Jeff Saut Presents: Minyans in the Mountains III
...if the investor or trader isn't in sync with the market, he is going to suffer losses.
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 itself determines the relative performance of all factors more accurately than any speculator can hope to interpret them." So said Don Guyon in One-way Pockets, a book written about Wall Street back in 1917. Nothing has really changed since then. Investors and traders can buy and sell based on their own interpretation of news events, but the market action itself determines the true trend and the most accurate interpretation. In other words, if the investor or trader isn't in sync with the market, he is going to suffer losses. So when the market speaks, if you wanna make money, you had better listen.
I began my keynote address at this year's Minyans in the Mountains with the above quote since the theme was "The Markets are Speaking, are You Listening?!" The confab was attended by some of Wall Street's "best and brightest," as well as 250 high-net worth retail investors, and was moderated by Barron's articulate Michael Santoli. While all of the conference's sessions were thought provoking, the question du jour was posed by Minyanville's founder Todd Harrison. Indeed, when asked on CNBC what the conference's intelligentsia were pondering, Todd responded:
"To understand where we currently are, we must fully understand how we got here because there is a huge difference between legitimate economic growth and massive debt-induced growth!"
And that, ladies and gentlemen, is a question investors should currently be considering. Another more tactical question was posed by market strategist Tony Dwyer, who suggested in the conference's last panel discussion, "The question investors should be asking themselves is if this is just a mid-cycle economic slowdown, or something worse?" In Tony's mind this is merely a mid-cycle slowdown with no recessionary overtones. The rest of the panel, however, was not so sanguine. Vicis Capital's co-founder John Succo framed the panel's discussion, much the same as Todd, by noting that there is a major difference between an income-driven economy, where incomes are re-invested, thus sustaining the economic expansion, and an asset-based economy that "feasts" on ever increasing debt. Also speaking on behalf of Vicis was Scott Reamer, who noted (as paraphrased by me):
The synchronized global credit-boom is ending. Such booms never end with a "pause" because you can't have a credit-boom without an ensuing credit-bust. You are seeing the "credit" stress-cracks more and more every month. And the idea that a failing consumer, who is 70% of the economy, is going to hand-off economic growth to a business capex spending-cycle just does not foot with reality, especially given the negative "knock on" effect that falling real estate prices are having on consumers' balance sheets. The consequence for the various markets is likely deflationary; however, the timing of such a deflationary event is difficult. Yet, this is what the markets seem to be sensing as "riskseeking" investors have become "risk-adverse" investors.
Then there was Greg Weldon, of Weldon Financial, who began by stating that while he had "no answers, that nevertheless after 36 years of credit-expansion the 'pain avoidance-driven' credit-expansion was coming to an end with unavoidable consequences." His advice: "protect yourself!" Chiming "in" on a more salubrious note, MacroMavens' insightful Stephanie Pomboy opined that fundamentals are only half of the investment equation and that investors also need to focus on liquidity. Plainly that is an observation not lost on my firm since we have been writing about the withdrawal of liquidity, by the world's central banks, since March of this year. Stephanie further noted that U.S. dollars, at the margin, are not coming back into the U.S. but are being held by oil-producing countries like Iran, Venezuela, etc. This is not an unimportant point, for as the astute GaveKal organization noted (again as paraphrased by me):
Re-cycled petrodollars tend to generate economic activity. However, as demonstrated by the Venezuelan President's (Hugo Chavez) recent whirlwind trip, he is buying weapons from Russia and China rather than reinvesting those petrodollars in economically productive projects that would spur economic growth.
Clearly, the same statement can be made about Iran . . . and don't look now, but the U.N.'s Iranian ultimatum date is rapidly approaching.
As for us, while we are eminently aware of the deflationary downside and are prepared to further hedge our portfolios against it (to some degree we already are hedged), deflation has historically been a "bad bet." Our now departed friend and mentor, Lucien Hooper, used to say, "betting on deflation is a once in a lifetime time bet and I don't make those kind of bets. It is much better to bet that the 'powers that be' will continue to debase the U.S. dollar with inflationary consequences. That has been the policy of the Federal Reserve since its creation in 1913." Consequently, we found ourselves most closely aligned with Thompson Financial's Director of Research, Michael Thompson. Panel member Thompson suggested that the fundamentals remain pretty good, although economic growth is indeed slowing. Yet, earnings look fairly strong for the next three to four quarters and valuations are not all that expensive. He does worry, however, if there is a psychological "investment shift" afoot that is contracting the valuation levels Wall Street is willing to pay for those future earnings.
Nevertheless, severe bear markets tend to be born of expensive valuations and negative earnings momentum, neither of which we see at this time. Nope, as stated at the conference, we think the economy is on a glide-path to "muddle" with a concurrent trading range for the major market averages. And that is why we continue to adhere to the strategy of our friends at Knott Capital Management, who believe that:
"Investors shouldn't have a highly optimistic or hardened pessimistic mindset. Proper sector-selection is the best tactic to achieve above-average investment results. We favor those industry groups where valuations are reasonable, pricing power is formidable, and earnings growth seems assured. We continue to sell-on-strength and buy-on-weakness. This defensive tactic is flexible and adjusts to the market's volatility. It also allows gains to accrue as 'money is taken off the table.'"
Like Charlie Knott, we too view "cash" as a viable asset class.
Consistent with these thoughts, as we have suggested all year, we think inflation is higher than stated and that will cause interest rates to rise by more than most think. In turn, that should bring out fallacious cries of a pending recession, which should give us a correction of more than just a few percentage points, setting up a decent "buying opportunity" for late summer or in the fall. Even after last week's conference we continue to feel this way.
In conclusion, as we promised the folks at the conference, here are two of the most important paragraphs ever written about investing (in our opinion), which we didn't get to include in our presentation due to time constraints. They were crafted by Edgar S. Genstein in the book Stock Profits Without Forecasting:
"During major sustained advances in stock prices, which usually occupy from five to seven years of each decade, the investor can complacently hold a list of stocks which are currently unpredictable. He doesn't worry about the top because he knows he is never going to sell at the top. He knows that the chances are overwhelming in favor of the assumption that he will get far better prices by waiting until after the top is passed and a probable reversal in trend can be identified than he will ever get by attempting to anticipate the top, and get out on the nose.
In my own experience the largest profits we have ever taken have come from stocks purchased while they were making a new high in a market which was also momentarily expecting the top. As I have already pointed out the absolute price of a stock is unimportant. It is the direction of the price movement that counts. It is always probable, but never certain, that the direction of the price movement will continue. Soon after it reverses is time enough to sell. You should sell when you wish you had sold sooner, never when you think the top has arrived. That way you will never get the very best price-by hindsight your individual transactions will never look daring. But some of your profits will be large; and your losses should be quite small. That is all that is necessary for a satisfactory, enriching investment performance."
The call for this week: Tony Dwyer is right, "The question investors should be asking themselves is if this is just a mid-cycle economic slowdown, or something worse?" While I think it is more than just a mid-cycle economic slowdown, I still don't see a severe recession, an opinion I have embraced since October 2001.Troubling, however, is the message from the D-J Transportation Average (DJTA), which has broken below its recent reaction low, as can be seen in the chart below (implication: economic weakness). If the D-J Industrial Average (DJIA) follows a similar pattern, we will once again have a Dow Theory "sell signal" like the one we wrote about in October 1999. Also troubling is the real estate chart below, which has foretold every economic slowdown since 1964. Consequently, we remain "predominantly defensive," to again use a phrase from Charlie Knott.
Source: Raymond James Research
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