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Jeff Saut: Wait For Your Pitch


Opportunities abound if you're patient.


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.

"Humans suffer from an activity bias. Inactivity embarrasses us. When there are problems, our instinct is not just to stand there, but to do something... This (feeling) is universal: in baseball batters often prefer to go down swinging, even when the percentages suggest their best bet is to leave the bat on their shoulders and see if they can force the pitcher into giving them a walk. Again, it is very embarrassing to strike out with the bat on your shoulder. In sport, you can capitalize on these insights. If you take a penalty, you can kick it straight in front of you. Similarly, in investment, there is an activity bias, which creates opportunities for those who resist it."
--John Authers, The Financial Times

Warren Buffett has often quoted legendary baseball player Ted Williams, who stated, "Waiting for the right pitch is the most important thing for a batter." Of course, Mr. Buffett modifies Williams' quote for the investing world by noting, "There are no called strikes so you can watch stocks come by and wait and wait until the right pitch and no one is going to call a strike (on you)." Buffett goes on to say, "Wait for the fat pitch and then swing for the fences!"

And last week the Oracle of Omaha "swung," as the 77-year old investor disclosed that he has become the largest shareholder of Kraft (KFT), as well as offering to take $800 billion of municipal bonds off of the books of troubled insurers. While these moves are anything but altruistic, we do find it interesting that after years of lamenting there was a lack of attractive investment opportunities, Mr. B has suddenly sprung into action.

Clearly I am no Warren Buffett, yet I have managed to learn "patience" over the years, often commenting that, "The rarest thing on Wall Street is patience!" Indeed, for the well prepared investor volatility breeds opportunity if one has the patience to wait for a "fat pitch." Plainly, we have demonstrated patience by entering the new year in a cautious mode and waiting until the January "lows" to scale into some tactical trading positions. While the initial lift off of those lows afforded some respectable profits, the subsequent market machinations have left us with only marginal trading profits currently. Still, my firm is treating those January 22nd and 23rd price-lows as "internal lows" until proven wrong and think if the DJIA can better 12750, the chart configuration will look decidedly better. Reinforcing our bullish bias was a recent "buy signal" from one of our proprietary indicators. In the history of such signals there is no precedent for a major collapse following said signal in its 30-year history.

As for the strategic - or investment - account, hereto we have tried to demonstrate patience and discipline. First by rebalancing most of our long-term "stuff stock" positions (read: sold partial positions) even though we continue to embrace the stuff-stock theme. We have also demonstrated patience by avoiding big cap pharma for years until the past few quarters. Our recent "warming" to pharma shares is driven by the fact that they are cheap relative to the equity markets, cheap relative unto themselves, and cheap on their respective dividend yields. Moreover, even though we continue to think the U.S. economy will avoid a recession, it is worth considering that in the past four recessions consumer staples, healthcare, and materials have shown the best returns six months prior to the start of the recession, while financials, IT, and telecom have fared the worst.

My firm began its foray into pharma by recommending Johnson & Johnson (JNJ) and Pfizer (PFE). So far, two scale "in" purchases (or tranches) have been made and we are about at a breakeven point on these two names. More recently, we recommended Schering Plough (SGP) given the common shares' 45% price concession on what we consider to be a "one-off" event. In this case, however, we used Schering Plough's 7%+ yielding convertible preferred "B" shares (terms should be checked before purchase).

And, last week my firm "warmed" to Wyeth (WYE) when our pharma analyst upgraded the shares to a Strong Buy as concern about the fate of Pristiq, an antidepressant awaiting U.S. approval, left WYE shares at a discount to our estimated breakup value. Even without Pristiq, WYE shares are probably worth at least $51.00. Wyeth's free cash flow yield of 8.6% is superior the group's 6.0% and is likely to surge once the company finishes making liability payments for its diet drugs. Excluding those payments, free cash flow yield in the 12 months ended September is about 9.9%. The most immediate threat to my firm's recommendation is a potential rejection of Pristiq. Regulators are likely to decide by the end of this month. Our price target of $51.00 represents our estimated breakup value. Further, our estimate assigns no value to a pipeline that includes treatments for Alzheimer's disease and osteoporosis. And there, ladies and gentlemen, could be the real gem, for certain savvy seers suggest Wyeth's Alzheimer's drug actually works.

Plainly, my firm likes cheap stocks, as well as dividends. Manifestly, over the long term the compounding of dividends has accounted for roughly two-thirds of total returns as measured by the S&P 500. Over the next 15 years we think this will be especially true. Consider this; the baby boomers are starting to retire. With 2-year T'notes yielding only 2% the "boomers" will need more income to supplement their retirement needs. We believe this puts the "wind at the back" of dividend stocks that have the ability to produce adequate capital gains, as well as increase their dividends.

Along this "income" theme, while the REIT preferreds don't necessarily increase their respective dividends, they do afford "outsized" yields. REIT preferreds have rallied from the lows of December, with some issues up 15-20%, yet we still see select situations as an attractive opportunity. Credit risk is minimal based on REIT balance sheets and the relatively healthy state of the commercial real estate market. REIT preferred yields have not followed the falling yield of the 10-year Treasury over the past three months, but rather spreads have widened and now are trading on a level comparable to junk bond yields. The implied risk profile for these cash flows seems unjustified, and thus my firm recommends investors consider REIT preferred shares as part of their asset allocation. Although there are unique liquidity/trading characteristics and call provisions across almost all of the REIT preferred securities, my firm believes that they make attractive income plays for investors seeking above-average yield and minimal default risk. Two names for your consideration are Corporate Office Properties (OFC) using the 8%-yielding preferred "G" shares, as well as LaSalle Hotels' (LHO) 7%-yielding preferred "G" shares (for more ideas see our REIT Preferred Report dated 2/13/08).

Call for this Week: I am treating the January lows of 11971.19 (DJIA) and 4140.29 (DJTA) as "internal lows" until proven wrong. Additionally, I would view a breakout above the Dow's recent reaction high of 12750 as very constructive action. Meanwhile:

1) It's been six months since the Fed began cutting interest rates, which is the typical time lag when rate cuts start to be impactful.
2) The economic stimulus package passed.
3) Income tax refunds have started to flow and the stimulus packages' rebate checks will start in 12 weeks.
4) Conforming "mortgage caps" will be raised from $417,000 to $730,000 in eight weeks (the refi application index has already soared)
5) Money supply (M2) has increased $90 billion over the last two weeks.

Don't look now, but Ben Bernanke allowed the Federal Funds rate to dip from 3.00% to 2.75% for a day last week before snapping it right back to 3.00% in what we consider to be a signal short-term interest rates will be lowered again at the March FOMC meeting... causing one old Wall Street wag to lament, "Every government-sponsored economic stimulus program since 1948 has worked, so I am inclined to give this one the benefit of the doubt!"

No positions in stocks mentioned.
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