As blue chip stocks take a beating, help may come from secondary market
New York — Al Frank hopes he is seeing the start of a bull market in secondary stocks. At least, that's how he is reading the Dow Jones industrial average's fall of 77.97 points last week. Mr. Frank, editor and publisher of The Prudent Speculator newsletter in Santa Monica, Calif., says this action augurs well for the secondary, or over-the-counter (OTC) stocks. ``The secondaries are not losing as much as the blue chips. They will participate in the market,'' he stresses.
The blue chips of the Dow certainly took a beating last week, falling to 2561.38, as the dollar and bond prices fell and interest rates rose to their highest point since early 1986, possibly in anticipation of the Federal Reserve Board's Friday hike in the discount rate, from 5.5 to 6 percent.
In addition, the American trade deficit figures are to be released Friday. If they are higher than June's, which have been figured at $14.1 billion and $15.7 billion, according to various formulas, interest rates could increase, given concern that the dollar would fall farther.
Frank says the principle, or ``semi-truism,'' about secondary stocks is that before a market tops out, the secondaries, which are also called emerging growth stocks, receive a lot of play. A couple of factors fuel this, he says.
Institutions account for 80 percent of the market, and Frank says they tend to want heavily-capitalized, big-name stocks, which also appeal to foreigners. ``So, as the blue chips get more overvalued, money will seek out the undervalued stocks,'' he says.
This theory may be true in shorter-term cyclical markets, says Philip B. Erlanger, a vice-president and chief technical analyst at Advest Inc., in Hartford, Conn.
``Cyclical markets get tops more often, because the public is investing,'' he observes. ``If we see a long market where the secondaries outperform the blue chips, that will indicate that the public has entered the market at the top to speculate. ``But we're in a long trend now: We'll have periods where the secondary stocks will do well, but then they'll go to the back seat to the blue chips until the end of the market,'' he adds.
To Mr. Erlanger, the test of the secondary stocks' strength is their performance in a market advance. ``It's more significant to see the secondaries outperform the Standard & Poor's 500 or Dow when the market is growing,'' he explains. In August, the S&P 500 index of the broad market rose nearly 9 percent, while the NASDAQ, the secondaries' exchange, was up only 6 percent. The NASDAQ industrials had led the market since January.
While the market has not seen a play in the secondary stocks, there has been a perception that the market is overvalued, says Gene Jay Seagle, director of technical research for Gruntal & Co. Inc., in Stamford, Conn. ``Given comments about lower returns, yields below 3 percent, and blue chip stocks selling at 20 times earnings, the market is ripe for a correction to undo that overvaluation,'' Mr. Seagle says.
Only when the correction takes place will a rally occur in which the secondary stocks take part, he adds.
The secondary stocks sometimes have trouble getting their share of the spotlight. Although the Dow only measures 30 blue chip industrial stocks, the companies issuing the stocks are large, well-established financially, and well-known. The secondary stocks, on the other hand, are launched through NASDAQ, the National Association of Securities Dealers Automated Quotations, where companies get their names out to the public. The smaller companies are often offering far less stock, which can limit their appeal, especially to bigger buyers.
``It is true that small stocks move in different ways than large stocks,'' observes Marshall Blume, a professor of finance at the Wharton School of the University of Pennsylvania. ``And in certain economies, larger firms do better than smaller firms.''
Yet there are large and well-established OTC companies, such as Apple Computer and MCI. The National Association of Securities Dealers says that 2,000 of the NASDAQ members could meet the financial requirements to list on the American Stock Exchange and 900 could be on the New York Stock Exchange.
Another factor favoring blue chips is the liquidity they provide. Liquidity, or having enough shares to allow large transactions without a substantial drop in price, is important in view of the tremendous market volatility, says Neil Crespi, senior partner and head trader at Monness, Crespi, Hardt & Co. Inc., in New York. ``At the point we are now, assuming 2,600 or 2,700 in the Dow, I'm most concerned about liquidity. The secondaries have not performed with the Dow, and if the Dow were to correct, you'd have to have liquidity. You shouldn't be involved with the secondaries unless they will be liquid,'' he advises.
Mr. Crespi is not sure that the secondary stocks will come into their own in this bull market. ``The Dow is being led by foreign money now, and the OTC stocks that will perform have good numbers and good growth rates,'' he says. Institutional investors have become increasingly interested in secondary stocks, because of their diversity. Prof. Blume and another Wharton professor, Irwin Friend, found that in 1979 institutions with at least $100 million in equities had invested 93.2 percent in NYSE common stocks, 13.3 percent in American Stock Exchange issues, and 5.5 percent in other issues, mainly secondaries. By June 1985 these figures had changed to 90.3 percent in NYSE issues and 8.4 percent for OTC stocks. The Amex figures remained unchanged.
Not everyone is ready to line up behind the secondaries. Marshall Acuff, a portfolio strategist at Smith Barney, Harris Upham & Co. in New York, says ``the NASDAQ has gone up, but not as rapidly as the more senior indexes. In my view, the blue chips will continue to lead this market.'' Many factors have contributed to the NASDAQ's relative strength, Mr. Acuff says. First, there has been much recent profit-taking in the Dow. Also, there has been positive action in the OTC technology stocks; about 30 percent of the NASDAQ is in technology, he says. In addition, NASDAQ's financial stocks are performing better. Indeed, about the only area Frank of The Prudent Speculator is boosting now is the large California savings and loan industry, which he says is undervalued and making a lot of money.
Acuff says the blue chips will continue to lead the market, for many reasons. ``They are reasonably valued relative to their future earnings growth. Second, the economy will continue to grow moderately. If it grew quickly, people would become interested in the secondaries.'' Also, overseas funds tend to favor the major stocks. History also is on the side of the blue chips, Acuff observes, despite the small companies leading the market from the late 1970s through 1983. ``Big companies have led since, and I don't see that changing,'' he says.
So, when will the market be ready for the secondaries? Seagle of Gruntal says that once the ``nasty spill'' occurring now passes, the market will swing up, later this month or early October, which will create speculative interest. ``As the economic picture becomes more positive, the individual buyer is attracted to the stocks that haven't had much play,'' he says.