Close

A Look at the Patterns for 1997's Winners and Losers

by Richard Evans

A Look At The Patterns For 1997's Winners And Losers Splash image

The year 1997 will go down in the record books in several ways. Not only did the major market indexes move into uncharted waters, but also it was the third year in a row that the Dow Jones industrial average rose 20% or better, an achievement never done before.

However, one market phenomenon that occurred in 1997 occurs every single year—some of the best gains in individual stocks came from those that were low-priced (from below $20 to below $5).

Table 1 lists the top 10 New York Stock Exchange winners for 1997.

Capital Trust earned the distinction of the top stock in 1997. However, the developments of its stock pattern were about as generic as could be. The stock also demonstrated that some of the best gains on Wall Street are from stocks selling under book value. At the end of 1996, when Capital Trust was making its move, the stock was selling for less than its book value of $2.68. One did not hear much about book value in 1997, with the Dow selling at over five times book, but stocks selling under book are still around, and as Capital Trust shows, that can produce winning results.

A low-priced and depressed stock, selling under book, and an unfolding pattern of accumulation around the lows can be a winning combination. Examining the patterns of the winners, and losers, of 1997 can help illustrate the use of technical analysis.

WINNING PATTERNS

In 1997, Capital Trust (CT) benefited not only from a better interest rate environment that favored the entire financial group, but it also had been undergoing somewhat of a transformation of its own.

Capital Trust at the start of 1997 was known as California Real Estate Investment Trust, where the firm made equity and mortgage investments in a diversified portfolio of income-producing properties. However, in July the firm adopted a new business plan, instead of becoming a specialty finance company in high-yielding “mezzanine” investments in commercial real estate.

In concurrence with the new business plan, CT made several changes in its own financial structure, selling 12,267,658 shares of cumulative convertible preferred shares to Veqtor Finance Company, LLC, a transaction which helped Veqtor to then own 90% of the outstanding voting shares of CT. That Veqtor Finance was an affiliate of Sam Zell did not hurt in the eyes of analysts either, as Zell was gaining some favorable publicity as one of the “titans” in real estate.

All and all, the favorable climate for the financials, the change in business plan at CT, and the affiliation with Sam Zell provided analysts good reason to “mark up” Capital Trust stock in 1997. CT reached a high for the year at 151/8 before closing out the year at 111/4.

However, as with most stocks that have a sudden surge in popularity, CT stock itself provided some key signs of accumulation long before, and at much lower prices, than when Wall Street began to “mark up” the stock in 1997.

Like many of the better turnaround opportunities, CT was really rising from the “ashes.” Prior to the 1997 advance, the stock was not only low-priced, but very, very depressed. The stock had really hit the skids: first going through the characteristic severe mark-down stage, followed by an extensive period of distress selling, then just languishing.

In the long-term picture, the stock was distributed above the 10 level from 1985 through 1987, with a 1985 high of 143/8. While the 1987 Crash did not occur for most stocks until October of that year, the financials were under pressure right from the start of the year due to rising interest rates. In fact, the financial strains that precipitated the 1987 Crash would eventually negatively impact all the financials, speculative issues like CT and blue-chips like Citicorp, resulting in this sector selling for 10 cents on the dollar by the early ’90s.

CT hit a low of 15/8 in 1991, and the stock thrashed around between 15/8 and 3 for the next couple of years before drifting off to still lower levels, hitting new lows of 11/8 by year-end 1995. At the lows the stock was down 92.1%.

Gain exclusive access to all of AAII.com, PLUS our market-beating Model Stock Portfolio — currently trouncing the S&P 4-to-1!

TRY US FREE for 30 DAYS!

Low-priced and depressed stocks can stay low-priced and depressed for some time. The economic factors that send a stock down 90% or more do not change overnight.

A lack of a sustainable rally is certainly a characteristic of distress selling, and in the final years leading up to the stock’s lows, there was not any sustained rally of note. CT stock would stage minor rallies from time to time, but there were not any bullish zigzags, nor any advances through any prior resistance levels, both factors which imply a bullish trend. Up until early 1996, there was nothing but a predominately bearish pattern in the stock.

In 1996, the picture began to change (see Figure 1), as the stock hit its final lows and began to move higher.

CT traded in its low range through May, but in early May it broke out, rising 1/4, closing at 15/8 on volume of 18,000 shares. For several sessions CT traded between 11/2 and 15/8, but it then moved up to the next level of trading, at 13/4. In doing so, CT broke above the significant level of resistance at 15/8, the first such bullish move in over three years.

When a stock has been languishing and then breaks above an important resistance level, the odds increase that the major trend is now bullish. In rising above 15/8, CT was rising in an intermediate uptrend, and quite likely, the major trend was bullish as well.

By early July, CT moved up into a trading range of 17/8 to 2. The importance of this price level is evident by the extensive trading at 2 that had taken place earlier in late 1993 and early 1994 when 2 was support. In August, the stock moved as high as 23/8 on expanded volume of 26,100. As CT broke higher through another significant resistance level, all trends were definitely bullish.

Typically at the end of extensive declines, low-priced and depressed stocks will show such a pattern of a strong intermediate trend moving higher, breaking through several resistance levels and downtrend lines.

However, as the stock is rising in an intermediate trend (trends which tend to last three weeks to as many months), some level of resistance will always bring the intermediate advance to a halt, reversing the stock and sending it into an intermediate consolidation.

The current intermediate trend would end as the stock approached 3, a level which had considerable importance, providing a resistance level as far back as 1991. After a few weeks of “slippage,” CT then dropped sharply to close at 17/8 on November 15, on a huge volume of 77,000 shares.

Note the reversal role that the 17/8 to 2 level would now play—it had served as resistance earlier in July, but now that CT had broken higher, it acted as a support level. A pullback to support is the logical time to buy, and investors were afforded such an opportunity in November.

Following several weeks of trading between 17/8 and 2, CT would move higher; it closed out the year on December 31 at 23/4, on volume of 2,900 shares.

In early January 1997, the stock displayed a “consolidating” sequence, trading between 21/2 and

27/8. It is not unusual for a final bout of selling to enter the stock, for the stock to thus trade lower on heavier volume, then to pop back up into the prior trading range. The action is sort of like “clearing the air,” as the last of the sellers are absorbed. The stock is then free to advance, and advance it did.

On January 7, CT opened at 27/8 and closed at 3 on heavy volume of 56,800. CT had moved a little above the September-December highs. Most important, by closing at 3 on large volume, CT had absorbed more sellers, yet still moved higher.

On January 8, CT broke sharply higher as it finally bettered 3. The stock opened at 31/8, hit a high on the day of 3¾, and closed at 33/8, on volume of 80,900.

That CT was in a major bull market run, a run which would eventually earn the stock top honors for 1997, was unmistakable. Not only had the stock moved to new highs for the current advance, but also new seven-year highs.

In summary, the technical pattern in Capital Trust developed nearly as perfect as investors could desire. The stock had a long decline, then the early signs of accumulation began to appear. Most importantly, investors had plenty of opportunities to buy in early, from the stock’s first move through significant resistance at 15/8 in June 1996, then buying on the subsequent dull pullbacks that frequently follow breakouts.

LOSING PATTERNS

Not all low-priced stocks are winners. Many low-priced stocks are losers. To be sure, all losers eventually turn into low-priced stocks. Table 2 lists the biggest percentage losers in 1997.

However, one has to look at the technicals and ask one simple question—is the stock under accumulation or distribution?

A good example is Westbridge Capital, the medical insurer that missed interest payments and ended up on the year down over 95%. While Capital Trust, the top stock gainer for 1997, had all the earmarks of accumulation, Westbridge Capital, WBC-1, had all the earmarks of distribution from the start: breaking of uptrendlines, breaking of support levels, and panic selling. This stock could only show the feeblish of rallies, followed by more erosion and more panic selling.

CONCLUSION

The best opportunities arise in stocks which are down 90% or more. However, the opportunity stocks are not only down substantially, but they have been down for a long, long time. They are not “recent” low-priced stocks as a result of recent panic-selling, but they have been low-priced stocks for some time because Wall Street has lost interest in them.

Truly depressed stocks have had time to percolate. Recent big-plungers need to demonstrate whether they can regroup, and that process takes time.

Examining the patterns of winners and losers for the year illustrates some important lessons. In short, promising stocks can be found among those that are depressed and priced low. But look for stocks that have been depressed for some time, and have started to show a pattern of accumulation.


Discussion

No comments have been added yet. Add your thoughts to the discussion!

You need to log in as a registered AAII user before commenting.
Create an account

Log In