Jeff Saut Presents: Goldilocks?!
...near-term enthusiasm has a cautionary tone after this week...
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.
We attended the Raymond James 27th Annual Institutional Investors Conference last week, which was graced by more than 600 institutional portfolio managers (PMs) and some 300 presenting companies. While most of the corporate presentations were excellent, many of the attendees averred that the "real" insights came not from the formal presentations, but from the subsequent private "breakout" sessions with the CEOs/CFOs. We too found the breakout sessions informative; however, the majority of our time was spent interfacing with various PMs. In those meetings, the repeated macro-questions centered on last Friday's employment numbers. Our response was that with many of the indices breaking down, a "Goldilocks Number" was needed. Indeed, too hot a number would lead to a "hit" in the bond market, which would cause an initial rally in stocks that would not be sustainable due to those higher interest rates. The quid pro quo was that a softer than expected number would lead to a big stock-swoon on failing economy concerns. Therefore, what was needed was a "Goldilocks Number," and unsurprisingly that is exactly what we got.
Plainly, Friday's employment figures were "not too hot and not too cold," with non-farm payrolls rising by 243,000 (consensus was for a 225,000 rise), while last month's figures were revised down by some 23,000 jobs (170,000 jobs versus the reported 193,000). Meanwhile, the unemployment rate rose to 4.8% (from 4.7%), verily a Goldilocks report. Therefore, we told institutional accounts early Friday morning that the "short-term lows were in" and that the major average would likely attempt to rise into this week's option expiration (Friday). Consequently, we were quite surprised by Friday's "muted" stock market opening that gave participants every opportunity to BUY the various indices for a trade into this week's expiration expiation. Yet, our near-term enthusiasm has a cautionary tone after this week, given our sense that the major averages are forming a "broadening top" pattern in the charts.
Our concerns come from the sequence of chart upside non-confirmations and weakening internals, as well as certain statements that were made last week. First was the statement from Iran that there would be "harm and pain for the U.S." if retaliatory actions were taken about Iran's nuclear program. That pronouncement was followed by Secretary of State Condoleezza Rice's comments that Iran was/is the "bank" for terrorist activities. Having lived inside the D.C. Beltway, we viewed those words as pretty aggressive. The crowning comments, however, came from President Bush, who stated that, "Iran's nuclear weapons program poses a GRAVE threat to the security of the world." Ladies and gentlemen, I have lived on this planet for 56 years, and studied political intrigue for 35 of those years; unfailingly, when the President of the United States uses the word "grave" it is significant!
Manifestly, the word "grave" has been used back to the time of President Roosevelt. And, most of the time it has been associated with the advent of conflict. Whether that is the case currently remains to be seen, but the precedent is certainly there, especially when taken in context with Iran's and Condi Rice's comments. In addition to our observations about the Iranian situation, one particularly prescient money manager summed the current environment by noting:
"I think the biggest shock for the stock market this year will be continually raising interest rates. Many people believe there will be 'just one more rate hike' by the Fed, but I ask: How can we continue to issue more and more debt without higher interest rates? The debt expansion, coupled with the new wariness that foreign investors have, will translate into less eagerness to invest in U.S. assets. Foreigners see, that for security reasons, Congress will not allow them to purchase some American assets. We are incurring economic risks while being oblivious to the consequences. Americans have a propensity for simplistic answers rather than analyzing the complexities of an entire situation. I see nothing improving; the trade imbalance is not getting better. We are not consuming less oil. Our kids are not being better educated. There is diversion of foreign and U.S. capital to other countries. Why should we think U.S. productivity will increase? Someone in government should list all the pertinent economic factors and their trends and present the data on TV, so more Americans can see where the country is going. Maybe then we could get together and try to reverse the injurious trends before we have even more serious problems."
As for the "here and now," we think the near-term price-lows are "in" and that the major market indices will attempt to rally into this Friday's triple-witch. However, such a rally is of little consequence to us since we believe the only question following the January Jump is whether you lose money quickly or slowly. As stated in early October 2005, when we recommended participants to get their respective "buy lists" together, and in mid-October when we advised folks to begin buying those stocks, we thought the envisioned rally would carry into January where a trading peak would be due. Following that "peak" we noted that the typical pattern would be the perfunctory quick/sharp pullback and then the prerequisite re-rally attempt that often carries the averages to a slightly higher price-high. From there our notes show that it is very difficult to make much money, which is why we currently have low exposure in the trading side of the portfolio. Moreover, so far only the DJIA has made a higher-high while most of the other major indices have been under distribution (NDX; SOX; etc.) and those upside non-confirmations continue to leave us cautious on a trading basis.
As for the investing side of the portfolio, if you believe in our "stuff stock" theme of the past 4½ years (energy, timber, cement, fertilizer, agriculture, water, precious/base-metals, etc.), and if you think our "grave" inference has merit, energy stocks (particularly coal stocks, preferably those with a yield), gold stocks, and T'bills should be bought right here given the fact that they are hopefully at the bottom end of their downside price reaction. As always, we recommend a scale-buying approach of buying 25% - 33% of long positions and then continuing to average "in" (Buy) over the next few months. On gold, to answer numerous questions, we remain bullish. Indeed, if gold is in the secular bull market we believe, every secular bull market we know has exceeded the price-peak of the previous bull market. That implies that the previous gold market price-peak, of $850 per ounce, will be exceeded before the "stuff stocks" secular bull market is over. For individual ideas on these investment themes we suggest contacting either the Mutual Fund Department, or the Closed-End Fund Department, for broad-based ways to invest. For individual companies, we suggest contacting our Liaison Desk (x72520), or our Houston-based/Canadian-based "stuff stock" analysts, for specific recommendations. In lieu of that, Julie Lachman (x75559) is the "touch point" for all of our international research.
Speaking to all those folks we have led into BlackRock Florida Insured 2008 Term Trust (BRF), which cut its dividend while we were traveling, we asked our Closed-End Fund Research Department to comment on the recent events. This was their response:
"As of 12/31/05 the fund's cash cushion was approximately $0.82759 per share, a drop from $0.9354 on 6/30/05. The cash cushion is built into net-asset value (NAV), which is currently $14.90. For the six-month period ending 12/31/05, the fund earned approximately $0.044638 monthly per share. Prior to these earnings, as of 6/30/05 the fund had earned approximately $0.049176 per share. Reduced earnings were a direct result of increased leveraging costs. On June 30, 2005 the fund's NAV was $15.50, so we've seen a drastic decrease, of which only $0.11 or so was attributable to the decreased cushion. There has been no portfolio turnover in the past 12 months, so the remainder of the drop in NAV is attributable to the fall in bond values. Just eyeballing the portfolios, most of the bonds are now trading at or slightly over par value. While I have no doubt that BlackRock will meet the $15 redemption target in December of 2008, it will come at the expense of current income. They now have to build up the NAV by at least $0.10, probably in the form of increased cash cushion (unless they can pull off buying some below par paper, which looks doubtful). With the fund earning $0.045 per share at the end of the year and now only paying out $0.0375, this shouldn't be a problem if the Fed ceases the short-term rate hikes. Higher short-term rates will directly reduce earnings. Are more dividend cuts likely? Again, if leveraging costs continue to increase due to Fed increases in short-term interest rates, then yes."
My suggestion regarding BRF is that if you need the long-term capital loss, like we do from being "long" stuffstocks for the past few years, you probably should take the long-term capital loss to offset some of the gains we have accrued in the "stuff stocks" over the years.
The call for this week: An upside stock "short squeeze" into this Friday's triple-dipple is a distinct possibility. Yet, I don't trust the potential rally and prefer to scale-buy select special situations. Some of the companies that I saw at the conference that made sense to me, and that have positive ratings from our fundamental analysts, include: Applebee's (APPB); Briggs & Stratton (BGG); Massey Energy (MEE); Macquarie Infrastructure (MIC); TNS Inc. (TNS); Valor Communications (VCG); and Wesco (WCC). Clearly, many other good companies presented at our conference and we suggest that you contact your institutional, or retail, broker for additional ideas.
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