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Jeff Saut Presents: Shipwrecked?!


We continue to feel the four-year cycle low comes later in the year.


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.

"The market, he had learned, was like the sea, to be respected and feared. You sail on its smooth surface on a placid mid-summer day; you were borne along by a favoring breeze; took a pleasant swim in its waters, and basked in the rays of the sun. Or you lolled in the quiet currents and dozed. A cold gust of wind brought you to, sharply – clouds gathered, the sun had gone – there were flashes of lightning and peals of thunder; the ocean was whipped into seething waves; your fragile craft was tossed about by heavy seas that broke over its sides. Half the crew was swept overboard . . . you were washed upon the shore . . . naked and exhausted you sank upon the beach, thankful for life itself . . ."

--"Memoirs of a Trader," from "Liar's Poker" by Michael Lewis

I begin this morning's missive with the above quote from "Liar's Poker" to kick off the debut of Pirates of the Caribbean: Dead Man's Chest, which set an all-time box-office record over the weekend. Certainly the Disney (DIS) organization is thrilled with the weekend box-office "take," as well as the roughly 25% year-to-date gain in its stock price. Yet while Disney's shares are doing great, most of the indices have not fared so well. Indeed, while the S&P 500 (SPX) is better by 1.38% for the year, many of the indices are negative. We had warned at year-end (2005) that 2006 was going to be a difficult investment environment and that sector/stock selection, combined with the discipline to manage risk (read: take losses quickly), would be the skill-sets needed to navigate this year's "heavy seas." Additionally, we advised participants from January into the mid-May "highs" to rebalance positions in their portfolios and hold the freed-up cash from those partial stock-sales in money market funds for the envisioned "buying" opportunities that should present themselves during late summer or early fall. Our mantra was:

"Inflation is likely higher than the politicos were telling us, which should cause interest rates to rise more than most think. And that will bring about cries that Mr. Bernanke is overdoing the monetary tightening, accompanied by fallacious (IMO) fears of recession, which should cause the equity markets to decline by more than just a few percent and give us a good buying opportunity in late-summer/early-fall, consistent with the four-year stock market cycle."

Well, foretold is forewarned, as Friday's economic numbers suggested a slowing economy, combined with the largest wage-rate jump in five years, causing one Wall Street wag to utter, "stagflation!" Hereto we wrote about the potential for "stagflation worries" over a year ago, although we placed the odds of such an environment at a mere 20%. However, the equity markets clearly pondered "stagflation" last Friday, causing a Dow Dive of 134 points. Last Friday's flop left participants wondering if this was the start of the downside retest of the mid-June lows we have been talking about. We think the odds favor such a retest and evidently we are not the only ones, for as the invaluable folks at note, "The S&P 500 is caught between the 50 (1273) and 200-day (1263) moving averages. While 1290 to 1295 is still a possibility, we would not be surprised to see another break of the 200-DMA and a retest of the most recent lows (1223–1230). We continue to feel the four-year cycle low comes later in the year." Also adding to the "retest chorus" was Lowry's weekend comments. To wit:

"If the current rally is the start of a broad, sustained market advance, then the Buying Power Index should be in a strong uptrend pattern, reaching new rally highs ahead of the major prices indexes, and the Selling Pressure Index should be dropping rapidly. But, that has not been the case. Since the rally attempt began on June 14th, the Selling Pressure Index has moved essentially sideways within a relatively narrow range, indicating that the desire to sell has not been exhausted; rather, sellers seem to have simply held back on selling temporarily, perhaps to take advantage of the rally. At the same time, the Buying Power Index has dropped to new multi-year lows again this week, show that buying interest has been drying up as the rally has proceeded. . . . Rallies occurring in the face of weakening demand are usually short-lived."

"Short-lived" indeed, for our "buy 'em" trading-call of June 13th has now seen all of our trading
recommendations stopped-out (read: sold), with decent profits, leaving the trading side of the portfolio back in an all-cash position. What the good folks at Lowry's didn't say in their weekend comments was that the Buying Power Index reached a new 15-year low last week (my mistake, they referenced that in the charts later in their weekend report).

Obviously we agree with the view that a retest of the recent lows is in order, having repeatedly opined that the typical bottoming sequence calls for a trading low, followed by a rally, and then a subsequent retest of those trading lows. If that downside retest is successful, then a decent rally can commence. At this time, however, it is unknowable if any retest will be successful, or if the mid-June lows will be decisively broken, leading to a more meaningful decline. And that, ladies and gentlemen, is why we have been husbanding cash all year, including even selling partial positions in our beloved "stuff stocks."

Regarding said "stuff stocks" (oil, gas, coal, timber, cement, fertilizer, agriculture, base metals, precious metals, etc.), while we remain long-term "bulls," even here the near-term situation is clouded. For example, last week crude oil tagged a new, all-time, price-high of $75.78 per barrel. Amazingly, however, natural gas simultaneously recorded a new post-2005 hurricane season price-low of $5.47. Meanwhile, aluminum was down 1.2% for the week, yet nickel rallied 14.5%! And, while gold gained 2.9% for the week, platinum was nearly unchanged. Interestingly, the Gold Bugs Index (HUI) and the Gold & Silver Index (XAU) have both traced out in the charts what is potentially a near-term head-and-shoulders "topping" things get "curiouser and curiouser," to steal a line from "Through the Looking Glass."

Consequently, we remain defensively postured in accord with our 2006 strategy, "Better to lose face and save skin!" We continue to invest and trade accordingly.

The call for this week: Well, the holiday-shortened week is over and it will be interesting to see what the various markets do now that the "players" have returned. While we are hoping for the best, we are prepared for the worst for as Lowry's concludes, "There has been no significant change in the character of the DJI's rally over the past week, which appears to be based more on a withdrawal of Supply than an increase in Demand. As such, the rally appears more typical of a correction in an ongoing downtrend than the early phase of a major move higher."

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