"sometimes Me Sits And Thinks And Sometimes Me Just Sits!"
By Jeffrey Saut | 16 June 2008
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"Sometimes me sits and thinks and sometimes me just sits" is an axiom that has saved us a lot of money over the years because we have learned the hard way that when you attempt to "force" a trade, or an investment (lunge left or lunge right), it tends to be a prescription for losing money. Indeed, as Charles Dow wrote, "The successful investor must be willing to ignore two out of every three potential money making opportunities." [[I.e., always err on the side of caution! Remember, it is a string of loss-free returns, rather than a high 'average' return with lots of minuses, that wins the compounding prize! (See my post on "Why Investors' Fail."): normxxx]] Accordingly, since recommending raising some cash at last May’s reaction price "highs," we have been "sitting" awaiting another good trading/ buying-point like the ones we identified at the January and March "lows." As stated, our preferred downside target has been the 1320 - 1330 level, basis the S&P 500 (SPX/1360.03), and late last week the SPX "tagged" the upper end of that envisioned zone.
Conveniently, in last Thursday’s verbal strategy comments, we actually suggested a scale "in" buying approach for trading accounts given we were near our target zone, as well as the fact that our proprietary overbought/oversold Trading Index was more oversold than it has been in years. Almost on cue the SPX carved out a trading-bottom and has subsequently lifted some 30 points. The question now becomes, "How long should any rally last and how far can it carry?"
To this question the astute Lowry’s organization noted in its Friday’s report. "The longevity of a rally is directly correlated to the strength of investor Demand during the rally. If Demand is broad and persistent, the gains could be significant. But if Demand is weak and selective, then the rally might best be used as an opportunity to sell." Since we are only two days into the rally, it is still too early to determine the extent of investors’ "demand," but we are constructive in the short/intermediate-term provided we are not in one of these 17- to 25-session "selling stampedes" (we rather doubt it).
Our near-term constructive stance centers on the sense that what we are likely going to experience is a "W"-shaped economic pattern. To wit, while we have repeatedly stated the economy is slowing, we have also been steadfast in the belief there would be no recession in 2008 (two negative quarters of GDP). That sense was/is driven by the fact that every government-sponsored economic stimulus program since 1948 has worked! And when taken in concert with the Herculean efforts of the Federal Reserve, we have been inclined to give this economic stimulus program the benefit of the doubt.
That said, we have proffered the economic slowdown might be interrupted by improving economic statistics (as we saw last week) spurred by the stimulus package. Moreover, this short-lived economic rebound should give participants the impression that all of our economic troubles are behind us, fostering a rally in the stock market. To us, the envisioned economic rebound would represent the middle part of the "W" pattern. Unfortunately, we think such a strengthening economic sequence will be accompanied by stronger than expected inflation readings, causing the Federal Reserve to raise interest rates, thus slowing the economy again; aka the back half of the "W," or an economic double-dip [[we're about due; we haven't seen one in a while, and with a new chairman and a relatively new slate of Fed governors, ...: normxxx]].
Last week the Federal Reserve reinforced our sense that we are in the middle part of the "W" when Ben Bernanke declared "Mission Accomplished" and changed his focus from "downside risks to the economy" to "inflation concerns." Clearly the Fed is worried the inflation "Genie" is climbing out of the bottle; and, if that happens, it is going to be very difficult to put said Genie back. Adding to the inflation worries were last week’s Import Prices, which rose at a 17.8% year-over-year ramp rate (the highest since 1983), with the ex-fuels Import Prices component increasing 6.1% year-over-year led by a 4.6% gain in import prices from China, causing one savvy seer to lament, "the days of importing deflation are over!"
Also bolstering our near-term stock optimism is a sense the "political will" has reached a tipping-point, whereby there is going to be a concerted governmental effort to arrest the vertiginous rise in the price of crude oil [[even the U.N. has gotten into the act; Secretary-General Ban Ki-moon has been telling the SA princes that the price of oil is driving the price of food around the world— that's a message that the princes are likely to respond to (and, indeed they have)— since they are deathly afraid of 'popular' uprisings: normxxx]]. You can already see the movement toward this end from proposals to ban speculators from the crude oil trading "pits" to dramatically increasing margin requirements. Notably, history shows that a $10 per barrel drop in the price of oil tends to translate into an additional point of P/E multiple expansion for stocks. Consequently, when we combine the aforementioned gleanings with the fact that it is going to be VERY difficult to have a negative "real" GDP report in 2Q08 given the recent strengthening economic numbers (retail sales, trade numbers, unemployment claims, PMI, etc.), we have got to be optimistic that the equity markets are carving out a near/intermediate-term bottom.
To us, last week marked a major change in the "body language" of the Federal Reserve. Our sense is that the Fed is now going to jawbone the U.S. dollar higher, and attempt to talk interest rates marginally higher, even though we don’t think the Fed will raise rates in the short run. Meanwhile, the politicos are trying to break the price of crude oil and other commodities. All of this is giving the "Street" the sense that the worst is in the rearview mirror; and, that even if Lehman Brothers (LEH/$25.81) defaults, the Fed’s "checkbook" will bail them out in a Bear Stearns déjà vu dance. These perceptions are why I believe we have [only] entered the middle part of the envisioned "W"-shaped economic environment, which should cause stocks to lift.
And, at least the corporate insiders are listening, for insider selling has fallen more than 60% year-over-year, while insider buying is up by about the same amount. Despite this optimism, however, many portfolio managers (PMs) seem to have adopted a new investing mantra— invest not to make money, but rather not to lose money— as many of their 'favorite' [high flying?] stocks have recently experienced "air pockets" on the downside. The PMs know that they have to stay pretty fully invested, so there seems to be a scramble for "safe" stocks. However, even these alleged "safe" stocks are breaking down, as can be seen in the chart patterns of General Electric (GE/$29.15), Pfizer (PFE/$17.99), Home Depot (HD/$27.53/Strong Buy), Eastman Kodak (EK/$12.83), etc. as things continue to get curiouser and curiouser.
The call for this week: In last Monday’s missive we wrote, "For whatever reason, last week’s schizophrenia caused the S&P 500 to break below its May reaction low, rendering a near-term price target into the 1320 - 1330 support zone. If that occurs, we would consider initiating ‘long’ trading positions as we did at the January/March trading ‘lows.’ It should also be noted that our proprietary oversold oscillator is close to rendering its first oversold ‘buy signal’ in years." Later that week, in Thursday’s verbal strategy comments, we told participants to begin a scale "in" buying approach in the indexes (ETFs) of their choice with close trailing stop-loss points. On Friday that "call" looked pretty good, but as Lowry’s notes, "The longevity of a rally is directly correlated to the strength of investor Demand during the rally." While only time will tell if this "lift" can gain momentum, we are optimistic and would point out that unlike the Bear Stearns crisis, gold is not rising and the U.S. dollar is not diving. These are NOT unimportant observations since last week’s news environment was certainly "dollar dour."
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"The Big W?!"
By Jeffrey Saut | 9 June 2008
"It’s a Mad, Mad, Mad, Mad World" is a 1963 comedy film that begins when the occupants of four vehicles stop on the side of the road to help another motorist who has careened off the highway in a spectacular crash. With his dying breaths Grogan (Jimmy Durante in his last screen appearance) tells the bystanders about $350,000 that is hidden in the nearby city of Santa Rosita "under the big W." With that, Grogan expires, and when the bystanders can’t agree on how to split the money, a slapstick road race begins to the city of Santa Rosita in search of "the big W."
This morning we revisit the "big W," except in this case we are referring to the potential for a "big W"-shaped economic pattern. To wit, while we have repeatedly stated the economy is slowing, we have also been steadfast in the belief there would be no recession in 2008 (two negative quarters of GDP). That sense was reinforced by the fact that every government-sponsored economic stimulus program since 1948 has worked! And when taken in concert with the Herculean efforts of the Federal Reserve, as well as the politicians, we have been inclined to give this economic stimulus program the benefit of the doubt.
That said, we have proffered that the economic slowdown we have been experiencing might just be interrupted, in the short term, by improving economic statistics driven by said 'stimulus' package, low interest rates (actually [increasingly] negative "real" interest rates), surging money supply, the Term Auction Facility (TAF) and the Term Securities Lending Facility (TSLF) [[aka the 'hundreds of billion dollar giveaway': normxxx]], et al. And, this short-lived economic rebound would give participants the impression that all of our economic troubles are behind us, fostering a rally in the stock market. To us, the envisioned economic rebound would only represent the middle part of the "W" pattern.
Unfortunately, we think such a strengthening economic sequence will be accompanied by stronger than expected inflation readings, causing the Federal Reserve to raise interest rates and thus slowing the economy again; to wit, the back half of the "W," or an economic double-dip. To this inflation point, last week Ed Hyman’s ISI organization noted, "The big news is in developing countries where ISI’s 22 country Foreign CPI Composition Index broke above 7%. It had been below this level since early 2002. The central banks are getting the message. The Philippines, Indonesia, and Brazil Central Banks all raised rates yesterday (6-4-08)."
Interestingly, last week showed how quickly perceptions can change on the Street of Dreams. Indeed, on Thursday numerous events (economic, M&A, etc.) gave market participants the sense the worse was behind us with no recession on the horizon. The result was last Thursday’s 214-point Dow Wow that made us feel like a "goat" since we had been telling folks we were confused on the stock market’s near-term direction and therefore recommended NO trading positions. The next day, however, we felt like a "hero" as the unemployment rate leaped to 5.5% (the highest level since October 2004).
Shockingly, the recondite birth/death model, which adds jobs the government "thinks" are being created, but can’t actually count, added 217,000 jobs (before seasonal adjustments) to Friday’s report or the numbers would have actually been far worse. When the employment report was combined with crude oil’s climb to new all-time highs ($138.54/bbl.), it set the stage for Friday’s Flop that left the senior index down an eye-popping 395 points. The late week action caused one old Wall Street wag to exclaim, "Can you spell schizophrenic?!"
Schizophrenic, as well as confusing, for the current investment landscape is like nothing I have seen in over 40 years of observing markets! The environment was, however, summed up about as well as I have seen by one particularly bright portfolio manager at the Muhlenkamp organization when Ken Dupre wrote (as paraphrased by me):
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I think Ken Dupre’s comments are "spot on" and would emphasize that the deleveraging of corporate and consumer balance sheets, combined with increased regulation/legislation, suggests an economy that will, at best, "muddle." This is consistent with our continuing thoughts that the government’s increasing movement toward intervention, and over-regulation, is our biggest concern! The only point I would contest in Ken’s comments is whether stocks, in the aggregate, are really "cheap." To be sure, using most interest rate-based valuation methods (Fed Model, Dividend Discount Model, Earnings Yield Gap, etc.) stocks are "cheap." However, using Graham & Dodd type measuring sticks (Price to book, price to dividends, price to earnings, etc.) stocks are more of a neutral value.
Nevertheless, for whatever reason, last week’s schizophrenia caused the S&P 500 (SPX/1360.68) to break below its May reaction low rendering a near-term price target into the 1320 - 1330 support zone. If that occurs, we would consider initiating "long" trading positions as we did at the January/March trading "lows."It should also be noted that our proprietary oversold oscillator is close to rendering its first oversold "buy signal" in years. If the SPX slides into the aforementioned support zone, it would likely tip our oscillator into "buy" mode. In the interim, as stated all last week, we "wait" in the trading side of the portfolio.
For investors, however, we continue to be opportunistic buyers noting that many of our recent investment ideas acted pretty well last week. Indeed, Strong Buy-rated Delta Petroleum (DPTR/$26.01) was up 18% for the week driven by expectations that drilling results from its Paradox Basin wells will make good reading when they are reported in July. Similarly, 10% yielding, Outperform-rated, LINN Energy (LINE/$23.78) was up nearly 5% on the week, while 6.8% yielding Alaska Communications (ALSK/$12.53/Outperform) and 5.8% yielding Embarq (EQ/$47.19/Strong Buy) resisted last week’s market machinations.
The call for this week: Friday’s Dow Dive of 3.24% was the first 3% down day since February 2007 when the senior index was carving out a "bottom." It was also a 90% Downside Day (points and volume were 90% to the downside), following Thursday’s 80% Upside Day, in true schizophrenic style. Also schizophrenically, oil and gasoline soared to new all-time highs, while the energy/economic sensitive D-J Transportation Average "tagged" a new all-time high. Meanwhile, General Motors’ (GM/$16.22) shares fell to a multi-decade low (so goes GM, so goes the economy), consumer net worth is down 1.0% year-over-year, the FDIC insurance deposit fund is close to its minimum statutory level [[there's been a rash of failures among banks NOT 'too big to fail'!: normxxx]], tax rebate checks appear to be driving the federal government’s deficit to over $450 billion, Britain is running dangerously short of electricity [[South Africa is already rationing electricity!: normxxx]], the Gangotri glacier (one of the Himalayan’s largest glaciers) has shrunk by half a mile in the last 25 years (we continue to embrace the theme of companies playing to the rebuilding of the electric/water infrastructures), the Baltic Freight Rate Index registered new reaction highs (read: buy the dry bulk shippers), NYSE short-interest is at record highs [[extraordinarily bullish! : normxxx]], Ed (Johnny Carson’s sidekick) McMahon’s house is in foreclosure, and we keep asking ourselves, "How can inflation moderate from such an allegedly low level (read: 'core' levels)?" Indeed, curiouser and curiouser, which is why we continue to chant, "Sometimes me sits and thinks and sometimes me just sits!" Manifestly, "It’s a Mad, Mad, Mad, Mad World!"
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""Random gleanings at 39,000 feet over the Atlantic""
By Jeffrey Saut | 2 June 2008
It takes 8 hours and 40 minutes to fly from Amsterdam to Atlanta. To be certain, that is enough time to contemplate the various market events since we departed a few weeks ago. Our parting words of advice were scribed on 5/12/08 in a report titled "Throw Deep." To wit:
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Eerily, on the following Monday (5/19) the S&P 500 (SPX/1400.38) peaked at precisely 1440 and quickly shed roughly 5%. The swoon left the SPX in the low 1370s, where it was in a near-term oversold condition, as well as testing its 50-day moving average (DMA). Accordingly, the snap-back rally from that 5/23/08 reaction low should have come as no surprise. The question now becomes, "is the recent rally the beginning of a significant upside move, or is it merely a throwback rally with more to come on the downside?" Unfortunately, the recent rally seems to be more of a withdrawal of selling-pressure rather than earnest renewed buying power. This is reflected by the fact that in the Operating Company Only Advance/Decline figures only 2.6% of the NYSE-listed domestic common stocks are at new 52-week highs, while more than 51% of stocks are down more than 20% from their respective 52-week highs.
Clearly the oversold condition that existed a few weeks ago has been alleviated. Moreover, the two 80% Downside Days (points and volume on the downside) that occurred during the recent decline failed to be offset by any of the ensuing Upside Days, which registered only a 62% reading on the Upside Days according to the astute Lowry’s Service. Additionally, the SPX’s 20-day "low" was breached to the downside in the recent correction (read: negative); and, the SPX was unable to sustain above its 200-DMA. Also, the SPX remains below "The Snake" (aka the 20-month moving average), referred to in our missive dated 5/12/08 (see the addendum at the end of this missive). All of this leaves the technical picture somewhat sketchy.
Our current caution is compounded by the yield-yelp of the 10-year T’note, which broke out above its 200-DMA in our absence, implying higher interest rates. We think longer-dated Treasuries are a SELL and those wishing to hedge their fixed income portfolios against higher rates have a couple of new closed end funds with which to do so (for further information contact our Closed End Fund department). Verily, higher interest rates have profound implications for various asset classes. And that, ladies and gentlemen, is another reason we have, after seven years of steadfast bullishness, recommended reducing/rebalancing stuff-stock positions (read: energy, timber, cement, etc.).
While longer-term we remain bullish on "stuff," with rising interest rates the "cost of carry" to own commodities increases. That linkage was potentially reflected in crude oil’s downside reversal during our travels. While we remain long-term energy bulls, if crude breaks below $120/bbl., professional money will view the recent parabolic price high of $135/bbl. as a near-term peak. As stated, despite these concerns we remain bullish on select energy companies. Last week that strategy was rewarded by Penn Virginia’s (PVA/$63.02) discovery in the Haynesville Oil Shale region, which rallied our stock recommendations playing to Haynesville (for further comments/ideas see our fundamental analysts’ reports).
Turning to the economy, amazingly just a few weeks ago the media was rife with comments that the U.S. economy was heading toward a recession of biblical proportions. We, however, maintained our staunch belief the economy would skirt "your father’s typical recession." Recent data tends to confirm that belief with employment, consumption, inventories, profits, etc. coming "in" on the stronger side. To our way of thinking the question now becomes is the economic slowdown "L-shaped," (down and flat), "V-shaped" (shallow with an economic acceleration driven by the monetary/fiscal stimulation), or a "W" (economic acceleration in the near-term followed by a double-dip slowdown a few quarters from now). I think a "W" scenario is the potential economic pattern for the balance of 2008 and 2009.
Indeed, certain finger-to-wallet indicators suggest the government-induced economic stimulus is going to OVER stimulate the economy in the short-term, leading to a torque-up in the inflation rate, which likely will be followed by a rise in interest rates that should slow the economy; aka, the double-dip, or "W"! Manifestly, many broader measures of inflation are significantly above the yield on 10-year Treasury Notes, rendering a negative "real" interest rate environment, as well as negative "real" returns for Treasury Note investors. This means inflation should continue along an upward trend for the next few years, because historically it takes about two years for monetary policy to achieve its maximum impact on inflation. We don’t think it will be any different this time.
As for the international markets, there is a reason European equities are about as cheap as they ever get relative to the U.S. markets. That reason is the $1.55 U.S. dollar exchange rate to the euro. While we are currently bullish on the U.S. greenback, the expensive euro should leave the European economy "muddling" for quite some time. Consequently, we continue to avoid investing in Europe except for select special situations. By far our favorite country for investment has been, and remains, Brazil. And while we would like to embrace Russia due to its natural resources, we have wrongly avoided investing there [[I think rightly!: normxxx]]. Our concerns center on the fact that Russia has confiscated, with minimal restitution [[and continues to do so: normxxx]], assets that were built with western capital and engineering prowess.
Further, Russia has a demographics problem. The birth rate in Russia is so low that by the middle of this century their population will be less than Yemen’s! As Herb Meyer notes, "Russia has one-sixth of the earth’s land surface and much of its oil. You can’t control that much area with such a small population. Immediately to the south, you have China with 70 million unmarried men of marriagable age, a potential nightmare scenario for Russia." Ergo, we continue to avoid Russia in favor of other emerging countries, many of which have had substantial price corrections year-to-date. Fortunately, we entered the new year wary of most international markets, having rebalanced (read: sold partial positions) our foreign investments late last year. Now, however, given their outsized declines, we recommend gradual re-accumulation. Our favorite way to employ this strategy is by purchasing MFS’s International Diversification Fund (MDIDX/$15.63).
Asset allocation, and sector selection, continue to be the drivers of overall portfolio performance. To this point, we remain under-weighted technology, consumer discretionary, and financials. While many pundits are screaming that financials are "cheap," we just don’t see it that way. For previously stated reasons, we think the financial sector will remain under pressure for years; and would note, the KBW Bank Index (BKX/75.87) "tagged" a new five-year closing low last week. At its peak the financial sector contributed 31% of the S&P 500’s earnings.
For comparison, in the 1980 energy bubble, energy-related companies contributed 26% to earnings, while at the tech bubble’s peak, tech accounted for 16% of earnings. With re-regulation of financial institutions coming, the result should be lower earnings with and attendant P/E multiple compression for the financials. On a market capitalization preference, mid-caps seem to have held up better during the recent stock market decline. And, we continue to invest accordingly.
The call for this week: "Sell in May and go away," is an old stock market "saw" whose long-term track record is compelling. To wit, starting in 1950 and investing $10,000 in the SPX every May 1st and liquidating on October 31st compounds to a shockingly small $10,026 today. Conversely, buying the SPX every November 1st and selling every May 1st compounds to $372,890 (according to Ned Davis Research).
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Yet we have learned the hard way that markets can do ANYTHING. For example, if you sold in May 2003 you missed a 30% rally into year-end. With near-term stronger than expected economic statistics, increasing risk appetites, and commodities normalizing (read: declining, which should be bullish for equities), we think we could be in the middle of the envisioned "W-shaped" economic pattern.
If so, the perception will be that the worst is behind us, and stocks could continue to levitate until we enter the backside of the "W" where a rise in interest rates should squelch any overly robust economic recovery. Consequently, we are currently "out" of trading positions and focusing on investment positions, preferably ones with a yield. Previously mentioned names for your consideration include: 6.6%-yielding Alaska Communication (ALSK/$12.94/Outperform); 11%-yielding LINN Energy (LINE/$22.67/Outperform); Schering Plough’s 7.6%-yielding convertible preferred "B" shares (SGP+B/$196.00), whose terms and details should be checked before purchase; and, 5.8%-yielding Embarq (EQ/$47.32/Strong Buy).
Addendum:
Our caution centers on the belief that all of our economic problems are NOT behind us, the Dow Theory "sell signal" of November 21, 2007, the double-top chart configuration in the SPX at 1560 - 1570, and "The Snake"— except in this case we are not referring to Kenny "The Snake" Stabler, but rather to the 20-month moving average (MMA) (aka "The Snake")— that has often represented the demarcation line of bull and bear markets. As can be seen in the nearby chart, the 20-MMA tends to mark the difference between the "bull" and the "bear." When the SPX is above its 20-MMA stocks are in an "up" phase. Even when "the snake" is marginally violated to the downside, but then quickly recaptured to the upside, the bull trend remains in force. However, when it is violated decisively to the downside, and stays there, caution is warranted.
Source: Thomson Reuters
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Normxxx
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