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Jeff Saut Presents: There's Something About Mary


Of particular note was that within the small-cap universe Healthcare, Energy, and Technology had the best returns over the next 12 months following a Fed cessation.

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.

"There's Something About Mary," except in this case I am not referring to the 1998 hit movie starring Cameron Diaz, but Mary Lisonti, captain of the Adams Harkness Small Cap Growth Fund (ASCGX). I have known Mary for some time. My firm has shared ideas with her, made money on her stock selections and even debated her on network TV. Indeed, roughly one year ago my firm termed her a gifted "stock-picker" on CNBC, although at that time we differed with Mary on the macro-environment for small-capitalization stocks for the first time in five years. That differentiation centered on my firm's macro-theme of being way overweight small/mid-cap companies from October 2001, to our market-weight strategy on them as we entered 2006. Verily, year-end 2005 found the large-cap complex more undervalued than it had been in more than 20 years, which is why my firm began the year overweight large-cap names. Our "changes in latitude changes in attitudes" vent was driven by the fact that according to our "pencil" small/mid-caps had rallied from 25%-to-35% undervalued in 2001, to 25%-35% overvalued by year-end 2005. For the first half of 2006 that overweight large-cap "call" made my firm look idiotic, yet since mid-June it has served us pretty well.

Don't get me wrong, my firm still thinks that small/mid-cap ideas afford the best opportunities for outsized earnings growth, as well as outsized capital appreciation, because by default small-caps have the ability to grow faster. It was just that the seven years of outperformance by this asset class had left them optimistically priced and far too popular with the investing public. While my firm continues to have a large-cap bias, our day with Mary refocused our attention on small-caps, which surprisingly have been responsible for many of the longterm capital gains we have realized over the past 12 months.

Manifestly, my firm found Mary's arguments for small-caps to be cogent. To wit, historically when the Federal Reserve quits raising interest rates, the small-cap complex has shown substantial outperformance versus most other asset classes. Of particular note was that within the small-cap universe Healthcare, Energy, and Technology had the best returns over the next 12 months following a Fed cessation. While I am not as certain as Mary that the Fed is going to reduce interest rates, I absolutely agree with her point that when the Fed "stops" small-caps tend to outperform. Moreover, history suggests that a gifted small-cap stockpicker has typically outperformed most other portfolio managers and clearly my firm likes many of Mary's smallcap stock selections.

Indeed, Mary's top ten holdings all posses the kind of metrics my firm deems important. For example, Tessera Technologies (TSRA), rated Outperform by our own fundamental analyst (Ashok Kumar), is a provider of miniaturization technologies for the electronics industry. The company's intellectual properties include more than 363 U.S. patents, and 70 international patents, covering a range of advance semiconductor packaging and interconnect solutions. Worth mentioning is that Tessera owns all of its intellectual property rights and has won all of its patent infringement suits (I mentioned this same "suit win" point when my firm was recommending Rogers (ROG) at $35 a little over a year ago). With PDAs, cell phones, wireless, etc. burgeoning growth, TSRA looks positioned to do well going forward.

Fuel-Tech (FTEK) is another of Mary's holdings. Fuel-Tech is a technology company active in the air pollution control and specialty chemical business. Its focus is on the worldwide reduction in nitrous oxide (NOx), as well as the fuel chem process, which "cleans" lower quality coal. If you believe, as I do, that tight coal supplies will drive the usage of lower-quality coal, FTEK is a "good bet," according to Mary.

While there are many other intriguing situations in Mary's portfolio, her selection of Vistaprint (VPRT) is of particular interest to my firm since in a past life we have written extensively on printing companies. Printing, ladies and gentlemen, is a "num nuts" business, yet vitally important to a small business' success. For example, caterers, taxi companies, pizzerias, flower shops, wedding arrangers, etc. need to differentiate their businesses from competitors. The most cost effective way to do that is using business cards, brochures, invitations, etc. And, this is where Vistaprint has found a way to serve the small business community on a cost efficient basis using its proprietary Internet software solutions. That focus has given Vistaprint a competitive advantage affording the price discounts available to larger companies to much smaller companies. Such a business model has allowed VPRT to achieve an ROE of roughly 19%, as well as a ROA (return on assets) of 13.7%. Serving some 7 million customers, in more than 120 countries, the company continues to garner market share.

As for the here and now, last week saw the DJIA track-out to new all-time highs. Not so, however, the D-J Transportation Average (DJTA), which continues to be a major "Dow Theory" upside non-confirmation. Speaking to the Transports, trucker YRC Worldwide's (formerly Yellow Freight) (YRCW) reduced guidance last week. As well, overall truck tonnage for the month of October was down 4% year-over-year, registering its largest decline since February 2001 and taking the "truckers" into recessionary mode along with housing and the autos. Nevertheless, as repeatedly stated, "We have learned the hard way that it is difficult to break the major-market averages down during the ebullient month of December." Moreover, I have opined that if the S&P 500 breaks out above 1415 (SPX/1427.09) it would probably lead to a "dash" into my firm's 1440-1445 price objective. We continue to trade and invest accordingly.

The call for this week: All eyes were focused on last Friday's laughable CPI report (+2.0% year-over-year). As Richard Russell states, "No inflation...does Bernanke have any kids who are heading for college? Do you have any doctor visits coming up? This month-to-month gauge of inflation is a fraud. How about year-to-year inflation? The Fed's whole strategy – continue inflating while publishing phony statistics showing that there's little or no inflation." While my firm is not as cynical as Dick Russell, it is worth considering that the Cleveland Fed's measure of the median CPI is up 3.7% year-over-year and that there was no relief in "rents" (+0.3%) and/or "homeowners equivalents" (+0.4%) in Friday's CPI report. When my firm combines our sense that inflation is higher than the government's figures suggest with double-digit tax-receipt growth (read: strong economic growth), a stronger than expected Empire State Manufacturing Index (23.1 versus the estimated 20.5), and the "New Orders" component of said report rising from 22.4 to 25.1, we are left with a feeling that the Fed may be on "hold" a lot longer the participants currently expect.
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