Jeff Saut Presents: Electrifying
Despite spurious fundamentals, weakening economic statistics, sticky interest rates, and a deteriorating U.S. dollar, the Dow Delight has continued.
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.
"I was reading Lowell Miller's (Woodstock NY utility's manager par excellence) 1Q '07 report and ran across a rather amazing statement. He stated 'some observers have suggested that new electricity infrastructure expenditures (which create both regulated and unregulated returns on investment) over the next twenty years may equal the entire market capitalization of ALL investor owned US utilities.' Wow...I was wondering if you had any thoughts as to how we might profit!"
We have marveled at the relentless upward march of the DJIA over the past months as despite spurious fundamentals, weakening economic statistics, sticky interest rates, and a deteriorating U.S. dollar, the Dow Delight has continued.
Clearly, the weakening dollar has had a hand in equities' exuberance, for as the measuring stick declines (aka the dollar) the indexes by default should rise. Consequently, is it any wonder with the euro tagging new all-time highs versus the U.S. dollar that stocks would strengthen? Yet, when you change the DJIA's measuring stick from dollars to euros you get a whole different picture (as can be seen in the chart below). Nevertheless, where you stand is a function of where you sit, and measuring in U.S. dollars, the Dow's surge above 13,000 last week left Wall Street's admiration society at heroic proportions as no fear of triskaidekaphobia reigned.
The DJIA Denominated in Euros
The weekly wiggle left the senior index better by 1.23% and up 5.28% year-to-date. Interestingly, the lowly D-J Utility Average (DJUA) is up a large 14.80% year-to-date while sporting a dividend yield of 2.81%. Even more interesting, since the DJIA's low of 7198 in October 2002 (we were bullish) the senior index has gained roughly 82% into last Friday's closing price. Amazingly, however, the DJUA is up some 226% over that same timeframe, not to mention the additional 20% return garnered from its yearly dividend over those years. Even when measured in euros, the utilities' outperformance over the DJIA is stunning!
My firm has been bullish on utilities since October 2001 as an adjunct to our "stuff stock" and PUHCA (Public Utility Holding Company Act) themes so often mentioned in these missives. Verily, I have suggested that the 1800s was the century of coal, the 1900s was the century of crude oil, and that the new millennium was likely going to be the century of electricity. Manifestly, if the world is at, or past, crude oil's production peak (where we consume more oil than we can find), it implies there needs to be a massive reallocation of crude oil resources over the next few decades. Indeed, utility companies will need to shift their "feed stock" for producing electricity from oil to something else since oil will increasingly be needed for gasoline purposes because there are no near-term alternatives to sate the world's burgeoning gasoline needs. Now some will argue that ethanol, biofuels, etc. are the answer. While "some" are probably right over the next 50 years, over the next 20 years these technologies cannot possibly gain enough traction to significantly impact our gasoline need.
No, the only way out I envision is electricity and the manner in which electricity is produced. My firm's sense remains that natural gas, coal (clean coal technologies), and nuclear power are the only answers to this dilemma and we have invested accordingly. Problematically, given the U.S.' aged electric infrastructure, this tectonic shift is going to require a Herculean effort with a similar attendant cost. Indeed, consider that the majority of America's transmission lines, transformers, and circuit breakers are now more than 25 years old. Also consider that the personnel required to run such equipment are retiring in droves while new electrical engineers are lacking. More importantly, the U.S.' electric complex is still operating in an analog mode despite the fact that we have moved into the digital age. In a digital world, devices require a digital-quality power supply free of signal variations. Clearly, as the U.S.' digital society grows there will be increasing demands placed on the electric complex to stay apace.
In past reports I have suggested that with the repeal of the PUHCA laws there was likely going to be consolidation among utility companies to gain the critical mass necessary to accomplish what is needed. This consolidation theme has already benefited my firm's investment accounts with names like TXU's (TXU) recently proposed buyout. Yet, this consolidation theme still makes sense for investors. Names for your consideration that are rated Outperform by my firm's research correspondent include: Constellation Energy (CEG); DPL (DPL); Edison (EIX); and PEPCO (POM). For the non-stock specific investor I suggest considering the Eaton Vance Utilities Fund (EVTMX), which is Highly Recommended by my firm's Open-end Mutual Fund Research Department.
As for the utilities' infrastructure investments, over the past six years my firm has recommended many names that play to the reconstitution of the electric complex. While my firm has "cooled" on names like ABB Ltd. (ABB), given its rally from $2/share to $20, as well as ITC (ITC) on its rally since our recommendation, there are other names worthy of consideration. Again, Outperformed-rated names from Raymond James' research correspondents include: AES Corporation (AES); Cooper Industries (CBE); and Shaw Group (SGR). And from Raymond James' research universe, Houston Wire & Cable (HWCC) is interesting. Coincidentally, SPDR State Street Global Advisors recently penned a "Point of View" report titled "Infrastructure: The Next Big Emerging Asset Class" that is highly suggested reading.
Turning to the equity markets, as previously stated, my firm marvels at the relentless upward march of the DJIA over the past months. Despite spurious fundamentals, weakening economic statistics, sticky interest rates, and a deteriorating U.S. dollar, the Dow Delight has continued. Last week that upside "march" continued with new all-time highs for my firm's cumulative advance/decline figures despite seriously overbought readings from our overbought/oversold indicators. Still, the DJIA's strength was confirmed by D-J Transportation Average, the D–J Utility Average and finally - repeat finally - the Semiconductor Index (SOX) has broken out to the upside in the charts. The "all skate" environment has lifted valuations back to where they almost were at their peak as can be seen in the attendant chart of the ValueLine's median P/E ratio (the ValueLine Index is likely the BEST proxy for the average stock). This does not, however, mean stocks cannot travel higher, for as Lord Keynes noted, "The (stock) market can stay irrational longer than you can stay solvent!"
ValueLine Index, Median of Estimated P/E Ratios
The call for this week: Oscar Wilde once opined, "A cynic is a man who knows the price of everything and the value of nothing." Clearly, Wall Street knows the 13000 "price" of everything, yet we continue to search for the "value" of things. To this point, I am currently searching for values in the "fallen angles" universe of stocks. Two recent additions to this list have been Johnson & Johnson (JNJ), which fell 15% from its November 2006 high into its recent $60/share low where the shares possessed their highest free cash flow yield in 17 years of 6.6%. I also like the idea of searching for value in the "trashed" subprime complex where my vehicle of choice remains Quadra Realty (QRR), which is rated Outperform by my firm's research correspondent, for as that old Chinese proverb goes, "Out of adversity comes opportunity!"
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