall in
consumer confidence. This was
evident in the University of Michigan’s consumer sentiment survey that had its
first decline since last September, falling from 93 to 90.9. 

This is very big news because
consumption accounts for almost 70% of the Gross Domestic Product, and it has
been consumption, rather than lagging business investment that has kept the
economy within the range of a possible recovery. The double dip scenario
goes as follows:

We are beginning to emerge from
recession through an “inventory led” recovery. As the recession began about a year ago, there was an accumulation of
inventories. Businesses cut back
heavily on production, which further worsened the recession. 

Now, however, that businesses have
worked off their inventories, they are starting to produce again, breathing life
back into the economy. In the
bullish recovery, increased production is eventually followed by increased
investments in capital equipment, more hiring and a resumption of a full-employment economy.

But HOLD ON! If,
in fact, consumer confidence and consumption begin to fall just as we are trying
to emerge from the recession, inventories will build again, businesses will
begin to cut back again, and the economy will sink back into the morass of the
double dip. Ominously, most of the
last severe recessions have been characterized by this double dip.

(3) Overhead Resistance

Blame boosters like those at CNBC
for the crustiest and scaliest overhead resistance a stock market has seen in a
very long time. Rather than just
view the market impassively as it unfolds, the CNBC-ites take a vested interest
in seeing the market go UP. So
every time the market does — maybe because of a short-covering rally or a
small technical correction — the boosters get all excited that we’ve
“reached the bottom.”

This excitement, in turn, brings
new dumb money into the market hoping to get in on the next move up.
Meanwhile, general macroeconomic conditions do not warrant a sustained
move up, so the smart money (hopefully, you) takes advantage of these “bear
market” rallies to sell or go short.

One immediate effect of this
process is to build another layer of overhead resistance into the market. Some of this new dumb money is now sitting on losing positions and
waiting until the stock price gets them back to even — at which point they
sell, igniting downward pressure and killing the rally.

Meanwhile, the rest of this dumb
money gets lost forever — a classic wealth transfer to the smart guys. And the
worst part of this zero-sum game is that the systematic fleecing
of dumb money denies the market the fuel it will need for a strong future
recovery. This observation leads me
to the statistic of the week.

Statistic of the Week

According to Bill O’Neil,
“80% to 90% of investors lost 50% to 75% of their equity” since the bear
market began in March of 2000. Ouch.

The Bottom Line: Daytrade to your heart’s content,
but be very careful holding positions when there is no clear market trend and a
high level of uncertainty.

Sector Watch

The continued unraveling of the
telecom sector is becoming unnerving. Qwest
(
Q |
Quote |
Chart |
News |
PowerRating) and Sprint
(
PCS |
Quote |
Chart |
News |
PowerRating) are now facing very heavy cash flow concerns as short-term
borrowing becomes hard to get in the wake of the Enron accounting scandals. Nextel
(
NXTL |
Quote |
Chart |
News |
PowerRating) is looking more and more like a basket case rather than a tasty
takeover target. It still gets
worse before it gets better.

The key tech sector to watch
remains semiconductor manufacturing. An
upswing in the chip cycle will presage an upswing in the broader economic cycle. But semiconductor equipment makers will see their boost at
a  much later time coming as manufacturing won’t be investing in new equipment until well
into the recovery.

The Macro Data — Past and Future

Last week, consumer confidence was
the big bummer, but other reports provided more positive news. A slowing rate in the fall of industrial production was widely
interpreted as the manufacturing sector reaching a bottom and the Producer Price
Index showed no signs of any core inflation.

This week, the most important
report is likely to be housing starts. The
housing sector is one of the first to lead the economy into recovery, and
housing starts is one of the best leading indicators for the sector. Any negative surprise here would jolt the markets.

Another report of note will be
international trade on Thursday. Look
for falling U.S. exports for any sign of a deepening global recession. That means you have to look beyond just the trade deficit numbers per se
to how the deficit is shaped — imports vs. exports.

Macroplay of the Week: MKS Instruments (MKSI)

According to company material, “MKS Instruments is
the world’s broadest provider of process infrastructure products and
technologies that increase productivity in gas- and vacuum-based manufacturing.
The products realized from the manufacturing processes controlled by MKS’
products range from sophisticated semiconductor, data storage and medical
devices to optical coatings.”

As a macroplay,
(
MKSI |
Quote |
Chart |
News |
PowerRating) has two things to recommend it. First, it is diversifying nicely out of its core semiconductor sector
into not one, but two counter-cyclical sectors — biotechnology and
pharmaceuticals. Its new “HPS
Series 25 BioPharm Fittings” are designed and manufactured for the
biotechnology and pharmaceutical processing industries.

Second,
MKSI manufactures the kind of equipment that semiconductor manufacturers will
gravitate to the most as the new generation of “jumbo wafer” producers jump
into the next cycle. Jumbo wafers
cut costs by up to 30%. Companies
without the capability to make the jumbo wafers will have to turn to companies
like MKSI to boost productivity to compete.

The
technical analysis of MKSI looks very favorable and suggests a possible breakout
move. The stock is under
accumulation and all four key moving averages, 10-, 21-, 50- and
200-day, are stacked up nicely one on top of the other. Bollinger bands have narrowed nicely. 

Beware,
however, a high beta (1.99) and an average volume a bit lower than liquidity
thresholds would warrant (238,000 shares).

Fundamentally,
the stock looks only mediocre, with an IBD rating of a flat C, but that still
puts it at 19 out of 63 stocks in the sector.

TIP:
As you track MKSI, be sure to keep an eye on ASM International as well
(
ASMI |
Quote |
Chart |
News |
PowerRating).BOTTOM
LINE:
MSKI likely
goes nowhere without the broader market, so be very careful. Still, this is a stock that could lead the way if things turn up.

If you have a favorite macroplay
you would like me to feature in this column, send me an e-mail at pnavarro@uci.edu
or go directly to my web site https://www.peternavarro.com. I’d love to hear from you. If
you missed beta testing the Art of the Macroplay, you may also want to check out
my web site for bargains on the presentation.