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Jeff Saut Presents: An Eerie Stillness


...still can't shake the "eerie" feeling that something's unnatural about the stock market's action.


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.

Back in the 1970s there was a TV series on every Sunday featuring Peter Benchley, the novelist who wrote the bestseller Jaws. We remember one Sunday show in particular. Benchley and the underwater photographer were diving on Australia's Great Barrier Reef, where they were assured sharks were always present. They saw and televised moray eels, manta rays, and every underwater creature conceivable...but no sharks. Day-after-day they continued diving, and it was more of the same. On the fifth day down, the underwater life seemed especially plentiful with a vast variety of specimens virtually everywhere...but, once again, no sharks. All of a sudden, an eerie stillness fell upon the scene. All marine life seemed to disappear. Then, out of the silence there it came, 20 feet of sheer terror...the Great White.

A current "eerie stillness" on Wall Street? Well, not really since the DJIA is resting some 1200 points above its mid-July lows. However, we still can't shake the "eerie" feeling that something's unnatural about the stock market's action. Yeah, I know that when anyone gets "wrong footed" in the markets there is the tendency to make excuses and my firm has clearly been too cautious since those lows even though, on a trailing 12-month basis, we continue to outperform. It's also worth noting that we're not conspiracy theorists, believing that Lee Harvey Oswald acted alone and that George W. Bush really did win the election. Yet, there remains an eerie "bid" in the equity markets since those July lows. For example, markets typically rally, then correct by about one-quarter to one-third of that rally's point gain, before beginning another rally phase. After that phase, they again correct by one-quarter to one-third before re-rallying. This, however, has not been the case recently. Indeed, every time it looked like the indices were about to correct, mysterious buyers materialized in the futures markets. Those "buyers" tend to widen the futures premiums so far above the cash markets that it attracts arbitrageurs. The arbs, in turn, short the futures and buy the appropriate baskets of stocks. That operation allows the arbs to "lock in" the spread between the futures price and what they paid for the basket of stocks, assuring them a risk-less profit and, in the process, driving stocks higher.

Evidentially, we are not the only ones that have noticed this "eerie situation" for savvy seer Dr. Robert McHugh ( recently wrote, as paraphrased by me:

The rally since July has been almost entirely short-covering. We get one big move, about once a week, on buying panic, then no follow-up. . . . Get this: all of the progress of this three-month summer/autumn rally, all of it, occurred in only nine days of trading, and all but one of the nine was a short-covering rally. . . . Other than those nine trading days out of 63 since July 14th, the other 54 days of trading produced only 4% of the upside progress, and zero since July 19th. ZERO . . .!

While my firm can't tell if those nine sessions were all "short covering," we did take the time to check Dr. McHugh's keen insights and found them to be right on point as can be seen in the chart below. Amazingly, those nine sessions [7-19 (+212); 7-24 (+182); 7-28 (+119); 8-15 (+132); 8-16 (+97); 9-12 (+101); 9-26 (+93); 10-4 (+123); 10-12 (96)] accounted for 1155 of the Dow's 1200-point gain from the July lows. Even more amazing is that on ALL of those nine trading days, according to our notes, showed that the aforementioned "mysterious" futures buyers were at work with the attendant arbs' action. When we combine this "mysterious" equity action with the "mysterious" re-balancing of Goldman Sach's (GS) much institutionally indexed commodity index (GSCI), from a 7.3% gasoline weighting to 2.5% into the November elections, we find ourselves "mysteriously cautious."

Those views were reflected in my firm's appearance as Brian Sullivan's co-host last Thursday on Bloomberg TV, as we suggested SELLING those stocks/sectors that have been working on the upside and BUYING those stocks/sectors that have not been working. That strategy is driven by the belief that with the institutions' October 31st fiscal year-end, they will be window dressing on the upside with the "working" sectors and "undressing" with the under-performing sectors. That should, at a minimum, provide a dearth of buyers for the darlings du jour and a cessation of selling in the underperformers.

Accordingly, my firm agrees with our fundamental analyst's "carpet bombing" downgrade of the casual dining sector, as well as the notion of selling the retailers, and the buying of the energy space. Names for your consideration can be found from our Houston/Canadian-based energy analysts. We also embrace the reaccumulation of the "stuff stocks," preferably names with a yield, between now and calendar year-end (oil, natural gas, coal, timber, base/precious-metals, cement, agricultural stocks, etc.). Moreover, we like the PUHCA themes (Public Utility Holding Company Act) as reprised in last week's New York Times article titled "A Power-Grid Report Suggests Some Dark Days Ahead," dated October 16, 2006. And just so we don't have to keep repeating it, the homeland security stock we spoke of on Bloomberg was L-1 Identity Solutions (ID), which is a global leader in biometric applications, including secure credentials and identification outsourcing.

In conclusion, for the past few months my firm has suggested that the equity markets were likely to rally on/off into the October 19th option expiration, or the institutions' fiscal October 31st year end, and potently into the November elections. While we don't trust it, nor understand it, in this business what you see is what you get! Yet, with 85% of the shares on the S&P 500 above their respective 50-day moving averages, we think the equity markets are WELL overbought. Still, the "ball" feels like it will go on into the ascribed timeframe, reminiscent of another Adam Smith quote from the book The Money Game:

"We are at a wonderful ball where the champagne sparkles in every glass, and soft laughter falls upon the summer air. We know at some moment the black horsemen will come shattering through the terrace doors, wreaking vengeance and scattering the survivors. Those who leave early are saved, but the ball is so splendid no one wants to leave while there is still time, so everyone keeps asking, what time is it? But none of the clocks have hands."

The call for this week: Again this morning those "mysterious buyers" have shown up, lifting the S&P 500 pre-opening futures from down about three points early this morning to nearly even as of this writing. Best bet is that performance anxiety will make the pros chase 'em into month's end where the Great White awaits...DA DUM...DA DUM...DA DUM...

No positions in stocks mentioned.
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