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Investment Strategy

Investment Strategy by Jeffrey Saut

I love . . . NYC!
July 18, 2016

For me, last week began on Sunday night at Michael Jordon’s restaurant in Grand Central Station with some portfolio managers (PMs). The conversation was informative as were the investment ideas exchanged (more on those ideas after I have had time to study them). It was more of the same at breakfast the next day with another PM. Around 11:00 a.m., my colleague (Andrew Adams) arrived to accompany me to Jersey City for a three-hour stint with PMs at the venerable firm of Lord Abbett. The first hour was spent with Justin Maurer and Tom Maher, co-PMs of the Lord Abbett Value Opportunities Fund (LVOAX/$19.15), which invests 65% of the fund’s assets in small/mid-capitalization companies believed to be undervalued with the rest of the money able to “go anywhere.” They like to find ways in the portfolio to play the themes they like. A few of the themes discussed were: 1) a shrinking of airline capacity, 2) that fiscal spending is coming, 3) that government spending is going to be a growth industry in 2017, and 4) backdoor plays in the cyber security space. Hereto we swapped investment ideas that I will be sharing in the days ahead. I really liked these guys; I liked the way they think, the way they use a thematic approach, and the way they invest.

The next hour was with Walter Prahl, who along with Joe Graham, manages the Lord Abbett Calibrated Dividend Growth Fund (LAMAX/$14.90). I would classify this fund as an equity income fund that likely will not unpleasantly surprise investors. The final hour was spent with my friend Tom O’Halloran, whose fund I own (Growth Leaders Fund/LGLAX/$22.41). Tom looks for companies that: 1) have attractive business models, 2) are organic entities (management), 3) are benefitting from healthy industry conditions, and 4) have a competitive advantage. Tom told us the tech revolution began with the integrated circuit in the 1960s (my first transistor radio) and has morphed into a race to overcome time, distance, and space. He offered up Grub Hub (GRUB/$29.80/Outperform) as an example. Subsequently, Tom took Andrew and me via water taxi to the NYC’s Union Club, which I had not been in for some 30 years, and we were joined by another friend, namely Eric Kaufman captain of VE Capital and founding member of Friends of Fermentation (a tip of the hat to another friend of Arthur Cashin). Next was dinner with my long-time friend and brilliant small-cap stock picker, Mary Lisanti, manager of the Leventhal/Lisanti Small Cap Growth Fund (ASCGX/$17.08), which I also own. This year has been tough for that asset class, but I think its (and her) time has come again. BTW, I only invest with PMs I know, not just professionally, but personally, like Mary, Tom O’Halloran, Eric, etc. As always, ideas exchanged in these meetings will be featured later in subsequent missives.

Comes Tuesday, the day arrives with another breakfast with PMs, and yet another meeting with PMs, and then it was off to Goldman Sachs’ (GS) world headquarters. I actually love GS and own the Goldman Sach’s Rising Dividend Fund (GSRAX/$21.14), which is managed by another friend of mine, Troy Shaver. That afternoon, Andrew and I met with Goldman PMs, two of which I had never seen before, and I was really impressed with their investment style. They manage the GS U.S. Equity Dividend and Premium Fund (GSPAX/$12.16). They buy dividend payers, the fund is sector neutral, it has a Beta of ~1, they sell away 20/30% of the upside using various strategies that serve somewhat as a downside hedge, the fund has an average annual distribution of ~6%, it has very little “line item” risk, and they are thoughtful about the tax ramifications of their distributions. We also met with Osman Ali, a PM I have met with a few times before. It was intriguing to hear him talk about “crowd sourcing”, “machine learning”, and “informational advantages.” Goldman Sachs has taken, for lack of a better definition, Artificial Intelligence (AI) to an art form. Their computers read 26 million reports/articles/10-Ks a year looking for key words to gain an informational investment advantage. For example, in April of 2015, their AI gleaned that web traffic had exploded for Home Depot and Lowes right before those companies’ share price leaped.

Wednesday started with a “hit” on Fox Business TV with Maria, who I have known for 25 years, followed by lunch with friends and then an interview with the good folks at the Wall Street Journal and Barron’s. That night, we met with some Wall Street types and had dinner at the fabulous Italian restaurant Scalinatella. The next day, it was an early meeting at Deutsche Bank Asset Management with about a dozen folks in attendance. At noon, it was a presentation for high net worth clients at our RJA Rockefeller Center offices, a stint at Bloomberg (great to see you Pimm Fox), and a “hit” for CNBC from the floor of the NYSE. Of course, each night was also accompanied with a confab at Bobby Van’s NYSE bar for libations with other members of Friends of Fermentation (FoF). Arthur Cashin was in rare form regaling his famous stories to my colleague Andrew. However, the most amazing meeting of the week was with my dear friend Craig Drill (Drill Capital), who typically arranges a lunch for my NYC visits.

At previous lunches icons like David Einhorn (Greenlight Capital), John Hathaway (Tocqueville), Ken Langone, Joe Perella (Perella Weinberg), Mike Price (MFP Investors) – well, you get the idea – were in attendance. Last Friday’s lunch did not disappoint. While I am not going to name the names, I will tell you the ex-director of the CIA was there, the foremost Alzheimer’s doctor in the world was there, folks from Lee Cooperman’s Omega Advisors attended, a Singapore-based PM was there, my friend Eric Kaufman (the best MLP portfolio manager in the biz) sat in, and there was a cast of others present. The CIA guy said that ISIS was “past its high-water mark and that the Muslim community will eventually confront them.” He also suggested, since ISIS is in decline, it makes them more desperate. The gentleman from Omega began, after I spoke, saying, “I didn’t think there was anybody more bullish than me, but I was wrong!” (that would me). He then listed his bear market check list with five key points: 1) accelerating inflation, or problematic inflation (not here); 2) hostile Fed (not here);
3) prospects for a recession (not here); 4) investor exuberance (not here); and 5) expensive valuations (not here given the interest rate environment). His conclusion, “The only way this secular bull ends in the near term is if there is a ‘black Swan’ event” and, I agree. He also spoke about the concept of “molehill to mountains” falsely trumpeted by the media, citing the Greece Gotcha’, the Italian Job, the Crimea Crisis, the Brexit Bashing (we were buyers of stocks on the belief that new all-time highs were in the offing), and the remaining list is legion. The Singapore PM stated the Japanese election assured more monetary stimulus, that Chinese steel companies are trading at two times earnings, and the commodity cycle has bottomed, and hereto a number of long stock ideas were mentioned that I will vet in the days ahead. The Alzheimer doctor was amazing stating that Alzheimer’s is one of the leading causes of death and that it is the greatest unanswered medical need. To make this point, he posited that if five million folks are affected, and it takes $50,000 a month to attempt to treat it, that foots to $250 billion with the government’s total Medicaid spending (excluding admin costs, accounting adjustments, or data for the U.S. territories) of ~500 billion. Given the aging baby boomers, that is a HUGE problem. While he suggested there are new drugs on the way, exercise and the Mediterranean Diet are a step in the right direction for prevention.

The call for this week: Bespoke points out that, “All ten sectors are overbought for the first time since [last] March” (chart 1). Plainly, we agree given our comments last week about the McClellan Oscillator. However, Bespoke also notes (as paraphrased), “In all the previous times when the S&P 500 has made a new all-time high, following at least 52 weeks below the old high water mark, the average return over the next 12 months has been 12.28% (median +12.30%) with an average pullback of 5.48% (median 2.73%).” Hence, folks waiting for the fabled 20% pullback are likely going to be disappointed. That said, it would not surprise me to see a sell off attempt this week that should not get very far. Meanwhile, while everyone is focused on the major indices at new all-time highs, few are watching the much maligned D-J Transportation Average (TRAN/7985.17) that is breaking out of a downtrend line that has been in effect since March of last year (chart 2). If successful, a new Dow Theory “buy signal” should be enforce. And don’t look now, but last week we experienced the third 90% Upside session in just as many weeks.


Genius clusters?
July 11, 2016

I have been very lucky in my career in terms of the people I have met. Working in New York City in the early 1970s I was fortunate to meet icons like Larry Tisch, Barton Biggs, Marty Zweig, Ace Greenberg, etc. Regrettably, I have lost, and am losing, many of those icons. While working in Washington DC I used to have high tea at the Hay Adams with Jean Kirkpatrick; and at a black tie affair I talked with a gentleman I would have never thought I would like. He was from Massachusetts and was pretty left of center. I talked to him for over an hour and was struck by his witty brilliance. I told him he should run for President and a few years later he did. His name was Paul Tsongas. While I have met all sorts of folks over the years, one person I have not met is Peggy Noonan, the weekly columnist for The Wall Street Journal (WSJ). She is one of the best writers/thinkers I have ever read. She is wicked smart and scribes articles everyone should read. Roughly two weeks ago she penned a WSJ article titled, “A World In Crisis, and No Genius in Sight.” The gist of the piece was about “genius clusters.” Genius clusters have occurred at certain points in history with one of the best being the one that invented America. She writes, “Somehow Franklin, Jefferson, Washington, Adams, Madison, Hamilton, Jay, and Monroe came together in the same place at the same time and invented something new in the history of man.” A little late in the article she opines:

There was a small genius cluster in World War II – FDR, Churchill, de Gaulle. I should note I’m speaking of different kinds of political genius. There was a genius cluster in the 1980s – John Paul II, Reagan, Thatcher, Vaclav Havel, Lech Walesa, Lee Kuan Yew in his last decade of leadership in Singapore. The military genius cluster of World War II – Marshall, Eisenhower, Bradley, Montgomery, Patton, MacArthur, Nimitz, Bull Halsey, Stilwell – almost rivaled that of the Civil War – Grant, Lee, Stonewall, Sherman, Sheridan, and Longstreet. Obviously genius clusters require deep crises, otherwise their gifts are not revealed. Historic figures need historic circumstances. Also members of genius clusters tend to pursue shared goals. We have those conditions now – the crises, and should be shared goals. Everything feels upended, the old order that has governed things for 70 years since World War II [is] being swept away. Borders have disappeared before our eyes. Terrorism, waves of immigration transforming whole nations, Islam at war with itself and parts of it at war with the world. In the West, the epochal end of public faith in institutions, and a dreadful new tension between the leaders and the led. In both background and foreground is a technological revolution that has actually changed how people experience life. It is a world crying out for bigness, wisdom, steady hands and steady eyes.  We could use a genius cluster.

Did I forget to mention that Peggy Noonan is brilliant?! But, where is the genius cluster that we so desperately need? It certainly doesn’t exist with the world’s leaders. It probably exists with some of the world’s military leaders; however, the politicians aren’t paying much attention to their advice. Clearly the world’s populations are seeking a genius cluster given things like the Brexit vote and the rise in popularity of Donald Trump. There is likely a genius cluster on the Street of Dreams, yet even here we see false prophets. I heard one of them late Friday afternoon on CNBC who has totally missed the rally off of the February lows and is currently calling this rally nothing more than a “bull trap.” Be that as it may, there is a book written by Ned Davis that resides on my desk titled, “Being Right or Making Money,” which is reminiscent of the quote, “Knowing and not acting can be as damaging as not knowing at all.” I would rather make money than be right!

Plainly, we have been “acting” since the February lows, believing those lows represented a major bottom, setting the stage for a rally to new all-time highs; and, last Friday that vision almost came true. Indeed the S&P 500 (SPX/2129.90) closed the week within one point of its all-time high (2130.82 on May 21, 2015). My thoughts on this were best expressed by the perspicacious Jim Paulson in an interview on CNBC last week (as paraphrased):

Stocks should make new highs soon, closely followed strategist Jim Paulsen said Wednesday. He's the second market watcher this week to tell CNBC's ‘Squawk Box’ to expect a record run. Paulsen, chief investment strategist at Wells Capital Management, sees the S&P 500 going to the 2,200 level, an advance of 4.75 percent from Tuesday's close, which saw the index break 2,100 for the first time since December. The S&P 500 on Tuesday was also less than 1.5 percent from last May's record 2,130.82 close. Ebbing deflation fears, prospects for better earnings later this year and improving world economies are all reasons to believe U.S. stocks should climb, he said.

If that sounds familiar, it should, for I am the other person that has been calling for new all-time highs. So on the better than expected payroll number (+287k vs. the estimate of 180k), the SPX closed at a new 52-week high last Friday, causing my friend Jason Goepfert (SentimenTrader) to write:

“The S&P 500 closed at a new 52-week high. Using weekly closing prices, this is the first new 52-week high in 50 weeks, the 3rd-longest dry spell in 20 years. Going back to 1928, when the S&P sets its first 52-week high in nearly a year, it has led to mixed shorter-term returns but positive medium- to long-term ones.”

Moreover, Friday morning the astute Bespoke organization noted:

With today’s stronger than expected Non-Farm Payrolls report, the S&P 500 is on pace to cross above and close above the 2,100 level for the 25th time in its history (red dots in chart). Since it first crossed above 2,100 back in February 2015, this level has been quite a stubborn one for the market. For example, the S&P 500 has never closed above 2,100 for more than 14 straight trading days, and in each period where the index crossed and closed above that level, the median number of days it was able to stay above 2,100 was just two trading days (average 3.2 trading days, see chart 1).

Meanwhile, investors’ bullish sentiment is low, cash levels in portfolios is high, the 2Q16 earnings bar has been lowered too much (down ~5%), ~65% of the stocks in the S&P 500 have a higher dividend yield than the 10-year T’note, and EVERYONE is defensively positioned.  That defensive positioning has spawned a new acronym STUB (staples, telecoms, utilities, and bonds). Remember when the term FANG (Facebook, Amazon, Netflix, and Google) became lionized the FANG move was long of tooth. Most recently, it is bonds that are actually gapping to the upside in the charts (chart 2). Recall, it was Jim Rogers (co-founder with George Soros of the Quantum Fund) who when asked how he makes money replied, “I buy fear and sell greed.” Then he was queried, “How do you determine when there is fear or greed?” He responded, “I wait until prices start gapping in the charts!”

The call for this week: I know it has been very easy to stay bearish this year given the constant bombardment of bad news, but my indicators, and the actual stock market, are telling us the resolution to the various economic/political messes is coming on the upside. Hence, I will leave you with this quote from my pals at GaveKal, “Most investors go about their job trying to identify ‘winners.’ But more often than not, investing is about avoiding losers. Like successful gamblers at the racing track, an investor’s starting point should be to eliminate the assets that do not stand a chance, and then spread the rest of one’s capital amongst the remainder.” Or how about this one, “Manage money for the environment that you are in, not the one you wish you were in.” Be bullish, my friends, be bullish . . .


Random gleanings over a holiday weekend after an unusual week
July 5, 2016

Well, you can only control what you can control. I think whatever your view of the world is, you have to invest. You can’t put the money in the mattress and in this day and age of low interest rates, you can’t put it in the money market fund or a bank CD, so invest, you must. Now, you might want to invest regularly. For people that are investing regularly, I would say for god’s sake don’t stop investing now. I know the market is not doing much this year, just about where it started a little bit down, but not much and bond yields are still very low, actually lower than they were at the beginning of the year, but you have to put your money to work. The alternative is – I mean, the only way to guarantee you will have nothing at retirement is to invest nothing along the way. So, you have to take your chances.

. . . John Bogle

As I read that quote from John Bogle I was reminded of another quote I used a few weeks ago from my friend Frederick “Shad” Rowe, proprietor of Greenbrier Partners the esteemed Dallas-based money management firm. To wit (as paraphrased):

Looking at each 20-year period on a rolling basis over the past 50 years, that is, we’ll look at 20 years, starting in 1965, then 20 years starting in 1966, and so on, returns on investment in the S&P 500 stock index for each period have fluctuated between 8% and 12% [per year]. Each period contained some bad years, but there were always more good years and they outweighed the bad results for every 20-year stretch. While the actuarially assumed rate of return for most public pension systems is approximately 7.5%, the stock market has managed to climb the proverbial wall of worry and offer superior returns, compared to virtually all available alternatives – if you stayed fully invested in the index for the full 20 years. Here is a prediction. A gigantic market move to the upside is coming, as investment committees assess their costs and reach the conclusion that the stock market is their best and only hope to meet their obligations.

Now let’s reflect on a few quips we’ve heard this year. Somewhere near the February “lows” a couple of bulge-bracket investment banks told investors to dramatically reduce their exposure to stocks; and one foreign-based investment bank actually said to “sell everything.” Certainly such advice is at odds with Shad’s wisdom. While there are many other examples of such disingenuous market advice, fast forward to the Friday morning following the Brexit vote. Hereto, in their “rush to instantly inform,” many pundits gave disingenuous and even wrong advice. Our advice was to take a deep breath and do nothing that Friday. Better to analyze things over the weekend, with clearer thoughts hopefully arriving Monday morning. Comes Monday and whispers of a “crash” were circling Wall Street, and as we suggested some stocks for your “buy lists,” stocks slid. To allay those crash fears we noted that nowhere in our exhaustive studies has there ever been a crash with the S&P 500 so close to all-time highs. Turning Tuesday (+269 points) arrived on time followed by Wednesday’s “win” (+284) making the two day two-step a back-to-back 90% Upside Volume skein, which is a pretty bullish occurrence, but left the equity markets overbought in the short term. That’s why we wrote in Thursday’s Morning Tack that a pause/pullback was likely at hand, but the upside should still be favored. Well, that proved to be disingenuous advice because the D-J Industrials rallied another 285 points that day. The pause finally arrived on Friday (+19), which brings us to today.

While Andrew Adams and I attempt to “call” the short-term moves in the various markets, we have never wavered in the belief the equity markets remain in a secular bull market that has years left to run. Last week CNBC asked me, in a preappearance interview, to list some reason why I am bullish. Here the list:

  1. The Brexit vote is not all that impactful for the U.S. since ~70% of U.S. companies’ revenues are domestic.
  2. Brexit may not happen.
  3. S&P’s earnings estimate for 2017 is $134.01 meaning at the recent low (1991) the forward P/E was 14.8x.
  4. The Global Earnings Revision Ratio has improved for the fourth straight month (analysts are raising earnings estimates).
  5. Interest rates are going to stay low for longer than most expect.
  6. The Advance/Decline line during the pullback acted great.
  7. Unlike in a financial crisis, the funding markets didn’t show any signs of stress (credit spreads).
  8. The S&P 500 recaptured its 20-month moving average quickly (read: bullish).
  9. As Jim Paulsen (Wells Capital) states, “It’s not like the U.K. is going to remove itself from the world economy and not trade with anyone. Once the emotion of this event fades, investors may get back to the fundamentals, which at least in the U.S. are looking better.” Or this from Guardian Capital’s Steve Bates, “Capitalism is a resilient and flexible organism and companies adapt quickly to new circumstances. This is why economies usually muddle through crises even in the absence of good leadership.”

Some of the other gleanings from a pretty unusual week include:

  1. Forget Brexit, the U.K. will emerge with a good trade, just like Switzerland.
  2. Share of world GDP in 2015: England 3.9%, Germany 4.6%, France 3.3%, U.S. 24.4%.
  3. Britain’s credit downgrade by S&P was the first sovereign downgrade from AAA by two notches ever.
  4. Brexit is giving the EU the potential to morph the continent’s countries into a super-state.
  5. Mexico urges North America toward integration after Brexit.
  6. Judge Posner sees no value in the U.S. constitution because our forefathers couldn’t have foreseen today.
  7. Gateway Pundit report states latest Reuters’ poll shows 52% of respondents were Democrats and 35% Republicans.
  8. Restaurant visit growth has stalled the last three months.
  9. Crude oil looks like it has made a double-bottom like it did last January/February (see chart on page 3).
  10. Norway oil workers avoid a strike.
  11. Does the failed auction of 1109-carat diamond signal the top in tangible assets?
  12. The move to eliminate the U.S. $100 bill fails.
  13. Amazon will give shoppers another chance at Black Friday on July 12.
  14. To be continued.

The call for this week: There is plenty of internal energy for an upside breakout to new all-time highs. Indeed, the Brexit decline has not changed our view that the February lows represented a major bottom, sinking the footings for a move to new all-time highs. Last week we experienced not only back-to-back 90% Upside Volume days, but back-to-back “buying climaxes” where 80%+ of issues traded advanced on the day. This is a rare event and last happened in December 2011 and January 2012 right before the S&P 500 (SPX/2102.95) gained ~24% (a tip of the hat to First Republic’s Jon Bull). Moreover, according to Fundstrat’s Thomas Lee (as paraphrased):

The S&P 500 fell 5% in two days. Of the 50 times that has happened since 1940, 16 occurred when the S&P 500 was above either its 50-day or 200-day moving average like now (in a bull trend), the median returns [going forward] have been impressive.

Not to be outdone, last Thursday my friend Jason Goepfert wrote, “Stocks jumped again, triggering the 3rd large up day in a row. Back-to-back-to-back gains of 1% have been rare, especially coming out of a multi-month low. When it has done so, the S&P 500 has been higher three months later every time, though the sample size is small.”

Well, the anticipated “pause” arrived on Friday and at 5:30 a.m. today it looks like the “pullback” is here with the preopening S&P 500 futures off about 12-points as the burgeoning Italian banking crisis takes center stage. We wrote last week that not only is it fears that Italy’s banking problems will spread to other countries, but that Italy is the linchpin for the EU. With an Italian referendum looming, if Italy pulls a Brexit the EU is in trouble. Nevertheless, we remain bullish.


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