Thursday, January 18, 1996
MARKET CLOSE

INDEX:

I. Market News: Earnings Season Rolls On
II. Heroes: IBM, Caterpillar, Sierra Semi, Silicon graphics, Great Atl & Pac Tea, Raychem, Borland, Human Genome, Quintel, Firefox, Maybelline
III. Goats: ADVO, IMC Global, Vigoro, Broderbund, Sierra On-Line, Diamond Multimedia, Microtest, LanOptics, Adtran, Micro Warehouse, S3, Trident Microsystems
IV. Investment Perspective: More Market Barometers?
V. Calendar: Friday's Economic Events

MARKET CLOSE

DJIA: 5124.35 +57.45 (+1.13%)
S&P 500: 608.24 +1.87 (+0.31%)
NASDAQ: 1007.24 +8.94 (+0.90%)

MARKET NEWS

A big move for the Dow fell largely on the back of two earnings surprises (Caterpillar and IBM), but technology shares in select companies fared well today also. As usual during earnings season, company-specific news seems to drive the market movements more than macro-economic factors. So, despite the fact that we're starting to catch up on the backlog of government indicators, most of them are so out-dated that investors are ignoring them in favor of individual earnings stories.

HEROES

It was earnings reports that drove today's big winners, led by the Dow behemoth to top all Dow behemoths---IBM <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:IBM)") else Response.Write("(NYSE:IBM)") end if %>. Acting like a slick young tech stock, IBM shot up $8 5/8 to $96 1/4, a mere 10% one-day move. Analysts were not as excited as the Street, however, with Gruntal & Co.'s Roxanne Googin pointing out that third-quarter shipping delays caused $250 million in mainframe revenues and $100 million in disk drive sales to be booked in the fourth quarter, possibly accounting for 1.5% of the 6.0% estimate out-performance IBM reported. Chicago Corp.'s David Wu pointed out that IBM had a lower tax rate in the fourth quarter than a year ago---33.7% versus 41.5%---bringing the overall tax rate for the year down to 37.5%. That said, there was some good news; IBM's progress in completing its restructuring paid off, with its troubled PC unit showing the greatest improvement. Although staff cuts outside the U.S. are taking longer than anticipated, IBM's CFO said in a conference call today the company intends to make selective acquisitions in the computer software and services industry as well as continuing to fund its stock buyback with its ample cash flow, a positive sign.

IBM was not the only Dow stock aided by an earnings surprise today. Cyclical Caterpillar <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:CAT)") else Response.Write("(NYSE:CAT)") end if %> was up $5 3/8 to $59 1/4 on its surprisingly strong fourth-quarter performance. Caterpillar made $1.53 a share versus expectations of $1.25, compared with earnings of $1.38 a year ago. Analysts had been preoccupied with the recently ended strike, slowing global demand and currency fluctuations. From the "gosh, we thought they were cyclical" column came Sierra Semiconductor <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:SERA)") else Response.Write("(NASDAQ:SERA)") end if %>, up $3 to $15 3/4 on a 262% increase in net income from continuing operations, almost twice the Street's expectations. Sierra Semiconductor makes specialty chips used for networking applications and has been unfairly branded by the price erosion of commodity DRAM and SRAM. In the "not cyclical, but out-of-favor" column comes Silicon Graphics <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:SGI)") else Response.Write("(NYSE:SGI)") end if %>, rising $2 1/2 to $26 3/8 after the Street saw that earnings weren't as bad as they had feared. Silicon Graphics, which makes graphics-intensive applications/workstation packages, issued a high-profile earnings warning a few weeks ago, causing the stock to crumble.

Analysts were out in force today, moving and shaking stocks as they tread. DLJ pumped up Great Atlantic & Pacific Tea Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:GAP)") else Response.Write("(NYSE:GAP)") end if %> from "under-performer" to "market performer," causing the shares to rally $7/8 to $21. Why anyone would get excited because the stock was now going to match the market as opposed to trailing it is beyond us Fools. Raychem <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:RYC)") else Response.Write("(NYSE:RYC)") end if %> got the thumbs up from Merrill Lynch today, which raised the company from "near-term neutral" to "near-term above average"---maintaining the requisite "long-term buy" rating. (We wonder if they issue "long-term sells". If your time horizon is big enough, anything can be a buy.) Raychem beat the Street, raised its dividend pay-out 25% and saw the stock soar $9 1/2 to $62 3/4 for its efforts. Borland <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:BORL)") else Response.Write("(NASDAQ:BORL)") end if %> also got the thumbs up from Schroder Wertheim, which put it on its recommended list, vaulting the shares $1 15/16 to $17 1/8.

Staphylococcus aureus. Odds are someone you know has had an intimate encounter with this all-too-common bacteria. Staph aureus is the most frequent cause of infections in hospitals, also contributing to wound infections and toxic shock syndrome. As a hospital-based bug, this sucker has become resistant to conventional antibiotics as only the strongest strains have survived. This is why Human Genome Sciences <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:HGSI)") else Response.Write("(NASDAQ:HGSI)") end if %> rose $8 1/4 to $39 3/4 today---a 26% rise---when it reported that it had mapped out 99% of the genome sequence for Staph aureus. The hope is that this map will be licensed by pharmaceutical companies who will develop a better defense to this virulent bad boy.

You mean you didn't see this acquisition coming? Quintel Entertainment <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:QTEL)") else Response.Write("(NASDAQ:QTEL)") end if %>, up $1 1/4 to $8 3/8, snapped up the remaining 50% stake of Psychic Readers Network, issuing 3.2 million new shares and giving the psychics a 17.6% stake in the new company. Quintel offers "telephone-based entertainment services," which we assume is a euphemism for those pervasive 900 sex-chat lines that so many unsuspecting people get soaked for when their kids get phone happy. (FYI---you can ask your local phone company to block all 900 calls---something to consider even if you don't think you will ever need it.) Other acquisitions that the psychics might have foretold? Netware connectivity firm Firefox Communications <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:FFOX)") else Response.Write("(NASDAQ:FFOX)") end if %> climbed $1 1/2 to $10 5/8 after FTP Software <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:FTPS)") else Response.Write("(NASDAQ:FTPS)") end if %> made an offer of a one-to-one share exchange, and Maybelline <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:MAY)") else Response.Write("(NYSE:MAY)") end if %>, up $2 7/8 to $42 3/8 after German-based Benckiser topped Francophone L'Oreal's offer for the American cosmetics giant.

GOATS

Inability to find a buyer as well as disappointing earnings sealed the doom of ADVO Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:AD)") else Response.Write("(NYSE:AD)") end if %> today, with the shares plunging $3 3/8 to $20 5/8 on heavy volume. Takeover experts were bitter as they had been led to believe the direct-mail and marketing services firm stood a good chance of selling itself with the assistance of Goldman Sachs. In an attempt to appease the angry Street, the Board of Directors announced a whopping $10 per share special cash dividend. The theory is that shareholders will get to realize a significant portion of their share value in cash and will thus be mollified into holding the shares. The fact that the company is tapping into its lines of credit to do this, though, makes it a dubious enterprise.

Analysts were at it with the clippers today, snipping their ratings on stocks like IMC Global <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:IGL)") else Response.Write("(NYSE:IGL)") end if %>, down $3 3/8 to $34 3/4 after DLJ's Charles LoCastro downgraded the company on concerns of a build-up in phosphate fertilizer inventories. Fertilizer competitor Vigoro <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:VGR)") else Response.Write("(NYSE:VGR)") end if %> was down $5 to $54 1/2 in sympathy. A rumor that all the fertilizer ADVO's management fed the Street about a buyout being the source of the inventory buildup was quickly denied. Montgomery Securities was also active, slashing its rating on Broderbund <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:BROD)") else Response.Write("(NASDAQ:BROD)") end if %> from "buy" to "hold," causing the "edutainment" giant to slump $4 1/4 to $45 1/2. Sierra On-Line <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:SIER)") else Response.Write("(NASDAQ:SIER)") end if %> saw fit to choke $2 1/8 to $18 3/8, apparently in sympathy.

An "unexplained" inventory loss led to an easily understandable collapse in price for Diamond Multimedia <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:DIMD)") else Response.Write("(NASDAQ:DIMD)") end if %>, down $9 13/16 to $16 7/16 today. The manufacturer of add-on peripherals for IBM personal computers basically lost $2 million worth of inventories and had to take a write-down for it in the earnings they just reported. Overreaction? Youssef Squali of Laidlaw & Co. things so, although he dropped the stock from a "strong buy" to a "buy" just in case. Microtest <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:MTST)") else Response.Write("(NASDAQ:MTST)") end if %>, down $2 3/8 to $5 7/8, reported today that someone stole $2 million in profits from the company, but has yet to call the police to investigate the situation. Reporting that earnings would only be $0.04 a share this quarter, compared to $0.06 last year, the manufacturer of local area network (LAN) cable management, diagnostic and connectivity products was cut to "market performer" from "market out-performer" by Oppenheimer. Competitor LanOptics <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:LNOPF)") else Response.Write("(NASDAQ:LNOPF)") end if %> released a similar note about stolen profits, and fell $2 1/2 to $13 for its troubles.

Networker Adtran <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:ADTN)") else Response.Write("(NASDAQ:ADTN)") end if %> reported earnings of $0.22 a share today, right in line with estimates. So why is the stock down $9 1/4 to $34 3/4? The company missed its consensus revenues target, which apparently caused the so-called momentum investors to bail out of the stock. Adtran posted revenues of $50 million where analysts were looking for $52 million---ironically killing the stock for having better-than-expected margins. Revenues increased 3.9% from the third to the fourth quarter as opposed to a 5.6% increase last quarter. Beating consensus earnings and revenue estimates is no protection, though; PC-product direct mail seller Micro Warehouse <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:MWHS)") else Response.Write("(NASDAQ:MWHS)") end if %> was down $4 to $32, even though it beat all the Street's numbers.

Graphics-chip maker S3 <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:SIII)") else Response.Write("(NASDAQ:SIII)") end if %> beat consensus estimates by 4.5% but sold off, down $2 13/16 to $12 1/16, after Cowen & Co. analyst Drew Peck downgraded the stock from "strong buy" to "buy" on inventory concerns. This might incorrectly be connected to inventory concerns of one of its major customers, Diamond Multimedia (see above story). Inventories at S3 increased 428% to $43.3 million---a sizable jump, to be sure. The hangover from Intel's inventory problems is also probably riling the Street. Wall Street rounded up the usual suspects, pounding all graphics chip high-flyers like Trident Microsystems <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:TRID)") else Response.Write("(NASDAQ:TRID)") end if %>, which was down $4 to $15. Needless to say, this was not a good day for Running with the Market.

INVESTMENT PERSPECTIVE: The January Effect? Reality or Hooey?

The January Effect. The words have been whispered on the message boards as if they foretold the Second Coming. In the modern pantheon of investment gods, right next to the busts in the antechamber of Peter Lynch and Warren Buffett, sits an engraved stone tablet with those two words on it.

The basic thesis behind the January Effect belief is that, for some reason, small cap stocks tend to outperform the broader market during the month of January. Some market prognosticators have gone as far as to say that as January goes, so goes the year. Reams of statistics seem to back up both claims.

The evidence does seem incontrovertible. In "Stocks for the Long Run," author Jeremy J. Seigel says that during the 68 Januarys between 1925 and 1992, the S&P 500 had an average return of 1.6% while the average return on "small stocks" was 6.9%, a difference of 5.3 percentage points. For the same period, the S&P 500 showed an average annual return of 12.4% while small stocks tore up the track with 17.4%, a 4.8 percentage-point difference. This data would suggest that small stocks actually under-perform large stocks for the rest of the calendar year.

There are only six years in the 68-year period where small stocks got creamed by large stocks, although four of these were in the last ten years of the data---1982, 1987, 1989 and 1990. The January Effect, however, does not appear to have much endurance; the majority of the so-called "effect" happens in the first week of New Year's trading and is completely gone by the second week.

What are the potential explanations of this "effect"?

* The tax year ends in December and begins in January. Tax selling depresses issues at year end.
* Smaller capitalization stocks are disproportionately held by small investors due to the liquidity requirements of large institutions.
* Small investors are more sensitive to tax consequences than large institutions, meaning that smaller capitalization stocks are going to be sold more because of tax reasons in December.
* There is an influx of funds during the year-end season that gets invested early in January, as well as many individual investors' New Year's resolutions to "invest."
* Institutional window-dressing to dump losers before year-end reports show investors what dogs these funds really held in the past year.

The main quibble I have with the "January effect" is the data series being used. Small companies have a greater propensity to go out of business than S&P 500 companies. In many of the databases used to generate these numbers, the bankruptcies are cleared out of the system after they happen, eliminating any downward pull they might have exhibited on the returns of small cap stocks. The extinguishing effect in databases handicaps the S&P 500 significantly because S&P companies just don't go bankrupt that often, meaning the S&P has to keep all of its worst losers. I think the differential, while it exists, is not as great as it appears. My conclusion? Anyone who stakes their portfolio on small stocks doing better in January better reconsider. The real difference is probably 2-3% if the data were complete, nothing to get excited about if you are looking for high-octane gains in your portfolio.

This objection has done nothing to dim the popularity of the "January Effect" theory. The effect has become so darn popular it has given way to the "The January Barometer," the theory that "as goes January, so goes the year." A cursory glance at the S&P 500 data supports this claim. Looking at the numbers from Fosback's Stock Market Logic over the period from 1949 to 1975, January's result predicted the market 24 out of 27 years, a rate of 89%. However, to cheer a result as "accurate" when January is up 10% and the other eleven months were down, but not enough to sink the annual result, seems downright silly.

Correcting this and comparing January to the other eleven months reduces the correlation to 22 out of 27, or 81%. Given that the S&P 500 went up 20 of those 27 years *anyway*, though, you could have done almost as well just by saying the market would go up over the same period, regardless of what happens in January. Over a longer period---say, back to 1926, the January Barometer is only right 64% of the time, the same accuracy rate someone could have achieved simply by making an unrelated claim that the market will go up every year. Using a dradle would probably be just as accurate; anyone relying on the so-called "January Barometer" obviously is relying on hearsay and not the facts.

CALENDAR: Friday's Economic Events

---December Employment Report (8:30)
---Third-Quarter Gross Domestic Product---revised (8:30)
---Univ. of Michigan January Consumer Sentiment (10:00)
---Weekly Commercial/Industrial Loans (4:15)

Byline: Randy Befumo (MF Templar)