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What to Expect From US Markets: From Airlines to Other Favorable Stocks

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Jeff Saut says he is treating last Monday's intraday low as a daily and intermediate term low.

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Stephen Moore wrote a Wall Street Journal article entitled, 'Atlas Shrugged': From Fiction to Fact in 52 Years. For those of us familiar with Ayn Rand's classic book (Atlas Shrugged), recent events eerily mirror her writings about the economic carnage caused by big government running amok. As Mr. Moore wrote:
For the uninitiated, the moral of the story is simply this: Politicians invariably respond to crises – that in most cases they themselves created – by spawning new government programs, laws and regulations. These, in turn, generate more havoc and poverty, which inspires the politicians to create more programs . . . and the downward spiral repeats itself until the productive sectors of the economy collapse under the collective weight of taxes and other burdens imposed in the name of fairness, equality and do-goodism.

In the book, these relentless wealth redistributionists and their programs are disparaged as 'the looters and their laws.' Every new act of government futility and stupidity carries with it a benevolent-sounding title. These include the 'Anti-Greed Act' to redistribute income and the 'Equalization of Opportunity Act' to prevent people from starting more than one business (to give other people a chance). My personal favorite, the 'Anti Dog-Eat-Dog Act,' aims to restrict cut-throat competition between firms and thus slow the wave of business bankruptcies.

President Ronald Reagan was the first to suggest that the nine most terrifying words in the English language are, "I'm from the government and I'm here to help." President Reagan also stated, "Government is not the solution to our problem; government is the problem."

Even President Clinton promised smaller government, but that promise ended on November 4, 2008 as voters elected President Barack Obama, ushering in an era of expanded government that Ayn Rand warned of 52 years ago (as a sidebar, we suggest watching this two-minute blurb from Milton Friedman). Yet, last week may have marked a historic shift in the country's ideological direction after Governor Scott Walker's resounding win in Wisconsin's recall vote.

Now I am not a Tea Party person, but since the historic mid-term elections I have argued that the Tea Party surfaced what Adam Smith wrote about in the book The Wealth of Nations. To wit – the political corruption that prevents prosperity – and that is exactly what we've got, the best Congress (the House and Senate) money can buy. Yet, that seems to be changing punctuated by last week's Wisconsin vote. However, the footings of the sea change began two years ago with the mid-term election where the majority of those elected were not professional politicians but rather came from the private sector. Moreover, if you talk to those newbies they will tell you they don't really want to be in Washington, but they think the country is off course and they want to try and reverse that course. I think this is a trend toward more practical leaders that will offer simple and pragmatic solutions to our country's ills rather than recondite laws like the aforementioned "Anti-Greed Act;" and, I think that is bullish for the stock market.

Last week the stock market thought so too as the S&P 500 (SPX) posted its best weekly gain of the year. The weekly win left the SPX higher by 3.73% and back above its 200-day moving average (DMA), which is now at 1288.41. Of course, my email inbox subsequently lit up with the question, "Was last Monday's intraday low of 1266.74 similar to the 'undercut low' you told us to 'buy' on October 4 of last year?" Early last week I really didn't know the answer to that question because after recommending recommitting some of the cash raised in the February - April timeframe over the past few weeks, the breakdown below my key pivot point of 1290 (basis the SPX) caused me to suspend the judicious recommitment of cash until the near-term direction of the market became clearer. To be sure, in this business it's better to lose "face" and save "skin"! By the end of the week the break below 1290 was indeed looking more and more like an "undercut low." Recall, it was Merrill Lynch's veteran strategist Bob Farrell who often spoke of "undercut lows" as being one of the better bottoming formations. For example, when the major averages trade below a previously well advertised stock market "low," causing participants to panic and "sell" and then the markets "turn up" and rally, such sequences often mark tradable "lows." This week should tell us if that is what happened last week.

Studying the market's metrics, since the May 1 rally high (SPX 1415.32) there have been two 90% Downside Days (90% of total points and volume traded was on the downside) culminating with June 1's 90% Downside Day. Those two Downside Days probably exhausted the sellers, at least on a short-term basis. Consequently, what was needed was some upside demand and the stock market took a step in that direction last Wednesday with a Dow Wow of 287 points that turned out to be a 90% Upside Day. The rebound carried the senior index back above my 1290 pivot point and therefore placed it in a position to build on last week's rally. Additionally, there is a full charge of energy in my daily internal energy model. Hence, if the SPX can surmount the overhead resistance around the recent reaction high of 1335, and stay above that level, the market should be able to move higher.

In terms of sectors, financials (+4.71%), materials (+4.38%), and technology (+4.28%) saw the biggest bounces for the week, while consumer staples (+2.56%) rallied the least. The rally left utilities and telecom services the most overbought sectors and energy as the only remaining oversold sector. Outside of the country, Italy and Russia were better by more than 7%; and for those focused on Spain's sovereign debt yields, maybe you should consider the fact that Spain's equity market was up 10.41% last week. China was the worst performer as participants feared economic slowing as telegraphed by China's interest rate cut and the lowering of gasoline prices.

Speaking to lower fuel prices, last week my firm's airline analysts lowered their fuel assumptions for 2013 by 19% and raised their ratings on several companies. Alaska Air (ALK) was upgraded to an Outperform with the comments from our analysts that Alaska Air has a best in class cost structure, balance sheet, and attractive valuation. Allegiant (ALGT) was moved to a Strong Buy given its leverage to lower fuel prices and strong earnings momentum driven by a 16-seat expansion project, Hawaii service, and carry-on bag fee. The change in our fuel price assumptions produces a very large change in earnings because jet fuel and related taxes and fees on average accounts for about 38% of total airline expenses. Moreover, the impact on earnings is obviously far greater for airlines with lower margins. As an example, our analysts boosted their earnings estimates for US Airways (LCC) by 25% this year and 46% next year. Interestingly, US Airways has been showing up on our proprietary screening models for months with positive implications. Other names that have positive implications and are rated favorably by our fundamental analysts include: Allstate (ALL), Davita (DVA), Dollar Tree (DLTR), Brinker (EAT), Family Dollar (FDO), and JB Hunt (JBHT).

The call for this week: Over the weekend the eurozone agreed to lend Spain up to €100 ($126 billion) to shore up its teetering banks. That decision prompted this from my friend David Kotok, captain of Cumberland Advisors:
The fact is the absence of banking collapses is good news. That is correct. Good news! We establish that good news by what we DO NOT see on TV. We do not see banks collapsing and failing to pay depositors. This means we may not witness the euro system collapsing and failing. Bank runs and deposit failures are symptoms of liquidity constraints. Liquidity is not to be confused with solvency. A prime example: Greece is certainly insolvent. It cannot pay its debt or its governmental bills. Nevertheless, Greece's banks still have liquidity because of Emergency Liquidity Assistance (ELA) funding. [Because] ELA exists the euro system agents know that they cannot permit euro system banks to fail to pay their depositors. Therefore, our conclusion is that liquidity issues will be addressed in the eurozone. The Spanish banking chapter is unfolding before our eyes. Markets have been pricing in a fear of systemic failure on the liquidity side. Market bears will be disappointed, because the liquidity failure is not going to happen. The next test is coming on June 17, with French and Greek elections.

Now we know why Spain's equity markets rallied over 10% last week. As for our markets, last week I said that I am treating last Monday's intraday low as a daily and intermediate term low. I still feel that way.
No positions in stocks mentioned.
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