Hectic price fluctuations are ahead, and the prudent investor has to be open to change.
In late May, Prime Computer was selling on the NYSE at 49 1/4. By early July, its price was 26, down nearly 50% in about six weeks. That's what's called a "shakeout" in Wall Street parlance.
A shakeout, however, is not the market strategy engineered by the "big boys" that it may seem. Rather, it is an unplanned exodus from a high-flying stock by "smart money" that bought it much earlier, patiently rode the up-trend, and now is cementing profits as the stock falters.The sudden and sharp reversal in the price of an erstwhile winner is called a shakeout because at the same time that smart money is abandoning the stock with profits, dumb money is bailing out with losses. Dumb money was pumped into the stock at exorbitant prices late in its move by people who at last couldn't resist its skyward sweep and figured it would go up forever. But such investors are easily scared out when reality dawns many points lower; if greed told them the price would keep rising, fear dictates it will go unimaginably lower. Many who chased the stock upwards now dump it, considering themselves lucky to still have their shirts.
At this stage, smart money (investors who are willing to buy a stock at low prices because they are confident the price is too low) has a look again at Prime Computer, and maybe they will just take all that panic-driven stock off dumb money's hands as a "favor." So what a shakeout accomplishes is to drive weak holders out and quickly put the stock back into strong condition preparatory to another intermediate-term rise.
To be sure, Prime was a special situation (the resignation of its chief executive officer trimmed off 6 3/8 points in a single day), but the June high-tech market was ripe overall for a decline, and Prime was on its way down anyway.At their June highs, just about everyone figured the bullish action was in technology stocks, and the stock market never does what everyone thinks it will. One of the best indicators of what everyone is thinking is to stand around a public quotation machine and watch which symbols are being punched in. If the public is staying with Sears, Natomas, and Procter & Gamble, all's right with the high-tech world. But if you start to see TNDM, CULD, and other such once-undiscovered companies showing up on the screen, you are being told that it's time to pull in bullish horns in that entire sector of the market. Indeed, as Prime was shedding 23 1/4 points ostensibly on adverse news, Tandem dropped some 19 and Cullinane about 20 without any help at all: And there were scores of other sizable declines as well.
Spying on Quotrons to sample the hopes of the man-in-the-street is this department's own rather basic but revealing method of analysis. In June, just before price collapses such as those cited above, there were also more traditional technical measures. For example, one reliable contrary-opinion indicator (a statistic based on market sentiment that is usually wrong, such as public odd-lot short-selling at the start of a bull market) has to do with institutions -- mutual funds, bank trusts, and the like. As professionally managed as they are presumed to be, institutions have rung up an unenviable record of being wrong at most market turns. Like the small public investor, the typical institution prefers to wait to make sure prices are rising before committing cash to the market. But that's not how the game should be played. By the time there's "proof" that stocks are in unassailable uptrends, smart money has been in for some time, and it's too late. When institutions or the public begin to chase stocks higher, that's when the rest of us ought to be selling. In June, institutional liquidity dropped to a four-year low, close to 10% of cash to total assets, showing that most of their funds were committed to the assumption that there would be a continuing bull market in stocks.
Another technical sign among the many was a surge in American Exchange specialist short-selling, denoting that these savvy professionals dealing with the more speculative issues on the Amex were convinced prices were about to fall.
But will the same sort of technical signs, only in reverse, tell us when to buy again?
This is a question that must be carefully considered. For one thing, technical analysis itself is undergoing change, if for no other reason than that it, too, is becoming a contrary indicator. Once everyone starts following the same information, as more and more are doing with home computers, the information becomes self-defeating. You can't act in concert in the stock market; somehow you have to place yourself against the crowd.
Also changing is the focus of the market. This department has already pointed out the irrelevance of today's price/earnings ratios. For example, the DJI and the S&P 400 have on average been in downtrends for years (the former has gone from 12 to 8 in five years, the latter from 10.4 to 9.4), while in the first six months of 1981, multiples of technology stocks generally doubled, to about 30. Again, two separate markets are developing.
Technical analysis may continue to have something to say about the components of supply and demand that lead to rising and falling prices, but it has yet to deal with the nature of major price declines in small growth stocks that have been at the heart of today's large stock market profits. The fiscal fact is that most of these companies can repeat their growth rates, perhaps not at the same steep slopes, but with sufficient increments to account for high P/Es. Smart money already knows that certain companies are simply too dynamic not to buy again, no matter what. And then (if it hasn't already happened) there'll be fresh price surges as confident investors rush back in. The saucers, triangles, heads-and-shoulders, and so on that technical analysts are enamored of will be less and less meaningful as a different pattern of buying and selling among such issues takes hold.
One reason that small growth companies will be able to keep themselves above the old-style bull market vs. bear market fray is that they already are changing the nature of investing. Except for a few flare-ups in the mid-1960s, for instance, Wall Street has never felt such intense heat as 1981's new-issues market has generated. IPOs frequently have been launched well above their prospectuses' preliminary estimated range, and have opened still higher in the aftermarket. For instance, Data I-O's prospectus proclaimed a maximum of $19 per share. But the issue came at 22 and first-traded at 28 over-the-counter. Micom, yet another vigorous growth situation, was initially indicated at 23 to 27, came out unabashedly at 30, and opened trading at 35 1/2. Crowth stocks are in demand -- that's a plain and simple fact of Wall Street. And when prices fall, smart money is going to become aroused.
Another recent departure of growth companies from traditional Wall Street modes was first noted by Equity Research Associates' John Westergaard: When a small growth company announces an additional stock flotation, its price tends to rise in the market. By the rules of the old game, threatened per-share earnings dilution would cause a stock to fall. What this about-face suggests, Westergaard concludes, is that the market "was realizing that small companies were worth more if they could demonstrate a capacity to raise equity capital and that the raising of such capital would not dilute earnings but would in fact accelerate earnings growth."
To this observation should be added that the ability to succeed in equity funding means a small, growing company with a need for working capital can afford to thumb its nose at interest rates -- an attitude not even giant corporations dare strike these days.
To stay ahead of the crowd that is always wrong, investors must make themselves aware of change, and be willing to commit to it. It may be a bit early this time around to abandon old ways altogether, but there's little doubt that the stock market is in flux, and technical analysis is becoming shaky. The wise investor will learn to read balance sheets and P&L statements, to evaluate product lines, and to understand industry groups and their future prospects. It's back to basics, but in a way that appreciates how smart money and dumb money will be tracing new chart patterns in certain stock trading.
The "action" is not going to leave high-tech and specialty growth companies in the near future. But their ups and downs are apt to get a lot more frenzied in coming months. Until this group matures and settles down into middle age, two basic investment rules apply: Don't chase high prices, but be willing to get back into shaken-out stocks even if the technical patterns have little to say.