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Bull Confirmed\?; Betting Against the Prince; Option Expense Perils

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Bull Confirmed?; Betting Against the Prince; Option Expense Perils

. . .And other tails of mystery and imagination. Well, not really. Originally, I'd planned to do a stream of consciousness tonight. But upon reflection I figured that a more meaty, concise, and focused effort would be more useful. After all, at the end of a stream of consciousness, the reader is usually unconscious, maybe even comatose with eyes glazed over. Besides, nobody likes a writer-induced nap, especially the writer with a deadline!

Anyway, three items have grabbed my attention lately. Today's confirmation of a Baby Bull is the most recent. But I've also been stewing a bit since last week on a Richard Russell (Dow Theory Letters) snippet I received from a trading buddy, and a longer-lasting topic of expensing options. On the latter, my focus has been in trying to answer the question as to why INTC and MSFT have declined to expense options in their income statement. None of this is rocket science, which we'll get to in a minute. But first. . .

Bull Confirmed?

We touched on this topic last week in the article about Baby Bull taunting Big Bear. If you missed it last week, t can be found here: http://members.OptionInvestor.com/options101/080802_1.asp. Anyway, strange as it may seem since I've been leading the secular bears' chorus for the last year and a half, today I can sing with the bulls. So how is that Fundamentals Guy drew this conclusion while building the ark for rough seas ahead?

Remember from last week, we know that cyclical bull markets can occur for weeks or even months within a larger bear market, and vice-versa (see 1997 and 1998). While cyclical markets do not reverse the bigger market trend, they can certainly trick a number of unsuspecting investors into believing that happy days are here again. Don't bet on it. As earlier noted, consider this a potential day of sunshine between storm fronts.

Now, about that sunshine - how do we know? Like last week, let's go the Dow chart.

Dow Industrial chart - INDU (weekly/daily/60):

First, with the weekly chart, we can see the continuation of green candles and continuation of the rising stochastic on both the 5 and 10 period lookbacks - bullish. Aside from that, we see the breakout of today's green candle on the daily chart - bullish. While the daily stochastic is bobbling a bit around overbought, doesn't that look promising? Careful. The 60-min chart shows an ascending wedge, usually considered bearish. But the 60-min chart deserves even more examination. Is it really bearish? Let's see by expanding it a bit.

Dow Industrial chart - INDU (60-min):

Hmmm. . .interesting. On the 60 min chart, the Dow is at a crossroads. We can't tell if the ascending pennant will drive the index temporarily bearish, or if the ascending wedge will drive the Dow bullish. Though we don't see it on this particular chart, the 50-dma is just under 9000 and could act as strong resistance. Should the Dow clear 9000, I would say the bull is confirmed.

Furthermore, the ascending lows tell us that the trend is back up, though one more decline to 8400 might signal the next bullish buying opportunity.

What else for evidence? Point and figure chart tells the same story with a triple top breakout. For traders, this isn't a daytrade event. But as a measure of risk and reward, the risk is now much reduced with the reward much higher thanks to the column of "X's". The math: 9 "X's" times a 50 point box times 3 equals 1350 points, plus 8450 equals 9800 price objective - bullish.

That doesn't mean it will get there and if it does, it won't do so in a straight line. But it is nonetheless bullish for the short- term investor. For the day or position trader, wait for the 3-box of "O's" pullback to line up with a stochastic oversold pullback to support.

Woops! This just in, Ralph Acampora has called a bottom to the market! For those who don't know Ralph, he was wrong at almost every turn over the last three years and quit making CNBC appearances because his prognostications became such a joke in the marketplace. He made a great contrarian indicator. Oh, well, maybe I should stay bearish %^)

Betting Against the Prince

What Prince? Prince Alwaleed bin Talal bin Abdulaziz al Saud, etc. of course. He's the Saudi Prince, who in most un-princely fashion bucked royalty to hustle large mid-east construction projects to earn his first billion dollars. From there he branched out into passive investing large dollars in U.S. companies, most notably Citicorp, Disney, and AOL, and in the not so notable Teledisic and Priceline.com. His wins in the first three make up for the losses on the latter two, though he would argue, ala Warren Buffet, that it isn't a loss until sold. He has been very successful in the real estate development business too. Anyway, I can't argue with a $10 bln (give or take a few) net worth. He has done well.

But I fear that his U.S. stock fortunes may be in danger, as may anyone's who also has a stake in C, DIS, or AOL. Here's the deal. There has been innuendo and scuttlebutt - the U.S. government has not done a good job of keeping this a secret - that we could freeze Saudi Assets in the U.S. as a penalty on the Saudi's (mostly royalty, but who's discriminating?) for "harboring and sponsoring" terrorist acts against the U.S. As a prince who earned his fortune the hard way, Alwaleed won't get any favorable treatment. I might add that 600 families of 9/11 victims filed suit against the Saudi government today seeking $1 trillion in damages. It's clearly heating up.

That said, if I were a prince, or any Saudi royalty for that matter, with assets about to be frozen in the U.S., would I sit idly by? I don't think so, Tim! I'd be getting those shares off shore or sold and taking the cash off shore, or partially sold and taking the cash off shore. Common element? Getting the holdings out of the U.S. Richard Russell brought this up last week, and it could amount to hundreds of billions of dollars or even $1 trillion. That is clearly not good for stocks in general just because of the sheer volume, but it might be particularly tough on C, DIS, and AOL (as if they didn't have enough troubles of their own) if word got out that the prince was selling. It won't matter why. When word gets out that a huge holder is liquidating shares, the twitchy are prone to sell now and ask questions later. . . something to think about if you own any of these three or others in which the prince is involved. Caveat Emptor.

Option Expense Perils

Here's something else that's been bugging me for weeks. That is, the failure of supposedly respectable companies failing to implement a policy of reporting employee stock options as an expense. While Coke and General Electric have taken the high road and announced their intent to expense options, Microsoft and Intel, most notably have stated their intent NOT to do so. Funny, this comes from respected tech companies who's earnings have taken a hit in the last 28 months.

Oh wait, did we just swerve into something noteworthy? Their earnings have taken a hit in the last 28 months without expensing options? By definition, wouldn't their earnings be lower than already announced, along with their guidance in coming quarters? Yes, is the correct answer.

Now here's something else I learned from John Mauldin in his August 1st letter (www.2000wave.com - a free read and worth infinitely more than every penny!):

"We did a simple spreadsheet. We analyzed the 15 largest NASDAQ companies, which represent about 37%, give or take, of the $2 trillion NASDAQ index. We input their 2001 pro forma profits, their real profits, the fair value of the options expense and then let the computer tell us what affect this would have on their Price to Earnings ratio (P/E). (I rely upon the Bear Stearns report for the pro forma earnings and options expenses. The rest is from Yahoo/Finance, or company reports.)"

"But as an example, Microsoft had pro forma (operating) earnings of $11 billion, and real bottom line earnings of $7.3 billion. They also had $3.3 billion of option expense. At today's price, they have a P/E of 34. Option expenses reduced their income by 46%. This would increase the P/E to 63, based upon 2001 earnings."

"For the group of 15 firms, total 2001 pro forma earnings added up to $25 billion. Real earnings were about half, or $13 billion. But total option expenses for the 15 firms were $12.5 billion. That means pro forma income was cut in half, and real, Honest-to-Pete profits were a mere $423 million, give or take a few million."

"These 15 firms have a total market cap of roughly $750 billion (the total value of their stock). That means the combined P/E ratio based upon 2001 earnings which deduct option expenses, and using their stock price today, is a little north of 1,789!"

"I should note that Comcast and Cisco do bring the average down. If you take away their $4.8 billion losses (after option expenses), the P/E after options expenses is a far more reasonable 142."

"I should also note that if you take away Microsoft, the combined earnings of the remaining 14 is a NEGATIVE $3.5 billion. That means 14 of the largest NASDAQ firms could not combine to make a profit, if you deduct the expense of their options. Seven of these firms had negative earnings once options were deducted."

There you have it folks; data to match your hunch. Collectively, these companies made no money even during their heyday. They are worse off now, and to expense options is to admit much lower (MSFT) or no (nearly all others) profitability. That, in my opinion is why we will not see tech companies expensing options anytime soon. Caveat emptor here too.

Tales of Mystery and Imagination

Just for fun, I have to share this e-mail I got from a good friend of mine who works in a publicly traded company that supplies industry, from high tech to low tech, with raw materials. Apparently they just got some new software! This is the Mission Statement:

"The Enterprise Design is an evolving sum of SAP functionality, configured for the processes that are intended to be globally consistent. We will use versions of the Enterprise Design to designate the addition of functionality as we build on to the design. Each version will have a defined scope, and eventually the Enterprise Design version "n" will be equal to the functionality envisioned in the Global Blueprint (the definition of Company X's intended end state scope of functionality for the entire business)."

Anybody get that? Me either. But it reminds me of a maxim noted by John Rutledge (money manager, economist, Forbes columnist) many years ago. "Every new buzzword introduced and used in the boardroom is good for a 10% decrease in earnings." Umm, lets see...Enterprise Design, functionality, global consistency, version "n", envisioned, Global Blueprint...look for earnings to fall by more than half! ;^)

That's it for now. Make a great weekend for yourselves!

Buzz



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