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“... Look for hysteria to see if you shouldn’t go the opposite way, but don’t go the opposite way until you have fully examined it. Also, remember that the world is always changing. Be aware of change. Buy change. So many people say, ‘I could never buy that kind of stock.’ ‘I could never buy utilities.’ ‘I could never play commodities.’ You should be flexible and alert to investing in anything. ... Sometimes the chart for a market will show an incredible spike either up or down. You will see hysteria in the charts. When I see hysteria, I usually like to take a look to see if I shouldn’t be going the other way. ... Just about every time you go against panic, you will be right if you can stick it out.
. . . How do you pick the time to go against the hysteria? I wait until the market starts moving in gaps. ... Never, ever, follow conventional wisdom in the market. You have to learn to go counter to the markets. You have to learn to think for yourself; to be able to see that the emperor has no clothes. Most people can’t do it. Most people want to follow a trend. ‘The trend is your friend.’ Maybe that is valid for a few minutes in Chicago, but for the most part, following what everyone else is doing is rarely a way to get rich. You may make money that way for a while, but keeping it is very hard. ... Good investing is really just common sense. But it is astonishing how few people have common sense; how many people can look at the exact same scenario, the exact same facts and not see what is going to happen. Ninety percent of them will focus on the same thing, but the good investor – or trader, to use your term – will see something else. The ability to get away from conventional wisdom is not very common.”
... Excerpts of interview with Jim Rogers, from “Market Wizards”
September 1, 2010 to February 18, 2011 was a pretty good “year” with the D-J Industrial Average (DJIA) gaining roughly 23.7%. Indeed, the “buying stampede” that occurred over those months is now legend with today being session 132 without anything more than a one- to three-day pause/correction (recall it takes four consecutive down days to break the back of a buying stampede). Previously, the record stood at 52 sessions, and while the current stampede is not officially over, as stated three weeks ago – my hunch is it has ended. I participated in most of last year’s rally, but turned cautious (not bearish) on just about everything coming into this year. In retrospect that was a good “call” on most developing markets, and not so good a “call” on developed markets, as professional money scrambled into a panic to keep up with the Jones, the Dow Jones that is. Yet as Jim Rogers states, “Just about every time you go against panic, you will be right if you can stick it out.” Accordingly, I stuck to my discipline of selling partial investment positions, allowing some long-term capital gains to accrue to portfolios, and increasing my cash positions in order to take advantage of investment ideas that have recently surfaced, like WMB.
To be sure, unlike many investors, I consider cash to actually be an asset class. To put this loathsome asset, i.e., cash, into perspective, Seth Klarman, an outstanding value investor, dissected the faulty rationale that “cash is trash” during an interview in Grant’s Interest Rate Observer. To wit:
“They compare the current yield on cash (lousy) to the current yield on longer-term bonds or (the) dividend yield from a stock. Cash nearly always loses in this comparison, and investors feel quantitatively justified in doing what career and client pressures cause them to do anyway. It makes no difference how overvalued these alternatives may be in an absolute sense.”
Further, I would note Seth’s point that investments be made “not because cash is bad, but because the investment is good.” I think some people lose sight of this fact.
Now, coming up to Seth’s key point, which is ignored by nearly everyone:
“One of the biggest challenges in investing is that the opportunity set available today is not the complete opportunity set that should be considered. Indeed, for almost any time horizon, the opportunity set of tomorrow, which could be greater, narrower, or similar in scope but different in specifics from today’s, is a legitimate competitor for today’s investment dollars. It’s hard, perhaps almost impossible, to accurately predict the volume and attractiveness of the future opportunities; but it would be foolish to ignore them as if they will not exist."
All of this brings us to the current state of affairs as expressed in this email from one of Raymond James’ financial advisors:
“Jeff, in light of what could be a historic meltdown going on in the Middle East, the latest being Saudi police firing on protesters if reports are true, how about addressing your thoughts on that in Monday's commentary.”
To which I replied, “N-o-b-o-d-y can predict how events will play out in the Middle East, but I will try to comment on a few current market-related items.” I think the recent stock market weakness is a routine consolidation in an uptrend, albeit within the confines of the wide-swinging trading range of the past 10 years often referenced in these missives. That belief is reinforced by the fact that despite many ongoing tensions the Ted-Spread (3-month LIBOR vs. 3-month T’bills) has not widened and the yield curve remains very steep. This suggests no double-dip recession is on the horizon. Further, the monetary backdrop is favorable, earnings are strong, capital expenditures are increasing, chain-store sales have surged, ditto auto sales, and it looks to me like many of the stock indices in the developing markets have bottomed. Case in point, China’s Shanghai Composite Index. If correct, as the world’s second largest economy, the recent strength in China’s stock market is a monstrously positive thing since it would tend to indicate China’s economy remains vibrant.
Worth considering is that the anti-government demonstrations in the Middle East have heightened fears of similar events in China. To squelch such sentiments the Chinese government is likely going to provide increased subsidies to farmers and the urban poor. In turn, this should increase China’s domestic demand for “stuff” (read: commodities), as well as pull the world’s economies forward. Moreover, I have argued for some time that while China’s interest rate ratchets are being “spun” as an attempt to cool its real estate market, they also serve to bolster China’s internal domestic demand, increase the value of its currency, and consequently placate U.S. politicians’ calls for a stronger renminbi. Manifestly, China realizes that in the long run it needs to move from an export driven economy to one of rising domestic consumption, a fact that becomes readily apparent when reading China’s most recent “Five Year Plan.” To take advantage of this insight, I will be increasing exposure to China over the coming months. Those investments will center on companies benefitting from a boost in domestic consumption, yet I will be avoiding China’s property market because I do think it to be in a bubble.
The call for this week: Since September 1, 2010 the DJIA has not experienced anything more than a one- to three-day pullback/correction. Last Friday I received numerous calls asking if that would be the case here given Friday’s rally (+9.17 SPX). While markets can certainly do anything, I find it too convenient to have the S&P 500 (SPX/1304.28) stop its recent decline at the intra-day reaction low of 1294.26 recorded on February 24, 2011. To me, Friday’s rally looked like merely a retracement rally back up to the point of breakdown, following Thursday’s 90% Downside Day, rather than the start of a new uptrend. Still, I am not looking for a big decline and have actually begun to commit some of the cash raised over the last few months back into select equities. To reiterate, my favorite risk-adjusted ideas are: The Williams Companies (WMB/$29.98/Outperform); Campus Crest Communities (CCG/$11.30/Strong Buy); IBERIABANK Corporation (IBKC/$55.92/Strong Buy); LINN Energy (LINE/$38.13/Strong Buy); and the closed-end fund Royce Value Trust (RVT/$14.75). Speaking of closed-end funds, our Japanese closed-end fund investments got whacked last Friday on the tsunami tragedy. HowJapan plays from here, provided there is no nuclear meltdown, can be argued two ways. Arguing “the glass is half empty,” one can fret about the additional debt that will be needed to rebuild. Arguing “the glass is half full” suggests there will be a tremendous pick-up in economic activity. While I tend to embrace “the glass is half full” viewpoint, similar to my stance on the U.S. equity markets, investors should never let a profit turn into a loss. Accordingly, I will be watching our Japanese investments closely with that “loss point” in mind. Also worth considering, Japan has now lost 10% of its electric power, further increasing world-wide demand for oil, natural gas, and coal – clearly a drag on the world’s economy.
“Everyone kept saying ‘a top is not in place yet.’ They persistently pointed to the ‘normally reached’ levels of this or that statistic that were not yet there to reinforce their desire to remain bullish. Apart from statistical measures of increasing blindness, this unwillingness to acknowledge what they themselves were already feeling revealed a comfortableness, a confidence, a conviction that whatever was happening – short-term survivable dips – would continue until ‘the top,’ like a strip tease artiste of our youth would with decorum appear on stage, bow, and then, accompanied by applause from all the bulls eager to cash in on their excitement, would begin to twirl its statistical tassels in front of everyone.
I’ve gotten so old I can’t remember the names of those ladies at the Old Howard, but I can remember that all you got was a flash of this or that, before they waltzed off. Stock market tops are like that. You know it’s there somewhere if you squint hard enough, but you never quite see it, so you keep waiting for more. And then, in the end, as the curtain comes down on the bull market you realize that the one rule about tops is not that they provide this or that signal, but that they come before anyone is ready.”
... Justin Mamis, Insights, 1987
He said, “We are getting a lot of calls about why Jeff Saut has been so bearish the last few weeks.” I said, “I am not bearish, I am cautious and have done what prudent portfolio management calls for, I have sold partial positions, raised some cash and allowed long-term capital gains to accrue to portfolios.” He said, “That is being interpreted as bearish.” I said, “Not my problem.” In this case the “he” is Harry Katica, director of Raymond James’ Retail Liaison Desk, which fields questions from our financial advisors.
As for the aforementioned quote, long-time stock market observers will remember Justin Mamis as one of the most respected authors, philosophers, market pundits, and investment advisors of all time. His “Mamis Letter” frequently appeared in Barron’s and The Wall Street Journal, as well as many other publications. I was reminded of Justin’s quote while perusing various stock chart recently because I saw more “rounding top” chart formations on individual companies’ stocks than I have encountered in some time. In fact, the past few months remind me a lot of the “topping” environment that took place between December 1968 and the first quarter of 1969. Back then, while the major indices moved higher driven by a few favored stocks, there were similar “rounding top” formations on the majority of stocks. Verily, in early 1969 Wall Street was focused on but a few stocks that had captured participants’ fantasies. Back then it was any technology stock with a futuristic name: Xerox; Telex; Itek; University Computing; Control Data, etc. Meanwhile, as these fantasy stocks swirled higher, the broad base of stocks were traveling lower (read: being distributed; aka, being sold by smart money).
Fast forward to the last few months, Wall Street’s attention has again been captured by names like Apple, Netflix, Baidu, First Solar, etc., which were streaking higher while many other stocks were being distributed beneath the headline excitement of the darlings du jour. Indeed, since the first of the year I have felt like I was in the trading “twilight zone” as the major indices danced higher despite the numerous cautionary signals often mentioned in these missives. Yet the “dance” continued, that is until the past few weeks. Clearly, the last two weeks have felt like a change in the market’s tone punctuated by February 22nd’s 90% Downside Day (90% of total points lost and volume occurred on the downside) with a near 90% Downside Day last Tuesday (-168 DJIA). It was the second official 90% Downside Day of the year accompanied by the two nearly Downside Days of 3/1/11 and 1/28/11. Counter-balancing Tuesday’s near Downside Day was last Thursday’s nearly 90% Upside day, but alas that was erased by Friday’s Fade of 88 points (DJIA). Accordingly, I continue to think we are at/near a “tipping point,” As highlighted by the always insightful GaveKal organization:
“Now if the US$ bounces from here, it is likely that oil will follow food prices into their recent consolidation, allowing for equities to once again bounce back. However, if the US$ melts down, or if oil shoots up on further Middle-East unrest, then it is hard to see how equities will maintain the past few months' uptrend. So it does seem that we are at an important tipping point not just for the US$, but for most asset prices as well, which should not come as such a surprise since most assets in the world are priced off of the US$. (That) reality brings us back to a point Charles has been very vocal about over the past couple of months: we are rapidly reaching the stage in the cycle where the Fed needs to start tackling the weakness of the US$, and the surge in commodities, or risk undermining the very (economic) recovery it managed to jump-start. With that in mind, we would not be surprised if, in the coming days and weeks, various Fed directors come out to sound somewhat more hawkish in a bid to prevent commodities from further undermining the current recovery. ... Anyway, with so many unanswered questions, it is not surprising that equity markets are taking a breather.”
From GaveKal’s lips to God’s ears because late last week Fed Governor Thomas Hoenig suggested just that when he opined that short-term interest rates should be higher.
To be sure, the stock market’s changed tone over the past few weeks has been palpable, raising the question – does the recent sell-off, from S&P 500 (SPX/1321.15) 1344 to 1294, represent the sum total of the long anticipated correction? To answer said question we turn to the excellent Lowry’s service:
“Perhaps a better question to ask is, did market conditions prior to the recent rebound suggest adequate preparation for a renewed and sustainable rally? An examination of Lowry’s measures of the forces of Supply and Demand suggests the answer to both questions is likely no. . . . Strong rallies that experience weak and short-lived corrections are typically characterized by expanding Demand and contracting Supply. However, that has not been the recent pattern. . . . The market deals, however, in probabilities, not certainties. Thus, while conditions over the last few weeks were such that the probabilities suggested a correction longer than 3 days, investors should still be alert for signs a new, sustained rally has begun. The key element for any renewed rally is likely a pattern of strong, sustained Demand. Probably the clearest indication of this strong buying would be provided by two or more 90% Up Days, or a combination of a 90% Up Day and back to back 80% Up Days. The near-90% Up Day on Feb. 25 proved a 1-day wonder, so evidence of more sustained buying will likely be needed to indicate the start of a new rally.”
Indeed, cautious, but not bearish. That said, I can still find decent risk-adjusted investments that should be scale-bought, especially on weakness. In previous reports I have discussed names like Williams Company (WMB/$30.84/Outperform), as well as the closed-end fund Royce Value Trust (RVT/$15.19), both of which are special situations. This morning I offer another, namely Campus Crest Communities (CCG/$11.79/Strong Buy), which “missed” its quarterly earnings estimate last week with an attendant 18% decline in its share price, bringing the dividend yield to 5.4%. I like the strategy of buying fundamentally sound companies when one-off accidents happen because I think it takes much of the price risk out of the investment equation. For further details please reference our fundamental analysts’ recent research note on CCG.
The call for this week: This week I am celebrating the two-year anniversary of the stock market’s bottom by attending our institutional conference where more than 300 companies will be presenting to nearly 600 portfolio managers. It’s a great conference, as well as an appropriate time to reflect on the past 24 months. Recall, the bottoming process began on October 10, 2008 when 93% of the stocks traded on the NYSE recorded new annual low prices. It was then I declared, “The bottoming process has begun.” However, some five months later, on March 2, 2009, I stated, “The stock market bottoming process is complete and we are – all in!” Since then I have not really “backed up” on that call, although I have turned cautious at times. My best cautionary call was in late March 2009. My worst has been coming into this year for while my short-term caution on the emerging markets proved correct (long-term I remain very bullish), my caution on the U.S. markets has been wrong-footed, at least up until the last few weeks.
P.S. These will be the only strategy comments for the week.
Notes: Prices are as of the most recent close on the indicated exchange and may not be in US$. See Disclosure section for rating definitions. Stocks that do not trade on a U.S. national exchange may not be approved for sale in all U.S. states. NC=not covered.
“You might think that institutions, with their large staffs of highly paid and experienced investment professionals, would be a force of stability and reason in the financial markets. They are not. Stocks heavily owned and constantly monitored by institutions have often been among the most inappropriately valued.
Ben Graham told a story 40 years ago that illustrates why investment professionals behave as they do. An oil prospector, moving to his heavenly reward, was met by St. Peter with bad news. ‘You’re qualified for residence,’ said St. Peter, ‘but, as you can see, the compound reserved for oil men is packed. There’s no way to squeeze you in.’ After thinking a moment, the prospector asked if he might say just four words to the present occupants. That seemed harmless to St. Peter, so the prospector cupped his hands and yelled, ‘Oil discovered in hell.’ Immediately the gate to the compound opened and all the oil men marched out to head for the nether regions. Impressed, St. Peter invited the prospector to move in and make himself comfortable. The prospector paused. ‘No,’ he said, ‘I think I’ll go along with the rest of the boys. There might be some truth to that rumor after all’.”
... Berkshire Hathaway annual report – 1984
“Oil that is, black gold, Texas tea,” as the song about poor, but wise, Jed Clampett (Buddy Ebsen) goes, who got rich in the hit series The Beverly Hillbillies by discovering oil on his property. Similarly, investors have become enriched recently by owning oil stocks. Verily, crude oil has surged from ~$84 per barrel in mid-February into last week’s parabolic peak of $103.41 with an attendant ascent for most oil stocks. Obviously, the driver for Texas Tea’s triumph has been the recent unrest in the Middle East. As stated in Friday’s verbal strategy comments, “Libya is particularly troubling because I think there is a fifty-fifty chance that Gaddafi, rather than cede power, will begin blowing up Libyan oil pipelines to send a message to protestors – it’s either me or chaos.” No wonder oil soared pondering what would happen if 1.6 million barrels a day were suspended from world supplies, not to mention what happens if Algeria is next (Algeria produces 1.25 million barrels per day). To that point, while it is unknowable how high oil prices will travel if the unrest spreads, it is worth noting that oil prices tagged what many technical analysts term a major upside price objective last week. Indeed, a Fibonacci 61.8% retracement of oil’s price decline from $147.27 (July 2008) to $33.20 (January 2009) yields a price target of $103.69. Accordingly, while last week’s intra-day price high of $103.41 was not exact, it was close enough to qualify as “price objective achieved.” While I am not a big believer in “Ouija Board” analysis, in a past life I have studied Fibonacci, Gann, Elliott Wave, etc. and found them somewhat useful at tipping points.
Speaking of “tipping points,” the prescient folks at GaveKal recently scribed the following, as paraphrased by me:
“In recent years, investors have become used to an environment whereby a weak US$ usually meant an easy monetary policy from the Fed, which in turn meant greater risk taking and growth in emerging markets, rising commodity prices and higher equity prices. ... But in the past week or so, this usual balance between the US$ and risk assets seems to have broken down, most likely because the rise in commodity prices is no longer a sign of global growth but instead a source of growing concerns. ... Whether the US$100/bbl price tag now attached to oil represents some kind of psychological barrier or a real economic hurdle, the positive dynamic of the past few months has now rolled over and we clearly seem to be at an important tipping point for a number of prices. ... Now if the US$ bounces from here, it is likely that oil will follow food prices into their recent consolidation, allowing for equities to once again bounce back. However, if the US$ melts down, or if oil shoots up on further Middle East unrest, then it is hard to see how equities will maintain the past few months' uptrend. So it does seem that we are at an important tipping point not just for the US$, but for most asset prices as well, which should not come as such a surprise since most assets in the world are priced off of the US$. (That) reality brings us back to a point Charles has been very vocal about over the past couple of months: we are rapidly reaching the stage in the cycle where the Fed needs to start tackling the weakness of the US$, and the surge in commodities, or risk undermining the very (economic) recovery it managed to jump-start. With that in mind, we would not be surprised if, in the coming days and weeks, various Fed directors come out to sound somewhat more hawkish in a bid to prevent commodities from further undermining the current recovery. ... Anyway, with so many unanswered questions, it is not surprising that equity markets are taking a breather.”
And take a “breather” indeed with the S&P 500 (SPX/1319.88) surrendering 3.7% from the previous Friday’s intra-day high (1344.07) into last Thursday’s intra-day low (1294.26) before firming on Friday emboldened by news Saudi Arabia would step up production to plug any crude oil shortfall. Now call me cynical, but I doubt the Saudis have the capacity to accomplish their pledge and therefore am also skeptical of Friday’s rally. Inasmuch, I think what we have seen is just the opening salvo in a correction that will likely be in the 5% to 10% range before ending. Reinforcing that sense, the recent stock “high” was accompanied by the most bullish stock sentiment since the DJIA’s peak in October 2007 (69% “Bulls” according to Market Vane); as well, the Volatility Index (VIX/19.22) recorded its lowest reading since the summer of 2007 (read: too much complacency). Ladies and gentlemen, it is rare to see those kind of extreme readings worked off in a mere three sessions. So yeah, I believe the correction has more to run, yet I continue to think it is a mistake to become too bearish.
Consistent with that strategy, I am going to begin committing some of the cash raised over the past eight weeks back into stocks, preferably during bouts of weakness. Moreover, one of the good things about a market decline is that it gives you a chance to see which stocks hold up better than others. Since the beginning of the year I have suggested 19 stocks and closed-end funds from Raymond James’ coverage universe for your “watch list.” Of those, these are the ones that have held up the best: Altera Corp. (ALTR); CA Inc. (CA); Celestica Inc. (CLS); Skyworks Solutions (SWKS); Stanley Furniture Company (STLY); Stanley Black & Decker (SWK); Tempur Pedic International (TPX); The Williams Companies (WMB); and closed-end fund Royce Value Trust (RVT).
The call for this week: Last Tuesday was a 90% Downside Day whereby 90% of the total points, and total volume, was on the downside. It was the second 90% Downside Day of the year; and, we almost had a third as January 28th came within 0.05% of qualifying. History shows that such Downside Days are quickly followed by a rally attempt before the short-term correction resumes. Thus it should not be assumed Friday’s Fling ended the correction. In fact, under the surface Friday’s action didn’t look all that strong. This does not mean you should “dump” stocks here. The time to raise cash was over the past eight weeks, not now. That said, by my pencil the intermediate trend of the stock market is “up,” and therefore it is an opportune time to consider purchase of select stocks on your “watch list,” preferably during pullbacks. As the keen-sighted folks at Bespoke observe (as paraphrased by me): 1) the big stocks in the S&P 500 have held up better than the smaller names; 2) stocks with the best valuations have held up better than ones with high P/E multiples; 3) stocks with high dividends have outperformed; 4) stocks with high short interest have done worse than low shorted stocks; 5) stocks with low institutional ownership have outperformed; and 6) stocks with high international revenues have underperformed domestic names.
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