Jeff Saut: The 7% Solution?
Given recent occurrences the question now becomes "Has the overspent, undersaved U.S. consumer finally overdosed on debt?"
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.
As a child I was an avid reader of books about Sherlock Holmes. Recall that Holmes was a fictional detective brought to life in novels by author/physician Sir Arthur Conan Doyle.
Holmes was renowned for his intellectual brilliance and skillful use of deductive reasoning in solving difficult crimes. The book The Seven-Per-Cent Solution, however, was published as a "lost manuscript" by Holmes' constant sidekick Dr. Watson and was written/edited by Nicholas Meyer. In said book, Dr. Watson tricks his friend into visiting Sigmund Freud in an attempt to cure Holmes of his cocaine addition. During one encounter Holmes says to Freud, "I never guess(ed): it is an appalling habit, destructive to the logical faculty. A private study is an ideal place for observing facets of a man's character."
Unlike Sherlock Homes, the "crack cocaine" of our generation appears to be debt. We just can't seem to get enough of it. And, every time it looks like the U.S. consumer may be approaching his maximum tolerance level, somebody figures out how to lever "on" even more debt using some new and more complex financing vehicle. Indeed, participants "never guessed it is (such) an appalling habit" until recently. For years I have watched this levering-up process, often noting that it was taking an ever-increasing amount of debt to produce a dollar's worth of GDP growth. Given recent occurrences the question now becomes "Has the overspent, undersaved U.S. consumer finally overdosed on debt?"
An interesting insight to that question was scribed recently by Minyan Peter, who wrote:
"No one is talking about it yet, but I think the market will soon begin to realize that the credit card lenders have in essence become the consumer lenders of last resort. As consumers have become shut out of the mortgage and home equity world, the last available credit is plastic. One statistic that I have found very troubling is the degree to which credit card balance growth is running ahead of retail sales growth – a key sign that the consumer is stretched.
...To put this all together, take Target's (TGT) latest financial results and you can see the numbers for real. First, credit card balance growth was up 14% year-on-year – almost 1.5 times Target's sales growth of 9.5%. Second, thanks to this balance growth, reported year-on-year delinquency ratios are up only a little bit (60+ days delinquencies of 3.5% versus 3.4% a year ago), but the dollars of delinquent accounts are up almost 18% – to $242 mln from $205 mln – and, as an aside, 'late fees and other revenue' are up more than 36% year-on-year."
When I combine such insights with other gleanings of credit card limits being reduced, interest rates being raised on unpaid balances, statement closing dates being moved from late-month to mid-month, etc., there is little doubt that Archie Bell & the Drells are playing and the song is "Tighten Up." Clearly credit is tightening up, but so far it is not a credit crunch. As I have repeatedly opined, "a credit crunch is when the banks won't lend money."
Currently that is not the case! Indeed, it is just as easy now as it was a year ago for someone with a decent credit record to get a loan. Nope, what we have, ladies and gentlemen, is a "collateral crunch" (see past missives for an explanation); the risk is that the collateral crunch spreads into a real honest-to-gosh credit crunch that then morphs into a recession. While I don't think this is the way it is going to play, I have to admit the odds of a credit crunch/recession have risen.
Clearly, the stock and bond markets are worried about such a potential sequence – witness the strength in bond prices (i.e. lower yields) combined with last week's stock slide. Yet, participants should not have been surprised by the DJIA's "weekly wilt" because in last Tuesday's report I stated:
"The result is nearly a 7% rise for the senior index since the envisioned selling-stampede ended (on August 16th). Students of the market should know that a 7% 'throwback rally' is about all you typically get on the initial rally following a selling-stampede low. Furthermore, despite all the upside antics the three major averages (DJIA, S&P 500, and NASDAQ) have not been able to better the intraday highs that they recorded on August 8th at 13696, 1504, and 2628, respectively. While the NASDAQ continues to act better than the other two, all three indices are now in short-term overbought territory. Also worth noting is that despite five 90% downside days (total points and breadth recorded were 90% negative) since the markets' peak on July 19th, the markets have still not recorded the kind of oversold readings associated with a major bottom."
Plainly, the 7% "throwback rally" was the inspiration for this morning's title "The Seven-Per-Cent Solution."
And while I don't know if the markets will completely retest, or break, their respective August reaction lows, I continue to treat those lows as an "internal low" that can be traded against. Even if those lows are violated, I still believe many individual stocks made their "lows" in August. Moreover, I continue to embrace the themes that have made me so much money over the past seven years.
To that point, there was an article in last Wednesday's Wall Street Journal titled "How Ethanol Is Making the Farm Belt Thirsty," an obvious reference to my long-standing water investment theme. The "tag line" to the article's title read "More Cornfields, Distilleries Heighten Irrigation Worries; A Water Cop Cracks Down."
The gist of the article was that, driven by increased corn field plantings, this country's giant Ogallala Aquifer is being "sucked dry." Since I think there is a secular bull market in agriculture, with a concurrent bull market in water, this is not an unimportant observation.
Manifestly, the world runs on oil and water. You can live without oil, but you cannot live without water! I have embraced the water theme since 1989 and the agriculture theme since 2001.
In addition to the numerous individual stocks playing to these themes that have often been mentioned in these reports Veolia (VE) being one of them as featured in today's Barron's), there are also various funds (open-end, closed-end, UITs, ETFs, etc.). One of the most recent additions is the Van Eck Agribusiness ETF (MOO); and don't look now, but wheat prices screamed higher last week spurred by increased international buying. As for the water theme, the PowerShares Water Resources (PHO) and the PowerShares Global Water (PIO) are a good way to gain exposure to the world's most precious resource (water).
Interestingly, I got an update on another theme that continues to produce large gains for my clients as I traveled to Canada last week to speak at my Canadian affiliate's (Raymond James Ltd.) analysts' retreat.
I have long favored the Canadian oil sands projects due to my sense regarding peak oil production, geopolitical safety, and geographic proximity. While over the past few months I have been "shy" of the energy complex for previously stated reasons, I have never changed my longer-term bullish views on energy.
This is especially true for Canada's oil sands companies. In discussions with my Calgary-based energy team, I became reacquainted with two long-favored names, namely Talisman Energy (TLM) and EnCana (ECA). Due to space constraints I cannot elaborate on either of these ideas this morning, but suffice it to say both of these companies' oil sands properties appear to be pretty underpriced. For additional information please see Raymond James Ltd.'s recent reports.
The call for this week: My gold stock investment positions soared last week because the market evidently figured out the subprime bailout is going to cause a lot of U.S. dollars to be printed (read: inflationary). As my friend Stephanie Pomboy notes in her always insightful MacroMavens report (as reprised by Barron's):
"'Scarcely will they finish putting the subprime situation under house arrest' before policymakers will be forced to address similar problems in 'credit card debt, commercial-real-estate loans, CLOs... and beyond.' As the credit engine sputters, the repair crew will be forced to "print and spend." That, she says, is what gold has figured out. And equities, I might add, are only beginning to learn."
While I am clearly more constructive than that on the overall equity markets, it remains to be seen how stocks act when/if the August lows are retested and/or broken. Amazingly, despite the decline in interest rates, the D-J Utility Average (DJUA) continues to make lower lows, as seen in the attendant chart from my friends at thechartstore.com... as things continue to become "curiouser and curiouser;" I continue to invest accordingly.
Click here to enlarge.
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