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Jeff Saut Presents: The Yraunaj Barometer


This year, at least so far, the first three sessions have not been kind as the DJIA has gone backwards.


Editor's Note: The following article was written by Raymond James Chief Investment Strategist, Jeff Saut. It has been reproduced with permission for the benefit of the Minyanville community.

It's that time of year again when the media is all abuzz with that old stock market "saw": "so goes the first week of the new year, so goes the month and so goes the year." Admittedly, the January Barometer has a pretty good track record, for as the "Stock Traders Almanac" notes:

"The January Barometer predicts the year's course with a .750 batting average. Every down January on the S&P since 1950, without exception, preceded a new or extended bear market, or a flat market. The S&P gains during January's first five days preceded full-year gains 85.7% of the time."

Given that historically the equity markets have a bullish tilt 67% of the time, the first five sessions of the new year typically give the January Barometer a bullish start for the month. This year, at least so far, the first three sessions have not been so kind as the DJIA has gone backwards. Clearly, last Wednesday put a dent in the week's bullish bias as the DJIA's 118-point early morning upside sprint gave way to a mere 11-point higher close. Thursday's session wasn't much better, while Friday's 82-point decline left the senior index lower by 65 points for the first three sessions of the new year. And that, ladies and gentlemen, is why our firm titled this report "The Yraunaj Barometer," which of course is January spelled backwards. Yet, there is an indicator we give even more credence than the January Barometer.

Back in the early 1970s I was working on Wall Street and encountered a man who became our friend and one of my mentors. At that time Lucien Hooper, then in his 70s, was considered one of the savviest "players" in this business, as well as the second longest contributing editor to Forbes magazine (29 years). While known for many market axioms and insights, the one that stuck with me the most was Lucien's December low indicator. It seems as if only yesterday we were sitting at Harry's at the Amex having lunch when he explained it. "Jeff," he began, "Forget all the noise you hear about the January Barometer. That being, 'so goes the first week of the new year… so goes the month… and so goes the year.' Institutions can manipulate prices for a short period of time, especially during a holiday-shortened, New Year's week with a limited audience. Consequently, pay much more attention to the December low. If that low is violated during the first quarter of the New Year, watch out!"

Consistent with Lucien's advice, my firm tends to "put blinders on" for the last few sessions of the old year and the first few sessions of the new year because history suggests they can be fickle and whipsawish. They also can be inflection points. Recall, at year-end 1989 the Nikkei Index was nestled near 40,000, but as the new year began the Nikkei started a slide that wouldn't end until the spring of 2003 at 7600. Déjà vuishly, the Brazil markets broke out to new all-time highs on January 3, 2007 and then immediately sold-off sharply. The said sell-off caused the iShares MSCI Brazil Index Fund (EWZ) to break below its December low, as can be seen in the nearby chart. My firm has been bullish on Brazil over the past few years, and remains so on a long-term basis, but in the short-term we are considering selling one-third of our Brazil positions to "book" some profits and rebalance our portfolio.

Yet, Brazil is not the only market that has stumbled in the new year. Indeed, look at the charts of the Greater China Fund (GCH), or the Templeton Russia & East European Fund (TRF), which are down 22.9% and 22.5% from their respective recent highs. The downdrafts caused the TRF Fund to break below its December low, while the GCH Fund has not. Also breaking below its December low has been the Commodity Research Bureau's index (CRB) punctuated by a similar breakdown in crude oil. While many pundits are attributing crude oil's weakness to El Niño (read: weather), if that was the only reason the longer-dated energy futures should not be following the short-term futures' contracts lower. Nevertheless, I have to admit that in the short-run El Niño will go a long way in determining the direction of energy prices.

To that point, if this turns out to be a "giant" El Niño, rather than just a normal El Niño, the weather could continue to stay warmer than normal with concurrent pressure on energy prices that would likely spill over into other commodities. Whatever the outcome, last week's holiday-shortened trading skein saw the CRB lose 5.3%, while the energy heavy Goldman Sachs Commodity Index shed a shocking 7.1%. I have seen such breakdowns before and the sad fact is that while there may be a dead-cat bounce in the short-term, the price damage that has been done will take time to repair.

Nevertheless, while price is reality, some other things caught our attention last week. For example, the economic data continued to send conflicting signals. On the stronger side, the manufacturing ISM Index traveled back above 50, mortgage applications rebounded, nonfarm payrolls rose by a strong 167,000 (+100,000E), and average hourly earnings climbed to a new cycle high (+4.2% year/year) to name just a few of the stats. On the weaker side, holiday retail sales look to be the weakest in years, auto sales at the big three stunk, commodity prices plunged, factory orders were reported at less than expected (+0.9% versus the +1.3% estimate), pending home sales softened (down 0.5%), and Mortgage Lenders Network (a large subprime lender) stopped accepting loan applications and laid off 80% of its staff, citing deteriorating conditions. Yet by far the statement of the week came from homebuilder Lennar's (LEN/$49.66/ Underperform) CEO:

"Market conditions continued to weaken throughout the fourth quarter, and we have not seen tangible evidence of a market recovery."

So much for Alan Greenspan's sense that the worst for housing is behind us, as participants seem to be confusing short-term stabilization with a housing "bottom."

All of this continues to leave my firm with "blinders on," as well as in cautious mode. And, evidently we are not the only ones since the recent CFTC data shows the smallest net long positions in the S&P futures since last April and we all know how that turned out. Does this mean I want to sell stocks short? Not really, because none of my firm's indicators have rolled over yet, but some of them are pretty close. Despite my caution, however, it should be noted that there are still themes that make investment sense. Take Wal-Mart's (WMT) announcement last week that it plans to go solar by installing solar panels on some, and potentially all, of its stores. This could be a major driver for U.S. photovoltaic demand with positive ramifications for SunPower (SPWR). There was also a new bill introduced by five Senators, which, if passed, would massively boost renewable fuel standards with positive implications for ethanol. My Alternative Energy analyst (Pavel Molchanov) penned a report centered on this theme with three attendant stock ideas (VSE, AVR, PEIX). As for a special situation yield idea, Williams Partners L.P. (WPZ) was added to the Focus List recently. My analyst expects this MLP's EBITDA to increase from $59 million to $217 million and its cash distributions (read: dividends) to ramp from $1.73 per share to $2.41.

The call for this week: My firm still has our "blinders on," but is watching the DJIA's December low of 12194.13. This week will kick-off the 4Q '06 earnings' reports beginning with economically sensitive Alcoa (AA) tomorrow. It will be interesting to see if earnings momentum is waning as we believe it is. Consequently, with sticky bond yields, and decelerating earnings momentum, I remain cautious.

No positions in stocks mentioned.
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