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Jeff Saut Presents: "Margin Call Gentlemen"

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...in the short-run the only question now is whether you lose money quickly or slowly...

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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.

"Margin call gentlemen" is a line from the 1983 hit movie "Trading Places" starring Eddie Murphy, Dan Aykroyd, and Jamie Lee Curtis. Said line is delivered to Mortimer and Randolph Duke by the President of the Commodity Exchange (Alfred Drake), after the Duke's unsuccessful attempt to "corner" the orange juice futures market. Similarly, last week looked like a massive "margin call" for most of the commodities, as well as our stuff-stocks, with many positions surrendering 5% or more. Margin call indeed, as the hot money dialed-up "1-800-Get Me Out." Some of that selling may have been induced by comments from
Japan that interest rates were going to rise. Since many hedge funds have been borrowing "cheap" money in Japan, levering it, and then buying stuff, any Japanese rate ratchet would obviously have an impact on the profitability of such heavily margined long positions. Then too, maybe it was the "call" from a major U.S. investment bank that the dollar had peaked. Whatever the reason, last week's action in the commodity pits was abysmal. Fortunately, we had reduced our energy stock positions by 20% to 30% back in August/September, sensing that oil was making an intermediate parabolic peak.

While the commodity pits were trashed last week, the equity and bond markets hung in there pretty well. Still, the lack of any continuity made it extremely difficult to make any money. Clearly that sequence is in keeping with our recent comments. To wit, after reviewing our stock market notes of some 40 years, January Jumps tend to end during the second or third week of January with a sharp/quick downside reaction. That pullback is typically followed by another rally attempt that either fails to make a new monthly high (read: double-top), or makes a slightly higher high. From there, the only question in the short-term becomes whether you lose money quickly or slowly. Moreover, the odds that this sequence plays rise dramatically if the December low has been taken-out to the downside in that mid/late-January swoon. Unfortunately, this January's sharp/quick pullback from Dow 11048 (
1/11/06) to its downside crescendo of 10684 (1/20/06) "took out" the December low of 10709.42 and unfortunately reinforces the topping sequence laid out in these reports over the past few months.

Reinforcing our current timid stance, the astute Lowry's organization noted over the weekend:

"Although it is not always easy to see, the evidence is continuing to build that the stock market is in both the late stages of a bull market and the early stages of a bear market. As we have pointed out in past reports, the formation of major tops is a very gradual process that can take many months before it becomes obvious. Perhaps it is this almost slow motion process that makes it difficult for investors to see until it is too late."

Lowry's goes on to point out that its Selling Pressure Index has risen to its highest level in two years, while its Buying Power Index continues to sag. Additionally, Lowry's notes that of the 30 DJIA component stocks, only three have strong Power Ratings (read: strong trends) and that 20 of them have weak trends. Meanwhile, Joe Granville's on-balance volume studies are bearish and our proprietary indictors continue to flash cautionary readings. Unfortunately, all of these indicators leave us in the trading twilight zone, or as Lowry's concludes, "In this environment, the best strategy still appears to be one of holding on to only those stocks with strong Power Ratings patterns within the strongest Industries, but being ready to quickly cull out issues that fail to participate on rallies."

That said, we do not have much more to say about the upcoming week so we thought we would share a recent position paper from McKinsey & Company titled "Ten Trends to Watch In 2006." Due to my space constraints I have cut and pasted their comments into this report, but you should still get the meaning. The authors (Ian Davis and Elizabeth Stephenson) begin by noting "We would highlight ten trends that will change the business landscape:"

1. Centers of economic activity will shift profoundly, not just globally, but also regionally. As a consequence of economic liberalization, technological advances, capital market developments, and demographic shifts, the world has embarked on a massive realignment of economic activity. Although there will undoubtedly be shocks and setbacks, this realignment will persist.

2. Public-sector activities will balloon, making productivity gains essential. The unprecedented aging of populations across the developed world will call for new levels of efficiency and creativity from the public sector. Without clear productivity gains, the pension and health care burden will drive taxes to stifling proportions.

3. The consumer landscape will change and expand significantly. Almost a billion new consumers will enter the global marketplace in the next decade as economic growth in emerging markets pushes them beyond the threshold level of $5,000 in annual household income-a point when people generally begin to spend on discretionary goods.

4. Technological connectivity will transform the way people live and interact. The technology revolution has been just that. Yet we are at the early, not mature, stage of this revolution. Individuals, public sectors, and businesses are learning how to make the best use of IT in designing processes and in developing and accessing knowledge.

5. The battlefield for talent will shift. Ongoing shifts in labor and talent will be far more profound than the widely observed migration of jobs to low-wage countries. The shift to knowledge-intensive industries highlights the importance and scarcity of well-trained talent. The increasing integration of global labor markets, however, is opening up vast new talent sources.

6. The role and behavior of big business will come under increasingly sharp scrutiny. As businesses expand their global reach, and as the economic demands on the environment intensify, the level of societal suspicion about big business is likely to increase. The tenets of current global business ideology-for example, shareholder value, free trade, intellectual-property rights, and profit repatriation-are not understood, let alone accepted, in many parts of the world. Scandals and environmental mishaps seem as inevitable as the likelihood that these incidents will be subsequently blown out of proportion, thereby fueling resentment and creating a political and regulatory backlash.

7. Demand for natural resources will grow, as will the strain on the environment. As economic growth accelerates-particularly in emerging markets-we are using natural resources at unprecedented rates. Oil demand is projected to grow by 50 percent in the next two decades, and without large new discoveries or radical innovations supply is unlikely to keep up. We are seeing similar surges in demand across a broad range of commodities.

8. New global industry structures are emerging. In response to changing market regulation and the advent of new technologies, nontraditional business models are flourishing, often coexisting in the same market and sector space.

9. Management will go from art to science. Bigger, more complex companies demand new tools to run and manage them. Indeed, improved technology and statistical control tools have given rise to new management approaches that make even mega-institutions viable.

10. Ubiquitous access to information is changing the economics of knowledge. Knowledge is increasingly available and, at the same time, increasingly specialized. The most obvious manifestation of this trend is the rise of search engines (such as Google), which make an almost infinite amount of information available instantaneously. Access to knowledge has become almost universal. Yet the transformation is much more profound than simply broad access."

The call for this week: The markets currently have no continuity, which is consistent with our "call" that in the short-run the only question now is whether you lose money quickly or slowly. Hopefully the situation resolves itself with Dr. Bernanke's testimony. We remain cautious.



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