Jeff Saut Presents: As Good As it Gets?
While the first two sections of the Journal contained little inferential information, when turning to section "C," there "they" were.
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.
"What if this is as good as it gets?"
--Melvin Udall in the movie "As Good as It Gets."
I grabbed The Wall Street Journal as I raced for the airplane last Monday morning on my way from Jackson Hole to Dallas for meetings with portfolio managers and to do some seminars for my firm's Texas-based financial advisors. Once seated, I began my daily ritual of perusing the "Journal" as the plane climbed out. While the first two sections contained little inferential information, when I turned to section "C," there "they" were. Indeed, the right side column above the fold read, "Dow Theory Seems in Play For Some Bulls (as the) Transportation Average Joins the Industrials At a High; More Gains?" The story went on to note that the prior week had seen the D-J Transportation Average (DJTA) confirm the D-J Industrial Average's (DJIA) upside breakout to new all-time highs by FINALLY bettering its May 9, 2006 all-time closing high of 4998.95. At the time my firm stated that our studies of Dow Theory show that the longer such a confirmation takes to occur the less meaning it has, but I digress.
Nevertheless, the thing that really caught my eye in said article was a comment by John Wilson, Chief technical analyst at Morgan Keegan, who said, "It is kind of hard to make a case that it isn't about as good as it gets." As good as it gets...? If that's the case, I thought, participants should consider that old stock market axiom, "When things were as good as it gets; I sold!" And "sell" they did as most of the indices I monitor closed down for the week.
Interestingly, the only indexes in our universe that closed higher for the week were the D-J Utility Average (+2.6%) and the S&P 400 MidCap (+0.25%). Meanwhile, copper, tin,
silver and cocoa all gained at least 4%, but again I digress.
On the left side of section "C," and also above the fold, was another article titled, "Rising Stocks Kindle Worries Of a 'Melt-Up." This article began:
"Word is spreading on Wall Street that stocks may get rocked this year. It's not a meltdown investors are jabbering about: It's a melt-up."
The gifted author, Scott Patterson, went on to quote various stock market pundits that cited the indexes could be set up for a "powerful surge" driven by a stronger than expected economy, tame inflation, solid earnings, and a sense by investors that they are missing the "upside boat." Also mentioned in the bullish bias were private equity funds, hedge funds, and short sellers, all of which could add to the upside fireworks. Now call me too cautious, which would be correct for recent history, but I have seen such anecdotal evidence before and would note that these kinds of articles have historically come around upside inflection points.
I mention these inferential articles this morning because the equity markets feel "heavy" to me, most of my firm's proprietary indicators have "topped out" and are rolling over, many of the market's darlings like MasterCard (MA) got "spanked" last week, and the fact that valuations are not particularly cheap. Consider this commentary from the London-based newspaper the Financial Times:
"Stock markets often have an instinctive need for catharsis. Long, uninterrupted market runs inevitably invite speculation about how much more they can be sustained. A correction is often needed to clear the doubts before the run continues. The US equity market is now looking deep in overdue territory for such a move. The Dow Jones Industrial Average was expected yesterday to pass its 137th trading day since July 17 without a correction of 2 per cent or more, according to Ned Davis Research. That is the second longest stretch on record after a run between September 1953 and June 1954. And the Dow has gone 53 months without a correction of 10% or more.
Like an extended run of a ball landing black on a roulette wheel, that does not necessarily mean the odds have increased that the market is heading into the red next. But it is enough to raise uncertainty in investor minds. It is notable that the S&P 500 was expected yesterday to show its smallest monthly rise in January since July. Another signal also is not so bullish - the ratio of the market's price-earnings multiple to its earnings growth rate. So-called peg ratios for individual stocks have justly fallen out of favour. After all, there is no reason a stock should be considered undervalued just because its p/e multiple is below its earnings growth rate.
But at the macro level, Absolute Strategy Research (ASR) points out that the peg ratio at extreme levels has had a good track record in signaling market shifts. Ian Harnett, ASR managing director, says the peg ratio for the US market is now 1.83 times. Since 1988, there have been 11 occasions when the ratio has risen as high or more. Each time, the market has fallen subsequently over six and 12months. The average fall over six months was 8 per cent. Over a year, the average fall was 12.88%. ASR says when the peg ratio rises so high, it may signal the point where analysts have started cutting earnings forecasts but the market has yet to catch up. Given the track record, it is not something that should be dismissed out of hand."
So, as repeatedly stated in my firm's presentations last week, "We are cautious currently, believing that the next few months will provide more clarity regarding the economy, interest rates, earnings, the political winds, geopolitical events"...well you get the idea.
However, one area where my firm has been unwaveringly bullish for the past six years has been "stuff stocks," preferably stuff-stocks with a yield. Recall that our bullish vent has not just centered on oil, natural gas and coal, but timber, cement, fertilizer, grains, water, uranium, electricity (read: utilities), base/precious metals, etc., although at times we have urged caution even in these venues on a short-term trading basis. Most recently, my firm's mid-January "call" to re-accumulate energy stocks has proven timely given black-gold's rally from roughly $50/barrel to nearly $60 with a concomitant rise for the energy stocks. While my firm embraces many of our analysts' stock-specific energy recommendations, like 4%-yielding Canadian Oil Sands Trust (COSWF), for a shotgun approach we have liked BlackRock's 5.6%-yielding Global Energy & Resource Fund (BGR). Like crude oil's upside breakout, gold broke out to the upside in the charts last week with equal ebullience for the precious metals stocks. My firm continues to invest and trade accordingly.
The call for this week: Last week the DJTA declined 1.75%, potentially aborting the previous week's Dow Theory "Buy Signal." This is consistent with my firm's notes, which show that following a significant rally, when the Transports FINALLY do confirm the Dow's upside sprint, it is often a sell signal on a short-term trading basis. The resulting double-top chart formation can be seen in the following chart from the good folks at "thechartstore.com." For investors wishing to hedge their portfolios for such a potential sell-signal, my firm had dinner last week with David Tice of the Prudent Bear Funds (BEARX), whose funds are not just "short" equities, but "long" precious metals stocks. My firm thinks such a fund deserves at least a marginal investment in portfolios as an "anchor to windward."
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