Note:There is no Investment Strategy for XXXX. The most recent Investment Strategy from XXXX is available below.
Listen to the recording with one of the media players below:
Jeff Saut’s Daily Audio Comment is recorded every weekday, except Wednesday, at 9 a.m. ET. It is made available to the public on this Web page at approximately 1 p.m. ET.
For information about downloading a free media player, please see our Free Software page.
“I am a large volume importer of industrial hardware, mostly out of Asia. I just received my April ocean freight rate update. Container cost up 5% from March and up 21% from April 2009. For my products, the YOY increase represents a 3% increase to cost of goods. Cost of steel as we know is going up significantly and these price increases for us – contrary to what the popular spin may be – are effective immediately. Obviously, as we are replacing fast-turning inventory, we are passing on these increases immediately. About a year ago, I reported to you that our business was extremely slow and our inventories very high. Despite price increases going on offshore, I pointed out that in our world, these increases would take time to trickle through due to the high inventory levels that we and our competitors were sitting on. Our position was that if we had it in stock, we would sell at basically any price for cash flow reasons. Any new inventory would be sold based on actual current cost. Needless to say, the purchases we made through the year were very minimal as we (correctly) were not optimistic about business looking forward.”
“Now, business is still terribly slow but inventories have been depleted to the point that shortages are occurring. These shortages are exasperated by the fact that no one is buying any significant volume of replacement inventory. Our statistics would show that our purchases in March (for delivery this summer) are up about 400% from any given month last year BUT are still only about 30% of our peak going back before all hell broke loose. Can you imagine how this data can be spun by focusing on the former and conveniently ignoring the latter? We feel that we have hit bottom and have reasonable expectations to survive this debacle simply because we have downsized to about 20-25% the company we once were. Our domestic competitors and vendors overseas basically report the same. ... (The) bottom line is this: no one is (all that) busy but prices are literally skyrocketing. Smells like stagflation to me. Anyone who tells me that there is no inflation on the horizon is delusional and in for one hell of a shock.”
... a post on Bill Fleckenstein’s website Ask Fleck
Annualized inflation in India is running at about 15% and China is not all that far behind. In the Philippines, March’s inflation figure was just reported at +4.4%, up from the previous month’s 4.2%, with the cost of Philippine fuel/electricity/water up 14.6% over the trailing 12 months. In our country, since January 2009 the price of copper is up ~185%, crude oil is better by ~118%, and rubber is higher by ~167%. Moreover, from August of 2009 until now hog prices have rallied ~75%, while cattle prices have lifted ~19%. Such actions caused the Reuters CRB Commodity Index to travel above its 200-day moving average in June 2009 and stay there ever since (read: bullish and inflationary). Meanwhile, economists continue to insist there is no inflation because wage inflation is non-existent. That, however, may be changing given some of the recent “worker strike” announcements.
To us, inflation is assuredly returning, yet the degree of inflation is unknowable. Why are we so sure inflation will return? It is because for decades that has been the easiest political solution for the debt accumulation of our citizenry and our government. To wit, pay back the debt with “cheaper” dollars. Given the recent geometric rise of debt, we see only three ways out for our government: sovereign default (unimaginable); severe economic contraction (unlikely); or, currency debasement (read: inflation). We choose “door” number three as the most likely course. In past missives we have suggested that a 10% per year inflation rate, for the next five years, would go a long way in solving the nation’s debt problems. As one savvy seer writes:
“In 1979 the government ran a deficit of more than $40 billion – about $118 billion in today’s money. The national debt stood at about $830 billion at year’s end. But because of 13.3% inflation, that $830 billion was worth what only $732 billion would have been worth at the beginning of the year. In effect, the government ran up $40 billion in new debts but inflated away almost $100 billion and ended up with a national debt smaller in real terms than what it started with.”
So yeah, we choose inflation. Recently, however, in addition to inflation, another “way out” has been proffered as the phrase Value Added Tax has emerged. Wikipedia defines VAT as “A Value Added Tax (VAT) avoids the cascade effect of sales tax by taxing only the value added at each stage of production. For this reason, VAT has been gaining favor over traditional sales taxes. In principle, VAT applies to all provisions of goods and services. VAT is assessed and collected on the value of goods or services that have been provided every time there is a transaction (sale/purchase). The seller charges VAT to the buyer and the seller pays this VAT to the government.”
Hey “body politic,” have you not learned ANYTHING about the folly of a VAT tax from the Europeans?! I think it was my beloved France that first introduced the VAT tax over 50 years ago; and, the implementation of that spurious tax spread quickly across the region. It is a politically sly tax because it is embedded into the price of everything you buy. Frighteningly, body politic can raise said tax at their collective will. Accordingly, the government controls the revenue stream, which permits government to do what it does best e-x-p-a-n-d! Hey America, are you listening? Such a tax only aids in lowering an economy’s structural growth rate with a concurrent compression in corporate price earnings multiples. And if you don’t believe me, the only state in this country to ever use a VAT tax has been my home state of Michigan – ‘nuff said!
Speaking of increased government intrusion into the private sector, there was an interesting story in last Friday’s Wall Street Journal titled “The Massachusetts Insurance Blackout.” The gist of the article is that the state’s Governor, for purely political reasons, rejected 90% of the non-profit insurers’ requests for a price increase (think about that – not for profit organizations). As it turns out, those insurers lost $100 million last year, making it impossible for them to pay the anticipated cost of healthcare claims. As stated, “It may even threaten the near-term solvency of some companies. So until the matter is resolved, the insurers have simply stopped selling new policies” – ‘nuff said.
Ladies and gentlemen, our government is running amok. As Dr. Ed Yardeni writes:
“The wall of worry is higher now following the passage of ObamaCare. The coming tax hikes could depress consumer spending and increase the odds of a subpar recovery in employment. The new law is likely to raise healthcare costs and widen the federal deficit, which might explain why the 10-year Treasury bond is as high as 4%. This can’t be good for consumer spending and profits. The Obama administration is likely to be emboldened to push congress to pass more of its liberal agendas, which is bad for business. Yet, I remain bullish until November 2, 2010. That’s when our democratic political system will determine whether the liberal agenda will prevail, or will be reversed by a conservative backlash. Until then, I expect that better-than-expected earnings, along with near-zero money market rates, will continue to push stock prices higher. If the political backlash occurs, then a powerful year-end rally is likely. If the liberal agenda prevails, 2011 could be a very good year for the bears.”
The call for this week: We are on the road this week and consequently these will likely be the only strategy comments for the week. That said, our short-term indicators have wrongly been counseling for caution since mid-March. But as Lowry’s notes, “The probabilities have favored a relatively brief and shallow reaction. Investors can use such periods to upgrade portfolios by reviewing holdings to identify laggard issues to be sold, and use the proceeds to buy stocks with stronger Power Ratings within the strongest Sectors and Industry Groups.” Plainly, we agree and since March we have mentioned more than 20 such stock names from the Raymond James universe of stocks.
“Let me tell you how it will be there's one for you, nineteen for me ‘cause I'm the taxman, yeah, I'm the taxman. Should five per cent appear too small be thankful I don't take it all ‘cause I'm the taxman, yeah I'm the taxman.”
. . . The Beatles
Well, it’s that time of year again when, as the Beatles state, “There's one for you, nineteen for me ‘cause I'm the taxman.” For the record, mandatory tax withholding began in 1943 and as one of the crafters of that event said – I wish we had never allowed the government to automatically withhold the tax from peoples’ paychecks because by doing so folks just don’t realize how much they are actually paying! To be sure, taxes are going up, especially on the alleged “rich.” Now as I understand it, “the rich” is defined as anyone making more than $200,000 per year, or $250,000 for a couple. While that certainly sounds like a lot of money, I challenge you to examine a family of six, four of which are kids in private colleges, combined with a mortgage payment/two car payments/ state and city income taxes/etc., and see how much money is left over at the end of the day. Still, “tax the rich” plays well politically despite the fact the top 1% of wage earners pay roughly 29% of the total taxes, while the top 5% pay a bit more than 47%. Shockingly, that leaves only 53% of the tax load for the remaining 95% of wage earners. As philosopher, economist, and journalist Henry Hazlitt wrote:
“When people who earn more than the average have their ‘surplus,’ or the greater part of it, seized from them in taxes; and when people who earn less than the average have the deficiency, or the greater part of it, turned over to them in hand outs and doles, the production of all must sharply decline. For the energetic, and able, lose their incentive to produce more than the average; and, the slothful and unskilled lose their incentive to improve their condition.”
Ladies and gentlemen, we don’t have a tax shortfall problem; we have a government spending problem. As the Washington Times writes, “For the first time since the Great Depression Americans took more aid from their government than they paid in taxes.” Manifestly, our government is becoming an increasing “spender” in the economy and that should worry you. Indeed, a recent study from the sharp-sighted folks at the GaveKal organization shows what occurred in the United Kingdom when the government became an increased “spend” in that economy. By examining the nearby chart:
“(Where) the top red line represents the ratio between central government expenditures and GDP (on an inverted scale), and the grey line on the bottom panel represents the ratio between the value of the UK stock market and the operating surplus for UK companies as reported by the national accounts (a PE ratio of sorts), something emerges quite clearly. A rise in government spending (the red line declining) leads, over time, to a decline in the structural growth rate of the economy and to lower PEs.”
Click here to enlarge
Whether GaveKal’s UK analogy “ports” to the United States is a reasonable question; but if so, it implies we are in for a lower structural economic growth rate and lower P/E multiples for the major market indices.
More importantly, although I consider myself fortunate to have forgotten most of the economics I leaned at university, the current $12.2 trillion national debt, plus the other commitments and contingencies that bring the total to $13.5 trillion, is alarming. Let me size that for you, if you spent $1 million per day since the founding of Rome (~2700 years ago), as of today you would have accumulated “only” $1 trillion in debt. Now take that $13.5 trillion debt figure, and add the ~$42.9 trillion in unfunded obligations figure (Social Security, Medicare/Medicaid, etc.), and you have a $56.4 trillion “debt hole;” and, that hole is only getting deeper! As Ray DeVoe writes:
“In conclusion, Columnist Thomas Friedman had an article in the New York Times titled ‘Never Heard that before’ that I found rather disturbing. He was attending the World Economic Forum in Davos and had discussions with many of those attending. As he wrote ‘I heard a phrase being bandied about by non-Americans – about the United States – that I can say I have never heard before: political instability’.”
Nevertheless, while the bond market seems to be reflecting some of these concerns (read: higher rates), the equity markets are not sensing the degree of fiscal tightening that is going to be needed as last week the S&P 500 (SPX/1178.10) tacked on another 0.99%. That “weekly win” left the SPX’s three-week skein at +2.4% and us with “egg” on our face once again. Obviously, we have been wrong-footed (on a short-term basis) for the fourth time since our “bottom call” of March 2, 2009, having turned cautious, but not bearish, three weeks ago with the SPX in the 1150 – 1160 zone. That “cautionary counsel” was driven by numerous indicators we have come to trust over the years. Yet, those indicators have been trumped by the near-term upside momentum. Fortunately, while trading accounts are not fully engaged, investment accounts are. That strategy is based on the simple thesis that booming corporate profits are fostering an economic recovery, which is leading to an inventory rebuild and a capital expenditure cycle. In turn, said sequence should promote a hiring cycle, and then, a pickup in consumption. We think, in the intermediate-term, such a sequence should bolster stocks into mid-summer, even though we remain cautious as the second quarter begins.
In any case, despite our near-term caution, the aforementioned “virtuous cycle” should persist until the markets begin to discount the 2010 mid-term elections next November. Through our lens, those elections may well serve as a referendum on the liberals’ versus conservatives’ agendas. If the liberals prevail, it could spell a pretty tough year for stocks in 2011. If, however, there is a conservative backlash (read: no tax increases combined with spending cuts), it could provide the footing for a decent 2010 year-end rally. Meanwhile, our “call” for the return of inflation is playing with crude oil and copper breaking out to 20-months price highs. To put it simply, the U.S. has only three options: sovereign default (unimaginable); severe economic contraction (unlikely); or currency debasement, which has been the preferred political strategy for decades. Inasmuch, we choose door number three and have/are positioning accounts for inflation. Further, our long-standing recommendation of “buying” Japan is finally bearing fruit with many Japanese centric closed-end funds and ETFs tagging fresh reaction highs last week as Japan’s new export orders hit a six-year high. We also think technology stocks should continue to outperform. Most tech companies don’t have significant retiree healthcare obligations, nor do they have a lot of debt on their balance sheets. Verily, tech companies tend to be cash rich because they retain their earnings. Some such names from Raymond James’ research universe, all of which are Strong Buy-rated, include: Radiant Systems (RADS); CA Inc. (CA); Micron Technology (MU); Nuance Communications (NUAN); Harris Corporation (HRS); NVIDIA Corporation (NVDA); and Sybase (SY).
The call for this week: For 13 months we have heard the bears growl that this is just a rally in an ongoing bear market with a double-dip recession surely in the cards. Meanwhile, we have clung to our belief in the aforementioned “virtuous cycle.” Plainly, the data suggests the growth in factory orders, shipments, production, payrolls, and capital spending are likely to stay perky in the months ahead. That is the way profit recoveries work and why the stock market continues to rise. Accordingly, while we have been too cautious for the past three weeks, we have never abandoned our belief the equity markets would trade higher in the intermediate to longer term. Still, there are some “cracks” beginning to appear. For example, last week Warren Buffett’s Berkshire Hathaway issued bonds that commanded a lower yield than those offered by the U.S. government. Also of interest was Social Security’s revelation that it will show a deficit this year rather than in the projected deficit year of 2017. Those topics, however, are for a future billet doux.
“The Berkshires seemed dreamlike on account of that frosting with ten miles behind me and ten thousand more to go.”
... James Taylor, Sweet Baby James, 1970
Obviously when James Taylor wrote the song “Sweet Baby James” he was referring to the snowcapped peaks of the Berkshire Mountains, which is where I spent most of last week making presentations to some of Raymond James’ retail clients before jaunting off to Boston to speak with institutional accounts. Interestingly, the institutional accounts wanted to know what retail accounts were “doing,” while the retail accounts wanted to know what the institutions were doing. Accordingly, at least from my observations, order flow from retail investors suggests that they have under-played the current equity rally and are instead buying bond funds. In fact, ~70% of retail order flow into mutual funds has been into bond funds, and not short-term oriented bond funds, but long-duration bond funds. In their attempt at “desperately seeking savings,” in a perceived conservative manner, I believe retail investors have little idea of the risk they are incurring. Having seen a few market cycles, I can recall what happened to the price of long-term Treasury bonds when interest rates rose throughout the 1970s. While I feel somewhat better about corporate bonds and distressed debt than Treasuries, I am not nearly as aggressive on those vehicles as I was some 18 months ago. Instead, I have actually been counseling accounts to scale back (read: sell partial positions) in such vehicles now that yield spreads have narrowed so dramatically.
There is, however, one Boston-based family of mutual funds that is advising retail clients NOT to buy long-dated bond funds. That is a pretty rare message for any mutual fund family because selling funds is how they make money. Said company is MFS, and its mantra is – if you buy bond funds, they should be short-term bond funds – which we think is pretty sound advice. During our meetings with some of MFS’s portfolio managers (PMs) we espoused the market views so often chronicled in these missives. Yet, part of the fun of such sojourns is hearing what the PMs have to say. For example, our friend Thomas Melendez, captain of the MFS International Diversification Fund (MDIDX/$12.07), which we continue to recommend, gave us an interesting sound bite. He asked, “China has 1.3 billion people, so how many cars are on the road?” The answer is only 26 million! Thomas then concluded that the CEO of the Chinese car manufacturing company he recently met was not counting sheep to put him to sleep, but rather cars; as well as the money he was going to make from them. My takeaway from those comments reinforced the recommendation of the Chinese car and battery company BYD (BYDDF/$9.85), which is followed by our research correspondent, and is 10% owned by Warren Buffett.
Another MFS portfolio manager, namely Jeffrey Morrison, was recently asked to assume oversight of the MFS Sector Rotational Fund (SRFAX/$14.51), another fund we embrace. To be sure, for the market environment we envision going forward, sector rotation should have a place in most investors’ portfolios.
Some of the other comments that caught our ear were quips like:
1) “Don’t tell me to buy Proctor & Gamble (PG/$63.69) because Wall Street is going to expand Proctor’s P/E multiple by one point. Just give me stock ideas that are turnaround situations, with operating leverage, like Atlas Pipeline (APL/$13.75).”
2) “Be cautious on Brazil short-term because the upcoming elections could throw their markets a curve ball. As well, with 9%-yielding Brazilian bank CDs the hurdle-rate for Brazilian equities is high; and, Brazil looks as if it just might just raise interest rates.”
3) “India is a great long-term investment. It has by far the best management teams I have ever seen! But in the near-term, valuations are expensive and inflation is running around 15%, which is why India has recently been raising interest rates.”
4) “I like your insight that non-financial American corporations have over 5% cash on their balance sheets. But, did you know corporations ended last year with 11.4% of their ASSETS in cash? In fact, just to get back to ‘norms’ would require ~$500 billion to be spent?”
5) “I like your agriculture theme and particularly your ‘spin’ on soybeans.”
To this last point, soybeans are a member of the legume family. Legumes, it should be noted, have an affliction called “nitrogen fixation.” That means, unlike corn, you don’t grow more soybeans per acre by throwing fertilizer on them. Manifestly, the only way to grow more soybeans is to plant more acres. Enter China, which has a voracious appetite for soybeans given their protein content. Yet, China’s farming acreage is shrinking due to the scarcity of water. Moreover, it takes a great deal of water to grow soybeans. China, therefore, imports roughly 50% of the world’s production of soybeans, which is one of the reasons we have recommended Archer Daniels Midland’s (ADM/$28.42) convertible preferred shares for the past 18 months. Despite its rally, and the fact that there are no near-term catalysts, the convertible preferred shares continue to possess an attractive dividend yield and are followed by our research affiliate. Coincidentally, Jim Grant, eponymous captain of Grant’s Interest Rate Observer, recently wrote about Benjamin Graham’s seven metrics for investing in a stock. While on December 12, 2008 there were eight such companies meeting Graham’s requirements, today there is but one. That company is Archer Daniels Midland.
Speaking to the stock market, while the intermediate/longer-term outlook remains positive, the shorter-term environment continues to counsel for caution. Granted, we may be “talking” our position, having been too cautious since recommending that strategy on March 15th with the SPX at 1150. However, as Charles Dow stated – The successful investor needs to be able to ignore two out of every three money making opportunities. Or as Warren Buffett puts it, “The market is very efficient at transferring assets from the impatient investor to the patient investor.” Anyhow, we are patient, and our indicators are still well overbought. Also, the MACD indicator is on the verge of flashing a short-term “sell signal,” the number of NYSE new highs has narrowed noticeably, the upward revisions in analysts’ earnings estimates has narrowed while analysts’ Buy ratings relative to Sell ratings is at an eight-year high, and last week saw the S&P 500’s (SPX/1166.59) first 1% downside session in weeks – the longest such skein of the current “bull run.” Further, last week there were two sessions of “negative key reversals” (Thursday and Friday), which by our pencil is a sign of distribution of stocks (read: caution). As our technical analyst Art Huprich observes:
“Within the context of the current intermediate-term uptrend, on a short-term (trading ) basis, and similar to what occurred on September 23, 2009 and October 21, 2009, the S&P 500 recorded a negative key reversal formation (last Thursday and Friday)! The intraday high to intraday low decline for each previous instance was 5.6% and 6.5%, respectively.”
The call for this week: The bond market is at kiss-and-tell levels as the 10-year Treasury yield approaches its reaction high of ~4% (see chart). As repeatedly stated, we think this “higher rates” mindset is what’s behind the U.S. Dollar Index’s strength as it broke out to new reaction highs last week. We also believe both of those events are responsible for the Reuters/CRB Commodity Index’s weakness. Still, we are able to find good risk/reward situations for the investment account, even though we are on the sidelines in the trading account. Last week three more stocks followed by our Canadian research team became of interest: North American Energy Partners (NOA/$8.58/Strong Buy); Northern Dynasty Minerals (NAK/$9.04/Strong Buy); and Fortress Paper (FTPLF/$18.69/Strong Buy). As always, Blue Sky issues should be checked before purchase.
Click here to enlarge
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 report’s conclusions.
Read Full Article »