The Importance of Brand Name Watching
(April 24, 2005)
Dear Subscribers and Readers,
I hope my subscribers have all had a good week. It was a very exciting week last week, but as we know, exciting weeks usually provide only drama and a lot of losses. The key to making money in the stock market over the long run is to study it and individual stocks very well, take your position, and wait for your stocks to go up. If you're more of a trader, then put stop losses under your buy prices. Remember the 80/20 Principle that we discussed last Thursday morning? To be in the top 20% of all investors that make 80% of the profits, you have to remain unemotional. It is hard, I know, especially if you're watching the markets everyday. But you just need to do it, and one way to do it is to take positions that you expect to do well over the intermediate or long-run.
Readers who are familiar with our work could probably recall the tremendous amount of importance I put on the concept of "a brand name" when it comes to evaluating a company or an investment in a company. A brand name is part reputation, part familiarity - not to mention the unquantifiable/psychological thrills that a consumer gets when he or she purchases something that bears his or her favorite brand name (such as a Porsche or a LV handbag). The concept of the brand name first arose with the advent of advertising and mass media in the 1930s - further compounded by the advent of the 40-hour work week - which allowed consumers more time to enjoy the things that they bought (it is not a coincidence that Disney was founded during this time - as people were working too much to watch cartoons prior to the 1930s and as its major asset was its brand name). For readers who are interested in reading more about "branding," you can surf to the Interbrand.com website. The article on the Top 100 Global Brands is a must-read.
One of the important theses of this week's commentary is this: In a healthy, cyclical bull market, the shares of most of the biggest brand names or the fastest-growing brand names in America should be doing extremely well - i.e. the relative strength (vs. a major index such as the S&P 500) of most of these companies should be rising. At the very least, the share price of these companies shouldn't be falling. When I first started writing this week's commentary, I titled it "Industry Watch Update" but after some careful thought, I decided to change the gist of our commentary and re-titled it "The Importance of Brand Name Watching" instead. The reason: I believe that "brand name watching" in a cyclical bull market is even more important than watching the performance of specific industries (with the possible exception of the Philadelphia Bank Index in a reflation environment) - since these companies represent the best (in terms of both business model and the brightest talent) the United States has to offer. Before I go on to discuss the specific brand names that I have been watching, let's first look at last week's action in the stock market (this is supposed to be a lead-in, by the way). I will now go ahead and show you the daily chart of the Dow Industrials vs. the Dow Transports from January 1, 2003 to the present (note: this is the only regular chart I will show you this week since there is a huge list of charts I am going to show our subscribers this week):
As implied by the above chart, both the Dow Industrial and the Dow Transportation Average only sustained a weak bounce last week. In fact, if the huge rally on Thursday (which was the biggest rally in two years - readers should keep in mind that bear market rallies tend to be quick and ferocious while bull market rallies tend to be slow and steady) did not materialize, the Dow Industrials would have been down 136 points while the Dow Transports would have been down 60 points for the week. The downtrend still remains in play.
Now, for the main gist of our commentary: the action of major indices such as the Dow Industrials and the Dow Transports does not give the full picture of the stock market, i.e. the breakdown of the many important stocks and sectors over the last four to five months. More specifically, it does not show the break down and/or the underperformance of many important brand names, such as KO, MSFT, and IBM.
In the Top 100 Global Brands article written by the folks at Interbrand.com, Coca-Cola was ranked number one - with a brand name that is claimed to be worth $67.4 billion (or fully two-thirds of its market cap). We have discussed Coca-Cola in our commentaries before - sure, KO has had its own problems, but the lack of volume growth has continued, as evident by the latest quarterly earnings report from about a week ago. It should also be noted that Coca-Cola participated in the last bull market from the early 1980s all the way to the summer of 1998 - at about the same time the broad market topped, and right before the Russian, Brazilian, and LTCM crises. Following is a weekly chart of KO (and a relative strength chart which shows the price of KO vs. the S&P 500) from January 1, 2002 to the present:
Looking at the above chart, please note that KO actually topped out approximately a year ago, while relative strength vs. the S&P 500 topped out in July 2004. Can a cyclical bull market continue its bullish way without the participation of the company with the most valuable brand name in the world? We will find out soon enough, but I highly doubt it.
Our brand name analysis now brings us to Microsoft (MSFT). Again, MSFT has its own sets of problems and concerns (for example, the next version of Windows, Longhorn, isn't due until at least 12 months from now) but wasn't it just six months ago when all the analysts were falling over themselves declaring that MSFT would go to $30 a share based on the promise of a huge, one-time dividend? Moreover, MSFT is also firing on all cylinders on the search market, although it is still too early to say whether they will make any significant inroads into the search market which is currently dominated by Google and Yahoo. Another fast-growing market is the market for collaboration tools and software (which is growing at over a 20% annual rate if one excludes email as a collaboration tool) - and it seems like MSFT is gaining the upper hand in its current war with IBM over collaboration. And yet, the performance of MSFT's share price has been dismal. The share price effectively topped out in late 2004 on the news of the huge, one-time dividend and it is now trading below both its 20-week (I like to use the 20-week moving average as one of the trend indicators when it comes to looking at weekly charts) and 40-week moving averages:
Relative strength is nothing to write home about either. Sure, MSFT is most probably no longer a growth stock, but it is still one of the most recognizable brand names in the world and has one of the most dominant business models. When a dominant company such as MSFT underperforms, then it is certainly time to take notice.
The number three global brand name according to Interbrand.com is International Business Machines (IBM). As the following chart shows, the share price of IBM is now at its lowest level in over two years, after it released a disastrous quarterly earnings report on the afternoon of April 14th - as its earnings of 85 cents a share for the first quarter missed consensus estimates by five cents per share:
It is interesting to note that IBM, just flirting with bankruptcy in 1993, managed to fully turn itself around in the next couple of years and participated fully in the bull market of the late 1990s - finally topping out in early 2000. The fact that IBM is now underperforming says a great deal of what kind of market we are currently experiencing, in my opinion.
Speaking of IBM, remember my conjecture on Thursday morning and last week when I mentioned that the "current phase" (a phase which began when broadband prices plunged because of the bursting of the telecom bubble) of globalization may be over for now? Readers should know that both the concept of "outsourcing" and "offshoring" plays a great and increasing role with the advent of globalization - and which both play a huge role in IBM's business model today. The fact that IBM - a leading outsourcer and offshorer - is seeing a slowdown in both of these business segments reaffirms my "conjecture" that globalization may be slowing down for now. I will discuss this phenomenon in more detail towards the end of our commentary. For now, I would just say this: The underperformance of IBM - especially with its stock price being at a level not seen since October 2002 - does not bode well for the major stock market indices up ahead.
Skeptics may now say: Well, this is all fine and good, but what you just talked about may just be the three exceptions, even though they are very valuable brand names and are some of the biggest companies in both the United States and in the world. Perhaps in a year's time, all three companies are replaced by three different companies at the number one, two, and three spots? I bet the company which saw its brand increased the most (percentage-wise) in this list must still be doing well, right? How about if we look at the share price of that company?
Well, look no further, folks. The company that you're talking about is Apple Computer (AAPL) - a company which, according to Interbrand.com, saw its brand name increased 23.7% to $6.9 billion as of July 2004. Following is a similar weekly chart of Apple from January 2002 to the present, along with a chart showing its relative strength vs. the S&P 500:
This latest breakdown of AAPL is made all the more interesting even as the latest quarterly earnings report showed that profits increased nearly six-fold from a year ago and that they also beat estimates by ten cents a share. The disappointment, though, was over guidance, in that AAPL is now only projecting a profit of 28 cents a share in the fiscal third quarter, as opposed to 32 cents a share that some analysts were looking for. As the above chart shows, AAPL hasn't fallen below its 20-week moving average since October 2003, and it hasn't experienced such a dramatic decline in its stock price since 2002. Could the bear be finally coming back? The shares of AAPL seem to indicate so.
Perhaps APPL was just a fluke and a one-trick pony (I hardly think so, and iPod currently still enjoys widespread popularity)? Perhaps Steve Jobs is really overrated, you may say? Should we look at another growth company? Well, a company that also did astonishingly well in this survey was eBay - a company that made the top 100 list for the first time last year at the 60th spot. According to Interbrand.com, eBay now has a brand name worth $4.7 billion, just $15 million less than Gucci - a company that is over 80 years ago and which also has an internationally renowned name. As you can see from the following weekly chart, eBay isn't doing so well either. In fact, the fall of eBay began with its last earnings report back in mid-January:
The breakdown of eBay is ominous, especially given the fact that eBay does not really have any meaningful competition in the online-auction arena. Companies such as Overstock.com do not stand a chance. The true skeptic may now be saying: Well Henry, you have featured old and slow-crawling companies, and you have featured a volatile (Apple) and a new and probably unproven company (eBay). How about a genuine cult brand which demands unparalleled loyalty from its customers? How about, say, Harley-Davidson (HDI)? As the article from Interbrand.com states: "The CLASSIC EXAMPLE of a cult brand is Harley-Davidson. The 101-year-old brand gained 4% in value this year to $7.1 billion. Sure, there are new models like the sleek V-Rod line and fresh features aimed at wooing women, but the real buzz comes from the 886,000 members of the company-sponsored Harley Owners Group. They're the ones who organize rides, training courses, social events, and charity fund-raisers. They pore through motorcycle magazines and wear the Harley-branded gear to feel more like rugged individualists and outlaws when they hit the road on weekends. A quarter of a million of them descended on Milwaukee last Labor Day to celebrate the brand's centennial. No wonder more than half of new Harley sales are to current customers who are trading up. The brand is self-reinforcing." Given the extreme loyalty of the brand's customers, one would assume that HDI would be doing well, given the supposed strength in the current economy, right? Well, the following chart is saying otherwise:
Other names that fared well on the Interbrand.com study aren't doing so well either, as evident by the following Amazon and Yahoo! Charts. Note that the share price of Amazon actually peaked 18 months ago!
If Yahoo hadn't reported better-than-expected earnings and guidance in last week's earnings report, it too would've broken down decisively. However, please keep in mind that the bounce in YHOO was really not that strong. YHOO is one of the few stocks that still hasn't broken down that our subscribers should keep track of going forward in the next few weeks (Note: I bet if the study was being updated right now, Google would also be on the list. Therefore, investors should keep an eye on Google as well).
Starbucks, which saw its brand name increased in value by 12% in 2004 (but which saw its ranking drop from 93 to 98) has been one of my favorite stocks for the last five years. Personally, I frequent Starbucks quote often - I am known to go to Starbucks five to six times a week on average. As I noted on our MarketThoughts.com discussion forum, it is interesting to note that until three weeks ago, SBUX has not traded below its 40-week moving average since January 2003.
If last week's "A Turn in the Tide" commentary didn't convince you that we may be in for a more serious decline this time around, then hopefully, this week's commentary has been convincing enough. When the share prices of the biggest and the fastest-growing brand names in the world are collapsing right in front of our eyes, it is wise to sit up and take notice. I am surprised that not a single analyst that I know of has reported this fact in more detail.
Now, back to our previous discussion regarding the slowdown at IBM and the fact that it may also be a leading indicator of a potential slowdown in outsourcing and offshoring in general. Following are weekly charts of three of the most prominent outsourcers/offshorers besides IBM - Accenture (ACN), Infosys (INFY), and Affiliated Computer Services (ACS). While the following three stocks had not exhibit a similar breakdown pattern than that of IBM's share price, it is noteworthy that the shares of all three of the following outsourcing/offshoring companies have all underperformed or even broke down in recent weeks:
Whether this slowdown (in outsourcing/offshoring and perhaps in the world's economy) is only temporary still remains to be seen, but this author is already bracing for it, compounded by the fact that anti-trade policies are now being branded around the world and the fact that the world's major Central Banks are cutting back on liquidity. However, the final authority may actually be the Commodities Research Bureau (CRB) Index, as the performance of emerging markets around the world have traditionally had a huge correlation with the performance of the CRB Index. Following is a ten-year chart showing the performance of the CRB and the relative strength of the CRB vs. the S&P 500:
For now, the CRB is still above both its 20-week and 40-week moving averages - suggesting that the latest decline over the last couple of months is only a correction so far. My advice for the coming weeks: Watch the CRB Index very carefully! That being said, I believe the chances of the CRB Index confirming the underperformance of the global brand names and the outsourcing and offshoring companies are now pretty high.
This commentary is getting very long and tedious already, so I will just go ahead and spend a few sentences updating you on our most popular sentiment indicators. As discussed in our Thursday's commentary, the bulls-bears% differential in the Investors Intelligence Survey increased from 17.2% to 21.5% for the latest week - never giving us the hugely oversold sub-10% reading that we had been looking for. Similarly, the AAII survey also managed to work off its oversold readings - with the bulls-bears% differential increasing from negative 28% to positive 4% for the week.
The Market Vane's Bullish Consensus was the only sentiment indicator (out of the three that we watch every week) which saw its participants got more bearish, as the Market Vane's Bullish Consensus decreased from 64% to 59% for the week. Keep in mind that we haven't seen a sub-60% reading in this survey since late August 2004. Furthermore, the lowest reading in 2004 in the Market Vane's Bullish Consensus was a reading of 56% - registered in mid-August 2004.
My guess is that the bounce in both the Investors Intelligence and the AAII is merely a bounce - and does not indicate a convincing reversal in the percentage of bulls and in the stock market. Moreover, this author would still like to see at least a sub-56% reading in the Market Vane's Bullish Consensus survey before we would consider going long in our DJIA Timing System.
Conclusion: Our message still remains the same. The short-term trend still remains down. Although I am now looking for a short-term bottom in the major indices pretty soon in terms of time frame, that short-term bottom may still be a long way away in terms of absolute points in the major indices such as the Dow Industrials, the Dow Transports, the NASDAQ Composite, and the S&P 500. For now, remain in cash - as the collapse of the major global brand names is a significant, ominous development - a development which is very extraordinary and which hasn't occurred since the cyclical bear market which began in early 2000 and ended in 2002. Translation: The latest decline may not be your average run-of-the-mill cyclical bull market correction which we witnessed so many times during 2004. Finally, the slowdown in the outsourcing and offshoring businesses is now evident and the possibility that we may now be near an end in the current phase of globalization (and a world economic slowdown) is now close to being realized.
Best of luck to our subscribers in the coming week!
Henry K. To, CFA