The Stock Market is Not the Economy

The Economic News Will Get Worse …

… But the Stock Market Might Not Care

Volcano Ready to Erupt?

I’m going to start this Cabot Wealth Advisory with a warning: Over the next three months, be prepared to see some of the worst economic data you’ve ever seen.

Why do I say this?  It stems from the only economic indicators I regularly monitor, from the Economic Cycle Research Institute. The firm basically invented the concept of leading economic indicators–the guy who started the popular monthly leading indexes for the U.S. government left decades ago, founded this firm, and took the process to a whole new level.

The company has dozens of indexes, but the main one I monitor is the aptly named Weekly Leading Index.  It has a great track record of telling us what the economy will look like in two to three months.

Here’s the whopper: This morning, the weekly leading index’s growth rate stood at a minus 24.6%.  And what exactly does that mean?  Well, not only has the rate fallen off a cliff in recent weeks, it’s also the lowest reading … ever!  And this is no small data series–ECRI says that its data goes back to January 1949, nearly 60 full years of information.  That tells me that the next couple of months should see the sharpest slowdown/recession in decades.

Thus, this morning’s unemployment report (240,000 jobs lost, on top of a downwardly revised 284,000 jobs lost in September) is almost surely just the tip of the iceberg.  I would venture a guess that we’re all going to be seeing some truly scary, once-in-a-lifetime readings on jobs, industrial production, economic growth, you name it.

Actually, that process is already underway.  Just this week, General Motors reported monthly vehicle sales of less than 200,000 for the first time in years.  The figure was down 45% from just a year ago!  GM Sales Chief Market LaNeve said, “In my 27 years in the industry, I’ve never seen a month like this,” adding that, adjusted for population growth, October was likely the single worst month for the auto industry since World War II.

Another example came last night, when networking behemoth Cisco sharply cut its guidance.  For the current quarter, it anticipates revenues will decline 5% to 10% from the prior year, compared to earlier estimates of a 6% gain.  It might not sound dramatic, but the difference is from $10.4 billion (analyst’s former estimate) to around $9.1 billion (the new guidance). 

If the Institute’s leading index is correct, and I believe it is, you should be ready for more such “worst in decades” readings in the weeks and months ahead. 

Now I’m going to continue this piece with another word of advice: You shouldn’t read too much into the coming economic data.

Why did I write about the approaching maelstrom if you should simply ignore it?  Because I want you to be prepared for some hugely worse-than-expected readings, and (more important) for all the hoopla and headlines that will surely come along with them.

What’s key to remember is that the market has already discounted much of the bad news you’re going to read about.  That’s why the major indexes are down more than 35% this year, and why they crashed in September and October.  That doesn’t mean the market will shrug off all the bad news–the big drop on Thursday after Cisco’s earnings outlook (along with horrible retail sales reports) attests to that.

My point is that the market is reacting to what the economic landscape will look like in six months, not the economic readings of yesterday.  And from that point of view, I continue to think there’s a good chance that the market is beginning a bottom-building process.

Despite the declines seen this week, most indexes are still well above their lows of mid-October.  And, more important to me, the market is now 20 trading days removed from its major October 10 low, when a still-unbelievable 88% of all NYSE stocks hit one-year lows.

Stocks could (emphasize could) be starting a re-test process, where the major indexes again fall back to their October 10 levels.  Historically, bear market bottoms see these re-tests, and they usually occur anywhere from 25 to 40 trading days after the initial low (October 10, in today’s scenario).  So we’re right on schedule.

Seeing this process unfold also makes sense because, to get a sustainable rally (if not a whole new bull market), you need leadership, which is defined by companies with solid sales and earnings growth, and whose stocks are well traded and have built solid launching pads.  Right now, there are just a handful of potential leaders–at the start of a big rally, you’ll see a couple dozen, with more emerging soon after.

A re-test, then, is not something to fear, but has historically been a necessary and (eventually) bullish event that’s led to a sustainable upmove.  The latest successful bottom/rally/re-test process came earlier this year, in January and March.  While that didn’t lead to a new bull market, it did lead to a two and a half month rise, led by commodity stocks, providing some nice profits.

Thus, on the indexes, here’s what to watch for: See whether the Dow can hold above 8,000 to 8,300 or so, and if the S&P 500 can hold the 850 area.  If they decisively break below those levels … well, then, just remain defensive, and be glad you’re holding on to your capital.

However, if the indexes do re-test those levels sometime in the next couple of weeks, sit up in your chair–the market may have laid the groundwork for a few good months ahead … despite what the economic indicators may say.

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As I’ve written many times, when looking for the leaders of the next advance, you want new stocks–or at least newer names–with strong growth and, preferably, new and revolutionary products.  It’s also a good sign if this stock has recently reacted well to its third-quarter earnings report. 

Volcano (VOLC) has all of these traits, and that’s why I’m watching it.  Here’s what I wrote about it in Cabot Top Ten Report on September 22:

“Volcano is looking to change the practice of ultrasound imaging.  Instead of using a wand outside the body, Volcano’s ultrasound catheters allow doctors to see blood vessels (and the plaque that blocks them) from the inside. These catheters don’t just take pictures; they can also distinguish one kind of plaque from another. Volcano sells consoles that display pressure and flow characteristics, then achieves additional revenues from the sale of single-use disposable catheters. At the end of 2007, the company had an installed base of 2,400 intravascular ultrasound (IVUS) consoles and over 800 functional measurement (FM) consoles. That’s not bad for a company founded in 2000. Volcano continues to develop and offer additional functionalities to its products, encouraging upgrades of existing equipment.  2007 was the company’s first profitable year, and earnings are still dodgy. But the small number of institutional owners is hanging tough, indicating some interesting potential. The company has been grabbing market share from Boston Scientific, and that’s expected to continue.”

On Wednesday night, the company reported another great quarter, as it indeed grabbed market share.  Revenues were up 40% to $44.1 million, thanks to a 78% jump in IVUS system sales and a 29% leap in IVUS disposable sales.  Earnings reached 6 cents a share, well above estimates, and management raised guidance going forward.

To me, the big-picture bullish statistic is that there are 6,000 catheterization labs (examination rooms in hospitals with diagnostic imaging equipment used in catheterization) in the U.S., Europe and Japan, and only 10% or so have IVUS systems. But that figure could jump to 90% within five years!  That spells huge, huge opportunity for Volcano.  The stock is still base-building, but if the market improves and VOLC can break above 19, it could be a big winner.

All the best,

Mike Cintolo

Editor’s Note: Michael Cintolo is the editor of Cabot Top Ten Report, and each week, no matter the market environment, his proprietary OptiMo stock screening software uncovers the stocks that are under the most accumulation.  The result: You get 10 stocks each week, along with reasons why the smart-money crowd is buying up the stocks.  And you also get suggested buy ranges and follow-up for every name, as well as the ability to email your questions directly to Mike.  If you want to be assured of knowing all the leaders of the next advance, you owe it to yourself to give Cabot Top Ten Report a try.


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