Jeff Saut Presents: Kong Hei Fat Choi
Bulls make money, Bears make money, but Pigs often get slaughtered!
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.
"Kong Hei Fat Choi," as the Chinese say (or as we say Happy New Year), for the Chinese New Year officially began on February 18th. And, with the Dow Jones Industrial Average (DJIA), gold, corn, et al. at their recent price highs, isn't it appropriate that this is the "Year of the Pig?" According to the Chinese Zodiac, as reprised by chiff.com, Pig personality traits include:
"Intellectually curious, honest and tolerant, those born in the Year of the Pig can be relied upon for their loyalty and often make true friends for life. The Pig can be very naive, however, and may easily fall victim to the unscrupulous who take advantage of their idealistic nature - as Pigs see everyone as loyal and caring as they are. Although forced to play the fool many times, they will just as likely hold fast to the notion that everyone is at heart decent and admirable... Stubbornly optimistic, the Pig will not tolerate those with well-meaning advice on how to be a Pig, but since they dislike quarreling and discord their anger usually cools quickly."
And last week the "Pigs" rushed into technology stocks emboldened by a report from one of Wall Street's best and brightest who trumpeted the upcoming capital expenditure (capex) cycle that is going to be driven by the upgrade to IPv6 (Internet Protocol version 6) from version 4. The capex "surge" argument centers on the notion that with the switch to IPv6 the number of Internet addresses will need to expand exponentially, network usage will triple, the efficiency of broadband will have to be increased, etc. While all of this is no doubt true over the long cycle, my firm is suspect that it will drive a huge capex cycle in the short/intermediate term. Indeed, as we understand it there are actually two separate themes afoot in said capex argument.
The first theme refers to the wireless 3G network, which in many cases is already built-out or nearly built-out (Cingular would be a good example). While attention was drawn to the 3G architecture last week when a number of operators announced new handheld devices (cell phones, Blackberry, Palm, etc.), it is difficult for my firm to envision a capex surge given that much of the 3G network is already in place. That said, my firm does believe that 3G will provide a tremendous boost to the desirability of handheld devices by making them more robust. Manifestly, one of our major themes for the past few years has been that the hottest thing going in technology is delivering more content (audio, video, data, etc.) to the handheld device. This is one of the reasons my firm has been bullish on the tower stocks since if you don't have the "real estate in the sky" (a.k.a. towers) you can't deliver the content. The two tower names from our telecom analyst's coverage list my firm has been using are American Tower (AMT) and Crown Castle (CCI). As for names playing to the 3G theme, my firm's analysts like Motorola (MOT) and RF Micro Devices (RFMD).
Separate, and apart, from the first theme is the argument that IPv6 will require a large deployment of additional routers, servers, switching systems, etc. While this is true in the long-term (four to five years), it is unlikely to be a near-term driver for a surge in capex and therefore is not a short/intermediate-term investable theme. For example, Raymond James (RJF) won't do anything for the IPv6 rollout other than upgrade its handheld devices to 3G as the old ones wear out.
Another "Kong Hei Fat Choi" phenomenon that has been occurring was reflected in a recent headline that read, "Golden Pigs Disappearing Off of the Shelves Faster than They Can Be Replaced." The article went on to say that this particular Chinese lunar New Year is believed to be especially auspicious because it is a "Golden Pig Year," which only comes around every 60 years. And maybe, just maybe, that is one of the things responsible for gold's 12.4% rise from its January 5, 2007 low of $603 per ounce to last week's upside breakout high of $677.80. Interestingly, however, while gold has broken out the gold stocks have not, as reflected in the price charts of the Gold BUGS Index (HUI) and the Gold/Silver Index (XAU). Historically, such a divergence has been a signal for caution and my firm sees no reason to view it differently this time. Therefore, while my firm remains adamant that precious metals are in a secular bull market that will eventually see gold's 1980 price peak of $868/ounce bettered, in the short-term we are getting cautious on gold and the gold stocks. There is another "Year of the Pig" theme centered on the burgeoning baby-boom that is occurring as couples try to ensure their newborns get a happy, wealthy life by being born in the "Year of the Pig," but we can't figure out how to make money off of that one.
Yet, by far the most important inferential event my firm observed last week came not from China, but from China's neighbor... Japan. I have been bullish on Japanese stocks since the Spring of 2003. Not so the Japanese Yen, which my firm has viewed negatively due to Japan's low interest rate environment. However, that view changed last week, leaving us now with a yen for the Yen. This strategy change was driven by Japan's recent GDP figures that showed an annualized growth rate of 4.8% (the fastest pace in three years), strong personal consumption (+1.1% y/y), and an attendant 2.2% "pop" in capex spending (+2.2% y/y). Such ebullient figures suggest that the era of Japan's ZIRP (zero interest rate policy) is likely drawing to a close and with it the weakness in the Yen. If correct, my firm could be seeing the beginning of the unwinding of the now ubiquitous "Yen carry trade."
Recall that in past missives I have spoken of the Yen carry trade in that it was a wonderful trade to borrow in Japan at zero percent interest rates, leverage that money, and buy something else that was either going up in price or that yielded more than your cost of money. Everything worked great as long as the Yen held steady relative to the U.S. dollar, or even better... declined. But, given the popularity of the Yen "carry trade" by the hedge fund community, the short-position now prevalent in the Yen could produce a protracted Yen rally. The "lift off" for the potential rally in the Yen can be seen in the Yen's chart formation which can be seen below. The chart shows a low at 0.8249 followed by a subsequent throwback rally to 0.8382, leading to an "undercut" low of 0.8241 on February 12, 2007. I have seen a lot of "major lows" made by such undercut moves, especially when they are followed by upside breakaway "gaps" like the one seen in the nearby chart. To capitalize on this inference, my firm recommended long Yen positions in our verbal strategy comments in the newly created Currency Shares Japanese Yen (FXY) that began trading last Wednesday at 82.69. While my firm only has a one-third long position "on" for the trading account, we see de minimis downside for the Yen from here and would add to long positions on pullbacks.
As for U.S. markets, it was another new all-time high for the DJIA last week, so I thought we would take a look at the Dow's components to see just how many of them had exceeded their respective all-time highs, most of which occurred in the spring of 2000. Amazingly, of the Dow's 30 components only seven, yes a mere seven, are above their all-time highs! General Electric (GE) is typical of this eerie phenomena and GE has historically been a precursor of the stock market's future direction. To wit, GE made its price high at $60.50 per share in August 2000 and currently resides 40.7% below that high water mark. Most recently, GE's shares have broken down in the price charts and if they trade below their reaction low of $35.48 they should be viewed with negative implications for the overall stock market. While my firm has clearly been too ambivalent on the major market indices, we still find ourselves "long" an awful lot of stocks since we have been able to find numerous situations that are just plain "cheap." Case in point, our January 8, 2007 recommendation at $38.57 per share on Strong Buy-rated Williams Partners L.P. (WPZ) where our fundamental analyst expects this MLP's EBITDA to increase from $59 million to $217 million and its cash distributions (read: dividends) to ramp from $1.73 per share to $2.41. My firm continues to invest accordingly.
The call for this week: The current rally is now the third longest in duration since 1900 without so much as a 10% correction. Moreover, recent surveys show that hedge funds are about as long stocks as they ever get (read: a bearish indication). Further, my firm doesn't like the tone from Capitol Hill, where Congressional Democrats are leaning more and more toward an activist tone on trade tariffs and regulation on just about everything. Combine this with the slowing foreign purchases of U.S. assets (TIC flows) and my firm remains cautious. Remember, BULLS make money, BEARS make money, but PIGS often get slaughtered!
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