Saturday, July 21, 2007

The Trader: Get Ready For A Rougher Ride On The Bull

Barron's The Trader: Get Ready For A Rougher Ride On The Bull

   (From BARRON'S)
By Kopin Tan

The Dow Jones Industrial Average took 126 days to move from 12,000 to 13,000, and then just 58 days to zoom to 14,000. What are the odds it'll make 15,000 in time for . . . Thanksgiving?

That collective chortle you hear is one reason why Dow-15,000 cheerleaders -- yes, new uniforms have been ordered, again -- believe what sounds improbable isn't entirely impossible.

After all, stocks managed to rally in the face of hostile energy prices, rising interest rates and a debilitating housing market. But even if the next leg up doesn't depend so much on cooperative conditions, it will hinge on investors' willingness to continue to give the market the benefit of the doubt.

That willingness was tested Friday, a day after the Dow reached 14,000, when stocks pulled back from a three-week-winning streak and traders heaped blame on China's decision to raise interest rates, as well as disappointing earnings reported by Caterpillar (ticker: CAT) and Google (GOOG). But those are just the convenient culprits.

"We're at the point in the mature cycle where we all know excesses have been built up, and everyone is watching for signs that point to the end of the cycle," says Jeffrey Kleintop, chief-market strategist at LPL Financial. "The market's perspective will get even more short-term from here, and the bull will be a rougher ride."

That volatile bout of profit taking took the Dow down 56, or 0.4%, for the week, to 13,851. The Standard & Poor's 500 reached a record 1553 Thursday but ended the week down 18, or 1.2%, at 1534. The Nasdaq Composite Index slipped 19, or 0.7%, to 2688, while the Russell 2000 fell 19, or 2.3%, to 836.

Because bulls' faith has been so richly rewarded for so long, it likely will continue to be extended -- until one day when it is betrayed.

So far, housing weakness has made every watch list, as have potential inflation, slowing U.S. growth and the sliding dollar. The subprime-mortgage crisis? Flagged again by the Federal Reserve just last week. "Credit stress related to resets of subprime mortgages will not become significant until later this year," cautioned J.P. Morgan's strategists in a note. In fact, the worry list is as swollen as the ranks of bears who drove New York Stock Exchange short interest to nearly 13 million shares in July, the fifth monthly record in a row.

But if such vigilance ultimately limits the sting of downside shock, the market also isn't nearly as bearish as contrarians claim. Bullish option bets are increasing. Many money managers say they would not be surprised if stocks suffer a correction -- nothing too serious, of course -- but most still expect the market to finish the year securely higher. This smug consensus increases the likelihood that an already identified peril might still worsen enough to unsettle, if not exactly shock.

A recent pulse-taking shows what quickens traders' heart rates. In a Merrill Lynch survey of 186 global-fund managers this month, 72% believe credit or default risk posed an elevated threat to financial-market stability. That was followed by monetary risk (44%), geopolitical risk (39%) and protectionist risk (38%). Curiously, business-cycle risk worried just 8% of the crowd.

None of this surprises anyone watching the recent drubbing of financial stocks and the stampede toward cyclical sectors. But it "begs the question: Just how long can the business cycle decouple from rising credit risk?" asks Merrill equity strategist Karen Olney.

As confidence about global growth rises, the cadre of respondents overweight cash also relaxed from 18% in June to 13% this month, and average cash balances sank to 3.4% -- the lowest in more than three years.

Another telling thing: two-thirds of fund managers expect stocks to become more volatile over the next year, but remain optimistic -- evidence investors are still giving the market the benefit of any doubt.

Is there a more unloved group right now than regional banks? The triple threat of subprime contagion, rising defaults and uncertain interest rates dogs the entire sector, but that's not all People's United Financial (PBCT) struggles with.

The 165-year-old Bridgeport, Conn., parent of People's Bank went public in April when it converted from a mutual-holding company -- just in time for the subprime saga and the exodus from financial stocks. Its bland, blah name doesn't cram easily into headlines, and even a $3.4 billion IPO failed to score much press.

The neglect is perplexing given the company's heft ($5.3-billion-market cap, $14 billion in assets), sound balance sheet ($2.1 billion in excess capital), and very promising prospects.

But that's not all. No props were given to a communicative management that has earnestly alerted investors of its intention to do a deal. So when People's recently announced a $1.9 billion agreement to buy Chittenden (CHZ), a complementary Vermont bank that will add another $8 billion in assets, "surprised" investors puked up more shares.

As a result, the stock has slid 16% over three months to about 17.90 -- a good-entry point for many reasons. Its stronghold in Connecticut's moneyed, suburban sprawl is miles from the housing woes of Florida, Nevada and California. "Excellent core deposits and strong funding rates make it a lot less dependent on interest rates," says Anton Schutz, who manages the Burnham Financial Services Funds and who has been adding shares.

Valuation also is attractive, with shares trading at 1.8 times book value, or 19.6 times forward earnings. Those profits will be further boosted next year after People's absorbs Chittenden, which has 133 branches throughout New England. Stifel Nicolaus says the stock is worth 24.

With the merger, People's takes another step toward building a stalwart banking platform in the Northeast. True to its New England roots, management has under-promised on likely cost saving, and such stoic reserve improves the odds that future surprises will be happy ones.

Concerts for a cause have only gotten bigger 22 years after Bob Geldof's musical group hug for Africa, and on the calendar rarity that is 07/07/07, Live Earth staged a "concert for a climate in crisis" over 24 hours on seven continents. But there was only one place fans could go to catch Linkin Park in Tokyo, Duran Duran at Wembley and the Police at Giants Stadium: the Internet.

To manage traffic to, the climate alliance turned to the king of content-delivery networks: Akamai Technologies (AKAM). The Cambridge, Mass. company has a dominant share of the growing CDN market. Yet shares have fallen 15% since February as other tech stocks surged.

Grand expectation is one factor. The stock sold off in April after Akamai reported a 63% profit jump but kept its forecast conservative. Investors expect a strong showing when Akamai reports earnings Wednesday, but a cautious outlook and any ensuing selling could open a door for longer-term investors.

Recent competitive concerns are valid, but overdone. Rivals like the newly public Limelight Networks (LLNW) offer a viable, cheaper alternative. But Akamai has a vast global network of more than 20,000 servers that often sit on providers' premises, and offers speedy and guaranteed delivery for which customers willingly pay a premium. That's one reason why clients from Apple (AAPL) to Yahoo (YHOO) turn to Akamai. The NCAA's pick for streaming March Madness to all those home (and, okay, office) computers? Akamai.

At about 49, Akamai shares trade at 29 times forward earnings -- still reasonable given its product sweep and early-mover stronghold in this fast-growing market.Friedman Billings Ramsey has a price target on the stock of 64.

Analysts see profits rising from 88 cents last year to $1.28 in 2007 and $1.71 in 2008, and such projections could easily be met -- or exceeded -- in the tectonic shift to distribute all manner of media online. For a computer-savvy generation unabashed about sharing all aspects of their lives with friends (or just friends-to-be), the world is a stage, and Akamai is the stage manager.

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