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Jeff Saut Presents: Everybody's Bullish


...we currently have upside hysteria...


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.

"I've seldom seen a time when almost everything and everybody appeared bullish. Bullish on the stock market, bullish on emerging markets, bullish on commodities, bullish on the dollar, bullish on housing, bullish on the economy. But there's a problem. You see, the great buys, the great profits, are made when we're loading up on stocks in the face of universal bearishness. When were stocks and houses a great buy? The answer is during 1942 and 1949 and 1958 and 1974 and 1980. Those were major stock market lows, and stocks bought during those times ended up providing their buyers big profits. Conversely, stocks bought in 1966, or 1971, or 2000, when stocks were popular, ended up giving their buyers headaches and losses.

Today, bullishness is in the air, people are spending with abandonment, mergers and acquisitions are a daily event, volatility is low and no one is buying puts, price/earnings are high and dividend yield is low, and mutual fund cash is at record lows. Stocks bought in this kind of atmosphere generally do not end up providing investors with profits."

. . . Richard Russell – Dow Theory Letters

I have read Dick Russell off-and-on since entering this business in 1971. Dick was mega-bullish at the 1974, and the 1982 stock market "lows." I can still remember his counsel at the 1974 bottom that no bull market in history has begun without a big rally in the steel stocks and he consequently recommended U.S. Steel (X), which rallied 400% into the 1976 market "highs." Dick was equally bearish (like us) in 4Q '99 following the "Dow Theory Sell Signal" of September 1999. Unlike us, Dick did not, per se, turn more constructive on stocks in October 2001 and reiterate that bullish stance at the "retest" lows of March 2002. He did, however, recommend many of our "stuff stocks," and has been particularly constructive on our precious metal stocks (and precious metals mutual funds). He has also been steadfastly bullish on the yellow-metal itself (read: gold) for the past five years. As well, Dick has accumulated numerous high quality yielding investment-vehicles consistent with our "shortage of income" theme. Indeed, in the low-return environment, we have, and continue to envision yields playing a HUGE roll in the total return on portfolios.

Consider this, since 1926 stocks, in the aggregate, have returned roughly 10.4% per year. Interestingly, 5% of that return has come from earnings growth, 0.9% has come from P/E multiple expansions, yet 4.5% of that 10.4% per annum return has come from dividends. Ladies and gentlemen, that means that more than 70% of equity returns over the last 80 years has come from dividends! No wonder for the last six years we have tried to emphasize correct sector selection, and select stock selection within those sectors, but we have also attempted to focus on stocks with yields. Combining that strategy with the discipline to sell your losses quickly has produced some pretty stunning returns.

Verily, everybody is currently bullish on e-v-e-r-y-t-h-i-n-g, save me, and a gentleman that runs a "small" company named Berkshire Hathaway (BRK). Moreover, again this morning we reiterate legendary investor Jimmy Roger's investment style who, when asked how he made all his money, averred, "I BUY downside panic and SELL upside hysteria!" Clearly, we currently have upside hysteria given the various upside breakouts by the various indices as repeatedly trumpeted by the media. Yet, while we believe in some of those upside breakouts, we are skeptical of others. Plainly, we are skeptical of last week's "expiration," quadruple-witch-induced upside breakout by some of the major market averages. However, the breakout by the Materials Index (XLB) warms the "cockles of our heart" since we are wicked "long" stuff stocks. That breakout also makes us want to increase our exposure to "stuff stocks." The quid pro quo is that the Dollar Index's 1.5% decline, and concurrent chart breakdown last week, makes us want to increase our exposure to 6.9% yielding anti-dollar "bet" Aberdeen Asia Income Fund (FAX). And that dollar decline caused one Wall Street wag to ask, "Are stocks really going 'up,' or is the measuring stick (aka the dollar) going down?"

Other situations that pique our interest are: 8.9% yielding Precision Drilling Trust (PDS), and 9.9% yielding Petrofund Energy (PTF), where we have suggested buying a one-third position with the ability to average "into" (read: scale buy) these situations over the next few months. As for our long-standing recommendation on water stock Synagro (SYGR), it was downgraded by a competitor last week, which could imply a holding-pattern strategy may currently be appropriate. Speaking to the water theme, it is worth noting that Canadian-based filtration company Zenon (ZEN) was potentially taken-over by GE (GE) last week, as "another one bites the dust." Manifestly, we remain bullish on the water as does GE's Mr. Immelt. Unsurprisingly, all of the investment ideas mentioned in this report possess a yield, which we believe gives investors the "margin of safety" often mentioned in Benjamin Graham's book The Intelligent Investor, a book lionized by Warren Buffett as the best book ever written on investing.

The call for this week: Breakout or fake-out? . . . It is the question du jour. We think that question will be answered during this less "noise-induced" week. We continue to believe the upside breakout by the major averages is likely a "fake out," which is why we remain cautious. That belief is reinforced by breakdowns in the market-leading Semiconductor Index (SOX) and NASDAQ 100 Index (NDX), as well as by the continual weakening of the market's internals. For example, while the DJIA rose to a new four and a half-year reaction-high last week, only four of the Dow's 30 components were at an equivalent new reaction high. Further, while the S&P 500 was up five days in a row, only 18% of the S&P's components were "up" for a concurrent skein of five days. Additionally, many of the "momentum stocks" have broken down badly and the markets are over-bought. As for last week's benign inflation statistics, and the raising of the debt ceiling, we have seen the truth and we don't believe it! Certainly in our world, inflation is running well above the official "core" rate of some 2%. And speaking to this country's burgeoning debt, again as Richard Russell notes, "In other words, this $8.2 trillion is the total amount of dollars owed to all holders of government debt instruments. Excluded from this total debt are all of the federal government's other liabilities, which total another $38 trillion. In The 2005 Financial Report of the United States Government, U.S. Comptroller General David Walker reported that 'the federal government's fiscal exposure now totals more than $46 trillion, up from $20 trillion in 2000.'" We have included two charts that speak to what is occurring on these fronts.


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