Investment Strategy by Jeffrey Saut“Context?!”
September 2, 2008
“If you show an American an image of a fish tank, the American will usually describe the biggest fish in the tank and what it is doing. If you ask a Chinese person to describe a fish tank, the Chinese will usually describe the context in which the fish swim. Americans usually see individuals; Chinese and other Asians see contexts. What happens if collectivist societies, especially those in Asia, rise economically and come to rival the West? A new sort of global conversation develops. The opening ceremony in Beijing was a statement in that conversation. The most striking features were the images of thousands of Chinese moving as one – drumming as one, dancing as one, sprinting on precise formations without ever stumbling or colliding. [It was] a high-tech vision of a harmonious society, performed in the context of China’s miraculous growth.”
. . . David Brooks in The New York Times
Obviously, we’re back from Raymond James’ National Conference in our nation’s capital. But, I’ve got to admit that between the conference’s educational sessions, dinners, wine, and the muscle relaxers I was taking for a disc-injured back incurred while “rigging” our Florida house for heavy weather (read: hurricane Fay), I didn’t pay much attention to the markets last week. Similarly, I recommended “rigging” portfolios for “heavy weather” late last year, fearful of many of the events that have come to fruition. Clearly, the “Year of the Rat” has lived up to its name since “Rats” have a tendency to be opportunistic with an eye for a bargain, but are unwilling to pay too much for anything. Because of their intellect and observatory powers, Rat people possess prudence and perception, which is why the Chinese say others should always listen to the advice of the Rat. “Rats” seem to be able to anticipate problems and are able to see the big picture. Like the “Rat,” we too have been opportunistic this year, often commenting that it seems to be more of a trader’s, rather than an investor’s, environment; so this morning I thought we would take our lead from the Chinese and try to look at the “context” of the markets from a longer-term perspective. To this point our technical analyst, Art Huprich, penned an excellent report last Friday based on his talk at the National Conference titled, “A Long Term Perspective and More.”
Art began by noting that when secular bull markets end (1982 – 2000) history suggests that the major market averages can move sideways for a decade (or more) with very little upside progress. To demonstrate this tendency, he referenced the secular bull market from 1949 – 1966, which saw the DJIA peak at 995 for a gain of 514% from those 1949 lows. Art described this period as a “fat cycle” when all you needed to do was “throw a dart” to make money. Following the DJIA’s secular price peak in 1966, however, came a “thin cycle” whereby there were a number of mini-bull and mini-bear markets, but by 1982 the senior index was actually 22% lower than it was in 1966. To readers of these missives such revelations should come as no surprise since we opined that following the decline telegraphed by the Dow Theory “sell signal” of September 1999, it was likely going to be a range-bound environment for the S&P 500 (SPX/1282.83). That did not, and does not, mean investors cannot make money.
Manifestly, investors have made a lot of money on our “call” in 4Q01 to make oversized investments to “stuff stocks” (energy, timber, cement, base/precious-metals, water, etc.), preferably stuff-stocks with a dividend yield. Similarly, we have favored small/mid-capitalization stocks over their large-cap brethren during that same timeframe; and, as Art observes, the outperformance of the small/mid-cap complexes has been noticeable. To wit, while the SPX gained 64% from 4Q01 into 4Q07, the S&P Small Cap 600 was up 149% and the S&P Mid Cap 400 was better by 132%. Both Art, and I, continue to favor the small/mid-cap complexes given their superior relative strength. As for value versus growth, on this question I have always agreed with Warren Buffet’s comments that, “We view this as fuzzy thinking. In our opinion, the two are joined at the hip: Growth is always a component in the calculation of value. . . . In addition, we think the very term ‘value investing’ is redundant. What is ‘investing’ if it is not the act of seeking value at least sufficient to justify the amount paid?” Nevertheless, to placate our readers, both Art and I currently favor “growth” over “value” across the entire capitalization spectrum.
Speaking to the S&P Macro Sectors, at the present time there does not appear to be ANY particular leadership, which is one of the reasons investors, and the major market indices, are having such a difficult time. Still, in parsing the sectors, the three that look best are healthcare, consumer staples, and technology. Technology is particularly interesting since the tech sector has the largest exposure to foreign earnings and therefore should benefit from the dollar’s demise even though the greenback has firmed recently. For the last eight years, however, we have avoided the marquee tech stocks, except for an occasional trading foray, often commenting that, “The leaders of the last cycle rarely lead the next cycle!” That stance has left us out of the Cisco’s (CSCO/$24.05/Market Perform) of the world; yet we have attempted to get at technology via “backdoor” investments in subsectors like Homeland Security via names like Cogent (COGT/$11.00/Strong Buy), L-1 Identity Solutions (ID/$16.48/Strong Buy), and Argon ST (STST/$24.97/Outperform), all of which are favorably rated by the respective fundamental analyst.
One of the more ubiquitous questions at the conference was about international investing. While we recommended substantially reducing international and “stuff stock” exposure at the end of last year for previously stated reasons, we have warmed to them again given the substantial declines they have experienced. That said, Art showed a particularly interesting chart in his presentation that was the S&P 500 divided by the SPDR MSCI AWCI ex-U.S. ETF (CWI/$34.15). The chart suggests that the U.S. (domestic) markets have been outperforming most of the world’s equity markets even though it doesn’t really “feel” like it (see nearby chart). As Art concludes, “I would have a smaller slice of international exposure and increase my ‘slice’ of U.S. exposure.” The intellectual argument for this view rests in America’s improving trade balance driven by the boom in exports. Interestingly, our nation’s large trade deficit has tended to serve as the financing mechanism for many emerging economies. The fact that “prop” is now shrinking is a worth consideration. Nevertheless, for our international “slice” we still like open-end mutual funds like Quaker Global (QTRAX/$8.41), MFS International (MDIDX/$13.34), Ivy Asset (WASAX/$25.35), and Blackrock Global (MDLOX/$18.37), to name but a few.
Unsurprisingly, during many of the conference’s sessions we heard the phrase, “You can’t ‘time’ the markets;” to which we reply, “total sophistry.” While true it is nearly impossible to day trade with any consistency, we argue that if you have patience, and wait until the trading odds are tipped so far in your favor that if you are wrong you are going to be wrong quickly with hopefully de minimis losses, you can indeed supplement the investing side of your portfolio with some opportunistic trading. This strategy is reinforced by many of Wall Street’s premier hedge funds that do “trade” with a portion of their capital and have consistently produced returns that substantially beat the major market averages. To be sure, this year has been more of a trader’s market than an investor’s market and we have attempted to act accordingly. For example, we were bullish at the January “lows,” cautious at the February “highs,” aggressively bullish at the subsequent downside retest of the January “lows” in March, yet cautious at the mid-May “highs” when we recommended shedding trading positions. We got pretty bullish again around the beginning of July, sensing the “selling stampede” was nearing an end and recommended that trading types purchase those groups with the worst relative strength characteristics since they had been compressed the most and were likely to give us the biggest bounce-back rallies. Unquestionably, those groups turned out to be financials and real estate; and given the HUGE rallies they have experienced since those mid-July “lows,” we have advised participants to reduce those “bets” accordingly.
The call for this week: The “Pros” return from holiday this week and with them the “volume” should also return, giving the SPX the ability to break out above its August 11th closing high of 1305. If that plays, our long-standing 1320 – 1330 price target comes into view and maybe more. But the time to be aggressively bullish was at the mid-July “lows,” not here. Nevertheless, with the “Gustav Gotcha” in the rearview mirror, and crude oil down $7.00 per barrel this morning, the pre-opening futures are dancing higher. Yet we’ve seen this act before over the past two weeks with the DJIA gaining 608 points, and losing 724 points, leaving the net change at a frustrating -116 points. However, there have been ways to still make money, like the NASDAQ Biotech Index that “tagged” a six-year high; as things continue to get curiouser and curiouser . . .
“The 545 People Responsible for America’s Woes”
August 25, 2008
Greetings from Washington, D.C., where I am speaking at the Raymond James Financial Services National Conference, so these will likely be the last strategy comments of the week. Nevertheless, I love “the Beltway” having lived and worked here for many years, yet Washington is more of a “process and power” town rather than a “product and money” town. This was most recently demonstrated when a mere two Congresspersons shut down debate on the much needed energy bill, adjourned Congress, and literally had to turn off the lights to force the rest of their colleagues to leave the Capitol building! In the mess we currently find ourselves, such shenanigans sadly remind me of my elementary school days, which is why I am penning this morning’s missive.
To begin, in the movie “The American President,” President Andrew Shepherd (played by Michael Douglas) states, “We've got serious problems, and we need serious people. And if you want to talk about character, Bob, you'd better come at me with more than a burning flag and a membership card. If you want to talk about character and American Values, fine. Tell me where and when, and I'll show up. This is a time for serious people, Bob, and your fifteen minutes are up. My name is Andrew Shepherd, and I am the president.” Plainly, ladies and gentlemen, serious times require serious people!
Secondly, it should be noted that I am apolitical. In fact, my industry makes sure I stay that way. But being in Washington, D.C., concurrent with the start of the Democratic Convention, and approaching the elections, I couldn’t help reflecting on the candidates’ pandering to a largely uninformed electorate while avoiding the really hard issues that need addressing. Again, bear in mind that I am indeed apolitical and that none of these comments are sponsored by Raymond James. Also know that my bumper sticker reads, “Re-Elect No One.” And with these thoughts in mind, I urge you to consider the following prose from syndicated columnist Charley Reese:
“Politicians are the only people in the world who create problems and then campaign against them. Have you ever wondered why, if both the Democrats and the Republicans are against deficits, we have deficits? Have you ever wondered why, if all the politicians are against inflation and high taxes, we have inflation and high taxes? You and I don't propose a federal budget. The president does. You and I don't have the Constitutional authority to vote on appropriations. The House of Representatives does. You and I don't write the tax code. Congress does. You and I don't set fiscal policy. Congress does. You and I don't control monetary policy. The Federal Reserve Bank does.
“One hundred senators, 435 congressmen, one president and nine Supreme Court justices - 545 human beings out of the 300 million - are directly, legally, morally and individually responsible for the domestic problems that plague this country. I excluded the members of the Federal Reserve Board because that problem was created by the Congress. In 1913, Congress delegated its Constitutional duty to provide a sound currency to a federally chartered but private central bank. I excluded all the special interests and lobbyists for a sound reason. They have no legal authority. They have no ability to coerce a senator, a congressman or a president to do one cotton-picking thing. I don't care if they offer a politician $1 million dollars in cash. The politician has the power to accept or reject it.
“No matter what the lobbyist promises, it is the legislator's responsibility to determine how he votes. CONFIDENCE CONSPIRACY: Those 545 human beings spend much of their energy convincing you that what they did is not their fault. They cooperate in this common con regardless of party. What separates a politician from a normal human being is an excessive amount of gall. No normal human being would have the gall of a SPEAKER, who stood up and criticized G.W. Bush for creating deficits. The president can only propose a budget. He cannot force the Congress to accept it. The Constitution, which is the supreme law of the land, gives sole responsibility to the House of Representatives for originating and approving appropriations and taxes.
“Who is the speaker of the House? She is the leader of the majority party. She and fellow Democrats, not the president, can approve any budget they want. If the president vetoes it, they can pass it over his veto. REPLACE THE SCOUNDRELS. It seems inconceivable to me that a nation of 300 million cannot replace 545 people who stand convicted – by present facts – of incompetence and irresponsibility. I can't think of a single domestic problem, from an unfair tax code to defense overruns that is not traceable directly to those 545 people. When you fully grasp the plain truth that 545 people exercise power of the federal government, then it must follow that what exists is what they want to exist.
“If the tax code is unfair, it's because they want it unfair. If the budget is in the red, it's because they want it in the red. If the Marines are in IRAQ, it's because they want them in IRAQ. There are no insoluble government problems. Do not let these 545 people shift the blame to bureaucrats, whom they hire and whose jobs they can abolish; to lobbyists, whose gifts and advice they can reject; to regulators, to whom they give the power to regulate and from whom they can take this power. Above all, do not let them con you into the belief that there exist disembodied mystical forces like ‘the economy,’ ‘inflation’ or ‘politics’ that prevent them from doing what they take an oath to do. Those 545 people and they alone, are responsible. They and they alone, have the power. They and they alone, should be held accountable by the people who are their bosses – provided the voters have the gumption to manage their own employees. We should vote all of them out of office and clean up their mess.”
“Gumption,” now there’s a word from an era gone by that seems to have faded from the American lexicon. As I recall, “gumption” is defined as initiative and/or common sense. It’s also a word I would ascribe to a “real” statesperson. According to Winston Churchill, “A politician thinks about the next election, a statesman thinks about the next generation.” Unfortunately, at least in this town (D.C.), there are not many “statespersons” left because when you tell the electorate what really should be done for the benefit of future generations, you get voted out of office. For example, I know hundreds of retired couples that receive in excess of $500,000 per year of interest/dividend income from their investments. Now I don’t know if the figure is $300,000, $500,000, or $1,000,000 per year in such income, but at some level you should not be entitled to Social Security payments because you just don’t NEED them! Common sense? You bet it is, yet you won’t hear any politician proposing such legislation because as Winston Churchill stated, “A politician [only] thinks about the next election.”
And, here they (read: politicians) go again as the table seems to be set that will take policy responses to the housing/ financial crisis in an unorthodox, wrong-footed, direction. History, however, shows quite a few instances whereby unorthodox steps have turned out badly. Nevertheless, last week the “cry” went out to use taxpayers’ money for reconstituting the Reconstruction Finance Corporation (from the 1930s), as well as the Resolution Trust Corporation (1989), to ameliorate the financial fiasco (read: bigger government and more government intervention). Yet, the RTC did not recapitalize the banks’ balance sheets, nor did it purchase distressed properties, which is likely what is currently needed. Further, it is increasingly evident that the government will use its “balance sheet” to shore-up the GSEs (Government Sponsored Entities) like Fannie Mae (FNM/$5.00) and Freddie Mac (FRE/$2.81). Unfortunately, a few “statesmen” recognized this potential problem YEARS ago, and said so, but their warnings went unheeded by the “politicians.” Still, rumors of the potential GSE bailout rallied the equity markets last Friday, renewing hopes that a new “up leg” for stocks is in place. While I would certainly like to believe that is the case, the metrics just don’t suggest it.
Indeed, while we were pretty bullish at the mid-July “lows,” we subsequently sold those trading positions into strength, thinking that the upside “buying stampede” would exhaust itself in the typical 17–25 session timeframe, which implied the equity markets were due to peak during the week of August’s option expiration (August 15th). Moreover, many of the finger-to-wallet indicators we use to identify major market “lows” were sorely lacking at last month’s downside selling climax. However, we opined that the “selling stampede” in groups like energy/gold might be coming to an end during that same option expiration week since their respective downside skeins had lasted the perfunctory 17–25 sessions. Accordingly, for trading accounts, we recommended the scale-down buying of select Exchange Traded Funds (ETFs) playing to those groups. And given the large rallies in those groups last week, prudent trading types should have sold partial positions respectively. As for investment accounts, we continue to emphasize the clean balance sheet, solid fundamentals and dividend yielding names so often mentioned in these missives.
The call for this week: According to Lowry’s, “[Last] week’s increase in Selling Pressure, to its highest level of the bear market (thus far), plus the lack of 90% Downside Days immediately preceding the mid-July market low[s], showed no signs of [the] diminishing selling so vital to the start of a sustained market advance. . . . [Indeed] The rally in the DJIA from its July low to [the] August high has been characterized by a steady increase in Supply (read: sellers) and sluggish Demand (read: buyers). This combination appears much more consistent with a rally in a bear market than with the start of a major move higher.” Regrettably, that’s the way it has been since we wrote about the Dow Theory “sell signal” of last November. Meanwhile, the DJIA (11628.06) and S&P 500 (SPX/1292.20) have broken below their respective March 2008 “lows,” while the small-cap (SML/387.46) and mid-cap (MID/814.92) indices have not. And don’t look now, but commodities had their biggest weekly rally in decades last week as things continue to get curiouser and curiouser.
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