Johnson: Expectational Analysis

08/27/2004 12:00 am EST


Chris Johnson

Editor, The Winning Edge

"Our focus is on the sentiment of the market," says Chris Johnson, director of quantitative analysis with Schaeffer's Investment Research"We look for stocks that are either over-loved or over-looked over by the Street, to find opportunities to invest." Here are his latest favorite ideas.

"Our approachwhich we call Expectational Analysis recognizes that sentiment that runs counterintuitive to recent price and fundamental activity often provides trading opportunities. For example, we expect that a stock that has outperformed the market both technically and fundamentally, yet possess signs of continued pessimistic investor sentiment, to be one that would continue to perform strongly. The reverse is also true for stocks that we avoid.

"Much to the dismay of investors, the majority of 2004 has been spent in a tight trading range, offering little opportunity to those following the crowd. From a sentiment perspective, the market's trading range became the investor's own worst enemy, as some complacency found its way into the market, even as it traded in this range. The result, a psychological blow to the market as the major indices recently broke through the bottom of this long-term range instead of its top. Now the market has been put into the position of trying to fight its way back to the range levels or risk further downside potential. With fairly significant long-term technical resistance above current market levels, the latter seems to be the more likely winner in this coup. With the broad market direction offering little hope for the longs, investors are faced with a stock pickers game. The picks below are a few of those that I consider strong candidates for the rest of 2004, along with a stock to be wary of.

"Following our Expectational Analysis approach, Federal Express (FDX NYSE) is an interesting opportunity. Its current put/call ratio of 1.17 indicates that there are more puts open than calls on FDX, a sign of pessimism from the options market. Additionally, the number of analysts that rank FDX a "hold" outnumber the number of analysts recommending the stock as a "buy." This pessimistic sentiment is unwarranted, as the company has been a relative-strength leader for 2004. At some point, the negative sentiment will begin to change to optimism as the stock continues its drive higher. This paradigm shift will bring new buyers to the market for FDX.

"Another stock in a similar situation is Qualcomm (QCOM NASDAQ). The equity's current put/call ratio of 1.08 is higher than all others taken for the security over the past year. This pessimism has built despite the fact that the share price of QCOM continues to make new 52-week highs. With the majority of analyst rankings falling in the "hold" category, there is room for the analyst community to improve their view of QCOM, which would spark more buying of the stock. Recent short interest activity saw an increase of roughly six percent in shares.

"A stock currently at the other end of the sentiment spectrum is Microsoft (MSFT NASDAQ). Recent fundamental and price weakness has hit the software giant, which has also seen a huge amount of optimistic sentiment. Despite becoming a relative-strength laggard in the current market, sentiment on MSFT remains optimistic as its put/call ratio registers a reading of 0.59, indicating that there are nearly two times the number of calls open on MSFT than puts. This combination of optimism and struggling fundamentals/technicals results in MSFT being on my short list for stocks to keep at an arms length."

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