By Kopin Tan
STOCKS SNAPPED A FOUR-WEEK LOSING STREAK, but the less- than-snappy comeback heralds a new era of meeker expectations and more moderate gains.
In China, where the year of the bull gives way this weekend to a new Year of the Tiger, authorities again raised the share of deposits banks must hold on reserve. By moving to tame credit expansion, China shows the lengths it would go to preserve economic prosperity, even if it meant muzzling short-term growth. That curbed the enthusiasm for cyclical stocks, and crude oil pulled back Friday after a four-day rise.
In the U.S., the weight of expectation continues to drain any delight. So far, companies reporting fourth-quarter earnings have beaten estimates by a staggering 11%, near the highest on record. Hasbro /zigman2/quotes/201249319/composite HAS +4.93% (ticker: HAS) saw sales rise 12%, while Google /zigman2/quotes/205453964/composite GOOG +1.86% (GOOG) plans a broadband network. But a stock market that had already rebounded 70% wanted better surprises.
If last year's rally was propelled by anticipation of a swing from recession to recovery, 2010 has so far been all about the grim anticipation of muted growth under a regime of higher government deficits and rising taxes.
The Dow Jones Industrial Average emerged from its four-week slide with a restrained bounce, ending the week up 87, or 0.9%, to 10,099. The Standard & Poor's 500 rose 9 points, or 0.9%, to 1076. The Nasdaq Composite Index climbed 42, or 2%, to 2184, while the Russell 2000 jumped 18, or 3%, to 611. The dollar rose against the euro for a fifth straight week.
Since Jan. 19, the S&P has corrected 8.1%, or 9.2% from its recent intraday high to low. Roughly two-thirds of global markets have retreated 10% or more. Only one in every four U.S. stocks is still trading above its 50-day average, compared to more than 80% a month ago. With everyone awaiting a pullback, the huddle of investors who believe we're entering a full-fledged correction recently surged to 40%, the highest since 1983.
The question, of course, is whether these investors are done selling. Because the economy is still improving, and stock prices have moderated, JPMorgan strategist Thomas Lee thinks contrarian investors should scour for "post correction" stocks to buy. He screened for stocks favored by the firm's analysts that have fallen more than 15% from recent highs, and which sport targets more than 35% above current prices. His list of 24 stocks includes U.S. Steel /zigman2/quotes/200069642/composite X +9.33% (X), Alcoa /zigman2/quotes/200686102/composite AA +3.69% (AA), Owens Illinois /zigman2/quotes/200272047/composite OI +9.29% (OI), Qualcomm /zigman2/quotes/206679220/composite QCOM +2.92% (QCOM), Quanta Services /zigman2/quotes/203420082/composite PWR +3.34% (PWR), Freeport-McMoRan /zigman2/quotes/200215692/composite FCX +6.47% (FCX), Office Depot /zigman2/quotes/204015456/composite ODP +2.97% (ODP), and Invesco /zigman2/quotes/200294387/composite IVZ +8.89% (IVZ).
For all the fear about government defaults in Europe, it's a good sign that systemic-risk measures remain muted. But the ranks of stock-market climbers have thinned. A 9.2% pullback "falls short of the feeblest of corrections," notes Brown Brothers Harriman analyst Scott Davies, who's bracing for a 10% to 16% correction in the first half.
Luckily, "valuations aren't so out of whack that we'd expect the bottom to fall out," says Jack Ablin, Harris Private Bank's chief investment officer. For example, the market's earnings yield suggests the S&P 500 is about 9% undervalued relative to long-term triple-B-rated corporate bonds.
But momentum indicators ought to be closely watched in this churning, range-bound market, and the S&P 500 has recently slipped to just 7% above its 200-day average. If that edge shrinks below 5%, watch out.
Schweitzer-Mauduit /zigman2/quotes/208081440/composite SWM +4.18% (SWM), which makes tobacco paper and cigarette components, saw a third of its market cap go up in flames Thursday after a loyal, big customer, Philip Morris (PM), declared it would sample a competitors' wares.
Some traders smell a bargain. After all, the beloved stock had run up 251% last year and had swelled its fan base. Shares recently fetched 15 times projected profits, but now command less than 10 times, quite a markdown within 24 hours.
Schweitzer may represent good value, but there could be more swings in the short term. Founded in 1545 and spun out from Kimberly Clark /zigman2/quotes/201766540/composite KMB +1.13% (KMB) in 1995, Schweitzer has built a nifty little niche in pricier, value-added products like lower-ignition propensity (LIP) -- or less flammable -- paper and reconstituted tobacco leaf that better meet safety regulations. That helped it to snag a 36% share of the tobacco-paper market outside China, and expansion into emerging markets should help offset declining volume in the West.
By suing four rivals for patent infringement, Schweitzer is rigorously defending its turf -- although resolution may take two to four years. Philip Morris also says it intends to try just a small batch of competitors' product, so the direct impact is small -- for now.
But Schweitzer's five biggest customers drive 60% of its sales, and it's too soon to tell if other cigarette companies, all pressured by chastened smokers and dwindling volume to cut costs, will follow Philip Morris' lead in trying to stoke competition among suppliers. Street analysts also have yet to adjust their profit estimates, although Goldman Sachs on Friday slashed its target price -- from 96 to 47.