Jeff Saut Presents "Midwest Musings and Inflationary Scares"
Editors Note: The following note is courtesy of Jeff Saut of Raymond James and has been reprinted with permission. Jeff is the Chief Investment Strategist of Raymond James and has been a steadfast supporter of Minyanville.
Last week we journeyed to the Midwest to see some institutional accounts, do some seminars, and teach a college class. One of the great things about traveling is the time it affords to catch-up on some reading and this trip was no exception. As many of you know, we are currently reading the book "Unconventional Success: A Fundamental Approach to Personal Investment" by David F. Swensen. Recall that Mr. Swensen is Yale University's Chief Investment Officer and as such is responsible for managing more than $14 billion in endowment assets and other investment funds. He also authored the book "Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment." Notice that in the titles of both books David Swensen uses the word "Unconventional." This certainly seems appropriate as he begins his most recent book with the following paragraph:
"John Maynard Keynes wrote, 'Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.' The profound wisdom of Keynes's statement reaches into every nook and cranny of the investment world. Slavishly following conventional wisdom proves unwise, as the frequently trod path often leads to disappointment. Taking a well-considered unconventional approach generally proves sensible, as the less-traveled route provides greater opportunities for success."
As stated, "The profound wisdom of Keynes's statement reaches into every nook and cranny of the investment world." That, ladies and gentlemen, is because most investment professionals are afraid to travel the "unconventional" path, fearing performance-risk, bonus-risk, and ultimately job-risk. Yet, following the unconventional path has made David Swensen one of the best money managers of our era. Indeed, as recently noted in Fortune magazine (10/3/05), "Swensen has managed Yale's endowment for two decades and built one of the most spectacular investment records on the planet - up 16.1% a year (while the S&P 500 index gained 12.3%)." Also mentioned in the article is Jack R. Meyer, who has "unconventionally" managed Harvard's $22 billion endowment fund to a 15.5% annual return over the past 15 years (vs. 10.6% for the S&P 500). Both of these gentlemen are plainly unconventional.
For example, as of June 30, 2005 only 15% of Harvard's portfolio, and 14% of Yale's, was invested in domestic equities. That means roughly 85% of these brilliantly managed portfolios are invested in nontraditional investments! The breakdown of the balance of said portfolios is scattered between: foreign equities; private equity; fixed income; real assets; and absolute return (read: hedge funds). Unsurprisingly, years ago onlookers were horrified when these investment pioneers began deemphasizing bonds/cash in favor of such non-traditional investments. Yet, their theories proved correct, for while many of these "outlier" investments would have been risky on their own, taken in concert volatility actually went down and returns went up.
While we are certainly not in the Meyers/Swensen league, we too have been called "unconventional" over the years. Most recently that moniker was applied a little over three years ago when we began tilting portfolios toward "stuff" (timber, fertilizer, oil, gas, coal, base/precious metals, water, etc.). That strategy was driven by the mantra, "Invest in things that China and India need and dis-invest in things that they sell." We continue to think that strategy will be a winner for many years to come. Recently, however, we have recommended rebalancing some of those "stuff stock" positions given the fact that their price appreciation had caused them to become more than a 50% weighting in portfolios. Using oil as an example, beginning in mid/late-August we suggested that energy stock positions be rebalanced (read: sell 20% - 30%). That recommendation was driven by our sense that oil was making a parabolic "pig peak." At the time crude oil was changing hands in the high $60s - low $70s. Currently, December crude is around $61.60/bbl and has broken below it 50-day moving average (DMA), as well as three recent price-reaction lows located between $62 and $63/bbl. Consequently, oil appears to be vulnerable into the mid/upper $50s provided there are no terrorist tactics in the oil fields.
As for the here and now, last Monday/Tuesday we suggested that:
This week (read: last week) was/is pretty darn important. Indeed, investors typically like to begin the final quarter of the year in anticipation of a year-end rally buoyed by the November 1st "best six months of the year" (for investing) seasonality. Yet we approach this upcoming period with trepidation. Verily, with yesterday's super-strong Institute of Supply Management figures, which tanked the bond market, followed by the October 14th Consumer Price Index, retail sales, industrial production (not to mention the huge upcoming T'bond/note auctions), we think the next few weeks could produce the "inflationary scare" we have been warning about. While we think the "inflationary scare" will not gain sustainable traction, the perception that it might could cause the 10-year T'bond yield to rise above its August yield-yelp high of 4.44% with a concurrent stock swoon. Further, we don't like the broadening-top "Diamond Configuration" visible in the D-J Industrial Averages chart. A "Diamond Configuration" is described by StockCharts.com as, "an uncommon but recognizable reversal pattern that begins as a broadening formation and reverts to a symmetrical triangle after several swings to make a four-corner pattern. [It] normally occurs only in very active stocks and shows up more often during tops."
Consequently, as Charles Knott of Knott Capital Management so aptly opines:
"With these concerns, our risk-adverse and conservative nature forces us to maintain a 'predominantly defensive' investment stance. Investors shouldn't have a highly optimistic or hardened pessimistic mindset. Proper sector-selection is the best tactic to achieve above-average investment results. We favor those industry groups where valuations are reasonable, pricing power is formidable and earnings growth seems assured. We continue to sell-on-strength and buy-on-weakness. This defensive tactic is flexible and adjusts to the market's volatility. It also allows gains to accrue as money is taken off the table."
Obviously, we have raised a lot of cash recently, having rebalanced many of our "stuff stock" positions six to eight weeks ago, as well we suggested selling-out of ALL trading positions a few weeks ago. This is in keeping with the strategy of selling-on-strength and begs the question, "When do we buy-on-weakness?" And, to this question participants should take heart because our proprietary indicators are close to becoming as oversold as they were at the March 2005 lows (we were bullish on a trading basis). The other question currently is whether we get a capitulation downside selling-climax, or the much more difficult to identify selling dry-up. The next few weeks should tell the story . . . stayed tuned! In the meanwhile, we continue our scale-buying of 6.7%-yielding Enterprise Products (EPD/$25.13), and 8.8%-yielding Synagro Technologies (SYGR/$4.54), for the investment (read: strategic) side of the portfolio.
The call for this week: Last Wednesday constituted a 90% down-day. A 90% down-day is a session when down-points comprise 90% of up plus down-points (read: price) and at the same time down-volume is 90% of up plus down volume. Such readings are typically associated with either the beginning of a waterfall decline, or the end of a decline. As previously stated, "The next few weeks should tell the story."
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