Jeff Sauts Presents: "Try, Try Again"
Wall Street always measures itself in U.S. dollars, so what you see is what you get. And, what we "get" is a Dow near its all-time high in dollar terms.
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.
"In April 2002 – AIG, Pfizer (PFE) and Verizon (VZ) replaced AT&T (T), Kodak (EK) and International Paper (IP). But those have been the only changes. The amazing story is that 21 of the Dow stocks (71%) are 20% off their all-time highs and 17 Dow stocks (57%) are at least 30% below their all-time highs. There are two ways of looking at this unusual picture. (1)The majority of Dow stocks are well off their highs, which means that theoretically they have plenty of room to shorten their distance from their highs. If they do 'pull back' towards their highs, the Dow could climb into the 13,000, 15,000 or higher area. The other side of the coin (2) is that the Dow stocks may be simply bouncing back from oversold lows – and when the bear market reasserts itself, these stocks could 'fall out of bed' as the bear forces return. From another standpoint, the above list illustrates the great advantage to long-term investors in buying stocks that pay dividends."
. . . Richard Russell, Dow Theory Letters
I contemplated Richard Russell's words last Friday while sitting on the plane in Phoenix waiting for the rest of the passengers to board. Suddenly, I got the sensation the plane was moving forward, which I knew was impossible because we were still at the gate. Then I realized it was the plane next to us that was backing out. A similar illusion can be applied to the DJIA as it flirts with all-time highs. Indeed, are stocks moving up, or is the "measuring stick" (aka, the dollar) moving down? To wit, since the U.S. dollar's peak in February 2002 the DJIA has gained roughly 16% measured in dollar terms. However, if you change the measuring-stick from dollars to the Dollar Index (a basket of currencies), you get a completely different picture.
Indeed, since February 2002 the greenback has lost 30% of its value versus the Dollar Index, implying that a Dow index investment made at that time is still down some 14% in Dollar Index terms. That means the DJIA would need to be well above Richard Russell's 15000 level just to be "even" with its previous peak (11722) measured in U.S. dollars. Moreover, if you change the "measuring stick" to ounces of gold, the Dow fares even worse, having lost 65% of its value since the ratio's peak in August of 1998.
Wall Street, however, always measures itself in U.S. dollars, so what you see is what you get. And, what we "get" is a Dow near its all-time high in dollar terms. Still, my firm finds it amazing that 71% of the Dow's components remain 20% or more below their respective all-time highs, while the senior index flirts with its all-time high. For the past seven or eight weeks, however, we have suggested the Dow was going to break out to new all-time highs totally unconfirmed by the D-J Transportation Average, as well as numerous other averages. We have also suggested that the forecast Dow Wow was going to be driven by the "shared belief" that the economy was not headed into a recession, but rather a mid-cycle slowdown. To a large degree we think that shared belief is being driven by the stunning "crash" in the price of gasoline since August 3rd. While gasoline was probably set for a seasonal-decline following the summer driving season anyway, we learned something last week that clearly accentuated the decline.
As we understand it, back in late July Goldman Sachs decided it was going to reduce the weighting of gasoline in its widely followed commodity index (GSCI). Participants wanting to dissect the entrails of that decision may refer to The Financial Times story dated August 29, 2006 titled "Market Insight: Index shifts follows oil decline." Suffice it to say, Goldman took the gasoline weighting in its commodity index from 7.3% to 2.5%, for pretty mysterious reasons, in a gasoline-centric economy (IMO). Goldman even went so far as to scale-in those reductions at intervals between August and November. Accordingly, the billions of institutional dollars that "mimic" (read: invest) the GSCI have had to periodically SELL those gasoline futures contracts to stay in-sync with the index's new weightings. Unsurprisingly, unleaded gasoline prices peaked on August 3rd at $2.35/gallon, basis the NYMEX November future's contract, and crashed into last week's lows of $1.46/gallon for an eight-week price decline of 38%, causing one old Wall Street wag to scream, "SPURIOUS!"
The real-world impact of Goldman's decision has been to offset the current consternations in the real estate markets with a concurrent decline in gasoline prices combined with an attendant rise in equity prices. Nevertheless, we remain surprised that said liquidity-event was unable to lift the senior index (DJIA) to a new all-time high last week. Maybe that will occur this week, but last week's failure leaves us cautious in all of our accounts.
Consequently, we continue to favor the strategy of betting on increased volatility in the trading account using the Volatility Index (VIX/11.98), as well as the buying of those yield-oriented special situations that hopefully have already been through their respective "bear markets." Names for your consideration remain 9%-yielding Trinidad Drilling Trust (TDGNF/$13.10), rated Strong Buy by our Canadian energy analysts, and Chesapeake Energy's 4.8%-yielding convertible preferred. We also favor those long/short funds so often mentioned in these reports, as well as our risk-adverse friends' at the Quaker Funds (Charlie Knott), who has managed the Quaker Opportunities Fund (QUKTX/$11.25) to a 7% 12-month total return.
Additionally, we reiterate our recommendation on Strong Buy-rated Intermec (IN) since we believe the RFID (radio frequency I.D.) business will grow from a $100 million dollar a year business in 2005 to a $5 billion dollar a year business in 2009, irrespective of what happens to the economy. As our analyst noted last week:
"Last night on Jim Cramer's 'Mad Money' on CNBC, a caller during the 'Lightning Round' asked Jim what his opinion was on Intermec. Jim's response was something along the lines of, 'When Motorola (MOT) bought Symbol (SBL), it was a wake-up call for the whole group. If Motorola's willing to pay up for worst of breed, then I give one thumb up to Intermec, buuuuyyyy.' The endorsement by Jim is worth noting because Cramer's recommendations sometimes move stocks. Although we believe Intermec deserves 'two thumbs up,' Jim's enthusiasm surrounding Intermec is warranted. Recently, Metrologic (MTLG) received a takeover bid, and the more recent bid for Symbol by Motorola served to confirm that M&A activity is within the AIDC industry heating up. Following the takeover of both MTLG and SBL, Zebra (ZBRA) and Intermec (in that order) remain the most attractive takeover candidates within the AIDC space.
As a reference point, SBL was taken out at 25.4x our 2007 EPS estimate of $0.59 (group trading at 21.7x), and a MEV/EBITDA multiple of ~11.7x our 2007 estimate. Valuation on the Metrologic transaction was softer, reflecting a P/E multiple of 17.5x our 2007 EPS estimate of $1.06 including options expense. The lowball bid on Metrologic can be attributed to the fact that the investors who owned 49% of the company's shares will also hold ownership stake in the private company (and are thus indifferent on taking a lower bid now and higher ownership later, vs. vice versa). Consequently, we would not extrapolate the valuation on the MTLG transaction to predict future takeover premiums for the rest of the group. The Symbol transaction, however, appears to be a fair price and could, for the time being, be used as a starting point when trying to analyze potential transactions."
The call for this week: We had thought the DJIA would break-out to a new all-time high last week, but Friday's flop prevented that. So if at first you don't succeed . . .
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