Shah Wealth ManagementAn Independent Firm

Investment Strategy by Jeffrey Saut

Serenity now?

December 5, 2016

One of the funnier shows in the Seinfeld comedy series was “Serenity Now.” The show centered on that phrase (serenity now) as George’s father, Frank Costanza, repeats the phase numerous times every time he gets upset (see it here: serenity). This morning, however, we are using the phrase in reference to Leon Tuey, who states in a recent Edmonton Journal article (link) when referring to his “winter getaway” in Rancho Mirage: “I do absolutely nothing here. I watch the stock market all day long, just as I do at home in Vancouver.” “I get absolute peace and quiet here. A lot of people say, ‘Aren’t you lonely?’ And I say this is exactly what I seek: solitude, so I can think better.” Indeed, “serenity now.”

In said article, Tuey, a former guru at Canadian-based BMO Nesbitt Burns, said he believes this secular bull market has years left to run. While other pundits garner more headlines, Tuey has a habit of being right much more often than he is wrong. Now in his 80s, he is more content with making money for his clients than grabbing headlines. Extremely interesting to Andrew and I were his comments about this secular bull market. To wit: “As Tuey sees it, the first leg of the bull market began in October 2008 and ended in May of 2015, when stocks hit what were then new highs. The second leg began in February of this year, and he expects it to be the longest and strongest leg of all.”

Coincidentally, it was on October 10, 2008 we noted that 92.6% of all stock traded on the New York Stock Exchange made new annual lows. In our notes dating back into the 1960s that has never happened. It’s like an eight standard deviation event; it is not supposed to happen in your lifetime. At the time, we also stated the bottoming process had begun. It was in October 2008 the vast majority of stock bottomed. However, the financial stocks kept going down into March 2009, which is what carried the S&P 500 lower into its intraday low of ~666 on March 6, but we digress.

Students of stock market history will recall secular bull markets tend to have three legs. If Mr. Tuey is correct, we are barely into the second leg of this bull market, which as previously stated, he thinks is going to be, “The longest and strongest leg of all.” Of course that “foots” with our thinking that there is at least another seven to eight years left in this secular bull market. In fact, Tom Lee, sagacious captain of FundStrat, recently published a chart showing the potential for this “bull” to extend into the 2029-2034 timeframe. That seems a touch long to us, but heck, if that’s what the markets give us, we will certainly take it! I did find Tuey’s closing comments, in Gary Lamphier’s article, intriguing: “The second key point is that for the past 100 years or more, the more severe the economic downturn, the more powerful and enduring is the subsequent bull market. When you’re faced with financial Armageddon as the U.S. was back in 2008, the Fed eases much more aggressively than ever before, and they stay accommodative for much longer than normal.”

To be sure, all of this fits with our thesis the equity markets are transitioning from an interest rate-driven to an earnings-driven secular bull market. To that point, many of y’all know we are on an email “string” with folks like Arthur Cashin, David Kotok, Dennis Gartman, Bob Pisani, etc. It is a freewheeling exchange of thoughts that provides very interesting insights. Last Thursday, the savvy Bob Pisani wrote this:

President-elect Trump's proposed nominee for U.S. Treasury Secretary, Steven Mnuchin, said on our air yesterday that the administration was still targeting a reduction in the corporate tax rate from 35% to 15%. The current 2017 estimate for the entire S&P 500 is roughly $131 per share. Thompson estimates that every 1 percentage point reduction in the corporate tax rate could "hypothetically" add $1.31 to 2017 earnings. So do the math: if there is a full 20 percentage point reduction in the tax rate (from 35% to 15%), that's $1.31 x 20 = $26.20. That implies an increase in earnings of close to 20%, or $157. What does that mean for stock prices? The S&P is currently trading at a multiple (PE ratio) of 17, high by historical standards. Applying that 17 multiple to earnings of $157, we get a price on the S&P 500 of roughly 2,669 for 2017. That is 469 points or roughly 20% above where it is today.

Our sense is the new administration will not be able to get the corporate tax rate down to 15%, but even at a 25% rate, it implies an additional $13.10 to the S&P 500’s bottom up operating earnings number ($1.31 x 10 = $13.10). Using Bob’s same math produces an earnings estimate of $144.10, and at 17 times earnings, it renders a price objective of roughly 2450 for the S&P 500.

The equity markets have rallied hard on the belief in a pro-growth administration, reduced regulation, lower taxes, increased infrastructure spending, a reset on trade toward the benefit of American companies, and the reflation trade. If this optimistic scenario comes to fruition, the Penn-Wharton Budget Model targets between a 1.1% and 1.7% increase in GDP growth beginning in 2018. If true, GDP growth could ramp to ~3%+, suggesting stocks are not all that expensive. Verily, we have never wavered on the belief that we remain in a secular bull market. Such bull markets typically last for 14-15 years and tend to compound at around 16% per year. If past is prelude, we should have another seven-plus years in this “bull run.” Will there be pullbacks? Of course there will be, but pullbacks should be viewed within the construct of a secular bull market.

The call for this week: Recently, the S&P 500 experienced a “buying climax.” A “buying climax” is the near-term exhaustion of demand for stocks. The final surge of a “buying climax” tends to lead to an upward price spike followed by waning demand allowing prices to pause and/or pullback. We think that is precisely what happened last week. The pause has permitted the stock market’s internal energy to rebuild, suggesting the S&P 500 (SPX/2191.95) is getting close to grinding higher into our envisioned February short-term “timing point.” Indeed, the picture is clearly bullish when you look at chart patterns of the various indices. The SPX has broken out to the upside after a nearly two-year consolidation (Chart 1). Ditto on the D-J Industrials (Chart 2), and the Russell 2000 has been on a tear (Chart 3). Even the NASDAQ has broken out and, given its recent softness, has merely pulled back to its breakout point (Chart 4). And don’t look now, but the energy sector has broken out to the upside (Chart 5). Meanwhile, the economic news is getting better, and it’s not just here (link; auto-playing video). That makes S&P’s earnings estimate for 2017 of ~$131 doable; and if Bob Pisani’s comments are anywhere near the mark, stocks are not all that expensive. Manifestly, following the “profits trough” in 2Q16, earnings rebounded in 3Q16, a trend we expect to continue for the foreseeable future. Obviously, international investors, as well as U.S. investors, are beginning to sense this too. A little over a month ago, we wrote about the recommendation in a government-commissioned report for Norway’s Global Government Pension Fund (~$880 billion) to increase its exposure to equities from 60% to 70%. While they have not done that yet, it is a view many endowment and pension funds are slowly embracing. Quite frankly, it is the only way they can achieve their targeted returns. Over the weekend, another such gleaning occurred when the Finnish Pension Fund (~$38 billion) made the decision to no longer underweight U.S. equities. As for Italy’s “no” vote, as we told accounts in NYC last week, it is hard to believe it is not already “baked” into the various markets. That seems to be the case this morning with the S&P futures up some nine points.


Not afraid

November 28, 2016

Around the turn of the century a bandit rode in from Mexico, robbed a small Texas bank, and fled back across the border. A Texas Ranger picked up his trail and nabbed him in a Mexican village. The bandit spoke no English and the ranger no Spanish, so another villager was asked to interpret.

“Ask him his name,” said the ranger.

“He says his name is Jose,” said the interpreter.

“Ask him if he admits robbing the bank.”

“Yes, he admits it.”

“Ask him where he hid the money.”

“He won’t tell me.”

Leveling his pistol at Jose’s head the ranger said, “Now ask him again where he hid the money.”

Jose quickly blurted out in Spanish, “The money is hidden in the well in the village square.”

“What did he say?” demanded the ranger.

The interpreter replied, “Jose says he is not afraid to die!”

The translation and interpretation of the news can play a crucial role on Wall Street. This is especially true when it comes to public perception; and the media plays a dominant role when it comes to shaping the public’s perception. And their modus operandi is clear. For instance, everyone has heard of the classic, “Is the glass half full or half empty?” Well, when it comes to media translation and interpretation it’s almost always half empty. Bad news sells newspapers, gets more TV and radio time . . . good news doesn’t. I mean think about it, only a few weeks ago the media said that a Trump presidency would be devastating for the stock market and the economy. Now, because stocks have rallied, pundits see a boom. As the erudite King Report notes, “Wall Street is not rational; it is rationalizing.”

Keeping the translation and interpretation theme in mind, come with us now in the Mr. Peabody “WayBack” machine (WayBack). The time was May of 2015 and the S&P 500 (SPX/2213.35) had peaked around 2135. Subsequently, the index “back and filled” between that level and roughly 1800, on increasingly wrong-footed negative media news, until July of 2016 when it broke out to the upside and tagged ~2194. We counseled that upside breakout was significant and advised increased equity exposure. Silly us, because the SPX declined back to its 2080 – 2100 support zone shortly thereafter. Undeterred, we continued to recommend the accumulation of equities, believing another new upside “leg” for this secular bull was in the offing. So let’s examine what has happened.

In the final analysis what has happened is that the D-J Industrial Average broke out to the upside in the charts from a 14-month consolidation in July of 2016. In the process it registered a Dow Theory “buy signal.” Dow Theory is the interrelationship between the D-J Industrial and the D-J Transportation Average. We are one of the last practitioners of Dow Theory after the passing of our friend Richard Russell (Dow Theory Letters) last year. Dow Theory is not always right, and it is subject to interpretation, but it is right a lot more than it is wrong. There was a Dow Theory “sell signal” on September 23, 1999, a “buy signal” in June of 2003, another “sell signal” on November 21, 2007, followed by numerous “buy signals” since the March 2009 lows. Dow Theory says that the primary trend of the equity market is “up” despite all the alleged uncertainty. Of course with most of the indices trading out to new all-time highs, it belies the old stock market “saw,” “The markets don’t like uncertainty.” In point of fact, “uncertainty” is the friend of the well prepared investor!

As for the short-term, there was this from an astute, Canada-based portfolio manager, namely Craig White:

I came across the following chart in my morning readings. I believe you had talked about a Bollinger Band (BB) squeeze in recent months, noting that we were at a multi-year compressed reading. I do admit I am no expert on BB’s, but a ‘squeeze’ is a consolidation period of price, after which the price then breaks out in a particular direction if my past readings are correct. Looking at the chart (see chart 1 on page 3) highlighting the BB width, we can see that only 3 times since 1982 had we reached these recent ‘squeeze’ levels. The subsequent performance for equity markets was indeed favourable. I think it is no different this time.

Also waxing bullishly was Renaissance Macro’s Jeff deGraaf in last Wednesday’s MarketWatch article, as quoted by William Watts. To wit:

“The S&P 500 was up 3.4% in November through November 21. [deGraaf] found that when the S&P 500 is up 3.3% or more for the month through November 21, returns from that point through the end of the year average 200 basis points. When returns are less than 3.3%, the average is closer to 70 basis points.”

The call for this week: Interestingly, two of the longest secular bull markets chronicled in our notes began following Republican “revolutions.” The 1953 to 1973 bull market sprung from Eisenhower’s election (1952) and the subsequent infrastructure spending. The 1982 to 2000 secular bull market commenced with Ronald Reagan’s election (1980) and was initially driven by his administration’s tax cut and de-regulation policies. Yet Reagan’s secular bull market had a slow start, which is eerily being tracked currently. When Reagan was elected the D-J Industrials rallied from ~925 to 1017 (+9.9%). Then in early December the Dow pulled back to 900 from where the fabled Santa Rally began. That rally took the Industrials back above 1000 by year’s end only to see stocks decline into February where on February 5, 1981 President Reagan stated, “We have inherited the worst economic mess since the Great Depression.” Of course with that kind of statement stocks bottomed, carrying the Dow back to 1024, which is when Fed Chairman Paul Volcker jammed the prime interest rate to 21½%. From there stocks stumbled, registering a Dow Theory “sell signal” that would leave the Dow at 776.92 in August of 1982, which happened to be the “valuation low,” and the 1982 to 2000 secular bull market began. This is not an unimportant point, for the Dow made its “nominal” price low of 577.60 on December 6, 1974 (the lowest it would go in terms of price), but its “valuation low” (the cheapest it would get) came eight years later (8/12/82). So fast forward, the Dow’s “nominal” price low came on March 6, 2009, but the “valuation” low didn’t occur until October 3, 2011. Now consider this, NOBODY measures the 1982 – 2000 secular bull market from its “nominal” price low (1974), but rather from its “valuation” low of August 12, 1982. If that’s the case currently, this bull market is not as old as everyone thinks. Indeed, this secular bull may not even have gray hair! Look for a short-term trading peak in this overbought market that sets the stage for the fabled Santa Claus rally.


Don’t Lose Your Position

November 21, 2016

In honor of the Thanksgiving holiday this week, I thought I’d reshare the fabled Wall Street tale about a character named “old Turkey” from the 1923 classic Reminiscences of a Stock Operator. The book is one you should definitely read if you have not read it before, and reread if you have, for it is filled with all sorts of trading and investing wisdom. None perhaps is so famous, though, as the story of old Turkey, who, when asked why he wasn’t going to sell his stock in a company and buy it back later at a lower price, responded as follows:

“My dear boy,” said old Turkey, in great distress “my dear boy, if I sold that stock now I’d lose my position; and then where would I be?” Elmer Harwood threw up his hands, shook his head and walked over to me to get sympathy: “Can you beat it?” he asked me in a stage whisper. “I ask you!” I didn’t say anything. So he went on: “I give him a tip on Climax Motors. He buys five hundred shares. He’s got seven points’ profit and I advise him to get out and buy ’em back on the reaction that’s overdue even now. And what does he say when I tell him? He says that if he sells he’ll lose his job. What do you know about that?” “I beg your pardon, Mr. Harwood; I didn’t say I’d lose my job,” cut in old Turkey. “I said I’d lose my position. And when you are as old as I am and you’ve been through as many booms and panics as I have, you’ll know that to lose your position is something nobody can afford; not even John D. Rockefeller.”

And yes, pulling this story out the week of Thanksgiving may be a tad bit eye-rolling, but I was actually reminded of it last week when a few people asked me if they should be doing some selling right now while the market seems to clearly be in “risk-on” mode and many stocks have jumped very quickly. My reply echoed some of old Turkey’s wisdom by reminding them that this is a bull market and no one knows how high it could eventually go. You want to make sure you ride your gains for all you can get out of them, and, unless, a stock is breaking down below a critical level, selling it may end up costing you in the long run. There’s no guarantee that you’re going to get a significant correction to buy back in on either, and there is certainly the chance you don’t time it correctly even if you do. And if this does end up being one of those buying-stampede-type runs, you definitely don’t want to lose your position.

This rally still doesn’t really show signs that it wants to end, but holiday weeks such as this one can be a little unpredictable with the generally lower volume. Going back to 1945,the week of Thanksgiving has largely been better than average, with a 0.62% average gain and almost 75% of weeks finishing positive, but during this current bull market, the week has actually been a bit tough, with a 0.37% average loss. It’s not all bad news, though, since the negative Thanksgiving returns have usually set the market up for a strong finish to the year, with a 3.68% average return over the last month of trading going back to 2009 (Source: Bespoke Investment Group). And we’ll just have to see if some turkey and dressing can slow down the Russell 2000, which has now been up 11 consecutive sessions and continues to play the role of market leader. The small cap rally prompted Sentimentrader to do a study and this actually marks the best performance during a 10-day winning streak in the Russell 2000’s history (13.2% as of Thursday’s close). What’s more, the near-term performance following other 10-day streaks in the past has actually been quite good. One month later, the average return was 3.5% (median 3.7%) and 13 out of 16 periods ended higher, so that, too, bodes well heading into year end.

The third quarter earnings season has come to a close, as well, and 62% of companies ended up reporting earnings above analyst consensus estimates, which is right in line with the historical long-term average (source: FactSet). More interestingly to me, though, was that the cyclical sector earnings beat rates were, in fact, led by technology (74%) and the financials (69%), which means the profitability of the financials was already trending up and doing well even before the election result. This strengthening earnings performance also helps confirm why we saw the KBW Bank Index start to break out over the summer, and, of course, the banks could have more ground to gain in the next couple of years with higher interest rates and a possible rollback of some regulations.

So, overall, U.S. stocks don’t seem too concerned about much at the moment, but could a stronger U.S. dollar start to put pressure on future profitability and prices? You may have missed it last week, but the U.S. Dollar Index actually broke out above the two previous highs from early and late 2015 to reach its highest point since 2003! This recent spike likely concerns anyone who remembers the role the strong dollar played in 2014 and 2015 when oil prices collapsed and corporate profitability took a hit, but it is less likely we’re going to see a repeat of that type of impact this go-around. For one thing, the 10-Year U.S. Treasury rate has already risen 70% since July but the U.S. dollar has only jumped about 7% and oil prices have remained relatively stable during that time. By comparison, the recent move in the dollar is a far cry from 2014-2015 when it surged almost 30% as the market started to anticipate higher interest rates. In fact, we have only now returned back up to where rates were back then, and most investors seem to be okay with the current outlook for the Federal Reserve over the next several months. All in all, the strengthening dollar is something to monitor, but at this point it does not appear to be a game changer at current levels.

As mentioned, too, the fact that oil prices have remained relatively stable despite the recent strength in the dollar should be viewed as a favorable sign for the future price of the commodity. This resiliency is further evidence that we are in a completely different environment than in 2014-2015 when the combination of a surging dollar and tremendous oversupply led to oil prices collapsing, and, accordingly, our Raymond James energy team still expects crude to hit $60-70 in the next few months. A pause in the dollar, therefore, may be all that is required for oil to take yet another shot at getting and staying above the $50 mark.

The outlook for gold, however, is a little more questionable, as it has not held up as well recently and the price remains under pressure. Remember, people buy gold for many different reasons – protection, an inflation hedge, speculation – but it’s tough to make a strong case for it right now. As we have seen over the past couple of weeks, the market seems to be feeling better about overall conditions, which means investors are less likely to seek protection, and while there does finally appear to be a path toward higher inflation with the coming administration, it’s going to take some time for the expected stimulus measures to trickle down into the U.S. economy. We are also unlikely to go from worrying about world-wide deflation to world-wide inflation so quickly, and the Fed is obviously monitoring the situation closely and may be ready to raise rates at the first sign of a pickup in aggregate price levels. It is likely no surprise then that legendary billionaire investor, Stanley Druckenmiller, said last week that he has sold his large gold position and is now betting on a strong economic recovery (Source: CNBC.com) So, when it comes to gold, despite the fact that the $1200 level may result in some technical support, the metal still has some work to do to prove that it has hit a bottom and there appear to be better investment options in the near term.

And that leaves the call for this week: Further consolidation in the stock market is certainly possible with most equity indices still a bit extended and volumes likely to dry up with the Thanksgiving holiday here in the U.S. It remains unlikely we’re going to experience a meaningful dip, though, unless the market completely changes its opinion on the near-to intermediate-term outlook, so it is probably best to remain constructive. As old Turkey reminded us, you don’t want to lose your position in a bull market, and while it can be hard to just sit there and stare at your paper profits, it is the sitting that makes the big bucks over time. Therefore, remain patient, and if you do have some large profits to consider taking, remember to give some thanks to Mr. Market this week and he may just reward you with more.


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