THE SHAH GROUPIndependent Establishment

Investment Strategy by Jeffrey Saut

Rich man, poor man
February 1, 2016

Given the unmerciful “selling stampede” ushered in with the new year, I thought it would be appropriate to republish one of my strategy reports from a few years ago, because its advice is timeless. Indeed, after 45 years in this business, I have seen a number of cycles and developed a long-term perspective, much like Richard Russell wrote about in “Rich Man, Poor Man.” I like this story:

“In the investment world, wealthy investors have one major advantage over the little guy, the stock market amateur and the neophyte speculator. The advantage wealthy investors possess is they DON’T NEED THE MARKETS. I can’t begin to tell you what a huge difference that makes, both in one’s mental attitude and in the actual handling of one’s account. The wealthy investor doesn’t need the market, because he already has all the income he needs. He has money coming in via bonds, T-bills, money market funds, real estate, and stocks. In other words, the wealthy investor never feels pressured to ‘make money’ in the market.

The wealthy investor tends to be an expert on values. When bonds are cheap and bond yields are irresistibly high, he buys bonds. When stocks are on the bargain table and stock yields are attractive, he buys stocks. When real estate is a great value, he buys real estate. When great art or fine jewelry is on the ‘giveaway table,’ he buys them. In other words, the wealthy investor puts his money where the values are. And if there are no outstanding values, the wealthy investor waits. He can afford to wait. He has money coming in daily, weekly, monthly. In other words, he doesn’t need the market. He knows what he is looking for, and he doesn’t mind waiting weeks, months or years (they call it patience).

What about the little guy? This fellow always feels pressured to ‘make money,’ to ‘force the market to do something for him.’ When this fellow isn’t buying stocks at 3% yields, he’s off to Vegas or Atlantic City trying to win at craps or he’s spending ten bucks a week on lottery tickets or he’s ‘investing’ in some crackpot real estate scheme with an outfit that his bowling buddy told him about. And because the little guy is forcing the market to do something for him, he’s a consistent and constant loser. The little guy doesn’t understand values, so he always overpays. He loves to gamble, so he always has the odds against him. He doesn’t understand compounding and he doesn’t understand money. He’s the typical American, and he’s perpetually in debt.

The little guy is in hock, and he’s always sweating, sweating to make payments on his house, his refrigerator, his car or his lawnmower. He’s impatient, and he constantly feels pressured. He tells himself he has to make money fast. And he dreams of ‘big bucks’. In the end, the little guy wastes his money on the market, he loses his money on gambling, and he dribbles it away on senseless schemes. In brief, this ‘money-nerd’ spends his life running up the down-escalator. Now here’s the ironic part of it. If, from the beginning, the little guy had adopted a strict policy of never spending more than his income, if he had taken that extra income and compounded it in safe, income-producing securities – in due time he’d have money coming in daily, weekly, and monthly – just like the rich guy. Then in due time, he’d start acting and thinking like the rich guy. In short, the little guy would become a financial winner instead of a loser.”

I lost my friend Richard Russell late last year in a reoccurring nightmare where I continue to lose my mentors as they either pass away or retire. After more than 50 years of writing “Dow Theory Letters,” Richard Russell said the most popular piece he’s ever published is his “Rich Man, Poor Man” essay. In this day and age of constant advertisements, infomercials, junk mail, harassing cold calls haranguing all about how to make a killing in the stock market, real estate, commodities, etc. etc., etc., it’s refreshing to read some advice from an honest old pro that makes sense. Moreover, most stock-centric magazines you see tell you what mutual fund you should buy, how to invest to retire, how you can make it big in whatever. I would bet that those writers, advisors, and testimonial seers who concoct those pieces make more money selling their “pitch” than following their own advice. Putting that pitch on paper or through the TV, radio, or phone is a lot easier than actually putting up their own money. I know many stock brokers, advisors, writers, etc. who never invest themselves. Yet they make their money telling others how to do it. A case in point is a story in a widely read financial magazine. It chronicles a now successful promoter who, earlier, tried the get-rich-quick schemes, which didn’t work for him. So that led him to “why not trade commodities and get rich,” which again did not work for him, and then, later, “why not write a book about how to trade commodities and get rich.” To make a long story short, he made mucho moola selling the book and NOT investing his own money!

STOP HERE NOW and go back and read RICH MAN, POOR MAN again!

In the world we live in, few look at risk. Most only look at reward. The few who do look at risk (the educated, the street savvy, etc.) make their money at the expense of the great unwashed majority who swallow the noise nonsense about getting rich quick. Investing is a get rich slowly process. You have to put your money at risk in the face of uncertainty. Emotions run rampant before the uncertainty of floating, fluctuating, often violent and volatile markets. Constantly discounting prices are fickle and full of surprises. Disorder is usually the norm. Importantly, remember when you do invest and put your money at risk, you are using “after-tax” dollars. The federal, state, and local governments, along with sales tax, are confiscating more and more. While the POOR MAN pays fewer taxes, the RICH MAN pays much more when you take into account the top bracket rate including the surtax, the Medicare payroll tax, the work-sheet phasing out of deductions, and exemptions, etc. Therefore, when you consider straying away from a compounding type of investment, make sure you understand risk and that you get value and a margin-of-safety price concession. Maybe John Burr Williams, a pioneer in the concepts of modern portfolio theory, said it best, “The value of any stock, bond or business is determined by the cash inflows and outflows, discounted at an appropriate interest rate, which can be expected to occur during the remaining life of the asset.” Oh, and by the way, if you doubt the magic of compounding, consider this little ditty from Andrew Tobias:

“There was the king who held a chess tournament among the peasants and asked the winner what he wanted as his prize. The peasant, in apparent humility, asked only that a kernel of wheat be placed for him on the first square of his chessboard, two kernels on the second, four on the third and so forth. The king fell for it and had to import grain from Argentina for the next 700 years. Eighteen and a half million trillion kernels, or enough, if each kernel is a quarter-inch long (which may not be; I’ve never seen wheat in its pre-English-muffin form), to stretch to the sun and back 391,320 times.”

That was nothing more than one kernel compounding at a 100 percent square for 64 squares. Accordingly, remember the old adage, “He who understands interest – earns it, he who does not understand interest – pays it.”

The call for this week: So far this year, the “rich man” has not needed the stock market. That may have changed last week. Last Thursday, I said, “I think the equity markets are bottoming at session 21 in the typical 17-25 day ‘selling stampede’ sequence.” In Friday’s missive, I wrote, “I think the ‘selling stampede’ pretty much ended at session 21 with yesterday’s (last Thursday) whippy action between plus and minus, which is typically how bottoms are made.” About a week ago, I noted that, if we do bottom in the 17-25 session timeframe, the S&P 500’s (SPX/1940.24) first upside target zone would be 1940-1950. Well here we are, which makes this week critical. If we can get through 1940-1950, the odds that we have made a sustainable bottom increase notably. If we don’t, it would mean another downside retest. I will say that there is a FULL change of “internal energy” available for a pretty decent move from here. Stay tuned . . .


Saved by the bell
January 25, 2016

“Saved by the Bell” except in this case we are not referring to the late-1980s TV sitcom that focused on a group of high school teens and their principal, but last Wednesday’s closing bell on the floor of the New York Stock Exchange (NYSE). The day began well enough with the preopening S&P futures only off about 9 points when I slid into my trading turret around 5:30 a.m. From there, however, things got pretty ugly as the D-J Industrial Average (INDU/16093.51) went into a minicrash that would see the senior index shed some 567 points and in the process break below its August 25, 2015 closing low of 15666.44. Of course my phone, and email box, lit up with the ubiquitous question, “Hey Jeff, you chose to ignore the Dow Theory ‘sell signal’ of last August unless both the Industrials and the D-J Transports (TRAN/6778.54) broke below those lows. Well the Transports broke their August low last December and today the Industrials are doing the same. Do we raise more cash here?” The question was so prolific that I ended up cutting and pasting this response, “Intraday ‘price prints’ do not count in Dow Theory. It’s only the closing price that counts. Yet, if the Dow closes below 15666.44 I will have to go through my portfolio and look at the weakest stocks that have broken below major support levels and at least sell half of the position.” Fortunately, in Wednesday afternoon’s trading we got a stock market lift, leaving the Industrials at 15766.74, so I didn’t have to execute on that strategy. The next day, however, I got pounded again.

Thursday’s questions were driven by an article from The Street.com. The title read, “A ‘Dow Theory Sell Signal Suggests the ‘Year of the Bear’ Will Continue,” and was actually written by a very bright strategist I know, as he wrote:

This economically sensitive Dow Industrials closed at 15,766.74, below the prior closing low of 15,871.35 set on Aug. 24, considered Black Monday in China. [The] Dow Transports already closed below its Aug. 24 close of 7,595.08 back on Dec. 11 with a close of 7,524.64. This set up [is] a potential "Dow Theory Sell Signal" when the Dow Industrials followed (see the article here: (Suttmeier).

While he has the right closing prices for August 24, 2015, he has the wrong date for the closing lows of both indices. As often stated in these missives, the low closing prices for both the Industrials and the Trannies occurred on August 25, 2015, not on the 24th. To be sure on August 25th the Industrials closed at 15666.44 and the Transports at 7466.97. Hence, while the Trannies fell below their August low on December 18, 2015, the Industrials have yet to close below their respective August low.

On that same day I was also pounded with emails wanting to know where I saw that Goldman Sachs was telling clients to “buy” crude oil and did I think oil had bottomed? Hereto, I cut and pasted this response, “I have wrongly attempted to ‘call’ the bottom on oil three times last year and been wrong every time, so I am deferring to my energy analysts that say their model is more bullish than at any time in the past four years. They are looking for higher oil prices in the back half of this year.” As for Goldman’s bullish oil call, you can see that here (Oxford World Financial Digest); and, so far Goldman has been right as the March crude oil futures contract has rallied some 23% from last Wednesday’s intraday low into Friday’s intraday high. Of course such a rally in crude has produced rallies in the energy stocks (the average energy stock is up 22% from last Wednesday’s lows). Of particular interest to us is the recent rally in the mid/downstream master limited partnerships (MLPs). For the past few weeks we have suggested that investors have been able to buy an investment grade portfolio of such MLPs with an aggregate yield of over 7%, some of which is tax deferred because it is classified as return of capital. As always, names and fundamentals should be vetted before purchase.

So what happened late last week that gave us the first back-to-back “two step” (Thursday/Friday) in months that added some 327 points to the Dow? As I stated a couple of times on TV last week, I think the “fuel” was the surprisingly large $60 billion liquidity injection by the People’s Bank of China (PBOC) and the “match” was Draghi’s latest iteration of “whatever it takes.” Other metrics setting the stage for a rally were: 1) last Wednesday saw the highest odd-lot short selling by individuals ever (contrary indicator); 2) Google Trends showed searches for the term “bear market” at its highest level since March 2009; 3) stocks above their 50-day moving averages was below 10% (oversold); 4) the NYSE McClellan Oscillator was about as oversold as it ever gets; 5) more than 40% of the stocks traded on the NYSE traded to new 52-week lows on Wednesday (historic); 6) investors pulled $25.6 billion from U.S. stock mutual funds over the past three weeks, and the list goes on. As well, last Wednesday was session 15 in the envisioned “selling stampede” that tends to last 17 – 25 sessions before exhausting itself, which was close enough for government work. Still, so far we have only experienced a two-session “throwback rally.” As stated, such stampedes are only interrupted by one- to three-session pauses/rally attempts, making today extremely important, yet it certainly feels like this rally could last for a while with the SPX’s first target 1940 – 1950.

The call for this week: My friend Arthur Cashin has said, “When the fear of losing money overcomes the fear of looking stupid . . . that’s a bottom!” Last week that is exactly how many folks felt on the Street of Dreams. We’ll see if that mood prevails this week, allowing stocks to trade higher. A step in that direction would be for the major averages to rally for more than just three sessions. As for last weekend’s snow storm, which is being trumpeted as the worst storm for NYC ever, I drudged up the first paragraph from my report titled “The Great White Hurricane.” To wit:

“Unseasonably mild and clearing” was the weather forecast going into the Ides of March back in the year of 1888. And it was true, as temperatures hovered in the 40s and 50s along the East Coast. However, torrential rains began falling, and on March 12th, the rain changed to heavy snow, temperatures plunged, and sustained winds of more than 50 miles per hour blew. The “Great White Hurricane” had begun! In the next 36 hours, some 50 inches of snow would blanket New York City, and the winds would whip that snow into 40- to 50-foot snowdrifts. Telegraph and telephone lines were snapped, fire stations were immobilized, New Yorkers could not get out of their homes, 200 ships were blown aground, and 400 people would die before the storm was over. The resulting transportation crisis led to the construction of New York’s subway system.

P.S. – By far the best prose I read last week was written by Howard Marks of Oaktree Capital (Oaktree):

Especially during downdrafts, many investors impute intelligence to the market and look to it to tell them what’s going on and what to do about it. This is one of the biggest mistakes you can make. As Ben Graham pointed out, the day-to-day market isn’t a fundamental analyst; it’s a barometer of investor sentiment. . . . You just can’t take it too seriously. Market participants have limited insight into what’s really happening in terms of fundamentals, and any intelligence that could be behind their buys and sells is obscured by their emotional swings. It would be wrong to interpret the recent worldwide drop as meaning the market “knows” tough times lay ahead. . . . It’s important to understand for this purpose that there really isn’t such a thing as “the market.” There’s just a bunch of people who participate in a market. The market isn’t more than the sum of the participants, and it doesn’t “know” any more than their collective knowledge.


Assassins, hunters, and rabbits . . . oh my
January 19, 2016

It was a few weeks ago that I resurrected a line used in my September 10, 2001 missive from the movie Star Wars that read, “I felt a great disturbance in the force . . . as if millions of voices suddenly cried out in terror and were suddenly silenced. I fear something terrible has happened.” The quip was used because stocks should have been going up in the August/September timeframe of 2001 and they were not. The missive went on to read, “An appropriate line given our sense that for the past few weeks that something is/was out of balance in the universe.” That same “out of balance” feeling struck me again in late-December of 2015 when the Santa rally failed to materialize. This morning I am using another line from Start Wars that reads, “A long time ago in a galaxy far, far away” because I am referencing an article written some time ago titled “Being Wrong and Still Making Money” by Lee Freeman-Shor. The author begins by writing, “The investment ideas of some of the greatest investors on the planet today are wrong most of the time, and yet they still make a lot of money. How can this be? How can the world’s best investors get it wrong and still make millions?” The author continues by noting, “My findings suggest the odds are that an investor’s great idea will lose money. As such, before you invest a cent into an investment idea, it is imperative to have a plan of action as to what you will do if you find yourself in a losing position.” And folks, here is the secret of investing as written by Mr. Shor:

When losing, the successful investors I worked with planned to become either Assassins or Hunters. Assassins sold losing investments that fell by a certain percentage or that declined by any amount and showed no signs of recovery after a certain period of time. Hunters invested a lesser amount at the outset and with a plan of buying significantly more shares if the price fell. Hunters were also unafraid to sell if it became clear that they had made a mistake. The bad investors didn’t have a plan and consequently turned into Rabbits. When losing money, Rabbits neither bought more shares nor sold their holdings. Once forming an initial perception, Rabbits were achingly slow to change their opinion of a stock. Which tribe will you become a member of?

“Assassins, Hunters, and Rabbits . . . oh my” and for the past two weeks the stock market has certainly gone down the “rabbit hole” for the worst start of the year ever! The mauling has triggered a number of cautionary signals. First, the old stock market “saw” goes, “If Santa fails to call, the bears will come to Broad and Wall.” While cute, it does not have a particularly good track record. Since 1900 there have been 35 bear markets (a decline of 20% or more). Only 12 of them have been preceded by no “Santa rally” for a 34% accuracy rate. Second, another stock market meme states, “So goes the first week of the year, so goes the month, and so goes the year.” Hereto, while cute it is not actually what Yale Hirsch proffered in 1972 in the Stock Traders’ Almanac, now termed the “January Barometer.” To be exact, the actual “January Barometer” reads, “So goes January, so goes the year.” According to Jeffrey Hirsch the “January Barometer” has been accurate 75% of the time since 1950. So there is no signal yet from this indicator and we must wait until the end of the month for its guidance. Third, while not an axiom, the “December Low Indicator” was first explained to me in the early-1970s by Wall Street icon Lucien Hooper. It was over lunch at Harry’s (at the Amex) Bar & Grill that Lucien explained it by saying, "Forget all the noise you hear about the January Barometer; pay much more attention to the December low. That would be the lowest closing price for the Dow Jones Industrial Average during the month of December. If that low is violated during the first quarter of the new year, watch out!" To be sure, the December Low Indicator has registered a “watch out” signal as D-J Industrial Average (15988.08) traveled below its December 18 closing low of 17128.55 on January 6 of this year. The S&P 500 (SPX/1880.33) has done the same, given its December closing low of 2005.55.

Around the time the “December Low” was violated (January 6, 2016); Andrew and I began suggesting that we could be in a “selling stampede.” At the risk of repeating myself; selling stampedes tend to last 17 – 25 sessions, with only 1.5 – 3 session pauses/rally attempts, before resuming the downside skein. While it’s true there have been a few stampedes that have extended for 25 to 30 sessions, it is rare to have one last for more than 30 sessions. Today is session 13. Also, on CNBC for the past two Fridays I have repeated my mantra of “Never on a Friday,” meaning stocks rarely bottom on a Friday when they are into a weekly Downside Dive. Typically, the markets allow participants to brood about their losses over the weekend and show up the following Monday in “sell mode.” That worked in spades last week and we will have to see if it plays this week as well. That said, the stock market is very oversold on a short-term basis as represented by the percentage of NYSE companies above the 50-day moving average, which is now under 10% (see chart 1). As can be seen, the SPX is just about as oversold as it was at the August 2015 lows. Accordingly, it would not be a surprise to see a rally off of some kind of early week low this week. The question, once again, is will it be a 1.5 – 3 session affair, or something more.

There have been many reasons offered for the first of the year “fade” ranging from the Chinese economy, North Korea’s H-bomb, the Saudi Arabia/Iran tensions, crude’s crash, etc., but last week it was the U.S. economy. While I remain more concerned about the Saudi/Iran tensities, especially after last week’s Zawahiri jihadist audio recordings and written statement for Saudi citizens to revolt, the week’s wilt was attributed to the U.S. economy. Of the 19 economic reports issued four came in better than expected, three met estimates, but a large 12 were worse than expectations. Indeed, it was a mostly negative week for U.S. economic data bringing on cries of recession. At this point we do not see a recession on the horizon. As our economist, Scott Brown, Ph.D. writes:

The bottom line is that worries about China are not going to go away. The question is, what does it mean here? The U.S. economy is still largely self-contained. China, our third largest trading partner, accounted for 8% of U.S. exports in 2014 (that’s less than 1% of U.S. GDP). China has been a major importer of raw materials, so commodity exporters (Australian, Canada, and Latin America) are going to suffer. So, we’re talking about a broad global economic slowdown (that’s slower global growth, 3% or a bit less – not a contraction).

Speaking to a recession in China, last week Chinese trade data soared, credit stats showed an uptick in lending, and China’s crude oil demand surged to all-time highs while growth tracks China’s 10-year average (chart 2). And in this country, don’t look now, but the NIFB continues to predict higher wages (chart 3). So I will say it again, at this point we do not see a Chinese economic collapse, or a U.S. recession. That does not mean, however, the “selling stampede” is over.

The call for this week: I began last week in Sarasota, then off to Fort Myers, Naples, Fort Lauderdale, West Palm, and Lake Wales doing presentations for our advisors and their clients, as well as seeing institutional accounts. Thursday night’s Lake Wales dinner, at one of my favorite Italian restaurants in the world (L’Incontro), Pat Cain, of Pat Cain Wealth Solutions (http://www.patcain.com/), asked me about being “wrong.” I responded with a quote from legendary investor Peter Bernstein:

After 28 years at this post and 22 years before this in money management, I can sum up whatever wisdom I have accumulated this way: The trick is not to be the hottest stock-picker, the winning forecaster, or the developer of the neatest model; such victories are transient. The trick is to survive. Performing that trick requires a strong stomach for being wrong, because we are all going to be wrong more often than we expect. The future is not ours to know. But it helps to know that being wrong is inevitable and normal, not some terrible tragedy, not some awful failing in reasoning, not even bad luck in most instances. Being wrong comes with the franchise of an activity whose outcome depends on an unknown future (maybe the real trick is persuading clients of that inexorable truth). Look around at the long-term survivors at this business and think of the much larger number of colorful characters who were once in the headlines, but who have since disappeared from the scene.

PS: Both the SPX and INDU did not close below their respective August closing lows, so what we have according to Dow Theory is a downside non-confirmation; and stocks are very oversold. Look for some kind of rally attempt this week. This question remains, “Will it be just a 1.5 – 3 session affair, or something more?” This morning it is looking like “something more” as China’s weak economic data bring on hope of more stimulus and Iran’s pledge to produce 500,000 barrels of crude oil per day didn’t rattle the oil market, leaving the February future contract up 1.6% this morning. Accordingly, the S&P 500 futures are better by 30-points at 5:30 a.m. But the question remains, “Is it just another one of these 1.5 – 3 day affairs or something more?”


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