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Jeff Saut: A Market Surprise to the Upside?


We could see a long-distance sprint into quarter's end.

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.

I can calculate the motions of the heavenly bodies, but not the madness of people.
-Sir Isaac Newton

So wrote Newton after losing his fortune while speculating in what was known as The South Sea Bubble. The trouble began with the founding of the South Sea Company, which has been dubbed the "Enron of England," in 1711. This British stock company was granted a monopoly to trade with Spain's South American colonies in exchange for assuming the national debt England had accrued in the War of Spanish Secession.

The company's prowess grew so much that in 1719 it bought more than half of England's debt with newly created shares. As trade with the New World began, rumors swirled about the fortunes it would create for the company, and the stock soared. Over a few months, the shares increased in value from £100 to nearly £1000.

In August of 1720, the speculative fever broke and shares began a decline that would leave them at £150 by year's end. Since many loans had been made against the inflated shares, bankruptcies flourished and thousands of companies and individuals were ruined. An investigation in parliament found widespread fraud, and England's first lord of the treasury was obliged to dissolve the company and divide up its stocks.

If all of that sounds familiar, it should. I revisit the South Seas Bubble this morning, having returned from 2 weeks in Europe overseeing institutional accounts and conducting seminars. My last stop was Amsterdam, where a museum visit refreshed my memory of the Dutch Tulip Bubble (Bust) of 1637. Alas, all "bubble busts" are about the same, as Charles Mackay's terrific book Extraordinary Popular Delusions and the Madness of Crowds makes clear.

Whether it's John Law's Mississippi Scheme of the 1720s, or the technology bubble bust of our era, human nature just doesn't change. That's why one of the mantras that hangs on my wall reads: "The stock market is fear, hope, and greed only loosely connected to the business cycle."

The typical fear-hope-greed cycle can be seen in the following chart.

Click to enlarge

Beginning at the left with fear: Think the summer of 1982, when everybody was afraid to buy stocks, and the stock market began to rally. Moving along, in 1983 -- 1985 (halfway up the curve), investors were hoping stocks would retreat to those 1982 levels so they could comfortably buy. Unfortunately, the markets are never that accommodating. In 1986, greed overcame fear, and investors bit the bullet and bought stocks.

Beginning in the spring of 1987, most of the stock market's internals began weakening, many stocks were declining, and numerous indexes started to top out. The major market averages topped in the summer of 1987, leaving investors hoping stocks would rally back to their greed levels so they could break even and get out. Again, the markets did not cooperate. The stocks fell in a market crash when too many investors became fearful and sold.

Surely, it was fear that took the S&P 500 (SPX) down to its panic low of 666 on March 6. At the time, I was bullish, believing the bottoming process, which began in October 2008, was complete. While I didn't call it a "generational low" like the savvy Doug Kass (I think the generational lows for most stocks came in 1974 or 1982), I did repeatedly note that my firm's proprietary oversold indicator was more oversold than it was at either the 1974 or the 1982 lows.

Since then, I've been pretty bullish, thinking the lows have already been reached, and that I've heard the worst of the economic news. That view was based on the fact that the Fed has given us a huge increase in the oil that makes the economic engine run: money, decidedly negative real interest rates -- always the mother's milk of economic recoveries, and re-intermediation at the banks.
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No positions in stocks mentioned.
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