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Jeff Saut: Computers Can't Help Us Now, Plus Three Stocks to Watch in Today's Trading


In the next day or two, we'll see whether the predominant trend in the market has changed.


Well, it's "next week," and we'll have to see if last Thursday marked a change in the market's trend. In addition to taking the market's pulse, I'll be watching these "three-peat" stocks -- beat earnings estimates, beat revenue estimates, and raised guidance -- from Raymond James' research universe. Those names are Inteliquent (IQNT/$14.29/Outperform), Parkway Properties (PKY/$19.09/Outperform), and Skyworks Solutions (SWKS/$40.75/Strong Buy), all of which screen positively on my proprietary system. Also worth noting is that that same proprietary indicator remains "greened up" on the SPX -- and green is good.

This morning the preopening futures are lower. One reason is that Vladimir Putin has moved Bastion antiship missiles into Crimea. Those missiles have a 300-mile range and can destroy an aircraft carrier. Also this morning, the US is charging China with cyberspying on American firms. I think today/tomorrow are critical for the near-term direction of the equity markets.

Market Context

When we first put the computer on the air, we asked it what it wanted to buy and we couldn't wait to see what it reached for. It said, "Treasury bills and cash." We couldn't get it to buy anything. So we checked out the program again, and while we were checking out the program, the markets went down. Then we asked it again. The computer insisted on staying in cash. The market went down some more. We begged it to buy something. "There must be ONE stock somewhere that's a buy," we said. You see, even computer people are victims of these old atavistic instincts from the precomputer days. The computer just folded its arms. It wouldn't buy anything. Then, just when we were worried that it would never buy anything, right at the bottom it stepped in and started buying. The market started going up, and the computer kept on buying. Pretty soon the computer was fully invested and the market was still going up.

"What did it do then?" I asked. "The market was still going up," Irwin said, "and then one day it came AND ASKED US FOR MARGIN. It wanted to keep buying. So we gave it margin. After the market went up some more, it sold out of a bit, but came back to being fully invested; right now it has still got buying power." "Irwin," I said, "tell the truth now. If all these computers go on air, as you say, does an individual investor have a chance?" "There's always luck," Irwin said. "Luck -- which is to say a serial run of random numbers -- can happen any time. And the computer is out for really aggressive performance. An individual, with a longer time horizon, might be able to so do passably."
-- Adam Smith, The Money Game (1968)

My friend Jerry Goodman died recently. His nom de plume was Adam Smith, obviously taken from the legendary economist Adam Smith (1723-1790). In addition to the book The Money Game, Jerry wrote numerous other books. In his later years, he worked at another friend's establishment -- that friend was Craig Drill, eponymous captain of the insightful Drill Capital Management. Surprisingly, another Wall Street icon hangs his hat at that same place, namely Al Wojnilower, dubbed "Dr. Gloom" in an era gone by, along with his sidekick "Dr. Doom" (Henry Kaufman).

I revisit the "Computer Tutor" theme this morning not only because I'm still receiving voluminous questions about Michael Lewis' book Flash Boys, but because of last Thursday's computer-induced Dow Dive (-167). In previous missives, I've addressed Lewis' claim that the "game is rigged." Speaking to the "rigged" question, when I traded on the floor of the American Stock Exchange in the early 1970s, the specialists "rigged the game" by standing in the middle of the $20 bid and $20.75 offer spread and pocketed the $0.75 spread. High-frequency trading (HFC) has narrowed that spread to $20 bid, $20.03 offered. That's a huge advantage for the retail investor. Moreover, HFTs don't front-run your 300-share orders. They front-run institutional orders for, say, 1 million shares of IBM. Further, if you use a "limit order," there's no way any HFTs can take advantage of you. All of these HFTs beg the question: "Do computers really have intelligence?"

Ladies and gentlemen, the computer has no possibility of foreseeing things that may occur -- especially out-of-the-blue events (black swans) that catch humans by surprise. Certainly you can feed a computer historical data and set up a series of "what ifs" for potential happenings based on past experiences. But how do such past data-points help us foresee the Ukraine Upset? How do you program for rumors that move markets? How does the recent massive M&A trend effect select companies' valuations? The computer can't predict the when, the where, or the how of such events, or what the consequences are that follow. If the human mind can't foresee things that defy conceptual imagination, how can we program that into a computer?

Forecasting forward-looking markets with imagination outside of the "group think" is dangerous. Few have the nerve, or the creative ability, to put forward a forecast without the endorsement of the establishment. But financial history shows the art of making forecasts, in the midst of uncertainty at pivotal moments, is the one that relies on contrary imagination -- not human intelligence, not the one that's past data dictated by a computer. The abrupt break from the past, the norm, the establishment endorsement, shatters the secure sense of investment values.

For instance, the memory programmed into humans after the trauma of the Crash of 1929, and the subsequent 1930s Depression, pushed investors into bonds and away from the shockingly shrinking stock market that ruined millions of investors. That financially humbling experience made everyone appreciate the consistent rate of return on bonds, which, as opposed to the volatility and risks of stocks, was pretty apparent. Hence, from the Great Crash (1929) through World War II, bonds were regarded as the superior asset class.

At the time, anyone who thought differently was instantly vulnerable to public humiliation, like I was in September 1999 for my Dow Theory "sell signal" missive. Yet from 1945 onward, the correct asset allocation was the gradual shift from bonds to stocks. Equities were transitioning into a huge secular bull market and by 1954 had surpassed the 1929 peak price. Meanwhile, bonds had entered a stealth "bear market" as inflation quietly replaced deflation post-WW II, sending the long Treasuries from their once miniscule yield of 2% to over 15% by the early 1980s.

Entering 1998, the superior returns/rewards from holding stocks had become the gospel and worshipped by millions of buy-and-hold investors.  However, very quietly, deflation had returned to the financial world, from out-of-the-blue, via Southeast Asia. Inflation-fighters were being criticized as having fought yesterday's war, while that beggar-thy-neighbor, pushing-on-a-string deflation menace of the 1930s was actually threatening. You can be sure the computer nerds were NOT feeding the "what if" deflation scenarios into their machines. What if the once unthinkable (deflation) is now predictable? Ah, that begs the question: Are not the same nerds, and so called savvy seers who did not foresee the 2008 collapse, again missing what is going to happen here?

Now short-term forecasts, as I learned again last Thursday (I thought the market would rally), are dangerous. Still, on a macro basis, few have the stomach to act on a hypothesis without the endorsement by the majority! But isn't throwing money and debasing currencies a powerful case for reflating? I think it is. Meanwhile, who hasn't sought haven in US bonds? Who hasn't seen the 1929 comparison chart or heard about Flash Boys? For that matter, who doesn't think our government is dysfunctional, that GDP growth is abysmal, or that unemployment is too high?! What is the alternative? What forecast would be regarded as the most foolhardy? What asset allocation would seem unthinkable? I think it is to own dividend-paying stocks on the belief we're in a secular "bull market" that has years left to run. One way that I'm personally playing that theme is via the Goldman Sachs Rising Dividend Fund (GSRLX/$20.23), run by yet another friend, Troy Shaver, but I digress. Even though "Fear, Hope and Greed" manifestly make up one part of the psychological cycle of the markets, I think we're currently at "Relief," with "Optimism, Excitement, Thrill, and Euphoria" yet to come.

Last week, that feeling of "Relief" was shaken by Thursday's Tumble of 167 Dow points. Said decline caused the DJ Industrials (INDU/16491.31) to test their 50-day moving average at 16402.88, where support was found leading to Friday's feeble rally attempt. As I said on Friday, "Today is a throwaway session since markets rarely bottom on a Friday, giving participants over the weekend to brood about losses and then show up early in the week in sell-mode."

And indeed, Friday proved to be a throwaway day. For the week, the Dow surrendered 0.55%, while the S&P 500 (SPX/1877.86) was virtually flat. It's worth mentioning that the SPX made a new all-time high last week, as did the SPX's Advance/Decline Line (A/D). Meanwhile, the S&P Small Cap A/D Line tagged a new reaction low, as the divergence between the large-cap indices and the smaller-cap indices continues.

As for earnings, 56.7% of all reporting companies are beating their lowered earnings estimates, and 56% are bettering their respective revenue expectations. Further, forward earnings guidance is still positive. Interestingly, the NFIB Small Business Optimism Index is at its highest level since October 2007. Speaking to last week's softening economic numbers, the biggest "miss" was the Industrial Production report, but most of that shortfall was attributable to the falloff of 5.3% in the Utility sector due to the (get this) improved weather. This week, we get another plethora of economic data that I think will be mixed, but that should have a marginally stronger tilt.
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