Posts Tagged ‘jeffrey saut’

“I’m Dreaming of a Green Christmas” (Saut)

Thursday, December 20th, 2012

 

“I’m Dreaming of a Green Christmas”

December 17, 2012

by Jeffrey Saut, Chief Investment Strategist, Raymond James

While last week, and this week, often see distortions in individual stock prices due to tax loss selling, Santa Claus tends to arrive the following week. Indeed, the last week of the year, into the first two days of January, has a pretty good track record on the upside with a rally coming about 65% of the time. As stated in previous missives, I expect the same Santa rally this year driven by a “staged in” solution to the fiscal cliff. Most readers know that I have lived in the D.C. Beltway and have a good working knowledge of how our system works. And while this year’s “rhythm” has a different feel to it, I still expect a last minute solution. That has been my stance for the past few weeks based on this reality. Speaker John Boehner is under intense personal pressure to cut a deal because if he doesn’t he may not be reelected Speaker of the House when the new Congress convenes January 4th. Therefore, he will likely accept the 39.6% tax bracket for high wage earners and then focus the conversation toward entitlements and the debt ceiling. Evidently, I am not the only one thinking this. As the Wall Street Journal’s Kimberly Strassel writes:

“Since the President has not sent budgets out (the only one he did send out was voted down 79 to nothing in his own Senate) and he said what would solve the nation’s problems was taxing the rich, and we’ve said all along the amount of money that you get for this is just a few days of deficits. But since that’s really the only thing that you’ve proposed to do and that you’ve got a mandate for doing it, and a majority of people say that this certainly is fair — we’ve got a gigantic deficit and the rich have benefitted (directly or indirectly) from the money that’s been spent, so we’ll say fine, you can have that — we’ll concede, now the rest of the problems are yours. You’ve said that this will solve the nation’s problems — fine, we’ll sit tight and we’ve got the debt limit coming up and we will keep following along.”

If the Washington Waltz does play-out this way, then the Acapulco “cliff diving” exhibition will be off; but if not, the economy’s destiny will hang on how the “contest” is finally resolved.

One sector that should not be affected either way is technology. According to the discerning Don Coxe, of BMO Capital fame:

“They [technology companies] are self-financing, they have potent balance sheets, they have the patents, the visibility, and they are the best in the world at what they do pretty much, so this is a continuing source of strength for US stocks relative to other global stocks, and will help if we should fall over the fiscal cliff.”

Those comments were particularly timely given Raymond James’ Technology Conference last week. As one particularly keen-witted Wall Street wag wrote (as paraphrased by me):

“The most significant takeaways from our Tech conference yesterday were that while the broad tone seemed cautious, there were clearly signs of stability on the supply chain with a leading chip distributor calling for positive book-to-bill readings for October, November and the early part of December. Other companies with favorable ratings from our fundamental analysts, like Maxim (MXIM/$29.56/Outperform) and Analog Devices (ADI/$41.35/Strong Buy), also signaled stability versus existing expectations, while SDN (S4C Digital Network) fears and those surrounding Microsoft’s Surface products were calmed a few degrees [Microsoft is also favorably rated by our fundamental analyst (MSFT/$26.81/Outperform)].”

I like the technology sector for many of the reasons mentioned by Don Coxe.

Meanwhile, the equity markets struggled with only 5 of the 15 major indices I monitor closing positive for the week. Those five were the D-J Transportation Average (+1.15%), the S&P 500 Equal Weighted Composite (+0.09%), the two ValuLine Indexes (Arithmetic +0.37%; Geometric +0.30%), and the Russell 2000 (+0.18). The only three macro sectors that closed “up” on the week were: Materials (+1.64%), Telecommunications (+0.50%), and Industrial (+0.30%). The strength in the Materials sector is interesting because it is economically sensitive. Despite last week’s waffling action, by my work the DJIA, DJTA, COMP, and SPX (S&P 500/1413.58) all remain on short/intermediate-term “buy signals.” However, the Utility Index has registered an intermediate-term “sell signal.” Frustratingly, it has been difficult to surmount the SPX’s overhead resistance zone of 1420 – 1430, but that has been anticipated numerous times in these reports. Nevertheless, this still looks like an upside “continuation pattern” to me unless the support level of 1390 – 1400 is decisively violated.

Speaking to the U.S. Dollar Index (@DX.1/79.55), the weakness anticipated in mid-November has left that index down 2.4% and in jeopardy of breaking below its recent reaction low of 79.36. As stated in November, “A weaker dollar should be bullish for stocks,” and it has. I actually think the dollar’s decline accelerates from here. Said decline should also have been bullish for gold, but that has not been the case. What it has been bullish for is lumber (@LB.1/$345.00), which has traded out to new reaction “highs” as housing continues to strengthen. To me, all of this is suggestive of an economy that is not going to tilt back into recession. Even if we go over “the cliff,” provided it is not for too long, the economy should be able to survive, as should the stock market. The more important question, at least in the short-term, is the overbought condition of the equity markets, a condition that is quickly being corrected. Also worth noting is that while some sectors are overbought, others are oversold, the most obvious of which is precious metals. Another sub-sector that is oversold is the coal sector. Both sectors provide investor friendly risk/reward ratios. For names, we point you to our fundamental analysts’ research reports, or to Van Eck International Gold Investors Mutual Fund (INIVX/$17.46), as well as to Van Eck Coal Global Coal Market Vectors (KOL/$25.09). I am also sticking with my bullish “call” on China of four weeks ago using the ETF of your choice.

The call for this week: If the Mayan calendar is right, and December 21, 2012 represents the end of the world, none of my ramblings matter; and this week’s “call” should therefore be “party on Garth.” But if the earth doesn’t implode, I still think the upside in stocks should be favored. The fact is that governmental spending “cuts” should prove positive for the various markets provided they are too large and do not come too quickly. And while it’s true raising taxes is potentially short-term bearish, longer-term it is not; again provided it is not too much of a tax increase. This week is the key, a pullback to the 1400 – 1410 level, with a concurrent oversold reading from the McClellan Oscillator, could act as a springboard for fabled “Santa Rally.” But if 1390 is decisively violated, well, “If Santa fails to call the bears will roam on Broad and Wall!”

P.S. – I am in Montreal seeing institutional accounts where it really is a white Christmas …

 

Copyright © Raymond James

 

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The Magic of Compound Interest (Saut)

Tuesday, August 21st, 2012

“The Magic of Compound Interest”

by Jeffrey Saut, Chief Investment Strategist, Raymond James

August 20, 2012

There was a king who held a chess tournament among the peasants and asked the winner what he wanted as his prize. The peasant, in apparent humility, asked only that a single kernel of wheat be placed for him on the first square of his chessboard, two kernels on the second, four on the third – and so forth. The king fell for it and had to import grain from Argentina for the next 700 years. Eighteen and a half million trillion kernels, or enough, if each kernel is a quarter-inch long (which it may not be; I’ve never seen wheat in its pre-english-muffin form), to stretch to the sun and back 391,320 times. That was nothing more than one kernel’s compounding at 100 percent per square for 64 squares.

… “Money Angels” by Andrew Tobias

When compound interest works in your favor, it is a blessing. But when it works against you, it is a curse. Just ask Washington Mutual, or General Motors. More recently ask Greece, whose “debt chickens” have come home to roost. For example, Greece’s 10-year sovereign note sported a yield of around 5% back in 2010. Subsequently, it soared to more than 30% earlier this year, and currently changes hands around 24%. When yields are double-digits the power of compound interest working against the borrower is awesome. Consider the following example from the same book by Andrew Tobias illustrating the term of interest and return on interest:

Say you borrowed $1,000 from a friend and paid it back at the rate of $100 a month for a year. What rate of interest would that be? A lot of bright people will answer 20 percent. After all, you borrowed $1,000 and paid back $1,200, so what else could it be? Forty percent? No [it’s] more. If you’d had use of the full $1,000 for a year, then $200 would, indeed, have constituted 20 percent interest. But you had full use of it for only the first month, at the end of which you began paying it back. By the end of the tenth month, far from having use of $1,000, you no longer had use of ANY of the money. So you were paying $200 in the last two months of the year for the right to have used an average of $550 for each of the first ten [months]. That comes to a bit more than a 41.25 percent effective rate of interest. (Trust me).

I revisit this compound interest theme this morning because the recent rise in interest rates has been one of the most important events that have occurred over the past few weeks. The rate rise is important because this week the U.S. Debt Clock will cross above $16 trillion (excluding off balance sheet items), and if we stay on the same debt course by 2015 the U.S. will have accumulated $20 trillion in debt. Accordingly, the increase in the 10-year T’note’s yield, from 1.38% on July 24th to last week’s high of 1.86%, is significant. Consider this, by 2015, if our debt is at $20 trillion, an aggregate yield on that debt of 2.5% means the cost of servicing the debt is roughly $500 billion per year. At a yield of 5% our debt service cost would be $1 trillion; and at 10%, the yearly debt service would be $2 trillion, or nearly all of the $2.3 trillion our government receives in revenues! Unsurprisingly, most of the folks I talk to inside the D.C. Beltway realize we are on an unsustainable path; and that’s why I think no matter who is elected in November my sense is we are going to get smarter policy makers, more practical policy, and more productivity out of government. Currently few believe this is possible, but if you look at what’s happening at the grassroots level there are a lot of good things happening on both the “left” and the “right.” One entity that appears to embrace this more positive scenario is Mr. Market.

Indeed, while there are some pundits commenting on the recent increase in interest rates, there is NOBODY expounding on the fact that the S&P 500 Total Return Index is probing new all-time highs (see chart on page 3). To be sure, I am aware of all the bearish arguments swirling down the canyons of Wall Street, but the bears continue to misunderstand there is not a linear relationship between the fundamentals and the movement of the markets. Manifestly, it takes a massive deflationary shock, like what we experienced in 2008, to cause a waterfall decline in stock prices; and, I just don’t see that on the horizon. Actually, I think the rise in interest rates is more about the improving economic backdrop and the inflation that should accompany it. As the invaluable Bank Credit Analyst organization wrote back in 2007:

The history of the U.S. is characterized by a long-run increase in indebtedness, punctuated by occasional financial crises and subsequent policy reflation. The sub-prime blow-up is the latest installment in this ongoing Debt Supercycle story. During each crisis, there are always fears that conventional reflation will no longer work, implying the economy and markets face a catastrophic debt unwinding. Such fears have always proved unfounded, and the current episode is no exception. A combination of Fed rate cuts, fiscal easing, and a lower dollar will eventually trigger another upleg in the Debt Supercycle, and a new round of leverage and financial excesses. The objects of speculation are likely to be global, particularly emerging markets and resource related assets. The Supercycle will end if foreign investors ever turn their back on U.S. assets, triggering capital flight out of the dollar and robbing U.S. authorities of any room to maneuver. This will not happen any time soon.

“Not any time soon,” says the Bank Credit Analyst and I agree, which is why my mantra has been, “You can get cautious, but do not get bearish!” Importantly, I have likened the March 2009 “low” to the nominal price low of December 1974, which was the “print low” of the 1966 – 1982 wide-swinging, trading range stock market. Further, I have suggested the October 4, 2011 “undercut low” might be the equivalent of the “valuation low” of August 1982 before the 1982 – 2000 secular bull market began. Whether we are now into a new secular bull market is questionable, but secular “bull” markets typically arise when valuations are parsimonious, the economy is a mess, politics are leaning to the left, and individual investors have abandoned stocks. If that sounds familiar, it should for that is precisely the environment we have had for awhile.

Over the longer-term I will let Mr. Market tell us if we are in a secular bull market. As for the here and now, I have been treating the June 4th low as THE daily/intermediate-term cycle low. More recently, I opined that while the S&P 500 (SPX/1418.16) may pause, or pull back, around the 1400 level, but that any pullback should be shallow with the real bull/bear battle coming at the April highs of 1420 – 1422. And, that is where we were late last week. Typically the initial assault on a key resistance level like 1420 fails. It tends to take two or three attempts before a key level is surmounted. For example, the Reuters/Jeffries CRB Commodity Index (@CR/303.48) made a reaction high on May 1, 2012 at 307.95. Subsequently, it has tried to better that high on July 19th, August 9th, and is currently trying for the third time to close above its May 1st high (see chart on page 3). My sense is this time it makes it because triple tops rarely hold. That view is reinforced by the recent sell-off in the Dollar Index (@DX/82.54), which closed below its 50-day moving average on Friday. If the U.S. dollar keeps falling it should put the wind at the back of the CRB, as well as gold, which is also trying to break out above a triple top around $1630.

The call for this week: The S&P 500 Total Return Index (&SPXT/2469.00) is trying to break out to new all-time highs, as can be seen in the chart on the next page. It may also be pointing the way for the S&P 500 because if the SPX can decisively break out above its April highs of 1420 – 1422 it potentially brings into view targets above 1500. And while it is doubtful the SPX can breakout above those “highs” on its first try, I think it will indeed eventually break out. Of course, the grind higher from the June 4th low has been accompanied by total disbelief among individual and professional investors. That is reflected not only in the flow of funds by individual investors out of equity-centric mutual funds, but in the latest Commitment of Traders report that shows the “pros” have been caught heavily on the short side into a rising equity market. So the fuse is burning and I think it is just a matter of time until the SPX travels above 1422.


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Copyright © Raymond James

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Invest with the Best?! (Saut)

Tuesday, August 14th, 2012

Invest with the Best?!

by Jeffrey Saut, Chief Investment Strategist, Raymond James

August 13, 2012

“Finding the best person or the best organization to invest your money is one of the most important financial decisions you’ll ever make. It’s also one of the toughest. The right manager for someone else may not be the right manager for you, nor can you reasonably expect to find many objective, or even reliable, sources to help you narrow your choices. You will be bombarded with figures, charts, and statistics that seek to sell you on each adviser’s services … the sad fact is that too often you cannot even believe what has been presented to you.”

… Claude N. Rosenberg, Jr.

I have been a “fan” of the astute Mr. Rosenberg ever since hearing him speak back in the 1970s. Many will remember him as the founder of the San Francisco-based money management firm that used to bear his name, Rosenberg Capital Management, before changing its moniker to RCM Capital Management. Others will remember him as the author of numerous books on financial matters, one of which was Investing with the Best, which holds the above quote and deals with the daunting task of selecting an investment manager. Given the plethora of investment managers, each with their own investment philosophy and style, picking a manager is difficult. That’s why many individuals’ selection process consists of nothing more than looking at a portfolio manager’s track record for the past few years. We think such a simplistic approach is a mistake.

Apparently, Jeremy Grantham, eponymous captain of the money management firm Grantham, Mayo, Van Otterloo & Co., agrees. To reprise some of his thoughts: “Ninety percent of what passes for brilliance, or incompetence, in investing is the ebb and flow of investment style (i.e., growth, value, foreign vs. domestic, etc.). Since opportunities by style regress, past performance tends to be negatively correlated with future relative performance. Therefore, managers are often harder to pick than stocks. Clients have to choose between fact (past performance) and the conflicting marketing claims of various managers. As sensible businessmen, clients usually feel they have to go with the past facts. They therefore rotate into previously strong styles, which regress [to the mean], dooming most active clients to failure.”

This is where Raymond James’ Asset Management Services (AMS), as well as our Mutual Fund Research Department, can help. As unbiased intermediaries, these departments are committed to aiding clients in the hiring of an investment manager who most closely aligns the manager/mutual fund with the client’s views on the various markets, as well as their risk tolerance. To this point, I journeyed to the cooler climes of Boston last week to escape the Florida heat, speak at a national conference, and visit with over 20 portfolio managers (PMs). My first visit was with the folks at Pioneer Funds where I met with Marco Pirondini (Head of Equities) and his team, as well as Ken Taubes (Chief Investment Officer). I have spoken with Ken a number of times and find his wisdom both on stocks and bonds to be invaluable. Because of his long tenure as a bond manager, I was surprised when he opined that interest rates should bottom between now and year end. Given that “higher interest rate” view, I was particularly interested in speaking with Jonathan Sharkey who manages the Pioneer Floating Rate Fund (FLARX/$6.88) and the Multi-Asset Ultrashort Income Fund (MAFRX/$10.04). In a rising rate environment these two funds should fair pretty well. I discussed Jon’s investment style/strategy over dinner and found it to be closely aligned with mine. I was also interested in the Pioneer Research Fund (PATMX/$10.64) and will be vetting it, along with other Pioneer funds, over the coming months.

After a few more meetings with hedge funds that afternoon, I spent most of Wednesday with Fidelity. My first meeting was with Jurrien Timmer, co-portfolio manager along with Andrew Dierdorf, of the Fidelity Global Strategies Fund (FDYSX /$9.18). To me, FDYSX is tantamount to a global macro fund because it can “go anywhere” and “do anything.” That means it can invest in just about everything. Moreover, I like the fact that the fund has a technical analysis overlay to it, as well as a tactical leaning, since tactical is what has been working in this manic depressant market. Next was Charles Myers, captain of the Fidelity Small Cap Value fund (FCPVX/$15.27). Chuck told me that while he is really good at picking stocks, he is less confident with his market timing and sector selection abilities. Accordingly, he spends his days looking for good companies and thinking about portfolio construction. Indeed, he adds value to the investment equation through portfolio construction. He does run a concentrated portfolio (~70 names) and does adjust his turnover rate to take advantage of when the markets are more dynamic.

Fidelity Select Health Care Fund (FSPHX/$136.14) is managed by Edward Yoon and has provided very good risk adjusted returns over time. My meeting with him was informative as he thinks insurance companies and PBMs are part of the healthcare solution. Strategically, Eddie thinks the healthcare system has never let customers know what things cost, but that’s changing because employers are moving healthcare risks from their balance sheets to the employee’s balance sheet. This should be a boom for companies that provide consumers with the ability to analyze price competition between vendors. He also suggested there is going to be a shift from public to privatized Medicare. A couple of names he mentioned covered by our fundamental analysts were: Cerner (CERN/$71.12/Outperform) and Nuance (NUAN/$23.53/Strong Buy). My last meeting was with Steve Wymer, who told me the S&P 500 investment style is too conservative for a growth fund and the Nasdaq Composite Index is too aggressive, so he runs The Fidelity Advisor Growth Opportunity Fund (FAGOX/$40.87) somewhere in between. He thinks we are somewhere in the mid-cycle of a recovery provided Euroquake doesn’t derail us. Dinner Wednesday was with the good folks from Fidelity.

The next morning I arrived at MFS, which is an active global asset manager that employs a uniquely collaborative approach to build better insights for our clients. Their investment approach has three core elements: integrated research, global collaboration, and active risk management. Of course, “risk management” is a big thing with me for the essence of portfolio management is the management of risk, not the management of returns. My meeting was with Jim Swanson (Chief Investment Strategist) and eight PMs/analysts. Jim began by stating that people he meets in everyday life talk about how bad the stock market is. He then “closed” that comment by noting the S&P 500 is up nearly 12% YTD, while the NASDAQ Composite is better by ~16%. Moreover, when you impact those returns for the almost non-existent inflation, the “real” returns are awesome. The rest of the conversation was about the topics du jour (government, Euroquake, the fiscal cliff, etc.). Regrettably, I did not have the time to meet with my friend Thomas Melendez, who manages my favorite international fund, MFS International Diversified Fund (MDIDX/$13.27), or the PM of the MFS New Discovery Fund (MNDAX/$20.15), but that will happen next trip.

My final meeting was with Putnam to reconnect with Bill Kohli, portfolio manager of the Putnam Diversified Income Trust (PDINX/$7.65) that has so often been featured in these comments. It is one of only two bond funds I have featured over the years because I think PDINX is positioned for a higher interest rate environment. The fund has a 5.8% yield with zero duration. The fund employs 70 – 80 different strategies to pursue a diverse range of opportunities. For example, the fund is “long” non-agency RBMS (Residential Mortgage Backed Securities), but hedges that position with agency IOs (Interest Only). Hence, to lose money on those positions would require home prices to collapse over 50% from their already depressed prices. And then there was David Glancy and his Putnam Equity Spectrum Fund (PYSAX/$28.04). Hereto David thinks a lot about portfolio construction and combines stocks, bonds, bank loans, convertibles, opportunistic short-selling, and cash to produce returns. To this cash point, I was taught early in this business that cash is indeed an asset class for to assume the investment “opportunity sets” that are available today are as good as those presented next week, next month or next quarter is naive; and, you need to have some cash to take advantage of those opportunities. Evidently David thinks that as well because his cash position has varied from 44.4% in 2Q09, to 14.8% in 3Q10. David loves stocks and I could talk individual companies with him for hours. As always, all of these mutual funds should be vetted before purchase.

As for the stock market, not much really happened in my absence as the D-J Industrials (INDU/13207.95) experienced their tightest weekly trading range since January 2007. Of course, that was not the case a year ago when our sovereign debt was downgraded and equities collapsed 6.66% (the mark of the devil as well as the intraday low of March 6, 2009 where the new bull market began). Indeed, what a difference a year makes. Nevertheless, the rotation away from the defensive sectors and into Materials (+2.83%), Energy (+2.34%), and Technology (+2.10%) is an interesting observation because when the defensive sectors lead it is not indicative of a healthy and sustainable rally. Said rotation reinforces my belief that the upside breakout above the 1360 – 1366 level is for real and suggests we are finally setting up for another push to the upside. The real battle should be waged at the April highs of 1422. That said, the rally that began on June 4th has left ALL of the macro sectors overbought in the short term. It has also left the SPX at the top of the parallel chart channel (read: resistance) referenced in last Monday’s letter. Consequently, a pause or pullback attempt is not out of the question. Support remains in that 1360 – 1366 zone for the SPX.

The call for this week: The good: stocks are hanging in pretty well after an 11% rally from the June 4th low, earnings are still beating estimates by ~60%, earnings revisions are rising again, economic reports are strengthening, European equities have rallied while their sovereign yields have declined, the SPX continues to track the typical election pattern (see chart from the sagacious Bespoke organization), and there was a rare “buy signal” from the Bob Farrell sentiment indicator. The bad: all sectors are overbought, companies are beating revenues estimates by only 48.3%, the number of new highs is shrinking, upside momentum has waned, we are at the top of a parallel channel in the SPX chart. The ugly: forward earnings guidance is negative by 5.5%, the presidential election rhetoric is getting nastier, commercial hedgers have moved close to their most extreme short position in years, the Volatility index (VIX/14.74) is below 15 (read: no fear), gasoline had its largest two-week rise this year (+$0.18), and the list extends. Nevertheless, I think this is the pause that refreshes and not the start of a big decline.


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Copyright © Raymond James

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Yogi Berra? (Saut)

Tuesday, August 7th, 2012

by Jeffrey Saut, Chief Investment Strategist, Raymond James

“Yogi Berra”
August 6, 2012

“It’s hard to make predictions, especially about the future.”… Yogi Berra

To be sure, “It’s hard to make predictions, especially about the future,” and last week was no exception. I began the week, as stated in Monday’s missive, noting that there would be a trifecta of potentially market moving news events. The first was the two-day FOMC meeting where I thought the Fed would change its policy statement with a lean toward more accommodation. My reasoning was that the Fed would appear too political by waiting until the September meeting, just a few short weeks before the election. WRONG; and that was pointed out to me in spades on Thursday because while Wednesday’s “no change” policy announcement only produced a stutter step for the S&P 500 (SPX/1390.99), by Thursday the SPX swooned. Indeed, by mid-session the SPX had shed more than 20 points from Wednesday’s closing price (1375), and in the process tagged its intraday low of 1354. By the close, however, the index had recouped about half of those intraday losses, ending the sloppy session at 1365. Actually, Thursday’s late in the day recovery was yet another surprise to me because hereto my early week prediction was there would be no surprise from the European Central Bank meeting. But, a surprise it was with Mario Draghi unwilling to make good on his previous week’s market moving statement that, “Within our mandate, the ECB is willing to do whatever it takes to preserve the euro and, believe me, it will be enough.”

WRONG; and I had to suffer through that night’s, and early Friday morning’s, parade of pundits talking about how bad the employment number might be. Such musings should have had a dilatory effect on the preopening futures, but that wasn’t the case as a number of other rumors swirled down the canyon of Wall Street with positive implications. Still, everyone awaited the numba’! And as stated in Thursday’s verbal strategy comments, I had no idea as to what the number was going to be given the wide dispersion of previous reports; yet, my sense was it was going to be close to consensus. WRONG again because Friday’s number was much better than expected with nonfarm payrolls rising to 163,000 versus the median forecast of +100,000. Lost in the euphoria, however, was that the unemployment rate rose from 8.216% to 8.253%.

So it was three “strikes” and “out” for me and my predictions last week. About the only thing I got right was saying in Thursday morning’s verbal strategy comments that any pullback should be contained in the 1360 -1366 zone so often mentioned in these comments; and contained it was, with Thursday’s close of 1365. Given Friday’s surprise number, the SPX sprinted to its highest closing price since May 3rd and reinforced my more bullish stance of the past few weeks (as opposed to my previous trading range, but not bearish, stance). Friday’s Fling took the SPX up to the top of a parallel channel, as can be seen in the chart on page 3 from the astute Bespoke organization. If it can break out above that channel, last April’s reaction high of 1422 should be the next objective.

Regrettably, a strong earnings season has not been the driver of the upside breakout. Verily, of the 1,702 companies that have reported, the earnings beat ratio stands at 59.9%, well behind the S&P 500’s beat rate of 67.3% (376 companies have reported). Meanwhile, the revenue beat rate stands at only 48.2%. Yet by far the most troubling metric is the company’s forward earnings guidance, which is currently negative. Despite that forward guidance, the bottom up consensus earnings estimates for the SPX remain around $102 for this year and near $115 for 2013. If those estimates are anywhere near the mark, it means the SPX is trading at 13.6x this year’s estimates, and at 12x next year’s estimates, with concurrent earnings yields (earnings ÷ price) of 7.3% and 8.3%, respectively. Using the yield on the 10-year Treasury Note of 1.6% as your risk free rate of return produces what an analyst terms an equity risk premium of 6.7% basis next year’s estimates (earnings yield 8.5% – 1.6% risk free return = 6.9% equity risk premium, or ERP). Investopedia defines an ERP as:

“The excess return that an individual stock, or the overall stock market, provides over a risk-free rate [of return]. This excess return compensates investors for taking on the relatively higher risk of the equity market.”

QED, investors are being “compensated” by 6.7% (ERP) to own the SPX instead of the 10-year T’note.

While the aforementioned valuations are not as parsimonious as they were at last year’s October 4th undercut low (we were very bullish), they are still pretty inexpensive, offering the long-term investor a decent risk/reward ratio when combined with the SPX’s 1.9% dividend yield. Yet, I understand investors’ reluctance to commit capital since it seems like the trading of the “headline” < i>du jour is creating too much volatility. Interestingly, one vehicle that attempts to damp down some of that volatility is the PowerShares S&P 500 Low Volatility ETF (SPLV/$28.05), which consists of the 100 stocks in the S&P 500 with the lowest realized volatility over the trailing 12 months. This ETF currently yields 2.9%; as always, details should be checked before purchase.

Another strategy that has been working for the past few quarters has been to consider companies that have beaten quarterly earnings estimates, as well as revenue estimates, and guided forward estimates higher. Some names from the Raymond James research universe that have recently met these three criteria, are favorably rated by our fundamental analysts, and have “greened up” on indicators, like the SPX chart on page 3 shows, include: BioMed Realty Trust (BMR/$18.76/Outperform); Extra Space Storage (EXR/$33.45/Outperform); Kimco Realty (KIM/$19.94/Outperform); Power-One (PWER/$5.13/Outperform); Post Properties (PPS/$51.23/Strong Buy); and Wabtec (WAB/$78.38/Outperform).

The call for this week: As a sidebar, be sure to look at this month’s edition of < i>Gleanings for further insights from our economist, technical analyst, and my additional thoughts. As far as the stock market, last Friday’s rally extended the upside breakout by the SPX above the often mentioned 1360 – 1366 zone; and at this point, that breakout looks sustainable. The rally has also broken the index above the “neckline” of what a technical analyst would term a reverse head and shoulders bottoming pattern (read: bullishly). That said, the rally has left the SPX at the top of the parallel channel previously mentioned, as well as leaving every macro sector I follow pretty overbought in the short term. Also of note is that while the D-J industrials, the S&P 500, and the D-J Utilities bettered their June reaction highs, the S&P 400 MidCap, the S&P 600 SmallCap, the NASDAQ Composite, the Russell 2000, and the Value Line Arithmetic Index did not (read: potential non-confirmation). Still, the stock market’s internal energy continues to look strong, my proprietary indicators have been “green” on the S&P 500 for six weeks (see chart on page 3), the Dollar Index got crushed on Friday (lower dollar means the “risk trade” is back on), short interest on the NYSE is high, the equity markets survived a potential “flash crash” from the Knight Capital (KCG/$4.05/Market Perform) fallout, the recent investor sentiment figures were about as negative as they ever get, the public liquidated another $2.7 billion of domestic equity mutual funds last week (the highest weekly redemption of the year), the Spanish market rallied 7.41% on Friday, well y’all get the idea. Recently participants have been conditioned to sell each marginal breakout to a new reaction high because it has been followed by a pullback. I am not so sure this breakout plays that way. Indeed, I expect at least a test of the April highs (1422) over the next few weeks before a corrective phase begins.

P.S. – I will be in Boston all week spending time with portfolio managers, seeing accounts, and speaking at a conference. I will try and do my verbal strategy comments, but they are likely going to be abbreviated.

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“One Way Pockets” (Saut)

Tuesday, July 10th, 2012

 

“One Way Pockets”

by Jeffrey Saut, Chief Investment Strategist, Raymond James

July 9, 2012

“When a market fluctuates for several weeks or months within a narrow range, one of these three things is happening: pools and large operators are accumulating securities by absorbing the offerings of tired holders; or they are distributing certain stocks under cover of artificial strength in others; or the market is actually in a state of uncertainty and waiting a fresh impulse.”

… One Way Pockets by Don Guyon (1917)

This quote was taken from the book One Way Pockets, first published in 1917. As stated in the book’s more recent introduction – the author, who assumed the nom de plume of “Don Guyon” to avoid being identified with his wealthy clients – was associated with a boutique brokerage firm that had sizeable business with investors in all sections of the country. In 1915 he began an analytical study of the orders executed for certain active traders with the idea of determining the fundamental weakness, if any, in their speculative methods. The results were illuminating enough to afford corroborative evidence of general trading faults, which persist to this day. While I have found many of the book’s insights helpful to my investment process, and urge investors to study said book, there have been other investment methods of interest.

Perhaps the best way is to emulate some of the trading principles used by yesteryear’s legends, who beat the market no matter the emotions and mechanics of the institutional herd, is to study them. To wit:

Bernard Baruch – Eighty some years ago, he would research a stock, buy it, and then each time the stock rose 10% from his purchase price, buy an additional amount equal to his first purchase. If the stock began declining he would sell everything he had bought when the drop equaled 10% of its top price.

Baron Rothschild – His success formula was centered on the famous quote attributed to him – “I never buy at the bottom and I always sell too soon.”

Jesse Livermore – This legendary speculator profited enormously by calling the vigorous 1921 and 1927 advances correctly. In 1929 he reasoned that the market was overvalued, but finally gave up and became bullish near the top in the fall of that infamous year. He quickly cut his losses, however and switched to the short side. Livermore listed three major points for success: Sensitivity to mob psychology, willingness to take a loss, and liquidity (meaning that stock positions should not be taken that cannot be sold in 15 minutes in the market).

Addison Cammack – A broker from Kentucky, who swore by the two-point stop-loss. “If you’re wrong,” he said, “You might as well be wrong by two points as ten.” He followed this method successfully, and was one of the few bears to make a fortune on Wall Street and keep it.

Have we got you thinking about what trading strategy to follow? Well, we’ve been holding the best system for last. Here is the sure-thing formula for success, “Don’t gamble – take all savings and buy some good stocks, and hold them until they go up, then sell them … if it don’t go up, don’t buy them!” – Will Rogers

I first heard about One Way Pockets in the early 1970s when Merrill Lynch’s Chief investment Strategist referred to it as his “investment bible.” Since then, I have read the 64-page book a number of times and have always found it insightful. Obviously, the quote I began this report with has stuck in my mind and I think that quote is applicable for the current stock market because the S&P 500 (SPX/1354.68) has indeed been locked in a pretty narrow range since May 5th. Beginning with the June 29th Dow Delight (+277 points), however, it felt like the resolution of the two-month trading range might be to the upside because the SPX traveled not only above its 50-day moving average (DMA @1339.28), but broke above the 1360 – 1366 level that has contained recent rallies. Moreover, the trading action produced a fairly rare event in what a technical analyst would term a “bowtie.” Now a “bowtie” is created when there is a confluence of moving averages into what looks like a “bowtie” (see chart on page 3). In the current case the moving averages in question would be the 10/30/50-DMAs. While such a configuration does not tell us which way the stock market is going to go, it does tell us there is the potential for a move of some substance. For example, studying the attendant chart shows the “bowtie” of August 2011 preceded a ~14.5% decline. The quid pro quo is that the “bowtie” of mid-December 2011 kicked-off an ~18% rally. Regrettably, Friday’s employment numbers clouded the previously improving backdrop, yet participants should still not give up the bullish “ship” because one day does not make a trend. As stated in Friday’s verbal strategy comments, the upside breakout by the SPX had lifted it back into minor resistance and left it somewhat overbought in the very short-term. Therefore, a shallow pullback was not out of the question; and, the employment numbers served as the causa proxima for that pullback.

By Friday’s closing bell the disappointing employment report had pressured the SPX lower by 12.90 points, but off only 7.48 points for the holiday-shortened week. While the selling pressure increased during Friday’s session, it did not turned any of my macro models negative, at least not as of yet. Moreover, my intermediate-term model on the SPX has turned “green” over the past two weeks. As can be seen in the chart (page 3), once this indicator begins to “trend” it does not give you very many false signals (BTW, green is good and red is bad). Ergo, as of now I expect any pullback to be shallow and hence contained by the support level visible between 1335 and 1345 basis the SPX. That said, we still have NOT had the decisive/sustained upside breakout I was hoping for, which continues to leaves the equity markets mired in the now two-month trading range. While I expect the markets to resolve themselves to the upside, they don’t run the various markets for my benefit. Accordingly, I think the best strategy is to continue to accumulate the non-market correlated stocks so often mentioned in these missives. Those names are favorably rated by our fundamental analysts and posses decent dividend yields. That list now includes: Allstate (ALL/$34.79/Strong Buy); Covanta (CVA/$17.28/Strong Buy); Johnson & Johnson (JNJ/$67.64/Outperform); Plum Creek Timber (PCL/$40.00/Outperform); Rayonier (RYN/$45.66/Strong Buy); and Stonemor (STON/$26.25/Outperform).

The call for this week: This morning I awoke to headlines “Asia Signals Drop In Global Demand,” “Euro Zone Fragmenting Faster Than EU Can Act,” “European Worries Send Shares Lower,” and “Investors Brace For Shaky Earnings Season.” Such musings have the S&P 500 futures off about six points. Somewhat offsetting these negative quips are these headlines, “Fed Officials Favor QE3” and “Obama To Seek One-year Extension For Some Of Bush Tax Cuts;” but alas, this morning the negatives are outweighing the positives. If the futures open where they are indicated it would push the SPX into the upper part of the 1335 – 1445 support zone. While I expect that level to “hold,” if it doesn’t more defensive action is warranted.


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“The Virtue of Necessity” (Saut)

Thursday, July 5th, 2012

“The Virtue of Necessity”

by Jeffrey Saut, Chief Investment Strategist, Raymond James

July 2, 2012

Mikhail Gorbachev understands this rule of political survival: Make what you must do appear to be what you want to do. His economic reports this summer showed the Soviet Union’s desperation deepening, his perestroika failing. With top-level support crumbling, he staged a September coup. In the name of democratization, he concentrated government and party power in himself. That bought him time, but did not solve the most pressing problem: the huge chunk of Soviet production devoted to the military, now approaching 25 percent, four times greater than the U.S. share. Moreover, the cohort of draft-age Russians was shrinking, making military conscription more difficult. With no choice but to cut military spending, “President” Gorbachev turned that sour lemon of declining power into the most delicious lemonade. He came to the U.N. and told the world proudly that he was unilaterally reducing Soviet troop strength by a half-million. Not because he had to, you understand – purely motivated by idealism – [but] because “the use or threat of force no longer can or must be an instrument of foreign policy.”

What a combination of audacity and mendacity. Only the use of force keeps Communist regimes in power; only the “threat of force” from Soviet tanks keeps the people of Eastern Europe from overthrowing their hated puppet regimes. But the U.N. and the watching world heard what it wanted to hear – an uplifting, peaceful speech from an all-powerful Soviet leader that might have come from a freely elected American leader. The more gullible viewers thought they heard a genuine yearning for an end to Soviet expansionism instead of a rationale for a temporary retreat caused by economic necessity.

… William Safire, New York Times, 12/8/1988

“Economic Necessity” was a phrase replete in the media late last week and it brought back memories of the aforementioned quip by William Safire written in 1988. In the current case it is not economic necessity for Russia, but rather the European Union (EU). For months I have opined politicians, bureaucrats, and bankers are the same in Europe as they are here in that they do not want to lose power. And, if the EU implodes they all lose their power. Therefore, my sense has been the powers that be will continue to “paper over” Euroquake and buy time in hopes time will allow the EU to heal itself, just like we did with our Financial Fiasco (2007 – 2009). Manifestly, that “paper over” event is exactly what happened Friday morning with the EU summit announcement and the world’s markets soared. To be sure, some of the upside fireworks came from short-covering because participants have been rewarded for getting “short” in front of previous EU summits where the post-summit announcements have disappointed. This time, however, that was not the case, the announcement was substantial. Still, I think there was more at work than just short-covering.

Indeed, “your father’s” recession, and subsequent recovery, saw the two sectors that pulled the economy out of recession, namely autos and homebuilding, recording strong rebounds. Beginning in 2009 autos have done their job since we have gone from roughly a 9 million unit seasonally adjusted annual rate (SAAR) to nearly a 15 million run rate. The laggard has been homebuilding, but that appears to be changing. The Homebuilder’s Index is breaking out of a four-year base to the upside, suggesting the worst has been seen and discounted. Meanwhile, one of the things that got us cautious on housing was the rise in For Sale Inventory that began in mid-2005. Now, For Sale inventories have collapsed (see chart on page 3). The second thing that got us cautious on housing was the rise in the cost of a house at the same time inventories were increasing. Affordability, however, is currently at record levels (see chart on page 3). Such metrics have caused a noticeable improvement in sales. Recent reports indicate new home sales continue to accelerate. The seasonally adjusted annualized pace of new home sales (contract signings) rose 7.6% month-over-month to 369,000 units. Drilling down to the unadjusted data, May sales jumped 25% y/y and increased 6% sequentially, indicating that the positive momentum in housing has continued to build in recent weeks. Moreover, these results came as prices rose, with the median new home price climbing 5.6% y/y to $234,500 in May, which was an acceleration from +5.0% y/y in April. These are not unimportant data points because a pickup in homebuilding would not only add jobs, but should strengthen future GDP numbers. Also helping the economy is gasoline, which has fallen from $3.43 per gallon in April to $2.63 currently (basis the August futures contract). That decline is tantamount to a huge tax cut since every one penny decline in price adds approximately $1 billion to consumers’ purchasing power.

Given such metrics, I expect the same outcome that occurred for the past two summers. That being, recession fears, which caused those previous mid-year declines in equity prices, should give way to no recession with an attendant rise in equity prices. And, the rise may have already begun. Said view would gain traction if the S&P 500 (SPX/1362.13) can sustain an upside breakout above the ~1360 level that has contained recent rallies. If that happens, it would lift the SPX out of the trading range between 1290 and 1360 it has been mired in since mid-May. I think this scenario has a decent chance of playing since my weekly internal energy indicator has a full load of energy. My daily indicator’s energy level, however, was largely used up in Friday’s Fling, so maybe we see a pause and/or pullback attempt early this week that doesn’t get very far. Additionally, despite last Monday’s 138-point Dow Dive, following the previous Thursday’s Trouncing (-250 points), none of my risk and money flow indicators turned negative; and not getting bearish over the past few weeks has been a pretty good strategy.

Nevertheless, bearishness is in the “air” with participants in “panic mode” just like they were the past two summers. CALM DOWN, we have had a panic declines in each of the last two years and survived them. Verily, panics represent opportunity for the well prepared investor because the surest action in the stock market following a panic is the subsequent recovery. It’s almost a rule that after a panic there will be an advance that recovers roughly one-half of the points lost during the panic. Recall, last summer the SPX declined from its early July high (1356) into its “panic low” of August 9th (1101) and from there the bottoming process began. Remember that “bottoms” are a function of not just “price,” but “time” as well. In 2011’s “panic decline” the bottoming sequence took from August 9th until October 4th and from there not only did we recover half of the price decline (19%), but we experienced a 32% rally.

Consistent with these thoughts, if the SPX has a decisive and sustained breakout above 1360, we recommend putting some more cash back to work. Over the past few weeks we have featured non-market correlated situations, with decent yields and favorable ratings from our fundamental analysts, like: Covanta (CVA/$17.15/Strong Buy); Johnson & Johnson (JNJ/$67.56/Outperform); and Rayonier (RYN/$44.80/Strong Buy). This morning we revisit the long-standing theme that the master limited partnership (MLP) complex, which trades on average between 9 – 10 times EBITDA, is likely going to acquire select E&P C-corporations that trade at roughly 4 – 5x EBITDA because it is accretive to do so. Some names from our research universe with favorable ratings from our fundamental analysts that play to this theme, include: Denbury Resources (DNR/$15.11/Outperform); Plains Exploration (PXP/$35.18/Outperform); and Whiting Petroleum (WLL/$41.12/Outperform). And since the Energy sector is the most oversold of the 10 macro sectors, speculators might want to consider some our favorably rated, and thoroughly beaten up, coal stocks that presented at the fourth annual Raymond James Coal Conference. For ideas see analyst Jim Rollyson’s Industry Brief dated June 21, 2012.

The call for this week: In my opinion, last week the Commodity Index bottomed and the Dollar Index topped. If so, recession fears should abate in the months ahead. Moreover, if a recession was really on the horizon “junk” bond yields would be rising on worries of increased defaults and that is not happening with the iShare High Yield Fund (HYG/$91.29) attempting to make a new reaction high (i.e., lower yields). Further, if we are heading into a recession, why is the Market Vector Retail ETF (RTH/$42.26) within 1% of new all-time highs? Meanwhile, investors are frozen by the negative narrative of world and economic events and investors have been liquidating domestic mutual funds for about 30 months, investment sentiment is dour, NYSE short interest versus the SPDR S&P 500 ETF (SPY/$136.43) is rising, and there is a huge amount of cash on the sidelines, all of which is inconsistent with a stock market that is vulnerable to a big decline. With the aforementioned proprietary metrics, and the tons of internal energy built up in the markets, if the SPX can sustain a breakout above 1360 the upside could surprise even the “bulls.”


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“Happy Birthday America” (Saut)

Wednesday, July 4th, 2012

“Happy Birthday America”

by Jeffrey Saut, Chief Investment Strategist, Raymond James

July 3, 2012

This is my annual “Happy Birthday America” report, a tribute to Independence Day, because tomorrow our nation celebrates its 236th birthday. Yet, it was actually on July 2nd when America broke from Great Britain. Two days later the Declaration of Independence was signed, which is why we celebrate the occasion on the 4th of July. I always commemorate the day by re-reading the lyrics from the “Star-Spangled Banner” in honor of our forefathers’ courage. While most citizens know the first stanza of said anthem, few know the other three. Nor do they know the history leading up to the crafting of its words.

The year was 1812 and the United States was at war with England over freedom of the seas. It was a tumultuous time as Great Britain was struggling with Napoleon’s invasion of Russia. In 1814, however, Napoleon was beaten and England turned its attention to the United States. While many naval battles were fought, the fight eventually centered on the central part of the U.S. as the British attempted to split this country in half. Washington, D.C. was taken and then the Brits “marched” toward Baltimore, where a mere 1,000 patriots manned the cannons at Fort McHenry, whose guns controlled the harbor. If Baltimore was to “fall,” the British would have to take Fort McHenry.

The attack commenced on the morning of September 13, 1814, as 19 British ships began pounding the fort with rockets and mortar shells. After an initial exchange of fire, the Brits withdrew to just outside the range of Fort McHenry’s cannons and continued their bombardment for the next 25 hours. Surprisingly, on board one of the British ships was 35-year-old poet-lawyer Francis Scott Key, who was there arguing for the release of Dr. William Beanes, a prisoner of the British. Even though the captain agreed to the release, the two Americans were required to stay aboard until the attack on Baltimore was over. It was now the night of September 13th as the bombardment continued.

As twilight deepened, Key and Beanes saw the American flag flying over Fort McHenry. And, as reprised by famed author Isaac Asimov:

“Through the night, they heard bombs bursting and saw the red glare of rockets. They knew the fort was resisting and the American flag was still flying. But toward morning the bombardment ceased, and a dread silence fell. Either Fort McHenry had surrendered and the British flag flew above it, or the bombardment had failed and the American flag still flew.

As dawn began to brighten the eastern sky, Key and Beanes stared out at the fort, trying to see which flag flew over it. He and the physician must have asked each other over and over, ‘Can you see the flag?’

After it was all finished, Key wrote a four stanza poem telling the events of the night. Called ‘The Defense of Fort McHenry,’ it was published in newspapers and swept the nation. Someone noted that the words fit an old English tune called, ‘To Anacreon in Heaven’ – a difficult melody with an uncomfortably large vocal range. For obvious reasons, Key’s work became known as ‘The Star Spangled Banner,’ and in 1931 Congress declared it the official anthem of the United States.

Now that you know the story, here are the words. Presumably, the old doctor is speaking. This is what he asks Key:

Oh! say, can you see, by the dawn’s early light,
What so proudly we hailed at the twilight’s last gleaming?
Whose broad stripes and bright stars, through the perilous fight,
O’er the ramparts we watched were so gallantly streaming?
And the rocket’s red glare, the bombs bursting in air,
Gave proof thro’ the night that our flag was still there.
Oh! say, does that star-spangled banner yet wave,
O’er the land of the free and the home of the brave?

(‘Ramparts,’ in case you don’t know, are the protective walls or other elevations that surround a fort.) The first stanza asks a question. The second gives an answer:

On the shore, dimly seen thro’ the mist of the deep
Where the foe’s haughty host in dread silence reposes,
What is that which the breeze, o’er the towering steep
As it fitfully blows, half conceals, half discloses?
Now it catches the gleam of the morning’s first beam,
In full glory reflected, now shines on the stream.
’Tis the star-spangled banner. Oh! long may it wave
O’er the land of the free and the home of the brave!

‘The towering steep’ is again, the ramparts. The bombardment has failed, and the British can do nothing more but sail away, their mission a failure. In the third stanza I feel Key allows himself to gloat over the American triumph. In the aftermath of the bombardment, Key probably was in no mood to act otherwise? During World War I when the British were our staunchest allies, this third stanza was not sung. However, I know it, so here it is:

And where is that band who so vauntingly swore
That the havoc of war and the battle’s confusion
A home and a country should leave us no more?
Their blood has washed out their foul footstep’s pollution.
No refuge could save the hireling and slave
From the terror of flight, or the gloom of the grave,
And the star-spangled banner in triumph doth wave
O’er the land of the free and the home of the brave.

(The fourth stanza, a pious hope for the future, should be sung more slowly than the other three and with even deeper feeling):

Oh! thus be it ever, when freemen shall stand
Between their loved homes and the war’s desolation,
Blest with victory and peace, may the Heaven – rescued land
Praise the Power that hath made and preserved us a nation.
Then conquer we must, for our cause is just,
And this be our motto –“In God is our trust.”
And the star-spangled banner in triumph doth wave
O’er the land of the free and the home of the brave.

I hope you will look at the national anthem with new eyes. Listen to it, the next time you have a chance, with
new ears. Pay attention to the words. And don’t let them ever take it away . . . not even one.”

The call for tomorrow: “There is nothing wrong in America that can’t be fixed with what is right in America” … President Bill Clinton

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Atlas Shrugged!? (Saut)

Monday, June 11th, 2012

 

“Atlas Shrugged?!”

by Jeffrey Saut, Chief Investment Strategist, Raymond James

June 11, 2012

Stephen Moore wrote a Wall Street Journal article entitled, “Atlas Shrugged: From Fiction to Fact in 52 Years.” For those of us familiar with Ayn Rand’s classic book (Atlas Shrugged), recent events eerily mirror her writings about the economic carnage caused by big government running amok. As Mr. Moore wrote:

For the uninitiated, the moral of the story is simply this: Politicians invariably respond to crises – that in most cases they themselves created – by spawning new government programs, laws and regulations. These, in turn, generate more havoc and poverty, which inspires the politicians to create more programs … and the downward spiral repeats itself until the productive sectors of the economy collapse under the collective weight of taxes and other burdens imposed in the name of fairness, equality and do-goodism.

In the book, these relentless wealth redistributionists and their programs are disparaged as ‘the looters and their laws.’ Every new act of government futility and stupidity carries with it a benevolent-sounding title. These include the ‘Anti-Greed Act’ to redistribute income and the ‘Equalization of Opportunity Act’ to prevent people from starting more than one business (to give other people a chance). My personal favorite, the ‘Anti Dog-Eat-Dog Act,’ aims to restrict cut-throat competition between firms and thus slow the wave of business bankruptcies.

President Ronald Reagan was the first to suggest that the nine most terrifying words in the English language are, “I’m from the government and I’m here to help.” President Reagan also stated, “Government is not the solution to our problem; government is the problem.” Even President Clinton promised smaller government, but that promise ended on November 4, 2008 as voters elected President Barack Obama, ushering in an era of expanded government that Ayn Rand warned of 52 years ago (as a sidebar, we suggest watching this two-minute blurb from Milton Friedman – http://pajamasmedia.com/instapundit/69117/). Yet, last week may have marked a historic shift in the country’s ideological direction after Governor Scott Walker’s resounding win in Wisconsin’s recall vote.

Now I am not a Tea Party person, but since the historic mid-term elections I have argued the Tea Party surfaced what Adam Smith wrote about in the book “The Wealth of Nations.” To wit – the political corruption that prevents prosperity – and that is exactly what we’ve got, the best Congress (the House and Senate) money can buy. Yet, that seems to be changing punctuated by last week’s Wisconsin vote. However, the footings of the sea change began two years ago with the mid-term election where the majority of those elected were not professional politicians but rather came from the private sector. Moreover, if you talk to those newbies they will tell you they don’t really want to be in Washington, but they think the country is off course and they want to try and reverse that course. I think this is a trend toward more practical leaders that will offer simple and pragmatic solutions to our country’s ills rather than recondite laws like the aforementioned “Anti-Greed Act;” and, I think that is bullish for the stock market.

Last week the stock market thought so too as the S&P 500 (SPX/1325.66) posted its best weekly gain of the year. The weekly win left the SPX higher by 3.73% and back above its 200-day moving average (DMA), which is now at 1288.41. Of course, my email box subsequently lit up with the question, “Was last Monday’s intraday low of 1266.74 similar to the ‘undercut low’ you told us to ‘buy’ on October 4th of last year?” Early last week I really didn’t know the answer to that question because after recommending recommitting some of the cash raised in the February – April timeframe over the past few weeks, the breakdown below my key pivot point of 1290 (basis the SPX) caused me to suspend the judicious recommitment of cash until the near-term direction of the market became clearer. To be sure, in this business it’s better to lose “face” and save “skin!” By the end of the week the break below 1290 was indeed looking more and more like an “undercut low.” Recall, it was Merrill Lynch’s veteran strategist Bob Farrell who often spoke of “undercut lows” as being one of the better bottoming formations. For example, when the major averages trade below a previously well advertised stock market “low,” causing participants to panic and “sell” and then the markets “turn up” and rally, such sequences often mark tradable “lows.” This week should tell us if that is what happened last week.

Studying the market’s metrics, since the May 1st rally high (SPX 1415.32) there have been two 90% Downside Days (90% of total points and volume traded was on the downside) culminating with June 1st’s 90% Downside Day. Those two Downside Days probably exhausted the sellers, at least on a short-term basis. Consequently, what was needed was some upside demand and the stock market took a step in that direction last Wednesday with a Dow Wow of 287 points that turned out to be a 90% Upside Day. The rebound carried the senior index back above my 1290 pivot point and therefore placed it in a position to build on last week’s rally. Additionally, there is a full charge of energy in my daily internal energy model. Hence, if the SPX can surmount the overhead resistance around its recent reaction high of 1335, and stay above that level, the market should be able to move higher.

In terms of sectors, Financials (+4.71%), Materials (+4.38%), and Technology (+4.28%) saw the biggest bounces for the week, while Consumer Staples (+2.56%) rallied the least. The rally left Utilities and Telecom Services the most overbought sectors and Energy as the only remaining oversold sector. Outside of the country, Italy and Russia were better by more than 7%; and for those focused on Spain’s sovereign debt yields, maybe you should consider the fact that Spain’s equity market was up 10.41% last week. China was the worst performer as participants feared economic slowing as telegraphed by China’s interest rate cut and the lowering of gasoline prices.

Speaking to lower fuel prices, last week our airline analysts lowered their fuel assumptions for 2013 by 19% and raised their ratings on several companies. Alaska Air (ALK/$34.73) was upgraded to an Outperform with the comments from our analysts that Alaska Air has a best in class cost structure, balance sheet, and attractive valuation. Allegiant (ALGT/$65.70) was moved to a Strong Buy given its leverage to lower fuel prices and strong earnings momentum driven by a 16-seat expansion project, Hawaii service, and carry-on bag fee. The change in our fuel price assumptions produces a very large change in earnings because jet fuel and related taxes and fees on average accounts for about 38% of total airline expenses. Moreover, the impact on earnings is obviously far greater for airlines with lower margins. As an example, our analysts boosted their earnings estimates for U.S. Airways (LCC/$12.15/Outperform) by 25% this year and 46% next year. Interestingly, LCC has been showing up on our proprietary screening models for months with positive implications. Other names that have positive implications and are rated favorably by our fundamental analysts include: Allstate (ALL/$34.31/$Strong Buy); Davita (DVA/ $85.60/Outperform); Dollar Tree (DLTR/$106.72/Strong Buy); Brinker (EAT/$30.90/Strong Buy); Family Dollar (FDO/$69.58/Outperform); and JB Hunt (JBHT/$55.39/Outperform).

The call for this week: Over the weekend the eurozone agreed to lend Spain up to €100 ($126 billion) to shore up its teetering banks. That decision prompted this from my friend David Kotok, captain of Cumberland Advisors:

The fact is the absence of banking collapses is good news. That is correct. Good news! We establish that good news by what we DO NOT see on TV. We do not see banks collapsing and failing to pay depositors. This means we may not witness the euro system collapsing and failing. Bank runs and deposit failures are symptoms of liquidity constraints. Liquidity is not to be confused with solvency. A prime example: Greece is certainly insolvent. It cannot pay its debt or its governmental bills. Nevertheless, Greece’s banks still have liquidity because of Emergency Liquidity Assistance (ELA) funding. [Because] ELA exists the euro system agents know that they cannot permit euro system banks to fail to pay their depositors. Therefore, our conclusion is that liquidity issues will be addressed in the euro zone. The Spanish banking chapter is unfolding before our eyes. Markets have been pricing in a fear of systemic failure on the liquidity side. Market bears will be disappointed, because the liquidity failure is not going to happen. The next test is coming on June 17, with French and Greek elections.

Now we know why Spain’s equity markets rallied over 10% last week. As for our markets, in last week’s verbal strategy comments I said that am treating last Monday’s intraday low as a daily and intermediate term low. I still feel that way.

 

Copyright © Raymond James

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“1-800-GET-ME-OUT?!” (Saut)

Monday, June 4th, 2012

 

“1-800-GET-ME-OUT?!”

by Jeffrey Saut, Chief Investment Strategist, Raymond James

June 4, 2012

The “S” word makes most investors uneasy. They find the “B” word, “buying,” much more pleasant. Why is perhaps best explained in a book written by Justin and Robert Mamis titled “When to Sell.” Following are several poignant excerpts from that book:

“Stocks are bought not in fear but in hope. No matter what the stock did in the past it assumes a new life once a purchaser owns it, and he looks forward to a rosy future – after all, that’s why he singled it out in the first place. But these simple expectations become complicated by what actually happens. The stock acquires a new past, beginning from the moment of purchase, and with that past comes new doubts, new concerns, and conflicts. The purchaser’s stock portfolio quickly becomes a portfolio of psychic dilemmas, with ego, id, superego, and reality in a state of constant battle.”

“The public is most comfortable when they are sitting with losses. Because if their stocks are down from where they bought them, they don’t have to worry about them. Once he’s got a loss, the typical investor is sure he isn’t going to sell. He bears the lower price because in his mind it is temporary and ridiculous; it’ll eventually go away if he doesn’t worry about it. So selling at a loss becomes absolutely out of the question. And since it is out of the question, and his mind is made up for him, the struggle of any potential decision vanishes and he is able to sit comfortably with the loss.”

“To the public mind, selling is never sound. It always conveys the possibility of being wrong twice: first, admitting that they’ve made a buying error; second, admitting that they might be wrong in selling out. And if the stock has actually gone up, they are tormented; should they take a profit or hold for a bigger one? That creates anxiety, and anxiety breeds mistakes. But as long as they’ve got losses, and never have to decide, they can sit back comfortably and dream instead.”

“Through the entire market cycle lurks the fear of finalizing the deed, of taking it from dream to reality by selling. By not selling, by tightly holding on to his stocks, the investor never has to face reality.”

Yet, “selling” seemed to be on the market’s mind late last week punctuated by Friday’s Dow Dive of ~275 points. Said decline left the senior index down 8.74% from its May 1st closing high (13279.32) into Friday’s close (12118.57). While not all that big of a decline, it brought back memories of the past two years’ May – July corrections of 17% and 20%, respectively. Yet, investors should keep in mind that since 1928 there have been 294 pullbacks of 5% or more. Ninety four of them have been moderate (>10%), 43 have been severe (>15%) and 25 have been bear markets (>20%). What is interesting to me is that since last October 4th’s “undercut low” the chant from most investors has been, “We want a pullback to become more fully invested.” Now that we have the pullback everyone is in panic mode (again). To borrow a line from George Bernard Shaw – There are two tragedies in life; one is not to get your heart’s desire, the other is to get it! The “heart’s desire” for the bulls since last October has been the fact the markets have ignored all of the bad news. Verily, the senior index has turned a deaf ear to the worsening Euroquake situation, Iran, softening economic trends, deflationary dives in commodities, etc. Of course that “deaf ear” stance has changed over the past four weeks.

Indeed, the Dow’s decline is now 22 sessions long. Such “selling stampedes” typically last 17 – 25 sessions before they exhaust themselves; it just seems to be the rhythm of the thing. This has been my observation over the years in that it takes this long to get participants bearish enough to finally panic and throw in the towel by selling their stocks. While it is true some stampedes have lasted more than 25 sessions, it is rare to have one run more than 30 sessions. Today is session 23 on the downside. Obviously Friday’s Fade took out my failsafe point of 1290 on the S&P 500 (SPX/1278.04), leaving the DJIA (INDU/12118.57), the S&P 500, and the NASDAQ Composite (COMP/2747.48) all below their respective 200-day moving averages (DMAs). The bears will be quick to point out this is what happened right before the crashes of 1929 and 1987. However, the bullish argument is that over the past 20 years a break below the 200-DMA by the SPX, after it has stayed above it for three months, has typically led to a rally. Also worth noting is the decline has left most of the oversold indicators I rely on pretty oversold. Nevertheless, I told “callers” on Friday that when markets get into one of these selling squalls they rarely bottom on a Friday. What tends to happen is participants go home and brood about their losses over the weekend and “show up” on Monday in selling mode, which often leads to “turning Tuesday” (read: recoil rebound). Accordingly, the SPX needs to quickly recapture 1290, and stay above that level, if a rally is to commence. On the other hand, if the SPX merely bounces back up to 1290, and then falls sharply back, I would view that as a bearish sign requiring more downside hedging and/or the raising of some more cash. Fortunately, we recommended raising cash in February – April. Unfortunately, we recommended judiciously putting some of the cash back to work (but not much of it) into somewhat more defensive names like 3.8%-yielding Rayonier (RYN/$42.18), which has a Strong Buy rating from our fundamental analyst.

While Euroquake has been on center stage for weeks, Friday’s shockingly weak employment report brought the focus back to the economy and jobs. The 69,000 private sector payroll growth figure was well below the estimate of 150,000 and just to add pain to injury the unemployment rate ticked up to 8.2% from 8.1%. Still, investors should remember unadjusted private-sector payrolls have risen by 1.983 million over the trailing 12 months for roughly a 165,000 monthly average jobs gain. As our economist, Dr. Scott Brown, notes, “That’s not bad, but it is far short of what’s needed to make up ground lost during the economic downturn.” Now for weeks I have been discussing the weakening economic reports. That string of weakness continued last week given that of the 21 economic releases, 18 were weaker than expected, two were in line, and only one exceeded the estimate (that would be Continuing Claims). This softening trend could still just be a weather-related issue combined with skewed seasonal adjustments; the next few months will decide.

The call for this week: Friday was the first day of hurricane season here in Florida, yet the storm didn’t hit our beaches but rather blew onto the Street of Dreams with a 275-point “storm surge.” The media attributed Friday’s Flop entirely to the disappointing employment numbers, but the truth was the market was already headed down before the release of those numbers. And when the SPX’s 1290 level was breached, the rout was on. The result left all of the indexes we monitor near their lows of the day and the three major market indices (INDU, SPX, COMP) below their respective 200-DMAs for the first time in about five months. The bears will be quick to point out this is what happened right before the crashes of 1929 and 1987. However, the bullish argument is that over the past 20 years a break below the 200-DMA by the SPX, after it has stayed above it for three months, has typically led to a rally. And despite the break below my 1290 pivot point I can’t shake the feeling that all of this is just part of the bottoming process.

P.S. – I am on the road again this week seeing accounts and speaking at conferences.

 

Copyright © Raymond James

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I Should Have?!? (Saut)

Monday, May 21st, 2012

 

“I Should Have?!”

by Jeffrey Saut, Chief Investment Strategist, Raymond James

May 21, 2012

“… A man has rigged up a turkey trap with a trail of corn leading into a big box with a hinged door. The man holds a long piece of twine connected to the door that he can use to pull the door shut once enough turkeys have wandered into the box. However, once he shuts the door, he can’t open it again without going back into the box, which would scare away any turkeys lurking on the outside. One day he had a dozen turkeys in his box. Then one walked out, leaving eleven. ‘I should have pulled the string when there were twelve inside,’ he thought, ‘but maybe if I wait, he will walk back in.’ While he was waiting for his twelfth turkey to return, two more turkeys walked out. ‘I should have been satisfied with the eleven,’ he thought. ‘If just one of them walks back, I will pull the string.’ While he was waiting, three more turkeys walked out. Eventually, he was left empty-handed. His problem was that he couldn’t give up the idea that some of the original turkeys would return … ”

… Why You Win or Lose, by Fred C. Kelly

“I should have sold when the S&P 500 broke below its rising trendline on April 9th at 1397” (see chart on page 3). “I really should have sold on May 11th when the S&P 500 (SPX/1295.22) traveled below its April 10th intraday reaction low of 1357.38.” So exclaimed one disgruntled portfolio manager last Friday since the SPX continued to surrender ground. Plainly, the “I should have” crowd surfaced again last week as the SPX knifed through my envisioned support zone of 1320 – 1340, causing one savvy seer to exclaim, “Markets always go further than most pundits believe, both on the upside and the downside.” Yet the recent downside dive from May 1st’s 1415 level into last Friday’s close of 1295.22 has caused many of my indicators to register readings not seen in a long time. For example, the McClellan Oscillator is now at oversold readings not seen since the recent April 10th trading bottom (see chart on page 3). Then there is the CBOE Equity Put/Call Ratio, which is flashing a “buy signal” that has proven profitable at every downside inflection point since 1994; or, as the astute folks at Bespoke write:

“Following today’s 0.44% decline (5/16/12) in the S&P 500, the 10-day Advance/Decline line for the S&P 500 has now dropped down to –1,930. This is an extreme oversold reading based on historical standards. For those unfamiliar with the indicator, the 10-Day A/D line is simply a rolling 10-day total of the daily net number (of similar readings) shows that equities have historically rebounded after hitting such extreme oversold levels. Over the next week, the S&P 500 averages a gain of 1.21% with positive returns two-thirds of the time. Over the next month, the S&P 500 averages a gain of 5.58% with positive returns 83% of the time. Going out three months, the S&P 500 averages a gain of 7.68%, and over the next six months the index averages a gain of 13.35%.”

Adding to the litany of downside inflection-point indicators is the AAII (American Association of Individual Investors) survey that recorded its lowest bullish reading (23.6% bulls) since August 2010. Moreover, my parade of short/intermediate-term indicators shows a composite reading that is at historic levels. To wit, there have only been only four other times when my indicators have combined to show such negative inclinations. More than seventy percent of the time, given such readings, the major market averages have been higher a week later, while 92% of the time they have been higher a month later. Accordingly, unless we are in “crash mode,” and I don’t believe that, it is time to ready your “buy list” and begin judiciously recommitting some of that cash to stocks; and, that is what I have been recommending. Indeed, over the past week I have been recommending recommitting some of the cash we suggested raising in February – April. One of the techniques we have used to accomplish this at similar inflection points was first proffered by our friends at Riverfront Investment Group back in 2009. As stated:

“First, identify the quantity of cash to be put to work – example: 20%. Second, break the trade into digestible chunks – example: break it into four parts, 5% each. Third, implement the first trade today – example: invest 5% into equities today. Fourth, set a date for implementing the second trade – example: two months from today invest the second 5%. Fifth, implement third and fourth segments if market pullbacks occur – example: invest the remaining 10% of the cash on market pullbacks. And six, after the date of the second trade occurs, return to step one with the remaining cash – example: two months from today, if the market never provides the opportunity to buy on a pullback, break the remaining 10% up into 3-4 parts and follow a strategy similar to the one utilized for investing the first 10%.”

I think Riverfront’s strategy is appropriate since the SPX is probing its next downside energy level. Further, the stock market’s internal energy level is totally exhausted on the downside, implying a tradable bottom is likely at hand unless we are involved in a mini-crash. The real question thus becomes, “If we get a rally from this oversold condition is it the start of a new “up leg,” or is it just a compression rally that will be brief followed by still lower prices?” Speaking to that point, it is worth considering the SPX is currently trading at a P/E ratio of 13.1x earnings. Since record keeping began there have only been five occasions when a bear market began with the SPX’s P/E ratio below 15x. Another timely question is, “Will the recent Dow Dive trigger QE3, Operation Twist II, or targeting GDP?” While equity markets can clearly do anything, at worst we should at least get a relief rally from here and at best it could be the start of a new “up leg.” Therefore, I think the gradual re-accumulation of investment positions is the correct strategy. For those participants not wanting to try and “catch a falling knife” by purchasing the exchange-traded product of your choice, a more conservative approach would be to accumulate dividend-paying stocks. Some that screen well technically, and have a Strong Buy rating from our fundamental analysts, for your potential shopping list include: 3.0%-yielding Automatic Data Processing (ADP/$51.98); 3.8%-yielding Rayonier (RYN/$42.08); 4.3%-yielding Digital Realty Trust (DLR/$68.48); 5.2%-yielding Enterprise Products Partners (EPD/$48.48); and 8.2%-yielding Linn Energy (LINE/$35.24).

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