Jeff Saut: It's My Party...
All of the rally attempts since mid-September have been characterized by poor breadth, low volume, increased selling pressure, and decreased buying power.
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.
"It's my party, and I'll cry if I want to. Cry if I want to, cry if I want to. You would cry too if it happened to you."
- It's My Party (Shapiro/Gore)
And tears reigned on the Street of Dreams on Friday as the guests assembled for the 20th anniversary of the 1987 Crash. First "up" was Warren Buffet, who is cautious on the equity markets and opined that despite Countrywide Financial's (CFC) 60% price decline its shares are still not cheap. Next was hedge fund manager Julian Robertson warning that the upcoming recession was going to be a "doozy."
Then Bob Prechter of Elliott Wave fame suggested putting all your money under the mattress (buy T'bills) because things are going to get really bad. And that caused one old Wall Street wag to lament, "Oh Mr. Prechter, how I hate thee... let me count the 'waves'!"
Batting clean-up was Big Ben and the Fed Head's comments were anything but soothing for the equity markets. Pile on a trifecta of earnings warnings from Honeywell (HON), 3M (MMM), and Caterpillar (CAT) and was it any wonder the doleful Dow dove 367 points? Indeed, it's my party and I'll cry if I want to!
Readers of these missives, however, should not have been surprised by Friday's Flop since my firm has counseled for caution since mid-September when I wrote:
"Consistent with these thoughts, I am on 'hold' in the trading account, as well as the investment account, on a short-term basis. While bullish since the August lows, I have always maintained that bottoms tend to be a process involving both price and time. Potentially we have met the "price" requirement given the 20-session, 10% correction, "selling stampede" that culminated on August 16th. That is why I am treating the August lows as an "internal low" until proven wrong. It is now the 'time' component that I am contemplating. As previously noted, the 1990 and 1998 correction-sequences saw prices peaking in July, declining into August, and then rallying sharply before retesting those August lows in the September/October timeframe. Whether it plays that way this time remains to be seen, but I am cautious."
At the time the DJIA was changing hands around the 14,000 level, and despite a lot of bobbing and weaving, I don't know a whole lot of participants that have made much money since the ides of September. Indeed, the time to be aggressively bullish was in mid-August, not following a 1,500-point Dow Wow.
That said, my firm did recommend a couple of trading ideas late last week. As stated, the two things most "talking heads" have been chirping about recently is oil going to $100 per barrel and the U.S. dollar going lower. The pile-on effect of the ubiquity of these opinions left "long" oil / "short" the dollar very crowded trades. Therefore, on Thursday my firm recommended that traders take the other side of these trades on a short-term basis. Indeed, into last weekend's G-7 meeting I suggested the subsequent rhetoric would likely be an attempt to talk-up the battered buck. If that happens, overbought crude oil should weaken.
My firm's vehicles of choice were to go long the PowerShares DB US Dollar Bullish Fund (UUP), as well as "longing" the Claymore MACROshares Oil Down Tradeable Shares (DCR). "If," my firm said, "These trades are not working by Monday afternoon, or Tuesday at the latest, participants should exit them hopefully with small losses. Almost immediately the phones "lit up" with folks exclaiming that DCR was trading at a substantial premium and that I would be better off longing the ProShares Ultra Short Oil & Gas (DUG).
While that's probably true, my firm doesn't really care which vehicles are used. It is the idea of being long the dollar and short crude oil that I think is important. To be sure, Wall Street spends inordinate amounts of money in an attempt to find the coal stock that is going to outperform all of the other coal stocks. However, the real insight was knowing you needed to own some coal stocks four years ago. Clearly there are coal stocks that have outperformed my firm's, yet I am pretty happy with the ones I have embraced over the past four years. So, I'll say it again: "It is the idea of being long the dollar and short crude oil that I think is important"... at least on a short-term trading basis.
As for the equity markets, last week was pretty brutal with all the major indices my firm follows suffering substantial losses. I have been warning of such an environment, having discussed the mounting upside nonconfirmations in various indexes, and cautionary "finger to wallet" indicators, since mid-September. Still, even though my firm was prepared for a decline, its portfolios got "nicked" last week. Typically, following a session like Friday, one would expect a down Monday morning opening, followed by a rally attempt that fails to gain much traction, leading to a downside wash-out (and trading bottom) into Tuesday's session. Whether that pattern plays this time only time will tell, but I remain cautious. My worries center not so much on the burgeoning sub-prime contagion and attendant seizure of the asset-backed commercial paper (ABCP) markets, but rather the over-spent, under-saved U.S. consumer and the possibility that we are at a peak in the credit cycle.
Over the past few months credit card debt has risen noticeably. Ladies and gentlemen, when you have borrowed all the money you can against your first house, second house, 401(k), etc., the lender of last resort becomes by default credit cards. The inference is that U.S. consumers may be tapping their last source of cash. Unsurprisingly, the U.S. economy, which is two-thirds driven by the consumer, has become dependent on ever increasing credit expansion. In fact, according to certain savvy seers, beginning somewhere in the early 1990s consumers' "new debt" exceeded operating cash flow (read: income) as the source of new cash. That ratio has increased whereby last year it is estimated that households depended on "new debt" for nearly 90% of new cash flow. If correct, this begs the question: Is the real economy sated with debt? Clearly that's an intriguing question, for it implies that the Federal Reserve could just be "pushing on a string" in that no matter what the interest rate the consumer doesn't want any more debt. To a debt-driven economy the result would be obvious.
Consistent with these thoughts, I continue to underweight most sectors/stocks that are consumer-centric. Rather, I continue to like themes that should "play" irrespective of if the collateral crunch morphs into an honest to gosh credit crunch, which then has the potential of spilling over into a recession. In addition to themes like rebuilding the U.S.' aged electric complex and water infrastructure, I have invested in the defense and security arena for more than five years. And, investor appetite in the security arena continues to build as investors look to position portfolios in front of the 2008 elections, as business models in the sector mature, and as the cycle of security spending gradually gathers momentum. However, volatility remains a constant with the group. Companies supplying products to support the war have fared the best, followed by those with upcoming product or program cycles. Interestingly, in light of Friday's crashette (-367 DJIA points), a pattern has emerged where stock sell-offs are sharp on disappointing news but the ground is quickly retraced. Therefore, I see "buying dips" as a key strategy to outperform the sector and the overall market.
Spending on products suited for deployed troops in harm's way remained the most dominant spending driver for the group. Companies such as FLIR (FLIR) and AeroVironment (AVAV) continued to see strong order flow, deliver strong results, and have exceptionally optimistic outlooks for 2008. FLIR will almost certainly exceed consensus estimates next year and has positive announcements pending, while AeroVironment has the potential to do the same. Consequently, situations like these should be on your "watch list" for potential purchase should Friday's decline extend into a more serious correction.
The call for this week: Last Wednesday the DJIA's point and figure chart registered a short-term "sell signal." That signal was confirmed on Friday when the Dow closed below its 50-day moving average (at 13,558) and in the process recorded a classic "90% down-day." This should come as no surprise because all of the rally attempts since mid-September have been characterized by poor breadth, low volume, increased selling pressure, and decreased buying power.
Meanwhile, all of the gold indexes my firm follow's broke out to the upside last week. The whole affair is eerily similar to the 1987 Crash, which is why on Friday I reviewed notes from October 19, 1987. As stated, the pattern back then was a down opening, followed by a rally attempt that failed to gain much traction, leading to a downside wash-out (and trading bottom) into Tuesday's session. Other notes to myself on that fateful day included:
1) Today is a day to be experienced and not understood.
2) How do we make money from congressional investigations into the stock market crash?
3) The markets are taking no prisoners.
4) Mutual funds can't price their funds due to "locked markets" in individual stocks.
5) This is like the President Kennedy "steel crisis" in 1962, not 1929.
6) Is it possible to have an entire bear market in just 15 sessions?
Copyright 2011 Minyanville Media, Inc. All Rights Reserved.
Daily Recap Newsletter