Jeff Saut Presents: Lose Cash!
Can you imagine all the "Poor Grenvilles" out there desperately trying to "lose cash" as the DJIA broke out to a new all-time high last week?
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.
"'Poor Grenville runs a fund, one of a group of funds, and he is in charge of $100 million or so.'
...I asked Charley why Grenville was suddenly Poor Grenville.
'Poor Grenville,' said Charley, 'has gotten caught with twenty-five million in cash. It's a disaster. How would you like to have twenty-five million in cash with the Buy Signals you've just seen? Come to lunch. Poor Grenville has to lose his cash, right away.' I know it sounds little funny that having $25 million in cash is a disaster. It sounds just as funny to me as the phrase 'lose cash.' When it isn't your cash in the first place and all you are doing is taking the cash – somebody else's – and buying stocks with it. But professional money managers love to say, 'We lost five million in cash this afternoon,' meaning they bought stocks with it. I guess it sounds professional.
...As to why Poor Grenville's $25 million in cash was a major disaster, that is more comprehensible. Grenville should have all $100 million fully invested if the market is coming off the floor; his fund is 'performance-oriented,' trying for big capital gains. If Poor Grenville has $25 million in cash he guessed dead wrong at the bottom of the market, and in one career you don't get too many chances like that. Poor Grenville had gotten himself all ready for a big drop in October and now in January the market turned around and ran away without him. He has to make it up in a hurry."
--The Money Game, by Adam Smith
Can you imagine all the "Poor Grenvilles" out there desperately trying to "lose cash" as the DJIA broke out to a new all-time high last week? What's behind this buying panic and will it last? My firm has suggested the recent rally was preordained when Goldman Sachs (GS) reduced the gasoline weighting in its much followed Goldman Sachs Commodity Index (GSCI). By taking the weighting from 7.3% to 2.5%, Goldman literally forced the billions of institutional dollars "mirroring" the GSCI to sell gasoline futures. We find it interesting that Goldman chose to reduce the gasoline weighting in incremental stages right into the November elections, but that's a discussion for another time.
We also find it interesting that the Department of Energy has chosen not to buy any more crude oil for the Strategic Reserve, even though the reserve is below norms, but that too is a discussion for another time. Nevertheless, the "crash" in gasoline and crude oil prices, combined with a 4.7%-yielding benchmark bond, has caused the "Poor Grenvilles" of the world to "lose cash" driven by performance anxiety. Will it last? Well in last Thursday's strategy comments we opined that the typical trading pattern calls for a short-term peak likely sparked by a rebound rally in energy prices (notably, the Oil & Gas Index, as well as crude oil itself, is more oversold than it has been in years...see the chart below). The envisioned stock selling, however, should not gather much "steam," leading to a re-rally given the upcoming sequence of economic news.
This week we should see "Street-friendly" FOMC meeting minutes, job claims, trade figures, retail sales, beige book, and consumer sentiment reports. The following week should also see friendly economic numbers, keeping the proverbial "carrot in front of the horse" potentially into the October 19th "witch twitch." In fact, if the pattern plays perfectly, we could see on/off strength all the way into the November elections, where the "Foley Fiasco" has clearly raised the Democrats' chances of seizing power. If that happens, my firm doesn't think it will be particularly stock market friendly. And if you don't believe me, go to Representative Nancy Pelosi's (D-CA) Web site and read her agenda for the first 100 hours as the new Speaker of the House.
My problem with this whole rosy scenario is that I just don't trust it. It feels a lot like last May to me when everybody was focusing on the DJIA as it tracked-out to fresh five-year highs amid numerous nonconfirmations from various other indices. Moreover, despite what the media suggests, the DJIA is not particularly cheap. Indeed, the much watched index is trading at nearly 23x trailing 12-month earnings while earnings momentum is slowing. The Dow also has an earnings yield (4.4%) below the yield of the benchmark bond (4.7%), is changing hands at 3.4x book value, and possesses a paltry dividend yield of 2.2%. Of course, all of that does not mean that the Dow can't continue to trade higher, for as Saturday's New York Times' headline read, "Dow Sets a Record in Height, but Weight Had a Lot to Do With That." The article went on to say that how indexes weight their stock components has a lot to do with the index's performance. It also noted that while the Dow exceeded its January 14, 2000 high (11722) last week, only 10 of the 30 stocks in the index are higher now than they were back then. Surprisingly, as the Dow tagged a new all-time high last Wednesday, the average price of its 30 components was down more than 30%.
Evidently I am not the only one that thinks the environment is not exactly "cheap," for in the same Saturday New York Times, another headline read, "A Kink in Venture Capital's Gold Chain." The opening line was, "The high-risk, high-return venture capital business may have turned into all risk and no return...'The traditional venture model seems to us to be broken,' Steve Dow, a general partner at Sevin Rosen Funds, said in an interview." For the record, Sevin Rosen is a 25-year-old firm that is among the most respected in the venture capital industry. Shockingly, the firm has decided to abort raising money for its newest fund and is sending back the monies already committed by investors. The article went on to say, "But excess capital 3 is only part of the problem, the firm said. In its letter, it bemoaned what it described as 'a terribly weak exit environment,' a reference to the dearth of initial public offerings and a market for acquisitions at valuations that it considers too low to deliver the kind of returns that venture investors expect."
Obviously my firm agrees, which is why we continue to focus our investment accounts on special situations, preferably ones with yields, which hopefully have already been through their respective "bear market." Precision Drilling Trust (PDS) is a good example, which has declined from August's $38.00 price-peak into last week's sub-$28 low where the shares yield 12%. And, while Intermec (IN) does not have a dividend, we think this RFID player is giving investors another chance to accumulate shares in the low-$20s. Both of these issues are rated Outperform by our fundamental analysts. Additionally, in Thursday's comments we reiterated the fact that large-cap growth stocks are cheaper than large-cap value stocks for the first time in 30 years and recommended three Exchange Traded Funds (ETFs) to play that theme. Those ETFs are Vanguard Growth (VUG), Rydex S&P Pure Growth (RPG), and PowerShares Dynamic Large Cap Growth (PWB). Additionally, we recommended the PowerShares ranked by Rob Arnott according to book value, sales, income, and dividends that have been created over the last few weeks:
Then there are the long/short mutuals often mentioned in these missives.
In conclusion, remember these types of buying stampedes see sellers disappear, buyers chase, shorts panic, fundamentals pushed aside; and it just becomes a matter of satisfying demand. Also understand that nothing proves more bullish than rising prices – enthusiastic and winning buyers generate more positive interpretation of the news – all self-fulfilling until sanity returns. When will sanity return? My best guess is that at the latest it will be with the Republicans' defeat in the November elections.
The call for this week: The "Poor Grenville" club reconvenes as Wall Street turns a deaf ear to a continuing uranium enrichment program in Iran, Nigeria and now a North Korean nuclear bomb. Clearly the markets are ignoring the mounting geopolitical risks as they "dance" to that James Bond theme song "All Time High" by Rita Coolidge. Let's hope the music doesn't revert to another Bond theme song, namely "A View to a Kill."
Copyright 2011 Minyanville Media, Inc. All Rights Reserved.
Daily Recap Newsletter