Jeff Saut: Lose Cash!
Given the strong seasonality, the surging liquidity, and the clearly accommodative Federal Reserve, the upside has to be favored.
“Poor Grenville runs a fund, one of a group of funds, and he is in charge of $100 mln or so.
...I asked Charley why Grenville was suddenly Poor Grenville.
‘Poor Grenville,’ said Charley, ‘has gotten caught with $25 mln in cash. It’s a disaster. How would you like to have $25 mln in cash with the Buy Signals you’ve just seen? Come to lunch. Poor Grenville has to lose his cash, right away.’ I know it sounds a little funny that having $25 mln in cash is a disaster. It sounds just as funny to me as the phrase ‘lose cash.’ When it isn’t your cash in the first place and all you are doing is taking the cash – somebody else’s – and buying stocks with it. But professional money managers love to say, ‘We lost five mln in cash this afternoon,’ meaning they bought stocks with it. I guess it sounds professional.
...As to why Poor Grenville’s $25 mln in cash was a major disaster, that is more comprehensible. Grenville should have all $100 mln fully invested if the market is coming off the floor; his fund is ‘performance-oriented,’ trying for big capital gains. If Poor Grenville has $25 mln in cash he guessed dead wrong at the bottom of the market, and in one career you don’t get too many chances like that. Poor Grenville had gotten himself all ready for a big drop in October and now in January the market turned around and ran away without him. He has to make it up in a hurry.”
- The Money Game, by Adam Smith
Can you imagine all the “Poor Grenvilles” out there desperately trying to “lose cash” as the DJIA broke out to a new all-time high last week? To be sure, worried about the summer stock-slide the Grenvilles raised cash into those mid-August lows expecting stocks to sag further during the dreaded fall months. Much to their chagrin the Herculean efforts of the central banks, combined with some “Beltway rhetoric,” bottomed the equity markets on August 16. Since then the “consensus call” has become that we had the typical dreaded September/October stock market action back in July/August and the equity markets are now poised to travel higher into year-end. Given the strong seasonality, the surging liquidity, and the clearly accommodative Federal Reserve, the upside has to be favored. How aggressively it should be favored is another matter.
Indeed, for weeks I have chided investors that the time to be aggressively bullish was back in mid-August, not following a 1500-point upside “sprint” by the DJIA. I have cited numerous finger-to-wallet ratios that currently suggest a more cautious approach. Said indicators include: despite new all-time highs in many of the marquee indices, the Lowry’s Buying Power indicator remains near a six-month low; many of the advance/decline indicators are not confirming the rally; the inability of indexes like the Russell 2000 (RUT), a small-cap proxy, to rally to new highs, likewise confirming the faltering breadth; the Volatility Index’s (VIX) decline from a fearful 37.50 reading at the August lows to its now “no fear” level; the reemergence of risk-seekers as confirmed by my Risk Appetite chart and the now 60.2% bullish reading from the Investors Intelligence sentiment survey, which is its highest since December 2005; and the list goes on.
When taken in concert with other random gleanings, I am again cautious on the various U.S. equity markets. I doubt the subprime issues, and concurrently the pricing of opaque debt instruments, are behind us.
To this point, in Friday’s Wall Street Journal there was an excellent article titled “U.S. Investors Face an Age of Murky Pricing.” The article speaks to the staggering amount of opaque securities that do not get priced (marked-to-market) based on any readily available market price, but rather a mark-to-model based on what the algorithms of various computer models say they are worth. No wonder Moody’s downgraded a slug of subprime mortgage-backed securities last week! The article goes on to explain the pricing of various tranches of these securities as Level Two and Level Three, with Level Three securities being the murkiest of pricings. Interestingly, Goldman Sachs (GS) stated that the size of its Level Three assets, those that trade so infrequently that there is virtually no reliable market prices for them, amounted to $72.05 bln, or 7% of total assets, at the end of its fiscal third quarter.
Ladies and gentlemen, with consumer spending financed by mortgage equity withdrawals, whose mortgages have been sliced and diced into a spider web of opaque debt instruments, the extent of the contagion is still unknown despite the markets’ sense that the “Greenspan put” is alive and well. Moreover, the most financially-stressed homeowners are scheduled to see their low interest rate mortgages reset at substantially higher rates at a time when food and energy prices are soaring. Meanwhile, the political rhetoric is increasingly focused on more entitlements and higher taxes on the “rich.” Unfortunately, increased taxes on the alleged rich won’t come close to solving the debt-box we have painted ourselves into; implying taxes on everybody will be going up, including the preferred taxation of dividends and capital gains, a point that will eventually not be lost on the equity markets.
Plainly the U.S. dollar, which continues to acts like a drunk trying to stand up, has sensed the upcoming economic raison d’etre is one of printing more dollars and attempting to inflate its way out of said predicament. Likewise gold, as well as other tangibles, have “risen” to the occasion. Indeed, despite all of the talk about the strength in technology stocks, the strongest sectors last week were Energy (+2.53%) and Materials (+2.19%). For more than five years I have opined that every portfolio should have at least a 3% weighting in precious metals, or a mutual fund that plays to precious metals. Despite that mantra, the preponderance of accounts continue to shun gold, which has risen more than 200% over that timeframe (or twice the rate of the DJIA) yet still should be bought on any subsequent decline (see the attendant chart below).
Click here to enlarge.
My firm's current precious metals mutual fund of choice is the smaller, more nimble, OCM Gold Fund (OCMGX), managed by my friend Greg Orrell, which is up 17.5% year-to-date and up more than 24% on an annualized return basis over the last five years.
In conclusion, I agree with the prescient Richard Russell, of Dow Theory letters fame, who noted in his Friday missive:
“I had a long conversation last night with a very knowledgeable old-timer, a man who has been around Wall Street for decades. We talked about what phenomena might arrive that could propel the Dow and many of the leading big stocks into Spaceville. We agreed that there exists a ‘secret ingredient.’ That secret ingredient could be the newly formed (and rapidly expanding) Sovereign Wealth Funds. These are the funds set up by various nations to invest outside their usual hoards of currencies (these hoards being composed largely of U.S. Treasury bills, notes, and bonds).
We know that there is massive growth in the Sovereign Wealth Funds, the total of which is heading towards the staggering sum of $17 trln (that's seventeen trillion dollars!). The major object of these funds will be to diversify out of fiat paper into items of tangible value.
Is a large, well-situated corporation an item of tangible value? We both agreed that it is.
We therefore believe that a major goal of the Sovereign Wealth Funds will be to buy into and ultimately even take over many of the world's leading corporations. This whole area is one that has received surprisingly little attention. Yet, its significance is truly momentous. It all has to do with the fragility of the whole system of fiat currencies. And, the recognition that inflation or even hyper-inflation may be the wave of the future.
To review – a major trend of the future will be the move to diversify out of fiat currencies and to move into items of tangible value. Along those lines, a corporation like Proctor and Gamble (PG) may easily fit the bill. Entities like Proctor and Gamble or General Electric (GE) will be considered tangible values. Think about it – and the implications of that statement.”
The call for this week: Buy tangibles!
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