How Low Can These Stocks Go If European Debt Is Downgraded?

Includes: AA, BAC, C, DIA, GM, NOK, S
by: Brian Nichols

Last week I wrote an article suggesting that it may be time to purchase banking stocks for short-term gains, and was I ever wrong. I made my suggestion based on a technical view and what I believed investors thought was value. There are many stocks with investors who have apparently lost confidence, and these stocks will trade much lower with any bad news yet are slow to rise when the market trends higher. I have compiled a list, a technical view, of how low 7 of the most controversial stocks may go. I am using charts and performance history to determine the psyche of the investor, which is the goal of technical trading, and hopefully we'll determine whether or not these 7 stocks will continue to fall further.

Most would agree that the Dow Jones could very likely trend lower over the next few weeks. I believe that if European debt is downgraded it will send the markets in a straight shot down and result in great loss for some of the more volatile stocks. During the last month I've been using technical trends to make short-term investment decisions because in this market fundamentals are irrelevant, and investors are trading on emotion and fear rather than logic. I believe that each of the stocks I mention below could possibly double over the next year and I believe that each is significantly undervalued. However, in this economy you have to weigh all possibilities and what may occur in the coming weeks to both protect your investments and capitalize on the best possible price.

The chart below consists of 7 dates and 7 stocks and each stock's performance over the last four months. My goal is to show each stock's price during various points and time during the market's trend since August 3. The first date is August 3 which represents a value of 11,896 points on the Dow Jones; and the second date is August 11 which represents 11,143 on the Dow Jones. The remaining dates, and the value that each date represents, is reflected as dates where the market fluctuates between an 800 point swing in the Dow Jones. And of course it's not perfect, but I want to show how each stock has performed as the Dow Jones has traded back-and-forth between a range of 800 points. I believe that after looking at this chart you will have a better idea of risk-vs-reward and if any of these stocks are worth owning at this time.

Date Dow Value Bank of America Citigroup Alcatel-Lucent Sprint General Motors Alcoa
Aug.3 11,896 $9.54 $37.26 $3.64 $4.15 $27.17 $14.26
Aug.11 11,143 $7.25 $30.29 $3.48 $3.12 $25.81 $12.25
Aug.31 11,613 $8.17 $31.05 $3.66 $3.76 $24.03 $12.80
Oct. 6 11,123 $6.28 $26.02 $2.67 $3.01 $22.35 $9.88
Oct.31 11,955 $6.83 $31.59 $2.74 $2.57 $25.85 $10.76
Nov.25 11,231 $5.17 $23.63 $1.54 $2.38 $20.34 $8.95
Dec.12 12,021 $5.32 $26.90 $1.56 $2.39 $20.11 $9.04

As you can see three lines are bold within the chart; and these lines represent the lowest points of the Dow Jones, on this particular chart. The three lines represent three different dates with the Dow Jones being roughly 100 points apart. The other lines represent four dates where the Dow was roughly 700-800 points higher than the low dates in bold. And like I said it's impossible for this to be perfect because of the market's wild swings, but the goal is to create a chart of different dates with a range of approximately 700-800 points on the Dow Jones to find a trend within each of these stocks.

As you would expect, each time the Dow would drop by 700 points these stocks would trade lower. However, what I find to be interesting is that each time the market posts gains, these stocks are reluctant to trade higher as well. Just look at the last four dates; on November 25 the market was higher by 100 points compared to October 6, yet each stock traded lower on November 25, than on October 6. The same can be said for December 12, which is 66 points higher than October 31, yet each stock's price is significantly lower. To better illustrate I've included another chart below, which shows the difference in percentage for each of the above stocks between October 6 and November 25, and October 31 and December 12.

Oct.6 - Nov.25 (10%) (9%) (42%) (16%) (9%) (10%)
Oct.31 - Dec.12 (27%) (15%) (45%) (14%) (22%) (20%)

The chart above shows how much each stock dropped between the selected dates. And what's important to remember is that between each dates the market actually went up. I believe this shows the pessimism of investors regarding these stocks and further illustrates that these stocks may not have a bottom. I used 11,150 as the bottom of the Dow Jones because I believe that we will once again see this price in the next couple weeks. This prediction is far from my original prediction that the market could test 52 week highs in December. But I've changed my prediction because of the financial crisis in Europe and the likelihood of a credit downgrade in at least half of its nations.

I've heard some analysts say the markets are prepared for a European downgrade and that it's already priced into our markets. However I disagree, and believe that once it occurs the market will fall by a substantial amount, much like in August when the U.S. was downgraded. And since each of these stocks are now trading near the same price when the market was priced 800 points lower, just two months ago, I believe the loss could be devastating.

I believe the markets will fall in the coming weeks but then it will recover and these stocks will trend higher. We have no way of knowing what will occur in Europe or how exposed any of the above companies are to European debt. But what we do know is that recent history proves these stocks will drop with the market, which I believe is very likely if the European debt is downgraded. Below I have included one final chart; it shows the price that I believe each of the stocks above will post before trending higher. This estimate is based on each stock's recent performance and the percentage in which it's dropped as the market's fluctuated between 11,150 and 12,000, and the fact that it's dropped by a larger margin each time that it's completed this trend. I believe that if the market falls as a result of a European downgrade that each of these stocks will fall by its largest margin yet, and will reflect a total lack of investor confidence.

I will conclude by saying that investors could buy each of the stocks on this list at its current price and return huge gains over the next year regardless of its immediate trend. However, if the market falls, and by all accounts it appears that it will, then why buy now when you can buy each of these stocks cheaper and return larger gains over the next year? This fact is truly frustrating for value and fundamental investors, such as myself, when stocks such as these do not reflect fundamental performance. The banking sector is under heavy scrutiny because no one really knows how exposed they are to Europe or how future regulations may effect earnings. However, both Citigroup and BofA have shown fundamental progress during the last quarter with substantial revenue and earnings growth year-over-year. And although most will argue that earnings don't tell the whole story of banks, it does show progress and a movement in the right direction. Both Alcatel-Lucent and Alcoa are trading with much better margins compared to 2010 including significantly higher earnings. And GM has consistently outperformed 2010 during every month of this year in sales, yet trades with a near 50% loss. The only company without significant fundamental progress is Sprint, however it's had to survive without the most wanted product in communications, the iPhone, which it now has, and which should create optimism among investors along with its new network.

Overall, these stocks have unprecidented value and if you're patient each will return large gains over the next few years. Yet because this market doesn't consider these facts, and chooses to invest in European fear, these stocks will most likely trade lower. Therefore you shouldn't be surprised to see new lows, but I expect each stock to recover and post very large gains because in the end fundamentals will always prevail. For now, though, technicals are king, and I believe it's very possible that these stocks could reach the prices that I have listed below during the next month if a European downgrade is to occur.

Dow Jones 11,150
Bank of America $4.25
Citigroup $19.50
Alcatel-Lucent $1.10
Sprint $1.85
General Motors $17.2
Alcoa $7.5

Disclosure: I am long GM, S.

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