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Jeff Saut: How To Survive In An Artificially Maintained Market


The equity markets are short-term oversold and looking for any reason to rally.


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.

"Washington policymakers and politicians need to stand back and let this adjustment play out. Yet the U.S. body politic is panicking in response – underwriting massive liquidity injections that produce another asset bubble and proposing fiscal pump-priming that would depress domestic saving even further. Such actions can only compound the problems that got America into this mess in the first place. . . . America's aversion toward saving did not appear out of thin air. Waves of asset appreciation – first equities and, more recently, residential property – convinced citizens that a new era was at hand. Reinforced by a monstrous bubble of cheap credit, there was little perceived need to save the old-fashioned way – out of income. Assets became the preferred vehicle of choice.

"With one bubble begetting another, America's imbalances rose to epic proportions. Despite generally sub-par income generation, private consumption soared to a record 72% of real gross domestic product in 2007. Household debt hit a record 133% of disposable personal income. And income-based measures of personal saving moved back into negative territory in late 2007. None of these trends is sustainable... It is going to be a very painful process to break the addiction to asset-led behavior. No one wants recessions, asset deflation and rising unemployment. But this has always been the potential endgame of a bubble-prone U.S. economy. The longer America puts off this reckoning, the steeper the ultimate price of adjustment. Tough as it is, the only sensible way out is to let markets lead the way. That is what the long overdue bursting of America's asset and credit bubbles is all about."

- Stephen Roach

As I read the aforementioned quote from Morgan Stanley's (MS) Stephen Roach in the recent Financial Times article titled "America's Inflated Asset Prices Must Fall," I reflected on the phrases "clearing price" and "cleaning price." Recall that these phrases were lionized by my friend and mentor Stan Salvigsen, of Comstock Partners fame, back in the 1980s. Stan often referred to the clearing price as the level on the upside when "sellers" overcame "buyers," causing the stock price to peak and then decline. The quid pro quo is that the cleaning price was where buyers overtook sellers and a downside cleaning-price "low" was established. For too many years the powers that be have prevented any such "cleaning price low" in many asset classes. We have seen this intervention repeated in recent years as the central banks, politicians, corporations, etc. have stepped in and prevented a downside adjustment that would have "cleansed" the environment.

It happened again last week as Bank America (BAC) "stepped in" and doubled down its $2 bln "bet" on Countrywide (CFC) to prevent what looked to me like a bankruptcy for Countrywide. As I read the headlines it conjured up memories of other "double down" speculators, like Nick Leeson, who broke Barings Bank, as well as the Nobel Laureates at Long Term Capital Management whose averaging down tactics nearly toppled the entire financial complex. Ladies and gentlemen, the financial markets are quite adroit at transferring money from the hands of uninformed participants to the hands of informed participants if given the opportunity to do so. However, over the past few years the free markets have not been given this opportunity.

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"It's not nice to fool Mother Nature;" nevertheless, the laws of "nature" were stifled again by Bank of America, and it would not surprise me to see the Federal Reserve try a similar tactic this week. To wit, rumors are swirling that the Fed is going to do an inter-meeting interest rate cut on worries about this year's market mauling. While Alan Greenspan was notorious for such cuts, I agree with Mr. Roach that "Washington policymakers and politicians need to stand back and let this adjustment play out." Moreover, Greenspan & Company achieved at least some shock value from such maneuvers since it was a surprise to the markets, and was therefore able to spark a mood change that often jolted markets for the better. However, given Ben Bernanke's testimony last week, clearly he is more than willing to cut interest rates at any time.

Consequently, I doubt an inter-meeting rate reduction would have much more than a very short-term market impact and might actually be viewed as a sign of panic. Whatever this week's outcome, I will be watching the antics from Canada.

Indeed, greetings from Victoria, British Columbia, where the skies are clear, the air is pure, and the people are great! I have been bullish on Canada for the past seven years, and remain so, yet even in this land of plenty there are signs that the U.S. "disease" is spreading to Canada. Verily, last week the Canadian government reported that November's building permits fell nearly 10% month-on-month, which was shockingly below expectations and a very poor comparison to October's 7.3% rise. Taken in concert with Canada's weakening employment statistics, it suggests Canada's economy may be slowing. I will be weaving my way throughout western Canada this week and will be reporting my observations in next week's letter.

As for the U.S. markets, every index I monitor (save the D-J Utilities) now resides not only below their respective December low (December Low Indicator says "watch out"), but their November lows as well.

Scarily, many of them have also traveled below their August reaction lows! Plainly, this is ugly action and reinforces my sense that we may be involved in a "selling stampede." Such stampedes typically run 17 – 25 sessions before they exhaust themselves on the downside and are only interrupted by one- to three-day counter trend pauses/rallies. If so, today would be day 12 in said stampede. Fortunately for me, I entered the year (2008) in "cautious mode" and sporting a heavy cash position. While only time will tell if this is a correct strategy, I remain cautious.

One index that is not falling, however, is the gold index (GLD), as it has broken out to new all-time highs. This is not an unimportant point, for as my firm's technical analyst, Art Huprich, noted in his insightful report last Friday:

"Here is a quote I recently read by W.D. Gann, considered by many professionals as one of the greatest commodity traders ever. He states: 'When a stock or commodity advances into new territory or to prices it has not reached for months or years, it shows that the force of driving power is working in that direction. It is the same principle as any other force which has been restrained and then breaks out. Water may be held back by a dam, but if it breaks through the dam, you would know that it would continue downward until it reaches another dam, or some obstruction or resistance which would stop it. Therefore, it is very important to watch old levels of stocks or commodities. The longer the time that elapses between the breaking into new territory, the greater the move you can expect because the accumulative energy over a long period will naturally produce larger movements than if it only accumulated during a short period of time.'"

I urge you to read the aforementioned quote again, particularly the line, "The longer the time that elapses between the breaking into new territory, the greater the move you can expect because the accumulative energy over a long period will naturally produce larger movements than if it only accumulated during a short period of time."

It has been roughly 30 years since gold has traded above $850 per ounce. Consequently, is there little doubt that a lot of "accumulative energy" has been stored up over that timeframe? Obviously, I am bullish on gold, as I have been for seven years. Regrettably, very few have heeded my bullish gold "call." Yet, I think it is not too late to invest in gold. In past missives I have mentioned numerous precious metals mutual funds, but recently have focused on the OCM Gold Fund (OCMGX). Consider this: The Fed started cutting interest rate on August 17, 2007. Since that time, OCMGX has appreciated by nearly 50% as of 1/08/08. Manifestly, I still like gold!

Another mutual fund that has treated me well over the years is Quaker Strategic (QUAGX), managed by the astute Manu Daftary. Conveniently, Mr. Daftary is conducting a conference call on January 24th, which I think will make informative listening. Likewise, MFS International Diversification Funds (MDIDX) has treated me well over the years and I continue to consider it a centerpiece for the international component in most portfolios.

In conclusion, I had an interesting conversation with the owner of a real estate appraisal business in the Tampa/Saint Petersburg area on Friday. He thinks the housing cycle is bottoming, as evidenced by a noticeable pick-up in his business. Since he is on the "front line," I listened to his cogent comments intently. While I remain skeptical of real estate, if you believe the cycle is bottoming, I would watch the exchange-traded fund "ProShares Ultra Real Estate Fund" (URE), which yields more than 6% and has good leverage on the upside.

The call for this week: It is apparent that the Fed, the Treasury Department, President Bush, Congress, the Central Banks, et al. are going to resort to almost any measure to prevent a downside "adjustment" and a recession. While it is suspect they will be successful, the equity markets are short-term oversold and looking for any reason to rally.

Interestingly, the Healthcare complex was one of the few sectors that lifted last week, helping my firm's positions in Johnson & Johnson (JNJ), and Pfizer (PFE). I continue to invest accordingly.


No positions in stocks mentioned.
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