Jeff Saut: Survive the Spring
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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.
"As long as the roots are not severed, there will be growth in the spring."
- Chauncey "The Gardener" (Being There)
For the past few years, as spring has sprung and market pundits have expressed conviction about a return to robust economic growth, we have referenced the book "Being There" by author Jerzy Kosinski.
The story revolves around a simple-minded man named Chance "The Gardener," who knows only gardening and what he sees on television. Indeed, for his whole adult life Chance has not ventured outside the grounds of his employer's Washington D.C. manor. Eventually, however, the employer dies and Chance is cast out onto the streets, where through a mishap he encounters the wife of a D.C. powerbroker. Thinking her car was the reason for the mishap, she insists that Chance, "the gardener," who she interprets to be Chauncey Gardiner, come with her to her husband's estate. Benjamin Rand (the husband) is completely taken with Chauncey's simple, direct approach, and mistakenly attaches profundities to Chauncey's ramblings about gardening. Viewing him somewhat as a savant, Rand introduces Chauncey to Washington's elite, including the President. In one verbal exchange regarding current economic conditions Chauncey remarks, "As long as the roots are not severed there will be growth in the spring."
Well, here we are. It's spring again, yet this year instead of the typical cries of "As long as the roots are not severed there will be growth," many Wall Street pundits are worried. Their worries center on the worsening housing/real-estate situation, and the resultant financial debacle, which has been magnified by the overleveraged weaving of mortgages into a spider web of recondite structured investment vehicles, or SIVs. As housing prices have fallen, and foreclosures have risen, said vehicles have collapsed with an attendant hit to the financial sector's balance sheets that is now legend. Consequently, many financial institutions are currently in a "capital building" phase as they re-liquefy their balance sheets, implying major dilution for existing shareholders. Clearly, this is a negative backdrop for investing in the financial sector. I spoke of another negative implication for the sector in last week's missive. To wit:
"Focusing on individual bank stocks (to buy) might be a bit myopic when the potential 'real' insight is that the past 28 years of financial market deregulation has reversed. Plainly something has changed, and changed materially. To be sure, the tidal wave of "zaitechism" began reversing with SARBOX and the reversal has been accelerating ever since. Recently the ebb tide has turned into a 'rip tide' as the spider web of financial engineering (our Japanese friends call it "zaitech") was exposed by the collapse of many toxically structured investment vehicles (SIVs, SPIVs, VIEs, etc.) and punctuated by Bear Stearns' (BSC)bouleversement. Consequently, the tide is now flowing out after nearly three decades of financialization, which will no doubt crimp financial sector profitability with a concurrent compression in P/E multiples."
Fortunately, I've been way under-weighted in the financials for years, and have totally avoided investing in the large-cap banks for nearly ten years. Regrettably, I still feel that way despite the fact the financials could have a pretty decent trading rally as the short-sellers cover their shorts driven by the steepening yield curve. Indeed, many of the financial-related exchange-traded funds (ETFs) have broken out to the upside in the charts, and in the process, closed above their respective 50-day moving averages (DMAs). Clearly this is a positive development. Similarly, many of the housing-related ETFs have done the same amid the near ubiquitous disbelief that this was impossible. While I agree that longer-term, such rallies are likely a "bull trap," and that the fundamentals will worsen, in the near-term I expect the price strength to extend.
That same disbelief is rampant with regards to the major market averages, yet hereto I'm short-term positive. Manifestly, I turned bullish at the January 2007 "lows," cautious at the subsequent February "highs," and aggressively bullish on the March downside re-test of those January "lows," believing the re-test would be successful and that the ensuing rally would carry the averages above the February highs, eventually scooting into the 1400s basis the S&P 500 (SPX). From there, if the envisioned pattern continues to play, we should see a decline. To reiterate, that decline should be measured by "if" the U.S. economy spills into a recession (we seem to be the only ones left that doubt it); and that then, the extent of the decline should be measured by if the recession is short-and-shallow or long-and-deep.
To take advantage of the aforementioned potential stock market pattern, I've recommended numerous trading and investment positions. Speaking to the trading positions, I've continued to move stop-loss points "higher" as the rally has progressed; and would look to sell many of these positions into any "blue heat" upside type of hour toward SPX 1440. As for investment positions, while some of my recommendations have been stopped-out (read: sold), due to my "sell discipline" designed to manage the downside risk, others have done just fine. One that did okay until last Friday's earnings "hairball" was Microsoft (MSFT). I've often spoken about MSFT since hearing its story (see previous missives) from a particularly prescient portfolio manager (PM) at my March institutional conference. At the time the shares were changing hands around $28. If participants followed my strategy of scale-buying, they should have an average-weighted cost basis of around $29. Given that my fundamental research correspondents are rethinking their ratings, I'm using a $26 stop-loss point for this investment recommendation.
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