Jeff Saut Presents: War Market History
Whatever the outcome, our sense remains that the various markets will revert to a focus on the issues evident prior to the recent hostilities.
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.
"A scorpion needing to cross a body of water asks a frog to carry him on his back. The frog demurs: 'Absolutely not. You'll sting me and I'll die.' 'Don't be silly,' replies the scorpion. 'If I sting you, we'll both die.' Halfway over the scorpion stings the frog. 'Why have you done this?' cries the frog. 'Now I'll die and you will drown.' 'Don't you know that this is the Middle East?' replies the scorpion."
. . . Anonymous
Scorpion Hezbollah? . . . Well, maybe because just like the frog didn't understand the scorpion's actions in the aforementioned allegory, we don't understand Hezbollah's actions. As suggested in last week's missive, "we can't fathom what Hezbollah's goal was in inflaming Israel to the point of war that threatens Hezbollah's very existence. Typically such actions have an objective, but in this case Hezbollah's actions make no sense to us. I mean, what do they win . . . what is their goal?! And evidently I am not the only one in wonderment because the silence from most of the Arab-speaking world remains deafening!"
Almost on cue, the insightful folks at "The Stratfor Organization" responded. To paraphrase some of their thought-provoking gleanings:
The founders of Hezbollah have aged over the last 20 years and become wealthy, as well as ensconced in the Lebanese political process. Consequently, they are less adventuresome than they were in the past, begging the question, "Why are they (Hezbollah) increasing tensions with Israel and inviting an invasion that threatens their very lives?" To answer that question Stratfor outlines the history of Hezbollah that began as an alternative to the Nasserite Fatah movement (PLO), which split the Shiite community in Lebanon (Sunnis and Christians). More importantly, however, Hezbollah engaged the Israelis. Hezbollah, they note, is supported by Iran (radically Islamist), as well as Syria (secular and socialist). "They both share an anti-Zionist ideology, but beyond that, not much more." Strategically Hezbollah is aligned with Iran, but tactically it is aligned with Syria. When the Israelis withdrew from the Lebanese-occupied lands acquired in the war of decades ago, it was with the understanding that a Syrian-dominated Lebanon would maintain a security regime that controlled Hezbollah. The emergence of Hamas, however, destabilized the situation, catapulting Hamas into a leadership role. With the death of Arafat everything collapsed into a struggle for power between Hamas and Hezbollah. "At the same time the Iranians were deeply involved in negotiation over Tehran's nuclear program. They wanted as many levers as they could find to use in negotiations against the United States. They already had the ability to destabilize Iraq."
In conclusion, Stratfor states that Hezbollah knows one thing – that America does not know how to handle captives and therefore Hezbollah is likely to take captives in the current conflict. And there you have it, as poorly reprised by us. A much better version of the report can be obtained from the Stratfor website (www.stratfor.com).
As for the implications for our equity markets, as stated, "the situation, in our opinion, is currently not analyzable given the many moving parts," which is why we are holding out-sized positions of cash in both the investment account and the trading account. We have, however, included in this morning's report a chart of the timeline following previous conflicts and would note that historically the economic consequences of most post-war events prove to be unimportant. In the present example, the worst case would undoubtedly be a lengthy war in concert with a severe economic contraction. Whereas a short war, with a quick victory, would no doubt have a very positive effect on consumer confidence.
Whatever the outcome, our sense remains that the various markets will revert to a focus on the issues evident prior to the recent hostilities. Those issues remain a softening real estate market, rising interest rates, high energy prices, inflation, a weakening dollar, P/E multiple compressions, waning earnings momentum, weakening consumer spending, flat wage growth, and declining GDP momentum. And to that GDP point, it is worth nothing that while we have a healthy distrust of the government's measuring metrics, the one thing you can trust is tax receipts. And surprisingly, tax receipts are growing at around 10%. Ladies and gentlemen, 10% growth in tax receipts just does not "foot" with 2.5% GDP growth. "Somebody" is lying! Either tax receipts are getting ready to collapse, or the economy is going to continue to surprise on the upside. If economic strength is the "call," then while the Fed may pause at its August meeting, it is certainly not done with its parade of rate ratchets. If, on the other hand, the economic slowing is about to accelerate, the concurrent loss of earnings momentum is not a particularly pleasant environment for stocks.
As for the ubiquitous argument that stock P/E multiples are cheap based on forward-looking earnings estimates, hereto we are skeptical. Indeed, P/E ratios on forward-looking earnings are almost always lower, making stocks look undervalued. That was the case in 2000, 2001, 2002, etc. It is just the nature of Wall Street to overestimate earnings. Yet, the real driver of stock prices is what investors are willing to pay for those earnings, and as we have suggested for the past few years, P/E multiples are compressing due to rising inflation and rising interest rates. And that is why, despite double-digit earnings growth as measured by the S&P 500, stocks have gone nowhere for the past few years. That said, there is always a bull market somewhere and for the past few years we have suggested it was in small/mid-capitalization stocks, "stuff stocks," Japan, Canada, emerging markets, etc.
Turning to the charts, last week the DJIA briefly recaptured its 200-day moving average (DMA) at 10,943, but failed to hold above it. Meanwhile the S&P 500 (SPX) could not better its respective 200-DMA (1264) and remains negatively configured as its 50-DMA (1260) crossed below its 200-DMA. And don't look now, but the NASDAQ 100 (NDX) made a new yearly reaction low. Yet by far the most disturbing weekly event was the D-J Transportation Average's (DJTA) 205-point Thursday tumble. This is significant because the Transports represent "things" being moved around the country. The inference is that the economy is cooling off and maybe, just maybe, the overspent/undersaved American consumer is finally running out of "gas." This view is reinforced by chart breakdowns in the Retail Holders (RTH), the Housing Index (HGX), the Consumer Discretionary SPDR (XLY), as well as many of the marquee retail stocks.
Nevertheless, along the "there is always a bull market somewhere" line, we continue to think Japan is in a secular bull market, a view we have held since the spring of 2003. Given the Japanese iShare's (EWJ) 20% decline from its May highs, as well as the Japan Small Cap Fund's (JOF) 33% decline, we think those investors not exposed to Japan can began a scale-buying approach using these investment vehicles. We also think aerospace, energy, and water are in bull markets and would use the same scale-buying strategy for the PowerShares Aerospace and Defense (PPA), the PowerShares Water (PHO), and 5.9%-yielding Blackrock Global Energy Fund (BGR), which is selling at a 13% discount to its net asset value. Another name we have favored over the past few months has been UnitedHealth (UNH), which reported better than expected earnings last week. For further information on UNH, please see our healthcare team's recent report. As well, our positive view of one of our correspondents, namely Lehman's "10 Uncommon Values" Intuit (INTU), was reinforced last week by a competitor's upgrade to an Outperform rating.
The call for this week: "When the going gets tough the tough go on the road," which is why we were speaking at a conference last week and are on our way to Alberta, Canada this week. Despite the fact that the DJIA tested, and held, its May lows last week, we remain cautious. Indeed, not even last Wednesday's +213-point Dow Wow could stop Lowry's Buying Power Index from sinking to another multi-year low, indicating that demand for stocks continues to wane. We continue to invest, and trade, accordingly.
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