Seven Stocks With Animal Spirits the Specs will be Buying

By Victor Niederhoffer and Laurel Kenner

Far from the madding crowd’s ignoble strife

Their sober wishes never learned to stray

Along the cool sequestered vale of life

They kept the noiseless tenor of their way.

--Thomas Gray.

“Give us some more stocks we can make a killing on. Forget all that folderol you're always giving us about sociology, the arts, and baseball. We’ve got to get even".

That's the gist of the message we're hearing more and more from our readers these days. Especially now that their friends, or at least their acquaintances, are making fantastic gains in the last 45 days or so.

Yes, indeed. From the dusty badlands of the Mississippi to the svelte corridors of Wall and Main, the animal spirits are rising. The Speculators themselves are suffused with these spirits, and plan to buy the following 7 stocks:

Redback Networks

Lucent Technology

ADC Telecommunications

American Tower Corp

Nortel Networks

Crown Pacific Partners

Oak Technologies

As with most things, however, the road is much better than the destination itself, and therefore we invite you to join us as we recount our counts.

Whether it be the last month of the year, or the last week of the year as a precursor to the January effect, it is hard to deny that the season of bullishness is imminent.

The Speculators took out the pencil and envelope to ascertain exactly what the yearend tendencies are regarding animalistic spirits for the last 10 years. The results show two distinct patterns.

1. The S&P 500 index has closed up at a 90% rate in December over November. The Nasdaq Composite, when going up, climbs with greater ferocity. In January, the roles seem to be reversed – while the S&P 500 index is up over December an appreciable 78% of the time, the Nasdaq is up a more consistent 83% of the time – and with higher returns to boot.

2. The first week of January shows the real optimism with investors sending the Nasdaq up more than 3 times the comparable move of the S&P 500 index. It would seem that the slates are wiped clean, investors are willing to give risk a chance, and the sense of optimism yields a spring in the step in the middle of winter.

NASDAQ 100 CASH INDEX, SP 500 CASH INDEX.

PRICE CHANGE - LAST WEEK OF THE YEAR OVER THE PENULTIMATE WEEK

Week Ending	NDX Close	Weekly % Chg	SPX Close	Weekly % Chg	NDX over SPX
12/28/1990	199.42	-1.64%	328.72	-0.91%		-0.73%
12/27/1991	316.775	7.08%	406.46	5.02%		2.07%
12/31/1992	360.185	0.73%	435.71	-0.92%		1.66%
12/31/1993	398.28	2.04%	466.45	-0.20%		2.24%
12/30/1994	404.27	0.78%	459.27	-0.12%		0.90%
12/29/1995	576.23	-1.53%	615.93	0.65%		-2.18%
12/27/1996	835.19	0.14%	756.79	1.06%		-0.92%
12/26/1997	954.07	-1.63%	936.46	-1.09%		-0.54%
12/31/1998	1836.01	1.66%	1229.23	0.24%		1.42%
12/31/1999	3707.83	3.27%	1469.25	0.75%		2.53%
12/29/2000	2341.7	-3.88%	1320.28	1.10%		-4.98%
12/28/2001	1621.13	2.72%	1161.02	1.41%		1.31%

Average Price Chg		0.81%		0.58%		0.23%
Stdev		2.76%		1.57%		2.11%
% Pos		67%		58%		58%
Z		0.08		0.11		0.03

FIRST WEEK OF THE YEAR OVER THE LAST WEEK OF THE PREVIOUS YEAR

Week Ending	NDX Close	Weekly % Chg	SPX Close		Weekly % Chg	NDX over SPX
1/4/1991	196.825	-1.30%		321	-2.35%		1.05%
1/3/1992	334.825	5.70%		419.34	3.17%		2.53%
1/8/1993	365.54	1.49%		429.05	-1.53%		3.02%
1/7/1994	404.78	1.63%		469.9	0.74%		0.89%
1/6/1995	401.59	-0.66%		460.68	0.31%		-0.97%
1/5/1996	565.14	-1.92%		616.71	0.13%		-2.05%
1/3/1997	848.08	1.54%		748.03	-1.16%		2.70%
1/2/1998	1008.23	5.68%		975.04	4.12%		1.56%
1/8/1999	1973.66	7.50%		1275.09	3.73%		3.77%
1/7/2000	3529.6	-4.81%		1441.47	-1.89%		-2.92%
1/5/2001	2267.85	-3.15%		1298.35	-1.66%		-1.49%
1/4/2002	1675.03	3.32%		1172.51	0.99%		2.34%

Average		1.25%			0.38%		0.87%
Stdev		3.64%			2.17%		2.11%
% Pos		58%			58%		67%
Z		0.10			0.05		0.12

The results suggest that a pairs trade of long the Nasdaq short the S&P would be appropriate as of November monthend. However, The Speculators eschew a pairs trade as an equivalent to betting on a favorite to show, in a horse race.

And the monthly:

SP 500 CASH Index, NASDAQ COMPOSITE Index % Change in December over November 1984-2001
Monthend	NAZ COMP	Monthly %Chg	SPX Close	Monthly %Chg	NAZ OVER SPX
Dec-84	247.1	1.94%	166.26	1.64%	0.30%
Dec-85	324.9	3.47%	211.28	4.51%	-1.03%
Dec-86	348.8	-3.00%	242.17	-2.83%	-0.17%
Dec-87	330.5	8.29%	247.1	7.29%	0.99%
Dec-88	381.4	2.66%	277.72	1.47%	1.20%
Dec-89	454.8	-0.29%	353.4	2.14%	-2.43%
Dec-90	373.8	4.09%	330.22	2.48%	1.61%
Dec-91	586.34	11.92%	417.09	11.16%	0.76%
Dec-92	676.95	3.71%	435.71	1.01%	2.70%
Dec-93	776.8	2.97%	466.5	1.02%	1.95%
Dec-94	751.96	0.22%	459.27	1.23%	-1.01%
Dec-95	1052.13	-0.67%	615.93	1.74%	-2.41%
Dec-96	1291.03	-0.12%	740.74	-2.15%	2.03%
Dec-97	1570.35	-1.89%	970.43	1.57%	-3.46%
Dec-98	2192.69	12.47%	1229.23	5.64%	6.83%
Dec-99	4069.31	21.98%	1469.25	5.78%	16.19%
Dec-00	2470.52	-4.90%	1320.28	0.41%	-5.31%
Dec-01	1950.4	1.03%	1148.08	0.76%	0.27%

AVERAGE		3.55%		2.49%	1.06%
STDEV		6.34%		3.24%	4.50%
% POS		67%		89%	61%
Z		0.13		0.18	0.06

As far as we can see, there are two major reasons for the return of the animal spirits. First, since October 9 to last Friday November 15^th, i.e. within the last 7 weeks, there has been a profusion of incredible rises in individual stocks. For example in the S&P 600 Small Cap Index, more than 65 of them have gone up at least 50% in that period, and only about a hundred of them are down anything at all during that period.

Here are the 10 biggest gainers among them, all up ten fold or more:

S&P Small Cap 600 Index Top 10 Gainers from Oct 9 2002 Close
Ticker	Name	10/09/02	11/15/02	% Chg
		Close	Close

SML	S&P 600 Index	170.73	197.04	15.4%

RNBO	Rainbow Technologies Inc	2.91	7.92	172.2%
ATSN	Artesyn Technologies Inc	1.18	3.17	168.6%
BELM	Bell Microproducts Inc	3.61	8.12	124.9%
HLIT	Harmonic Inc	1.03	2.29	122.3%
SWKS	Skyworks Solutions Inc	4.16	9.039	117.3%
KOPN	Kopin Corp	2.51	5.36	113.5%
MESA	Mesa Air Group Inc	2.93	6.18	110.9%
AEIS	Advanced Energy Industries Inc	6.18	13	110.4%
KLIC	Kulicke & Soffa Industries Inc	1.95	4.01	105.6%
MANH	Manhattan Associates Inc	12.94	26.43	104.3%

Source: Bloomberg LP

The other reason is widespread knowledge concerning the January effect - the tendency in us for increased risk-taking near the end of the year. The one effect that is most clearly documented in this regard is the January effect. As the great sages, the keepers of the flame, the scorekeepers, the authors of the best book on investments ever, Triumph of the Optimists, Elroy Dimson, Mike Staunton and Paul Marsh clearly document: “Small cap stocks in Jan in the United States go up on average some 6%, more than the averages. These results however, are not for all countries and seasons.”

Professor Dimson kindly updated his work on small caps as follows in an email interview:

"Our evidence is that seasonality in the small cap premium is an effect observed in the United States but not universally. Tech stock performance has strongly influenced the effect in both the small cap

and big cap sector."

Our own research on price as a predictor of subsequent performance was reported in our June 21, 2001 article “5 high priced stocks ready to shoot skyward” (also available on the Daily Speculations website). Based on a complete enumeration of 20000 company years over a 15 year period using data from Value Line, we found that the correlation between the price of a stock at the end of a calendar year and the stock’s price appreciation in the first quarter of the next year was a significantly negative 0.09. In other words, the lower the stock price by December 31, the better the subsequent performance by the end of the first quarter in the next year.

Academic research on the relation between the current price level and price appreciation is scanty. The best we saw after an extensive search was the paper "January Effect – A Re-Examination” by Honghui Chen and Vijay Singal. Taking account of the tax regime change affected in 1986 under President Reagan, they study the potential for tax loss selling for each year from 1987 through 1998. They conclude that the January effect is caused by tax related selling. Tax loss selling occurs in December as investors sell those stocks with capital losses as an offset to those with capital gains, and that "in January, these losers earn high returns because the selling pressure has ceased, resulting in the January effect". In particular, they find that the stocks in the highest quartile of those having potential for tax related selling earn 6 percentage points less in the last 5 days of December than in the first 5 days of January.

Our friend, the erudite statistician and reader Mr. Martin Knight augments this explanation:

“Tax loss selling in December is mostly done by individuals (institutions do it in October) and so is concentrated in small cap stocks, particularly value, so general indexes like the S&P are not a good measure. It's an excellent strategy in some years (like December 2000) but not last year and I would doubt this year either.

For a truly profitable tax-loss season you need some combination of 3 factors:

1. Gains in some stocks elsewhere to motivate the tax selling in the first place.

2. Total despondency in a sector if not the general market, a feeling that the shares might never come back.

3. Moderate success of the strategy in the recent past otherwise too much money will be there buying to cancel out the selling.

At the end of 2000 we got the first one and the other two to an extent while in 2001 we got none of them. You could say that 2001's December was in September for an obvious reason.”

The greatest practical forecaster of all time, Sam Eisenstadt, Value Line’s Chairman of Research for the last 50 years has another explanation for what's happening. We spoke standing at the corner before the Blue Hill Troupe's magnificent performance of the Most Happy Fellow on Saturday, 16 November, and he opined: "The strong performance of animal spirit stocks recently is anticipation of the January effect. If December continues to display this characteristic, it'll move into November. Indeed, it seems to have moved into as early as October this year. This is normal behavior for a seasonal that everyone is aware of. I suspect in time it will disappear altogether".

The Speculators are always happy to stand on the shoulders of grandmasters like Messrs Dimson and Eisenstadt. However, they are not immune from certain animalistic passions of their own -.they like to count and speculate themselves. Along these lines, they have over and over again made big profits by buying low priced stocks at propitious occasions. Perhaps their best foray here came when they bought and recommended a basked of beaten down internet stocks in early 2001, and sold them after a month for an average triple digit actual gain. (Their purchases of low priced biotechs in the last year, however, have been a disaster).

They were helped mightily in the successful internet stock prediction and similar ones they made in early 2001 and 2002, by the fantastic rise in low priced stocks in recent years. During the first 5 months of 2001, for example, the lowest priced decile of Value Line stocks went up an average of 82%. Over time, the low priced stocks in Value Line's universe have gone up much more than the average. However, because of the seasonality of these returns, their large variability, the possibility of a small survival bias, and the absence of dividend calculations, this is not by any means a sure way to riches.

Inspired by the desire to make a profit and at the same time to provide scientific explanation to this phenomenon, The Speculators took out their proverbial pencils and envelopes to examine the relation between price level and subsequent performance in the companies that make up today’s S&P 500 index. We measured the change in price from the end of November to the end of January for each company for each of the last 5 years. The results show that the companies whose stocks have memberships in the Bottom 5, the Bottom 10, and the Bottom 20, ranked by price, clearly outperformed the Top 5, Top 10 and Top 20 membership stocks and the S&P 500 index itself.

PRICE APPRECIATION FROM NOV TO JAN, RANKED BY PRICE LEVEL OF STOCKS

	Group of 5	Group of 10	Group of 20	SPX

	From	To

	11/28/97	01/30/98
Lowest Priced Stocks	13.26%	8.32%	4.68%
Highest Priced Stocks	4.80%	0.95%	1.61%	2.60%

	11/30/98	01/29/99
Lowest Priced Stocks	12.67%	3.10%	14.31%
Highest Priced Stocks	23.00%	20.06%	14.74%	9.97%

	11/30/99	01/31/00
Lowest Priced Stocks	-2.50%	-2.97%	4.10%
Highest Priced Stocks	44.48%	28.12%	18.63%	0.40%

	11/30/00	01/31/01
Lowest Priced Stocks	54.03%	49.98%	39.14%
Highest Priced Stocks	-7.83%	-5.31%	-4.53%	3.88%

	11/30/01	01/31/02
Lowest Priced Stocks	15.74%	4.62%	0.33%
Highest Priced Stocks	-1.24%	0.79%	0.49%	-0.81%


November to January Summary:	Group of 5	Group of 10	Group of 20	SPX
Average Price Return Per Year Low Priced:	18.64%	12.61%	12.51%
Average Price Return Per Year High Priced:	12.64%	8.92%	6.19%	3.21%


Excess Return Per Year over 5 years

Low Priced over High Priced	6.00%	3.69%	6.32%
Low Priced over SPX	15.43%	9.40%	9.31%
High Priced over SPX	9.43%	5.71%	2.98%

Sample: From today's SPX members, the 5, 10 and 20 stocks that had the lowest and the
highest sticker prices on the Start Dates listed above in each November.

Source: Niederhoffer Management LLC, Bloomberg LP.

The excess return of the bottom 5 priced members of the S&P 500 index, of over 15% a year, was particularly striking in this regard.

But this is not the path to easy riches either. There is just too much variability involved.

A study of the performance of Value Line stocks classified by price at the beginning of year gives the following sobering results:

Stocks below $5.00 on 12/31/01:

Average = +9.0%

Std Dev = 62%

Stocks below $10 on 12/31/01:

Average = -15.3%

Std Dev = 52%

Stocks above $100

Average = +11.2%

Std Dev = 31%

The whole group:

Average = -16.2%

Std Dev = 32.5%

What's obviously required is something that combines all these disparate results. Something that takes account of the seasonality of the animal spirits, the tendency for those volatile low priced stocks to outperform on average, with a high uncertainty. What we felt was in order was to take the 25 lowest priced Value Line stocks as of Friday. November 15, 2002, and then to further filter them by something that signaled to us that the companies themselves had some confidence in the stock, and whose financials did not have excessive accruals.

Fortuitously our recent columns gave some guidance in this regard. We wrote on September 19,2002 of “Empty Shelves Signal a Rising Stock”; on September 26, 2002 suggesting that investors “Count on a Company’s Cold, Hard Cash Flow”; and more recently on October 24, 2002 identifying “5 genuine buys on a Street of Imposters”.

We filtered the 25 lowest priced companies through the prism of signaling reductions in inventory, improvements in Accounts Receivable, and net insider buying. We put them all together and came up with the best 7 stocks that we intend to buy at a propitious occasion in the future when the market takes an appropriate squall (for us, 2% - 4% from a recent high is an appropriate squall).

We list below all 25 stocks with the details on changes in Accounts Receivables and Inventory for the most recently reported quarter of 2002 over the matching periods in 2001; and net insider activity for 2002 updated through November 15, 2002. The 7 stocks we will be buying are at the top of the list.

Bottom 25 Priced Stocks In Value Line database on 12/31/01 filtered by Fundamentals & Insider Activity
TICKER	Change in Receivables	Receivables Rank	Change in Inventory	Inventory Rank	Inventory + Receivables Rank	Net Insider Activity
TICKER	Change in Receivables	Receivables Rank	Change in Inventory	Inventory Rank	Inventory + Receivables Rank	Net Insider Activity
RBAK Equity	-73.2%	2	-73.5%	3	5	Buyers
LU Equity	-64.1%	4	-70.8%	4	8	Buyers
ADCT Equity	-66.8%	3	-48.9%	6	9	Buyers
AMT Equity	-39.0%	8	-60.0%	5	13	Buyers
NT Equity	-48.0%	6	-43.1%	7	13	Buyers
CRO Equity	-36.1%	9	-26.0%	10	19	Buyers
OAKT Equity	-41.1%	7	-16.8%	12	19	Buyers
VTSS Equity	-30.9%	12	-35.4%	8	20	Buyers
DIGL Equity	-80.1%	1	4.9%	23	24	Buyers
PCLN Equity	-36.0%	10	0.0%	19	29	Buyers
FWC Equity	-5.7%	18	-15.3%	13	31	Buyers
RAD Equity	10.2%	23	-12.1%	15	38	Buyers
SIRI Equity	0.0%	22	0.0%	22	44	Buyers
AETE Equity	N/A	25	N/A	25	50	Buyers
XTND Equity	-30.2%	13	-100.0%	2	15	None
AIZ Equity	-4.6%	19	-26.7%	9	28	None
SAPE Equity	-51.0%	5	31.8%	24	29	None
KM Equity	0.0%	21	-23.1%	11	32	None
OPTV Equity	-25.5%	14	0.0%	20	34	None
ARTG Equity	-34.0%	11	-100.0%	1	12	Sellers
AES Equity	-18.5%	15	-14.6%	14	29	Sellers
ATML Equity	-13.5%	17	-10.9%	16	33	Sellers
OPWV Equity	-16.8%	16	0.0%	21	37	Sellers
SFE Equity	0.0%	20	-6.9%	18	38	Sellers
RCOT Equity	14.7%	24	-8.9%	17	41	Sellers

Source: Bloomberg LP, Niederhoffer Management LLC, Thomson Financial

Be sure to realize that probably 3 of these 7 are going to fall rather dramatically; that there is considerable uncertainty concerning our speculations and the statistical and practical validity of the results reported above.

Nevertheless, the animal spirits exist in The Speculators as well as in our readers at this time of the year, and we plan to swing for the home runs to get even, or possibly a little bit more.

FINAL NOTE:

We have available a list of the 100 lowest priced Value Line stocks and the 20 lowest priced S&P 500 Index stocks ready for our readers’ perusal at our website www.DailySpeculations.com. Furthermore, we have the usual erudite comments of our readers and mentors, those with knowledge of time and place on this subject also available. For readers who wish to critique, augment, or praise our work, kindly write to gbuch@bloomberg.net and we will send you the inventory, accounts receivable and insider trading analysis of these groups.