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Jeff Saut Presents: Where's Abe When We Need Him?!


Government intervention tends, over time, to lower the returns on invested capital for entrepreneurs, as well as cause collateral damage.


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.

"You cannot bring about prosperity by discouraging thrift. You cannot strengthen the weak by weakening the strong. You cannot help the wage earner by pulling down the wage payer. You cannot further the brotherhood of man by encouraging class hatred. You cannot keep out trouble by spending more than you earn. You cannot build character and courage by taking man's initiative and independence. You cannot help men permanently by doing what they could and should not do for themselves." (Abraham Lincoln)

Readers of these missives know that by far the biggest worry I have, the one that really keeps me up at night, is the political wind currently blowing in Washington D.C. Having lived in the Beltway, I have a pretty good network on Capitol Hill, and what is going on there concerns me. Indeed, the swelling movement toward protectionism, regulation and increased intervention is precisely what Abraham Lincoln railed against. As the astute GaveKal organization opines:

"Protectionism, amongst our five cardinal sins (the others being tax increases, increases in regulation, a monetary policy mistake, and a war), is most likely the worst sin of all. Protectionism inherently guarantees massive misallocation of capital and labour and ensures that, over the long term, 'rentiers' will earn more than 'entrepreneurs'."

Likewise, government intervention tends, over time, to lower the returns on invested capital for entrepreneurs, as well as cause collateral damage. Intervention can take the shape of protectionism, increases in regulation, higher taxes, higher interest rates, etc. A case in point would be the U.S. stock brokerage business, where the government, pandering to a "stock stung" public, closed the barn door after the horses had already bolted, by passing ill-conceived and onerous legislation. The result, after a few "bad apples" had already deceived public investors and bolted, was that the government over-regulated the business, causing a tectonic shift whereby foreign cities are rapidly becoming the world's financial centers, rather than New York.

Governmental intervention was also reflected in the blocking of Dubai's proposed purchase of U.S. seaport assets, the Congressional stone-walling of CNOOC (CEO: China's oil company)'s takeover bid for Unocal, and the list goes on. Moreover, the recent rhetoric from many of the presidential candidates is not only scary and disingenuous, but outright fallacious: things like cradle-to-grave entitlements, excess profit taxes on oil companies, onerous automotive regulations, a healthcare package that is totally unaffordable, increased taxes in general, etc.. Further, the pandering politicians are fostering the "class hatred" Lincoln warned of by falsely asserting that the "rich" don't pay their fair share of taxes. For the record, according to the IRS, the top 1% earners who filed individual income taxes paid 36.9% of all taxes and the top 5% paid roughly 57%.

Additionally, the bottom 20% of tax payers receive $8.21 in subsidies/benefits for every dollar they paid in taxes, while the top 20% get back $0.40 for each $1 they pay in taxes. "Where are the statesmen this country so desperately needs?" I scream just about every time I hear a politician speak. That "scream" has increasingly emanated from my corner office over the past few weeks.

Two weeks ago I bayed at the U.S. House of Representative's Natural Resources Committee as those folks passed a broad energy bill that actually repealed laws designed to accelerate the oil and gas permitting process. Last week my shrieks were directed at not only the politicos, but the Supreme Court justices that set this country back 40 years. Don't even get me started on the immigration bill, which, though reduced from its original 800 pages to 418 pages, proved to be the worst potential piece of legislation ever proposed, causing one savvy seer to ask, "They wrote the Declaration of Independence on two pages, and the Constitution on not too many more, so why did the immigration bill take over 400?!"

We discuss our government this morning because again, as GaveKal notes:

"The government fixes the rules of the game and has a primary influence on the overall returns on invested capital through fiscal policy, trade initiatives, government expenditures, etc."

And maybe, just maybe, the malaise inside the Beltway is what has stalled the stock market, which has gone nowhere for the past few months. Indeed, the S&P 500 (SPX/1503.35) remains trapped between roughly 1490 and 1540 despite strong rallies and equally strong sell-offs. While some suggest this is part of a "topping process," I think the jury is still out. Manifestly, until this trading range is decisively resolved with either an upside or downside breakout, I remain inclined to give the upside the benefit of the doubt due to numerous positive indicators. Last Wednesday, however, my cautiously bullish resolve was tested when the SPX broke below its June intraday reaction low (1487) and tagged 1484, yet still failed to close below its June 7, 2007 closing low of 1490.72.

Subsequently, in Thursday's verbal strategy comments, I stated that I have seen a lot of tradable "lows" made by markets that marginally break below much-watched levels just enough to shake stocks out of weak hands before reversing and rallying, and that was precisely what happened last Wednesday. Alas, however, Thursday and Friday's upside follow-through was lacking, leaving stocks virtually unchanged for the week. In such a whipsaw environment I have been adhering to our friend Barry Ritholtz's rules for how to play the long side safely. To wit: 1) Identify strong sectors with good money flow; 2) Look for stocks within those sectors with desirable risk/reward characteristics; 3) Screen for stocks with the best technical, fundamental, and earnings potential; 4) Find stocks that are near good entry points; 5) Avoid 'runaway momentum' names; and 6) Look for stop-loss protection that is a reasonable downside away.

Speaking specifically to point 1, I have been focusing on sectors playing to themes that I think do well irrespective of what the economy does. In past missives I have discussed the trillion dollars that is going to be spent rebuilding the U.S. electricity complex, as well as its water infrastructure. Radio Frequency I.D. (RFID) has also been a focus and last week Outperform-rated Intermec (IN/$25.31) got positive news in this regard. This morning I thought we would feature a new Exchange Traded Fund (ETF) that begins trading tomorrow under the symbol "ENY" and plays to another one of our long-term themes, namely energy. As I understand it, this ETF will overweight Canadian oil sands stocks when crude oil is in a bullish mode and overweight high-yielding Canadian energy trusts when oil is configured negatively. With Venezuela's oil sands projects virtually nationalized by Hugo Chávez, history suggests that country's oil production has nowhere to go but down, with bullish implications for Canada's oil sands projects. As always, terms and details of this ETF should be thoroughly vetted before investing.

The call for this week: "Stand with anybody that stands right. Stand with him while he is right and part with him when he goes wrong" is another Abe Lincoln "bon mot." And judging by the all-time low Gallup Poll confidence readings regarding the U.S. Congress, maybe the American public is ready to "part" with the current line-up of politicians, in keeping with my bumper sticker that reads "Re-elect No One!"

P.S. As detailed in Monday's "Stat of the Week," I am lowering my natural gas price assumption for full-year 2007 from $7.70 to $7.08/Mcf due to implications from the short-term gas supply picture. Given the essentially unabated run in energy stocks, including the E&P space over the past six months, I am dialing down my expectations for further gains among North American gas-weighted stocks until we have better visibility on summer ending storage. On the other hand, my near-term bullish outlook for oil prices remains
unchanged, and furthermore, I believe the stage is set for substantial improvement in gas market fundamentals heading into 2008. My firm's commodity price forecasts for 2008 remain at $10/Mcf for gas and $70/Bbl for oil.

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