Jeff Saut Presents: Escape From New York Redux
How this "more risk" preference will end is anyone's guess, but history suggests it will not be with a whimper.
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.
As most of you know, I have been traveling a lot the past few months to speak at various conferences and seminars. This week will be no different as I leave Wednesday for Memphis. Last Friday's sojourn to New York City, however, was of particular interest because I attended, and spoke at, the first ever "Minyans in Manhattan" confab. In attendance were such notables as: Barron's Michael Santoli, Steve Galbraith, Stephanie Pomboy, and Greg Weldon, to name but a few. While all of the speakers' comments were insightful, I found John Succo's (Vicis Capital) remarks about "risk" to be at the heart of what is currently occurring on Wall Street. To paraphrase John's comments:
When participants want to take on more risk in the various markets, they take out additional loans and buy assets with the money. When they want to assume less risk, they sell assets and buy Treasury Bills. That is the real driver of asset prices.
This is not an unimportant point for it suggests there is no need for an increase in money supply to drive assets prices, but rather a shift in "risk preferences" by participants. And maybe, just maybe, that is one of the reasons, when combined with a concurrent crash in gasoline prices, that equity prices have rallied since August despite the fact the adjusted money supply has been relatively flat (reference the St. Louis Fed's Web site). Indeed, as RCM Capital's Rob Parenteau opines:
"It is absolutely essential that you grasp this simple, but fundamental point, or you will spend many years lost in the wilderness searching for the penultimate global liquidity measure that explains any and all asset price movements. Such a Holy Grail to the investing universe does not exist because it is investor liquidity preference (aka risk appetite), not the actual pool of outstanding liquid instruments, that is the dominant force in asset pricing outcomes."
Currently, participants are assuming increasing amounts of risk as can be seen in the attendant chart of the Merrill Lynch Financial Stress Index. See the chart below.
How this "more risk" preference will end is anyone's guess, but history suggests it will not be with a whimper. Other "sound bites" from the conference that made my notes included:
- Almost 2% of the NYSE's entire market capitalization has been taken private (read: LBO'ed) since the beginning of this year.
- So much money is sloshing around in private equity funds that we now have the Jessica Simpson model of investing – "I don't know what it is, but I want it!"
- Private equity funds are looking to "lever" corporate America's under-leveraged balance sheets and exploit them accordingly.
- There are now more hedge funds than there are stocks and 60% of those funds are less than 5-years old. This trend will end with mediocre performance by most hedge funds.
- Gold is going up against most assets. And, foreign energy stocks are making new all-time highs and "pulling" U.S. energy stocks higher.
- The U.S. has the highest "real" (inflation adjusted) interest rates in the developed world, implying capital should continue to flow here.
- If current profit margins, and free cash flows, are sustainable, then the equity markets can continue to levitate. However, a "mean reverting" world suggests we are long-of-tooth in this trend.
- Sam Zell is not stupid! Therefore, the recent sale of his flagship REIT Equity Office Properties Trust (EOP) should be viewed as a watershed event.
- Bank indices are deteriorating against the S&P 500 Index (SPX). Since the Financials have roughly a 22% weighting in the SPX, this is troublesome.
- If the rumors about a Home Depot (HD) LBO were for real, the long-dated call options on HD should have collapsed and that just didn't happen.
- Volatility and Risk are currently being way under-priced by the markets.
Further comments from the conference may be found at "must have" Minyanville.
Another conference, where I recently pontificated, was centered on Growth and Technology stocks. This too was an interesting conference given that large-cap growth stocks are cheaper than large-cap value stocks for the first time in 25 years. This conference began with a quote from President John F. Kennedy. To wit, "Change is the law of life. And those who look only to the past or present are certain to miss the future." The future indeed as technology investment themes for the future were the dominate topic of this conference. While space constraints prohibit any discussion of these themes, I think you will get the idea from the following sound bites:
Managing, and/or the storing, of data; the sharing of data (collaboration); a shift from simply published content to a user community asking "what can I contribute?" (i.e., Minyanville's community approach); information aggregators; bandwidth; IT security; telepresence; nano technology; and, incorporating nano technology into healthcare devices leading to radical healthcare breakthroughs.
While there are clearly more technology themes afoot than these, my firm scribed these as the most important takeaways from the conference. Interestingly, last week's Business Week magazine contained an article titled "The Future of Tech," which contained the nearby chart of "enablers" for the next wave of gadgets and services. See the chart below.
Turning to the stock market, there were some interesting developments in my absence. For example, the D-J Transportation Average (DJTA) continued its upside non-confirmation of the D-J Industrial's (DJIA) "march" to new reaction highs. According to Dow Theory, this is problematic. Meanwhile, the D-J Utility Average (DJUA) tagged a new all-time high as things continue to become "curiouser and curiouser." Moreover, last week's weakness in the DJIA/DJTA caused both of those indices to break down below their respect uptrendlines that have offered support since last summer's lows. Not so in the NASDAQ, which successfully tested its respective up-trendline. However, the Dollar Index was another story as the greenback broke below this year's lows and looks like it will test generational lows between 78.19 and 80.39. See the chart below.
Also worth mentioning was the Goldman Sachs Commodity Index's 4.6% weekly rise, driven by Natural Gas, Unleaded Gasoline, and the "grains," on which my firm remains bullish. The strength in "grains" (corn, soybeans and wheat) is of particular interest since my firm has been unwaveringly bullish on them over the past few years. The "grains" strength is consistent with our views that given the burgeoning dearth of clean water, emerging countries will have to allocate their shrinking water supplies, implying that countries with abundant water, and arable lands, will become increasingly the suppliers of food to the 5- billion new entrants to the world's economies, but that is a discussion for another time.
The call for this week: As stated, my firm's preferred near-term trading pattern called for a "trading top" during the holiday-shortened week of Thanksgiving leading to a pullback into the second week of December and sinking the foundations for the fabled "Santa Rally" into year end. Whether that plays, or not, only time will tell, but we remain cautious consistent with the old stock market "saw," "If Santa fails to call, the bears will roam on Broad and Wall!" My firm continues to invest, and trade, accordingly...
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