Baby don't go
June 13, 2016
The year was 1964 when Reprise Records released the song “Baby Don’t Go.” Written by Sonny Bono, and recorded by Sonny & Cher (Cherilyn “Cher” Sarkisian), the song became a smash hit and set the duo’s career in motion. The repeating lyric in said song is “Baby don’t go, pretty baby please don’t go.” And that’s the song playing in the various streets of the European Union (EU) as the Brits contemplate leaving the coalition on June 23 (Brexit). The latest odds I saw were those of last Friday where Predata showed 46.04% of respondents wanted to stay “in,” while 59.96 wanted “out.” The media is spinning Brexit such that an exit might cause a domino effect with other EU members following the Brits, potentially setting the stage for a complete dissolution of the EU. I think the odds of that happening are remote, but the politics of a U.K. exit could be impactful. And as long as we are skirting the realm of politics, I found this story, written by my friend Arthur Cashin, to be intriguing and pretty funny. As Arthur writes:
After the close Monday, there was the customary meeting of the Friends of Fermentation. It was far from a plenary session with only a handful of members attending. Perhaps it was the marinating ice cubes, or just the small crowd, but something prompted one of the members to weave a rather illogical but intriguing (at least to me) political fantasy. Say you are a Reality TV celebrity and you decide to throw your hat into one of the presidential races of one of the major parties. To you it's a bit of a lark, primarily a vehicle to enhance your celebrity credentials around the country. In the beginning everything goes well. You claim that the powers that be are conspiring against you and trying to rig the election. Much to your amazement, the other candidates fall by the wayside and you become the presumed nominee. In some ways this is a problem; if you run and lose, the loss may diminish your brand. Worse yet, now that you stand alone, reporters are pestering you with very specific questions on world events, and if you are not fully up to date, they begin to portray you as someone who is less than knowledgeable. That will never do. To lose could be damaging enough to your reputation, but to lose and appear not to be on top of things could wound your image, or even destroy it. In my friend's fantasy, the candidate decides that the only way out is to do many outrageous things before the convention, forcing the party leaders to block the candidate and name a substitute. That allows the candidate to claim he or she was robbed and retain their newly enhanced image. It was an entertaining story but then the peanuts ran out. Guess we're stuck with our current logical election.
While termed a political fantasy, this essay certainly would explain some of the antics being unleased by Mr. Trump. And now you understand why every chance I get I meet with my counterparts of the Friends of Fermentation. Last week, however, I met with folks in Chicago. I would like to thank all of the people at BMO, Putnam, First Trust, Nuveen, and Harris for the ideas we shared, yet the highlight of the week was having dinner with my friend Kurt Funderburg, portfolio manager for First American Bank. Kurt and I worked together in a past life when he was my Healthcare analyst. Over dinner, we talked of old times and swapped investment ideas. One of his favorite names is Dollar General (DG/$91.44/Strong Buy), which is followed by Raymond James’ fundamental analysts with a Strong Buy rating. For more on the DG story, please see our analyst’s reports.
Another portfolio manager (PM) I spoke with was CEO, CIO, and PM of Perritt Capital, namely Michael Corbett. I have met with Mike before and have found him to be a good captain of capital. Two of the funds Mike manages are the Perritt MicroCap Opportunities Fund (PRCGX/$31.90) and the Perritt Ultra MicroCap Fund (PREOX/$14.57). For the record, microcaps have underperformed for the past few years. That underperformance is likely because they did so well in 2013 that valuations got stretched. To be sure, at last February’s low, the Russell MicroCap Index was down some 27%+ from its June 2015 high. Nevertheless, while the micro capitalization universe of stocks has been out of favor, I think it’s time has come. Like Wayne Gretzky states, “I skate to where the puck is going to be;” and I believe “the puck,” at least for some of your capital, should be micro caps going forward. Over the years, many investors have asked me, “If you were going to manage money again, how would you do it?” My response has been, “I would concentrate on micro caps where there is no or little research coverage because that is where the misvalued pieces of paper are.
While we are on the subject of portfolio managers, I will remind you that some of Putnam’s “best and brightest” will be on a conference call with Andrew Adams and me to talk about strategies, discuss individual ideas, and stress the importance of incorporating alternative strategies to help reduce portfolio volatility and risk. It should be a highly interactive and productive discussion. The call is designed to be for investment professionals only, but I am sure there will be some competitors listening. The webinar will take place this Wednesday, June 15, at 4:15 p.m. EDT. To attend the webinar, please click on this link, because there is no phone number. The audio will play through your computer. If you are having any technical difficulties connecting, please contact Putnam Investments at 1-800-354-4000.
So what else did we see and/or learn in our travels last week? Well, I heard a lot of interesting investment ideas from the PMs I met with. One PM pointed out that the iShares 20+ Year Treasury Bond ETF (TLT/$134.78) is breaking out to the upside in the charts (read: lower interest rates/see Chart 1). Another complimented Andrew and me on our call for the past 10 months, that the Dollar Index (DXY/$94.66) topped last year (Chart 2), was correct and suggested select sectors that should benefit from a weaker greenback (Chart 3). Still another PM wanted to know more about the current “buying stampede,” which at session 84 is clearly the longest I have ever seen. To that point, the invaluable Bespoke organization recently wrote:
It’s been nearly four months since the S&P 500’s 2016 low on 2/11, and while it may seem like the market has just gone up every day since then, we were somewhat surprised to see that the frequency of up days over the last four months has been far from extreme relative to the rest of the bull market that began in 2009. The chart (Chart 4) shows the percentage of positive days for the S&P 500 over a rolling four-month period going back to March 2009. As of Wednesday’s close, the S&P 500 has been up in 48 of the prior 84 trading days, which works out to an average of 57.1% of all trading days. In order to compare the current reading to prior readings, whenever the line in the lower chart is red, it indicates that the percentage of up days over the prior four months was greater than the current reading, while the blue line indicates a lower reading. As shown in the chart, there is a lot of red. In fact, the S&P 500 has had a higher percentage of up days over a trailing four-month period on 38% of all trading days since the bull market began. In the top chart of the S&P 500, the red lines mean the same thing as the bottom chart. As shown, in the majority of instances, these periods of consistent up days tended to occur in bunches. Heading into this week, there was no denying that the market was overbought in the short term, and while a period of consolidation or modest declines is possible, the consistency of buying over the last four months has been far from extreme, so it’s not as though investors have been blindly buying.
And now, in addition to Friends of Fermentation, you know why I think serious investors should have access to Bespoke.
The call for this week: In last Thursday’s Morning Tack, I wrote, “Certainly this rally is extended, yet we still don’t see evidence of any ‘sell signals’ or much bearish data. In fact, one of the few cautionary ‘flags’ comes from the McClellan Oscillator, which is overbought on a short-term basis.” So while the past two trading sessions have been painful, it has indeed corrected the overbought condition (Chart 5) I spoke of and still leaves the S&P 500 (SPX/2096.07) above its 50 and 200-day moving averages. Also of note is that crude oil broke below its rising trendline last week and that we expect a decent rally attempt after the Brexit vote. This week, investors’ attention will focus on the FOMC meeting, where we have been saying for months there will be NO rate ratchet and likely no rate increase until after the November election. Many of these machinations will be discussed in this Wednesday’s 4:15 p.m. webinar with myself, Andrew Adams, and some of Putnam’s best and brightest (click here to join the webinar). As I write this on Sunday night in Charleston, SC, the S&P futures are off eight points on Brexit fears, China’s slowing fixed investment flows (15-year low), this week’s FOMC meeting, the Bank of Japan meeting, and Friday option expiration. A close by the SPX below 2078.40 would trigger a short-term trader’s “sell signal” on the daily MACD indicator.
June 6, 2016
“I try to push ideas away, and the ones that will not leave me alone are the ones that ultimately end up happening.”
. . . J. J. Abrams, American film director, producer, screenwriter, and composer
Many of you know the way that I construct portfolios. I typically begin with a base of mutual funds, but not just any mutual fund. I tend to invest in mutual funds where I know the portfolio manager (PM) and like his or her investment style. Then, because I talk to these PMs, I hear lots of good ideas. I mean really, if Tom O’Halloran, who manages Lord Abbett’s Growth Leaders Fund (LGLAX/$21.99), has purchased millions of shares of Facebook (FB/$118.47/Outperform) in the mid-twenties one has to assume he has done the fundamental work. Having been a bottom-up stock analyst myself in a past life, I then can spend a half an hour looking at the earnings estimates, financial statements, recommendations, and the chart to decide if I am going to buy the shares. This is how I try to add alpha to a portfolio (alpha).
At the mid-February lows of this year, Andrew Adams and I had a lot of investment ideas and wrote about them in these missives. Our timing and pricing models were in sink and we suggested moving back into select securities. At the May lows, however, we were not as aggressive, for as stated, while our timing model nailed the mid-May lows, we never got down to the 1990 – 2000 level our pricing model had targeted. Still, given the intensity of the rally from the May lows (S&P 500 up ~3.9%), we are currently getting “pinged” for investment ideas. Admittedly, our models are calling for new all-time highs by the S&P 500 (SPX/2099.13), but in the very near term the SPX remains very overbought. Accordingly, we are not inclined to be super aggressive right here. For those wanting to commit capital on a risk-adjusted basis, there is a relatively new product from Raymond James’ Asset Management Services department (AMS) for your consideration. To wit:
While waiting for a more definitive breakout signal from our models, clients may want to increase their allocation to attractive dividend paying stocks. The best income ideas from the Raymond James Equity Research department may be found in the latest Equity Income Report, published last week. The report features the best yielding common stocks, with a separate section for MLPs, REITs, and business development companies. For a stock to be on the list, it must be rated Outperform or Strong Buy, have at least a $1 billion market capitalization, and a dividend yield exceeding 1.5%. When an analyst downgrades a stock, it is removed from the report. The recommendations are also available as a managed portfolio through Asset Management Services, which creates a diversified portfolio of the 30 highest dividend yields.
For those wanting to be more aggressive there are two relatively new names to the Raymond James research universe of stocks that have intriguing stories, favorable ratings from our fundamental analysts, and screen well using our proprietary algorithm. The first name is Blueprint Medicines Corporation (BPMC/$20.36/Outperform). As our analyst writes:
Blueprint Medicines Corporation is a development stage biopharmaceutical company based in Cambridge, Massachusetts. Leveraging a novel target discovery engine, it is focused on the development of small molecule kinase inhibitors for the potential treatment of cancer and rare genetic diseases.
The other name is Instructure (INST/$18.04/Strong Buy). Hereto, our analyst writes:
Based in Salt Lake City, Utah, Instructure is a leading provider of software-as-a-service (SaaS) based learning management systems (LMS), which are currently gaining significant market share in the education market. In addition, the company is beginning to address learning management and human capital management (HCM) needs of the much bigger enterprise or commercial market.
For more information please see our analysts’ reports.
As for Friday’s unbelievable employment report, well it was just that . . . unbelievable! As our economist, Scott J. Brown Ph.D., writes:
Payroll growth was much lower than expected in May, with softness spread across industries. Some of this may be noise. Some of it may be weather (pulling seasonal job gains forward) – prior to seasonal adjustment, we added 2.9 million jobs between January and May, vs. 3.2 million last year. Taken at face value, this is a disappointing report. However, even considering the usual amount of noise, the trend in job growth has slowed. This is likely because firms are having a tougher time finding qualified workers (that is supported by the anecdotal evidence). This report significantly lowers the odds of a Fed rate hike in June, July, and September. A negative for the dollar and the stock market. A plus for bonds.
And it was a negative for stocks, but only for about 50 minutes, for at 10:20 a.m. the D-J Industrial Average was down ~149 points (the low of the session) when mysterious “bids” showed up leaving the senior index down only 31 points by the closing bell. Likewise, the SPX found support in its 2080 – 2085 support zone and once again had “eyes” for the 2100 level at the “bell.” To me this smacks of a stock market that wants to trade higher, which would leave many PMs scrambling to play catch up. That’s certainly what Bank of America Merrill Lynch’s “sell side” indicator is suggesting as it shows Wall Street strategists’ recommended stock allocations fell to a lower level than at the March 2009 lows!
The call for this week: Friday’s upside reversal caused one old Wall Street wag to exclaim, “When the stock market ignores bad news that’s good news!” To be sure, there is not enough data to alter our “call” for new all-time highs as of yet. On a valuation basis the forward 12-month earnings estimate for the SPX (IBES) is $124.48, giving us a nearly 6% forward earnings yield and a forward P/E multiple of 16.9x. If new highs do emerge, the market probably will be led by the healthcare and technology sectors. That should put focus on the Health Care SPDR (XLV/$72.29) and the Technology SPDR (XLK/$43.94). Looking at the chart, it is worth noting that the XLV has broken out to the upside (see charts on page 3). Today “The Street” will put on rabbit ears at 12:30 p.m. to hear if Ms. Yellen has damage control on her mind, which has left the futures flat this morning.
PS – My friend Jason Goepfert (SentimenTrader) notes in Barron’s over the weekend:
Examining data beginning in 1928 shows that in 12 out of 14 years in which the SPX posted three consecutive months of gains following a 12-month low (like now), the market rallied for the next three months. If the fourth month rose as well, future gains in the months ahead were even better, except for 1930 and 1940.
May 31, 2016
“Nothin’ from nothin’ leaves nothin’ (Billy Preston)” . . . is the first line from Billy Preston’s hit song “Nothing From Nothing” recorded in 1974 on the album “The Kids & Me.” It was a song one of my bands used to play in an era long gone by. I recalled the tune while reading one market maven’s letter last Tuesday where the author commented that, “Monday was perhaps the nothingest of nothing days.” And, he was right because on that day the D-J Industrials limped through the session only to close down by a mere 8 points. To be sure, last week began as so many weeks have begun over the past 22 months. Recall it was in August 2014 that the S&P 500 (SPX/2099.06) first breached the 2000 level, but ever since the SPX has been trading in a relatively tight range of roughly 18%. As the good folks at LPL Research write, “[That’s] one of only five times it has traded in a range of less than 20% over a period of 22 months. Looking at the chart, 2005 and 2006 were the last times to see a range this tight. Of course, that was nearing the end of that bull market, but the two times before were the mid-1990s and late 1984. Both of those occurrences were simply a break in multiyear bull markets.”
To look at the chart, and subsequent previous tight ranges, see chart 1. This range-bound stock market has frustrated both bulls and bears alike, and while Andrew Adams and I have tried to “call” the tactical moves for the SPX over the last 22 months, we have never given up on our continuation of the secular bull market “call.” As often stated in these missives, we believe what has occurred is merely an upside consolidation following a ~220% rally from the March 2009 lows into the May 2015 highs. More recently, however, it is not the 2000 level investors are focused on, but rather the 2100 level (chart 2). Indeed, the SPX has tried four times to better the 2100 – 2134 overhead resistance level, as well as the May 2015 all-time high, and has failed on every attempt. Whether this current attempt will prove successful remains to be seen, but I would note that if we do break out to new all-time highs, it would leave many investors scrambling.
To this point, the SPX took a step in that upside direction last week as it broke out above the downtrend line that has been in existence since the mid-April 2016 high (chart 2). That breakout allowed the SPX to gain 2.28% last week, and while that was pretty good, it paled in comparison to the NASDAQ Composite (+3.44%) and the Russell 2000 (+3.43%). On a sector basis, Information Technology was the star of the week with a gain of 3.60% followed by Financials (+2.62%), which caused the S&P 500 Financial sector to experience an upside breakout in the charts (chart 3). In past comments, we have argued the only two macro sectors we can find real value in are the Energy and Financial sectors. Interestingly, there is another soon to be new sector in what will then be the S&P 11 macro sectors. The new sector will be Real Estate, with an obvious emphasis on Real Estate Investment Trusts (REITs), and the new sector will begin after the closing bell on August 31, 2016 (ET). As a sidebar, there will also be a new sub-industry for copper created at the same time.
Speaking to the REITs, my friends at arguably the premier real estate money management team of Cohen & Steers recently told me there should be more than $100 billion in demand for REIT stocks from 40 Act mutual funds just to get to a market weighting when the new sector becomes effective. While nobody has done the work on how much of the REITs will be bought by international investors, I did receive this quip from one portfolio manager that traffics in this space, “With the Bank of Japan (BoJ) now owning more than 5% in 12 different REITS and also owning more than half of the entire ETF market, the ex-Vice Finance Minister from the opposition Democratic Party basically said it’s easy to get in, but how are you going to get out. ‘As with any investment, you must always think about exit, but there’s no exit when you own half of the market.’ He is not calling for selling the BoJ positions, just to stop buying more.”
The large capitalization REITs international investors will likely be buying, which have positive ratings from our fundamental REIT research team, and that screen positively on our proprietary algorithm model, include: American Tower (AMT/$106.06/Strong Buy) yielding 1.94%; Equinix (EQIX/$366.56/Strong Buy) yielding 1.93%; and, Extra Space Storage (EXR/$92.93/Strong Buy) with a yield of 2.54%. Those names with the same metrics from our mid-capitalization research universe include: Apartment Investment & Management (AIV/$42.78/Strong Buy) yielding 3.1%; American Homes 4 Rent (AMH/$18.58/Strong Buy) yielding 1.08%; Douglas Emmett (DEI/$34.03/Outperform) yielding 2.62%; Mid America Apartments (MAA/$102.35/Outperform) with a yield of 3.25%; and, Regency Centers (REG/$77.20/Outperform) yielding 2.60%. With the “wind at their back” due to the new S&P sector status, we believe the REIT complex has higher prices in store. We think you should buy some of the favorably rated REITS by our fundamental analysts.
Between the “bookends” of last week: 1) most of the economic releases were weaker than expected; 2) despite that Janet Yellen kind of confirmed a rate hike in the months ahead would be appropriate (chart 4); 3) contracts to buy existing homes, new home sales, and mortgage applications all came in higher than expected (chart 5); 4) crude oil tagged $50 per barrel; 5) the AAII Bullish Sentiment figures dropped to the lowest level in a decade (chart 6); 6) the Philadelphia Semiconductor Index broke out to the upside (chart 7); and, 7) there was no post G7 “lift” for stocks. While there were many other metrics occurring last week, these were the ones that stood out to us.
The call for this week: All of the S&P macro sectors are either neutrally configured, or overbought, on a short-term basis. Similarly, the NYSE McClellan Oscillator is overbought suggesting at least a pause to last week’s “win.” However, our internal energy indicator for the equity markets has a full charge, the lack of bullish sentiment is wildly bullish, and with headlines like this in Barron’s, “Why the Stock Market Won’t Crash – Yet,” it continues to reinforce our belief the secular bull market has years left to run. As for “crashes,” while many (like the Barron’s article) refer to the events such as: the Banker’s Panic of 1907, the Kennedy Steel Panic of 1962, the 1973 – 1974 debacle, the 2008 – 2009 Financial Crisis, etc. as “crashes,” they are not crashes! A “crash” happens over a very short period of time. By my pencil, there have only been two crashes since 1900 (chart 8). The first was the 1929 crash where the D-J Industrial Average lost approximately 25% of its value in two sessions (10-28-29 and 10-29-29). The second crash came on October 19, 1987 when the D-J Industrials lost 22.6% in a single day. Those were crashes, the various panics like the Dot-com Bubble Bust of 2000 to 2002, and the aforementioned panics, were not crashes but rather bear markets. One could make the case that the “Flash Crashes” of May 6, 2010 and August 24, 2015 qualified as “crashes” because they both occurred in one day, yet they do not qualify based on the severity (percentage) of the decline. This morning, the preopening futures are flat on no news. And, that’s how it is at session 76 in the longest “buying stampede” I have ever seen . . .
Additional information is available on request. This document may not be reprinted without permission.
Raymond James & Associates may make a market in stocks mentioned in this report and may have managed/co-managed a public/follow-on offering of these shares or otherwise provided investment banking services to companies mentioned in this report in the past three years.
RJ&A or its officers, employees, or affiliates may 1) currently own shares, options, rights or warrants and/or 2) execute transactions in the securities mentioned in this report that may or may not be consistent with this reports conclusions.
The opinions offered by Mr. Saut should be considered a part of your overall decision-making process. For more information about this report to discuss how this outlook may affect your personal situation and/or to learn how this insight may be incorporated into your investment strategy please contact your Raymond James Financial Advisor.
All expressions of opinion reflect the judgment of the Equity Research Department of Raymond James & Associates at this time and are subject to change. Information has been obtained from sources considered reliable, but we do not guarantee that the material presented is accurate or that it provides a complete description of the securities, markets or developments mentioned. Other Raymond James departments may have information that is not available to the Equity Research Department about companies mentioned. We may, from time to time, have a position in the securities mentioned and may execute transactions that may not be consistent with this presentations conclusions. We may perform investment banking or other services for, or solicit investment banking business from, any company mentioned. Investments mentioned are subject to availability and market conditions. All yields represent past performance and may not be indicative of future results. Raymond James & Associates, Raymond James Financial Services and Raymond James Ltd. are wholly-owned subsidiaries of Raymond James Financial.
International securities involve additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets.
Investors should consider the investment objectives, risks, and charges and expenses of mutual funds carefully before investing. The prospectus contains this and other information about mutual funds. The prospectus is available from your financial advisor and should be read carefully before investing.