Jeff Saut: One-Day Reversal?
In this business price is reality since we are measured to the second decimal point every morning.
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.
"One-Day Reversals are not technical patterns suitable for trading in the same sense as the important reversal and consolidation pictures we have examined. They are mainly useful as a gauge in helping to find the precise top or bottom of a Minor move in order to protect profits on commitments previously made. The One-Day Reversal, the exhaustion gap, and day of exceptionally heavy volume following several days of movement in a minor trend, are strong indications that the move may have run out. Any of these three signals is worth watching for; any two of them together carry more weight than one alone; and the appearance of all three carries very strong implications of a Minor top or bottom."
- Technical Analysis of Stock Trends (Edwards and Magee)
I studied the book "Technical Analysis of Stock Trends" early in my career, encouraged by my father, who often opined, "The charts should be incorporated into any fundamental analysis because price is reality."
Indeed, in this business price is reality since we are measured to the second decimal point every morning; and last week's price action concerned me. To wit, I didn't care one whit when the D-J Industrial Average declined by nearly 300 points last Tuesday. What really bothered me was the concerted effort overnight by the world's central banks to re-liquify the system, and the fact that those efforts seemed to fail, as reflected by the equity markets' action the next day.
Verily, Wednesday's early morning response to the liquidification was to rally the DJIA nearly 300 points, which then peaked and started to slide, leaving the senior index better by a mere 41 points combined with poor market "internals." The resulting price action left what conspicuously looks like a one-day downside reversal in the charts. Moreover, that potential One-Day Reversal to the downside was accompanied by "heavy volume," thus meeting two of the potential three requirements mentioned in Edwards and Magee's legendary book.
I am always respectful of price and became increasingly concerned when Friday's Fade stopped me out of some of my "long" index trading positions. Further, it should be noted that Friday's Flop (-178) left the DJIA and the NASDAQ 100 (NDX) below their respective 50-day moving averages (DMAs).
Additionally, the D-J Transportation Average (DJTA, DTX) now resides below both its 50-DMA and 200-DMA, as do the S&P 500 (SPX), the S&P MidCap 400 (MID), the S&P SmallCap 600 (SML), and the Russell 2000 (RUT). Consequently, I am watching the DJIA's November low of 12743, and the DJTA's November low of 4366, as fail-safe points for my remaining trading positions.
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As for my investment positions, I was impressed with the Dollar Index's ability to rally in the face of last week's economic reports, reinforcing the strategy of reducing my long-standing anti-dollar "bets." To reiterate, I don't know if I am going to be bullish on the U.S. dollar for three weeks or three years, but I do know I no longer want to bearish on the greenback! The quid pro quo is that I continue to rebalance (read: sell partial positions) my beloved "stuff stocks" (energy, timber, cement, precious/base-metals, etc.).
Longer-term, I still like "stuff stocks" driven by the demand metrics fostered from the emerging markets.
Therefore, I am not rebalancing any of my "core" mutual fund holdings in names like Ivy Global Natural Resources Fund (IGNAX), which has gained 32% year-to-date. Near-term, however, I am worried that the "short" dollar, long "stuff stocks" trade has become entirely too crowded and continue to rebalance individual stocks accordingly.
So what else should I do? Well, since I have harvested (read: taken) numerous long-term capital gains by rebalancing many of my investment positions, I am looking to offset some of those gains by taking long-term losses in other situations that have not worked out so well. Granted, some of my "losers" will be sold for no apparent fundamental reason, but merely for tax purposes. Plainly this kind of tax avoidance strategy presents other investors with opportunities in various fundamentally sound situations. I think one such case is Outperform-rated VeriFone (PAY).
I have long prized VeriFone's business model, but have always considered it to be an expensive stock and thus never bought it. Recently, however, VeriFone's financials have been called into question with an attendant 50% share price decline. Recall that VeriFone Holdings, Inc. is a provider of technology that enables electronic payment transactions and value-added services at the point of sale. Its system solutions consist of point of sale electronic payment devices that run the company's and third-party operating systems, security and encryption software, and certified payment software, as well as third-party applications. Its system solutions process a range of payment types, including signature and personal identification number based debit cards, credit cards, contactless/radio frequency identification cards, smart cards, electronic bill payment, check authorization and conversion, signature capture and electronic benefits transfer.
I believe in VeriFone's favorable long-term business prospects and take the current management team at its word that the accounting irregularities announced on December 3 are limited to FY'07. Therefore, I think investors with a multi-year time horizon will be rewarded for purchasing shares of PAY. Last week my firm's analyst published his FY08 EPS estimate for VeriFone of $1.54, which assumes around 470 bp lower gross profit margin than previous estimates and includes $0.08 per share in incremental legal and accounting expenses related to the pending restatement.
If these assumptions are correct, at some point in the second half of FY'08, after the dust settles from the restatement and if the company regains its operational rhythm of outperforming consensus, shares of PAY could trade at a P/E multiple of 20x on current-year estimates (ex charges), or $32 per share. Historically, the transaction processing sector has traded within a 15-25x P/E multiple bandwidth on current year's earnings and enjoyed 15% EPS expansion, 10% top-line growth, and 20% operating margins.
As with Johnson & Johnson (JNJ) and General Electric (GE), I am using a tranche "in" strategy whereby I am recommending buying a one-third tranche and will look to buy additional tranches over the ensuing months until I achieve a "full" investment position. Indeed, for the well prepared investor, volatility affords opportunity. I continue to invest accordingly.
The call for this week: I have been constructive on stocks since the mid-August "lows." However, I turned cautious at the mid-September "highs," believing a downside retest of the August lows was in the offing. I got constructive again at the envisioned downside retest of those August "lows" in late-November, thinking the retest would be successful and said so in my firm's "Buy 'Em" report, dated 11/26/07.
Yet last week's One-Day Downside Reversal concerns me, which is why I am raising the stop-loss points on of my remaining trading positions. While the consensus believes last week's muted FOMC rate-rhetoric was the approximate cause for the stock market's decline, I think the week's stronger than expected economic reports suggest the Fed did the right thing. Manifestly, import prices surged 11.4% (y/y) and producer prices leaped 7.2% (y/y). The result left November consumer prices higher by 0.8% (month/month), following a 0.3% m/m rise in October, lifting the year-over-year inflation rate to 4.3% from 3.5%.
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However, taking these still understated, in my opinion, inflation figures at face value implies that the reported economic gains are not nearly as impressive as the headline figures suggest. For example, the recent 6.3% jump in retail sales becomes +2% in "real" terms when impacted for the 4.3% annual inflation rate (6.3% - 4.3% = 2%) as things continue to become curiouser and curiouser. Consequently, my motto remains what W. Wiley once said: "'Slow and steady wins the race.' Unfortunately, it seems we have a rather narrow-minded track coach."
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