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Jeff Saut Presents: Thriller?!


What defines a well-prepared investor?


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.

"It's close to midnight and something evil's lurking in the dark
Under the moonlight you see a sight that almost stops your heart
You try to scream but terror takes the sound before you make it
You start to freeze as horror looks you right between the eyes,
You're paralyzed."

. . . Michael Jackson

"Thriller" was the 1983 smash hit by Michael Jackson from the album of that same name. Yet, "Thriller" is also how investors should feel about the "Something evil's lurking in the dark" price declines we have seen over the past five weeks. We are certainly "thrilled," for said decline presents the "well-prepared investor" with opportunities! Or as that old stock market axiom goes, "When prices are high they want to buy, when prices are low they let them go." That mass-psychology mind-set was reprised in our strategy report dated May 15, 2006 and titled "Circle Completed?!" To wit:

Plainly, in mid-May "THEY wanted to buy." However, we adhered to our proprietary indicators that repeatedly showed the equity markets' "internals" had been deteriorating since January. Now, when "prices are low, they want to let them go." Meanwhile, like last October, we have gotten our "Buy List" together since hopefully we are a "well-prepared investor." And that begs the question, "What defines a well-prepared investor?"

By our pencil, the well-prepared investor is one that rebalances their portfolio when prices are "high" and sits on those "freed up" gains until once again prices are "low." That strategy hopefully provides the "margin of safety" cash-cushion that Benjamin Graham described in the last chapter of his legendary book The Intelligent Investor. Manifestly, the well-prepared investor is a realist and knows "trees" do not grow to the sky. For example, we have been steadfastly bullish on "stuff stocks" since October of 2001 (oil, gas, coal, timber, agriculture, fertilizer, water, cement, base/precious-metals, timber, etc.). Fortunately, the gains in those stuff-stocks, preferably ones with a yield, grew into oversized "bets" in portfolios by 4Q05.
Consequently, we entered 2006 noting that the accrued capital gains in our "stuff stocks" left them wickedly over-weighted in portfolios and therefore recommended that these stocks be increasingly rebalanced (read: be a scale-up seller of partial positions, but do not lose your long-term "core" positions).

That rebalancing strategy has allowed long-term profits to accrue to our portfolios. Year-to-date we have been holding those accrued gains in "cash" since we thought the equity markets peaked last January. While that view was true for many of the indices (NDX, SOX, HGX, HHH, GSO, etc.), it was blatantly untrue for the DJIA, the S&P 500, and the Russell 2000. Still, we have continued to husband "cash," believing the stock market was setting up for its first 10% correction since 1Q03. That's why we have been holding "cash," for unlike most we consider cash an asset class unto itself. Indeed, to assume that all of the investment opportunities that present themselves today are as good (or better) than the opportunities that will present themselves next week, next month, next quarter, etc. is naïve and investors need "cash" to take advantage of those future opportunities. While we are holding a lot of our cash in money market funds currently, we have also used what we consider to be certain cash-alternatives like FAX, ICPHX, FCO, and FCT, especially when their share prices pull back to support levels.

Unsurprisingly, the unprepared investor has recently been "dancing" to the last line of our opening quote, "You start to freeze as horror looks you right between the eyes, you're paralyzed." Paralyzed indeed, for the 22-session selling-stampede has been a "democratic decline," trapping the unprepared investor with losses in just about every asset class, including our beloved stuff-stocks. That decline has left many participants "paralyzed" like deer frozen in the headlights of a car. So where are we in the current selling-stampede skein?

Well, it is day 22 in the envisioned 17- to 25-session selling-squall and we think the equity markets are attempting to bottom. By our pencil the Federal Reserve news is past its emotional bearish-peak given Ben Bernanke's "Dr. Jekyll / Mr. Hyde" switcheroo (aka, dove to hawk). That sense was reinforced last week when the 20-year T'Bond broke out to the upside, suggesting lower interest rates. As well, we think the geopolitical emotional bearish-peak is behind us with the "let's make friends" Iranian proposal, combined with the Zarqawi "bombshell," so the only item left in the typical bottoming sequence is a "body" . . . hello Long Term Capital Management! Hopefully a "body" will surface this week concurrent with either a successful retest of last week's lows (SPX 1235; DJIA 10757; NDX 1526; etc.), or even better, lower lows driven by MUCH higher than expected inflation figures this week. In any event, like last October, we have pulled our "buy list" together and are pretty "thrilled" about being able to become an aggressive buyer of stocks again after being pretty cautious since mid-January. One of the stocks on our buy list is Strong Buy-rated Intermec, which is a leading manufacturer of bar code, wireless, and RFID (Radio Frequency Identification) systems. With the RFID industry expected to grow from a $100-million business in 2005 to a $5-billion business in 2009, mandated by behemoths like Wal-Mart (WMT) and the Department of Defense, growth prospects look favorable for the few companies in this space.

The call for this week: "It's a Thriller," at least for us, since we have been holding outsized portions of cash for the past few months and are "thrilled" about once again being able to get our "Buy Lists" together. For the record, we think long-term interest rates are going to trade lower in the near-term, ditto precious metal prices. On the Precious metals, however, we remain longer-term "secular" bulls. We also think, counter intuitive as is seems, the dollar trades higher in a counter-trend rally. As for the equity markets, last week the DJIA and the D-J Transportation Average (DJTA) registered simultaneous new reaction lows and, in the process, broke below MAJOR bottoms in the point and figure charts. Consequently, just like a heart attack patient doesn't get right out of bed and run the 100-yard dash, we don't think the equity market will do that either. Or as one savvy seer said, "Patience, Jeff, is currently the rarest thing on the Street of Dreams." We continue to invest, and trade, accordingly.

P.S. – Today's bonus question is, "If inflation worries are the causa proxima for the equity markets' demise, why are commodities crashing (inflation should be good for commodities) and why are bonds (TLT) rallying (inflation should be bad for bonds)?"


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