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Investment Strategy by Jeffrey Saut

Saving retirement

January 23, 2017

We have often written that when everyone is asking the same question, it is usually the wrong question. However, I have also found the converse to be quite true – if no one is asking a question, it is probably one that you want to at least ask yourself just in case. For this reason, my attention was drawn to a blog post by Peter Lazaroff of Plancorp last week that asked several big name financial commentators like Barry Ritholtz, Ben Carlson, and Josh Brown the following question: What issue in the world of finance isn’t getting enough attention? Naturally, with so much focus on the U.S. political landscape recently, I expected to see responses about such under-the-radar topics as European banks, emerging markets, or the need to raise the debt ceiling once again in March. Yet, to my surprise, most of the answers were about more fundamental personal finance themes such as low savings rates, the amount paid in fees, and the switch to passive investing, all of which likely have a bigger impact on an investor’s long-term returns than just some transitory news headlines.

Retirement savings, in particular, received quite a bit of real estate on the blog, with Isaac Presley of Cordant Wealth Partners pointing out that “the median retirement savings for individuals aged 55-64 is just over $100,000, good for roughly $4,000 in annual spending” (per the Government Accountability Office). That is a frighteningly low number for people who should be nearing or entering their retirement years, especially when modern medicine and a renewed focus on health keeps extending our life expectancy upward. According to the Social Security Administration’s actuarial table, a current 65 year-old female is expected to live another 20 years (to approximately 85), but one thing that is often overlooked about aging is that the older you get, the longer you are expected to live compared to the average life expectancy. For example, while that 65-year-old woman is currently expected to live to 85, a woman who has enjoyed enough good health to live to be 80 is then expected to live another 9.64 years, to the age of almost 90. The point is, there is a very good chance that retirees will require income for longer than they anticipate, and the average person is woefully unprepared.

I mention this fact because I am often asked how the stock market can keep going up now that all these baby boomers are in or entering their retirement years and are presumably switching out of riskier equities to move into bonds and cash. Well, that is definitely happening to some extent, but based on these retirement savings numbers and anecdotal evidence I have gathered from meeting with perhaps hundreds of Raymond James clients over the years, very few people can afford NOT to invest in stocks to help fund their retirements, especially with rates as low as they are currently. And sadly, the situation appears to be even worse for the younger generation that is just now starting to enter the period of their lives where they are expected to heavily invest in the stock market. According to a recent report by Young Invincibles, a D.C.-based think tank, Millennials have earned a net worth of just half of what their Boomer predecessors earned at the same age, making it even more important that they start investing for the long run NOW. Millennials cannot yet make up the difference if every Boomer decides to shun stocks and switch entirely to fixed income, but I do not think that is happening or is going to happen unless interest rates really shoot up over the next few years to provide a strong enough reason to sell stocks. Even with Social Security, $100,000 in savings is just not enough to fund a possible 30+ year retirement for most people, which means the upside potential of stocks should continue to have a place in almost all portfolios.

Of course, we firmly believe that stocks will remain good investments for the next several years, and the earnings data, so far, does seem to be supporting our view that we have entered an earnings-driven stage of the bull market as opposed to one primarily fueled by low interest rates. It is still very early in earnings season, with only about 15% of S&P 500 companies having reported, but the blended bottom-up operating earnings number, which includes actual operating earnings for companies already reported and the estimates for those which haven’t, is on pace to see 9% growth over the fourth quarter of 2015 (per data from S&P). That would be the best annual increase on a quarterly basis since the third quarter of 2014, and the growth has a good chance to improve even more if the pace of earnings beats continues. As we have written, this strengthening earnings landscape should not only help satiate those investors who still just don’t believe that conditions are getting better, but it also has a chance to greatly improve the valuation picture if earnings outpace price appreciation.

Our models and indicators continue to suggest, too, that some weakness may be on the horizon, which may help valuations look a little better sooner rather than later. We have said for weeks now that we were targeting late-January for the next patch of volatility, so we have taken our foot off the pedal a bit just in case. A strong earnings season may help limit the downside, and, again, we are not expecting anything like we got this time last year, but we do appear to be due for some market declines. Based on this great chart from Doug Short (Chart 1), it looks like this is the longest we have gone since the bull market began in 2009 without at least a 5% dip from a previous closing high (the last dip being February 2016). What’s more, the first 30 day period of a new presidential administration has a fairly mixed history, with seven out of the last eleven presidents seeing declines in the month after they took office. Interestingly, the best 30-day period for a new president going back to Eisenhower was actually when President Kennedy was assassinated and Lyndon Johnson took over during one of the darkest periods in American history (the S&P 500 gained 6.03%). If you remove that outlier, though, the average decline in the first 30-days has been -2.66%, with both Barack Obama and George W. Bush greeted with dips between 4-5%. Still, we continue to see higher prices in the intermediate and long run, an opinion echoed again last week by Warren Buffett during a CNBC interview on the eve of President Trump’s inauguration. "It doesn't work all the time perfectly," the billionaire investor and philanthropist said, "but you just look at where we go, milestone after milestone. Never bet against America. [I don’t know where the stock market will go in the next] 10 days or a year or two years, [but] it's going to be higher 10 years, 20 years from now."

The call for this week: It will, of course, be President Trump’s first full week in office and much of the attention will remain on him, his cabinet nominees, and what will be done during the first 100 days of his administration. However, it will also be an extremely busy week for earnings releases, with 70 S&P 500 companies reporting, including 12 of the 30 Dow components. Investors will not only be watching for continued signs of improving sales and earnings, but also will closely analyze just what management teams are saying about their outlook for their businesses under the new administration. Again, it is still early in the season, but so far the big policy topics cited on earnings calls have, not surprisingly, been tax policy and regulation, with 11 and 8 mentions, respectively, per FactSet data (Chart 2). There has also been double the amount of positive guidance issued than negative guidance, which is a favorable departure from the last few quarters where negative guidance dominated, and this trend will hopefully continue. We will also get the first estimate for 4Q GDP on Friday, and though this number will be revised several times in the future, it always draws plenty of attention. So, there is plenty to watch this week and plenty of news flow to finally break the market out of its slumber, but, of course, the market has also stayed plenty stubborn recently. There is still a chance with Dow 20,000 just sitting there right above us that the market rallies just enough to take that out, but we continue to believe stocks may have limited upside without some sort of pullback first. Therefore, remain careful and cautious and don’t forget to save for retirement!


The great rotation

January 17, 2017

By now, you have likely heard something, either directly or indirectly, about “The Great Rotation” from bonds into stocks. Just “googling” the term will pull up a whole host of articles written by practically every major financial news organization in existence, and it seems that every “bond king” and market strategist has weighed in with his or her own respective opinions on the matter. In short, the line of thinking behind the rotation is that, after 30+ years of interest rates in the United States generally falling and bond prices, resultantly, rising, an inflection point has been reached or is approaching where now interest rates will rise over time and bond prices will suffer. Most people, at least, seem to agree on that point to some extent, though what exactly that will mean for bonds and stocks as investments remains widely contested. Some have argued that this dynamic will prompt massive money flows to move from bonds into the stock market (producing the titular “great rotation”), while others contend it will not have as big of an effect on aggregate portfolio allocations as expected.

The financial media has tried quite hard to pitch this as a battle between Bill Gross, the well-known portfolio manager at Janus, and Jeff Gundlach, founder of DoubleLine Capital, who have shared a contentious past and don’t mind taking jabs at each other. However, to me, they seem to be saying the same thing except for a slight difference of opinion on the “key level” in the bond market. Gross has come out and said that 2.6% on the 10-Year U.S. Treasury is the line in the sand for the end of the bond bull market, while Gundlach argues that “second-tier managers” can focus on 2.6%, but 3% is the level to watch to “define the end of the bone bull market from a classic chart perspective.” In other words, both of these very smart bond guys, despite their minor differences, believe we are getting close to hitting that inflection point, with Gundlach going on to say that it is “almost for sure” that the 10-Year is going to take out 3% this year.

Meanwhile, we have already said that it is very likely that last July marked THE bottom for rates, when the 10-Year U.S. Treasury made an undercut low below the 2012 nadir before quickly recovering to shoot up about 125 basis points (almost a 100% move in percentage terms) by the end of 2016. The future trajectory for rates, therefore, does appear to be upward, but the exact path remains an unknown. Just as yields didn’t go straight down over the last three decades, they will not go straight up in the years ahead, as the last few weeks have reminded us with the 10-Year falling about 10%. Also, while the long-term chart of the 10-Year going back to the early 1980s looks to have already broken its downtrend line when using a linear scale (Chart 1), the logarithmic chart (Chart 2) still has some work to do and would need to better 3.5% before the downtrend is broken. 2.6%, 3%, and 3.5% may all act as fairly strong resistance, too, so it would not surprise me to see interest rates remain range-bound for much of 2017 until expectations about economic growth and inflation pick up enough to power rates above this resistance block. 3%, especially, may be tough to overcome in the next few months until we see just what the new administration’s policies are going to be.

So, what does this all mean for the stock market? Well, market strategists are sort of torn on that point, as well. Jeffrey Kleintop, chief global strategist at Charles Schwab, believes the fund flow shift from bonds to stocks that has taken place over the last two months, which has added $3 trillion to global equity values while bond values have dropped by $2 trillion per Bloomberg, “marks an important juncture” and has “years left to run.” Conversely, David Kostin of Goldman Sachs argued last week in a note that, many institutional investors, the ones who really move markets, are restricted from moving money out of bonds and/or owning stocks, so the impact of the “great rotation” may already be approaching its upper limit since allocations to debt securities are already near the lowest levels of the last 30 years.

The truth may lie somewhere in the middle, then. Overall, rates are still likely to be low and accommodative for the next couple of years when compared to their long-term averages, which should help keep interest in stocks high. At the same time, if we are correct and earnings growth picks up in the quarters ahead, that should bode well for stock prices, so we may still see a large amount of money flowing back from bonds into stocks, particularly among retail investors chasing returns, if stock prices go up while bonds are losing value and still yielding relatively low rates. However, David Kostin does make a fair point that we are certainly not going to see most fixed income investors suddenly switch to stocks – institutional investors are generally limited in what they can invest in by the terms of their portfolio agreements, and bonds will still play a large role for retail investors who need the diversification and income benefits that they can provide. So, on a net basis, I’d say that “the great rotation” may help provide a tailwind for stocks, but it might not be as “great” as many believe. At the end of the day, earnings and economic growth are still the primary drivers behind the stock market and, without this growth, interest rates and stocks may both have trouble rising significantly from current levels.

And on a more short-term basis, the S&P 500 seems to be having trouble rising at this very moment, with yet another week behind us where the index basically went nowhere. That’s not an exaggeration, either, as it opened the week trading at 2273 and finished just one point higher at 2274, putting in a total range of only 25 points in the process. Stocks continue to face tough resistance just above current prices, possibly because of that big test line (Chart 3) I have regularly referenced, but there just hasn’t been enough bad news out there to knock prices down. None of the major indices is really breaking down yet, and the NASDAQ has even managed to make new highs in the past few days, but there will likely come a point where the floor gives way if stocks can’t make any more progress on the upside.

As mentioned, our models indicate that late January could be when the market finally runs into trouble, and that could begin as early as this week unless we can break above the overhead selling pressure. It is options expiration week, too, which has historically been difficult in January over the last 18 years, according to Jeff Hirsch, the mind behind the Stock Trader’s Almanac. The S&P 500 has declined in 13 of those 18 years, with an average loss of 1.06%, and this expiration date also happens to come on inauguration day this year, which could up the volatility even more. And that leaves…

The call for this week: Earnings season should be the primary focus with this the first really big week for the 4Q16, though Donald Trump’s cabinet nominees and impending inauguration will continue to get a lot of attention. We will conclude the week with a new president here in the United States, and, as we have mentioned, this could be “buy the rumor, sell the news” type event where traders use the swearing-in as an excuse to take profits. Watch for a possible trading top coinciding with the inauguration, even if that doesn’t exactly make rational sense (when does the market ever make rational sense?). Also, expect even more attention to be paid to corporate earnings releases and conference calls this quarter to see how management teams are planning around the new administration. Investor sentiment seems to have greatly picked up since the election, but it will be interesting to see how companies feel given the uncertainty that exists with all the policy speculation. If managers are mostly in “wait and see” mode when it comes to future investments and strategic action, it could delay the impact Trump’s and Congress’s policies have on corporate earnings. However, we still believe the final earnings numbers will continue to show an improving growth environment, which will hopefully prevent any serious downside for the broad market. So, stay alert, as this has the makings of a pivotal week for the stock market over the short to intermediate term.


Buy C-R-A-P

January 9, 2017

We live in a modern world of acronyms and buzzwords, and the financial industry is certainly no exception. In fact, it may be one of the worst culprits, what with FANG, ZIRP, TINA, BREXIT, QUITALY, BRIC, etc. all entering the lexicon over the last few years. Yet, creating some catchy collection of consonants remains one of the most surefire ways to attract attention in this business since it, admittedly, makes for a great headline and gives strategists like us something fun to write about (“fun” being a relative measure). Well, now the new eye-catching acronym to watch, according to Tom Lee of Fundstrat is C-R-A-P – Computers, Resources, American Banks, and Phone Carriers – which are all levered to the investment recovery, inflation, and deregulation expected over the next year. Before I comment further on those recommendations, though, I want to point out that I like to follow Tom Lee’s thoughts because, like us, he lets the data do most of his thinking, and, like us, he was one of the few pundits last year who actually saw potential for the U.S. stock market. He backed that up, too, with one of the highest S&P 500 targets among strategists for 2016 (2325), but now, according to Bloomberg, he has the lowest price target for 2017 among the fifteen strategists they track (2275), further proof that he doesn’t just parrot consensus numbers.

Reading between the lines of his comments, Lee does not see substantial upside for the stock market as a whole in 2017, at least not without a pullback first, but he does believe potential exists among individual areas of the market. This line of thinking is consistent with our view that passive indexing may be more frustrating in this type of investing environment because you will be dragged down by the underperforming sectors and the increased volatility may make it more difficult to hold onto positions long enough to achieve the eventual performance. We generally agree, too, that the C-R-A-P stocks should do well in the political and economic landscape that many expect is on the horizon. If inflation does pick up, driven by fiscal stimulus and more robust economic growth, Fundstrat argues that the contemporaneous increase in wages will not hit technology company margins as hard given their reliance on more high-skilled workers, and we, too, continue to advise an overweight of Tech to benefit from the Computers sub-sector. The big acronym of 2015 and 2016, the so-called FANG stocks, may already be coming back into favor, as well, with Facebook Inc. (FB/$123.41/Outperform), Amazon.com Inc. (AMZN/$795.99/Outperform), Netflix Inc. (NFLX/$131.07/Outperform), and Alphabet Inc. (GOOG/$806.15/Outperform) all breaking out to new reaction highs last week.

We also continue to like the Energy sector for the Resources play, as our fundamental analyst team in Houston still sees upside for the price of oil over the next couple of years and the companies should be run a bit more efficiently after all the cost-cutting that has been implemented. Their current favorites in the space are Oasis Petroleum Inc. (OAS/$15.58/Strong Buy), Unit Corporation (UNT/$30.25/Strong Buy), Kinder Morgan Inc. (KMI/$21.81/Strong Buy), and Tesoro Logistics L.P. (TLLP/$53.80/Strong Buy).

There are no shortage of American banks to choose from, either, but Bank of the Ozarks Inc. (OZRK/$52.36/Strong Buy) and Signature Bank (SBNY/$150.50/Strong Buy) are the two preferred by our analysts at the moment. I have actually received some questions lately asking if the run in banks is coming to an end, and not just in the short-term but for good. We think that’s ludicrous considering Financials have largely underperformed the broad market going all the way back to the early 2000s and it’s going to require more than a two-month run to begin to correct that divergence (Chart 1). In the near term, yes, many of the banks have likely come too far, too fast, but pullbacks should still be for buying, in our opinion as the yield curve is largely expected to steepen further.

Finally, the Phone Carrier part of C-R-A-P is a little trickier, as Donald Trump has already come out in opposition of at least one of the proposed mergers to further consolidate the industry and put more control in the hands of the major players. However, if we do experience a run of broad deregulation across the general business landscape, the big phone carriers could see some benefits in the form of pricing power (per Forbes), in addition to improving demand as the overall economy gets better. Verizon Communications Inc. (VZ/$53.26/Outperform), AT&T Inc. (T/$41.32/Outperform), and T-Mobile US Inc. (TMUS/$56.77/Outperform) are all rated “buys” by our fundamental analysts.

Fundstrat concluded their C-R-A-P report by throwing in some caveats, including the risk that “sloppy White House organization creates confusion on U.S. policy, particularly as tweets become policy." They estimate the new administration could bring with it at least a 5% dip in the first half of the year, something that should come as little surprise given the great run we have enjoyed and should not be a significant concern. Coming into 2017, the biggest risk, in our opinion, was that no one seemed to be talking about any risks, and I think it’s pretty telling that Tom Lee is the most pessimistic strategist in the Bloomberg survey and even his year-end target is almost exactly where we are now – so not exactly bearish.

However, risks do exist (and these are just the obvious ones):

  • Perfection from Trump and the Republicans is largely priced in over the near term;
  • There is bound to be a disappointment at some point – either not enough stimulus or deregulation vis-à-vis market expectations or it doesn’t come quickly enough;
  • A few reports I have seen indicate that some businesses may be delaying further investments or other strategic actions until the new administration’s policies become clearer; if they are forced to wait indefinitely it could start to hurt the overall economy;
  • The same goes for many investors, who likely held off on selling positions last year with the expectation that lower taxes would be coming. The question now becomes do we see a round of delayed selling as soon as we get a better idea about the tax implications;
  • Considering investors everywhere are refreshing Twitter every few minutes to see what Donald Trump will say next, the market is always one tweet away from being scared off certain companies or industries.

So, it is not unreasonable to think we may start to see some weakness in the coming sessions as inauguration day approaches. As Jeff Saut wrote in our Morning Tack from last Thursday:

Our models continue to telegraph a move higher into late month, although approaching mid-month, we are trimming some of our enthusiasm. That view rests on the fact that we have played the rally pretty aggressively. However, from a tactical standpoint, we are taking a more cautious stance as mid-January approaches consistent with our model’s cautionary call for late January.

I have heard from a lot of smart people that the days around the inauguration could end up representing a short-term trading top, as profits from the election rally are locked in and we start to get a real idea of how President Trump will differ from Candidate or President-elect Trump. And if enough traders start to believe an impending top is coming, they may accelerate their selling. To be clear, we don’t anticipate any major correction to occur and we still believe stocks will largely go up in 2017, but a pullback in the 5-10% range would not be the worst thing in the short term and would likely give you a good chance to buy those stocks previously mentioned.

The call for this week: As SentimenTrader pointed out on Friday:

Despite a new all-time high in the S&P 500, there were more declining securities than advancing ones on the NYSE. The amount of volume flowing into those securities was the 5th-worst ever on a day the S&P hit an all-time high. And the percentage of issues reaching a 52-week high wasn't far behind, also lagging badly. The last time breadth was this bad at an all-time high in the S&P was the bull market peak on March 24, 2000.

Moreover, the equal-weight S&P 500 did not join its more common, cap-weighted cousin by making a new all-time high (Chart 2), and small cap stocks, which led for most of this recent rally, have finally started to slacken. So, market breadth does seem to be slumping a bit, which is often a preamble to weakness in the major averages, and we could start to see traders position themselves for short-term trading top coinciding with the inauguration. Therefore, if you are looking to take profits and reduce equity exposure, this coming week may be a good opportunity to do so. The anticipated weakness in the coming sessions should not significantly impact more long-term investors, and may finally give those who missed out on the election rally a chance to buy in, but it is cause to remain vigilant. The “big test” for the S&P 500 I have mentioned recently remains its place as resistance (Chart 3), and, unless we can rise above that level (roughly 2280-2285), there may be limited upside in the near term.


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