“Pounded” (Saut)

Tuesday, August 23rd, 2011

“Pounded”

by Jeffrey Saut, Chief Investment Strategist, Raymond James

August 22, 2011

I have been “pounded” with questions about the Dow Theory “sell signal” I spoke of; and, that occurred three weeks ago. The ubiquitous question has been – “Hey Jeff, how can you tell people to buy in light of the signal?” My response has been that such a huge amount of energy had been used up in rendering the Dow Theory “sell signal” that the market, at least on a short-term trading basis, is likely a “buy.” Reinforcing that view are numerous oversold readings of epic proportions. To be sure, one has to go back to the German Army’s invasion of France to find a session where less than 2% of the stocks traded on a particular day on the NYSE were “up” for the session, which is what happened two weeks ago (8/8/11). Yet to readers of these missives, such action should not come as a surprise. Indeed, for the past three weeks I have likened the current selling stampede to those of October 1978 and October 1979. When studying the charts of those periods one finds said declines came out of the blue on no fundamental news; and while many people have argued there are plenty of fundamental reasons for the current decline, I am not one of them. The 1978 and 1979 declines were straight down affairs ending with “selling climaxes” (like seen on 8/8/11). Subsequently, there were sharp rebound rallies peaking within four to five sessions, followed by a downside retest of those “selling climax” lows. Accordingly, in last Tuesday’s verbal strategy comments I said:

“If the October 1978/1979 sequence is correct, the throwback rally we are currently experiencing should peak in the 1200 – 1220 zone (last Tuesday’s intraday high was indeed near our signal point ‘throwback’ rally high estimate of 1206) leading to a pullback towards the recent intraday reaction low of 1101. Nevertheless, I am still respecting the Dow Theory ‘sell signal’ until it is reversed. Opinions, however, vary for Richard Russell (captain of The Dow Theory Letters) suggests there has NOT been a Dow Theory signal because he is using the July 2010 closing lows for the D-J Industrials and D-J Transports rather than the March 2011 ‘lows’ I have been using. For the record, those July 2010 closing lows were 9686.48 and 3906.23, respectively, which are a long way from the averages’ current levels. Whoever is right, enough damage has been done that the May 2nd ‘print high’ of 1370.58 for the S&P 500 is likely the high for the year. The quid pro quo is that last week’s 1101.54 ‘print low’ is either near the low, or the actual low, for the year. This week should reveal the answer if my 1978/1979 analogy is anywhere near the mark. If so, that leaves us hopefully range bound between~1100 and 1370 into year-end with my sense stocks will be at the upper-end of that range by December provided we don’t have a recession, a view I continue to embrace.”

My controversial non-recession “call” is driven by the fact that industry analysts are still bullish on earnings with the S&P 500’s (SPX/1123.53) consensus estimate approaching $114 for 2012. Corporate insiders are clearly bullish as they have been buying their own company’s shares at the highest rate since the bottom in March 2009. Layoffs have slowed and while the economy is certainly slowing, metrics like L.A. seaport traffic, railcar loadings, etc. are not falling off a cliff like they did prior to the 2008 recession. Moreover, China and India’s economies are still percolating; and as this week’s Barron’s writes, “It’s Time to Buy: After a 20% pullback, emerging markets offer strong growth at a discount price.” Then there is the European mess, which appears to be a little less of a mess, interest rates will remain tame for an extended period, it feels like tax reform is coming, and crude oil prices have collapsed. Indeed, change you can believe in is coming because according to The Washington Post, “The financially strapped U.S. Postal Service is proposing to cut its workforce by 20 percent and to withdraw from the federal health and retirement plans because it believes it could provide benefits at a lower cost.” Ladies and gentlemen, if correct that implies the post office is not only going to break its labor agreements, but throw Obamacare under the bus.

Speaking of throwing Obamacare under the bus, an Atlanta Federal Court did just that by ruling that Congress exceeded its authority by passing the “individual mandates,” which will surely be escalated to the nation’s highest court; but, such developments has the administration doing some pretty strange “things” like calling for market-based solutions. One such market-based solution is already at work in Puerto Rico. According to The Wall Street Journal (WSJ):

“A stimulus program on the island, long ripe with vacant houses and condos, has sent sales of new homes surging 80% and sales of existing homes up 24% in the past 10 months from a year earlier, even as the market in much of the U.S. mainland is dead. …One of the incentive program’s popular provisions offers qualified buyers down-payment assistance for homes purchased with a mortgage, as well as a second mortgage of as much as $25,000 that can be used to make down payments and pay closing costs. Buyers of new homes also pay no transfer taxes when a property changes hands, escape paying property taxes for five years and future capital-gains taxes, and pay no taxes on rental income for 10 years. Sellers don’t have to pay capital-gains taxes on profits.”

As stated, there is a change afoot inside the D.C. Beltway that is palpable and market-based solutions to our problems are but one example. As I told one of our more worried financial advisors last week, “We could solve the debt issue in very short order with a Value Added Tax (VAT).”

Tags: Chief Investment Strategist, Climaxes, Crude Oil, Declines, Dow Theory, Downside, Epic Proportions, Fundamental Reasons, German Army, India, Invasion Of France, jeffrey saut, Last Tuesday, Lows, Nyse, Out Of The Blue, Pullback, Raymond James, Retest, Signal Point, Stampede, Ubiquitous Question
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Jeffrey Saut: “Terminator 3: Rise of the Machines”

Tuesday, August 16th, 2011

Terminator 3: Rise of the Machines

by Jeffrey Saut, Chief Investment Strategist, Raymond James

August 15, 2011

I was in Chicago last week seeing portfolio managers (PMs), doing media “hits,” and presenting at seminars for our retail investors. The most ubiquitous question I received was, “Who is selling all this stock?” Clearly that’s a valid question since the parade of PMs on CNBC insisted they are not selling stocks, statistics show hedge fund managers are already pretty “light” on stocks, the international institutions I talk to are so underweight U.S. equities it is doubtful they are selling, and order flows show retail investors aren’t really selling individual stocks either (they are, however, liquidating mutual funds). So who’s selling? I think it is the “machines,” driven by high-frequency trading (HFT) and Exchange Traded Funds (ETFs). As defined by Wikipedia:

“In high-frequency trading, programs analyze market data to capture trading opportunities that may open up for only a fraction of a second to several hours. High-frequency trading uses computer programs and sometimes specialized hardware to hold short-term positions in equities, options, futures, ETFs, currencies, and other financial instruments that possess electronic trading capability.”

Exacerbating the situation are ETFs that are leveraged 2:1, or even 3:1, which if bought on margin implies 4 to 6 times leverage. Moreover, when ETFs buy or sell, they do so across the spectrum of stocks within their universe with NO regard for the fundamentals of any individual stock. So yeah, I think it is the “Rise of the Machines” that has compounded the “selling stampede” that began on July 8th, and hopefully ended on August 9th with what a technical analyst would term a long-tailed “bullish hammer” candlestick chart formation. If correct, that would make the stampede 23 sessions long. Recall, stampedes typically last 17 – 25 sessions, with only 1 – 3 session pauses/corrections, before they exhaust themselves. It just seems to be the rhythm of the “thing” in that it takes that long to get participants either bullish, or bearish, enough to act. Obviously, in this case, it would be bearish enough. Consistent with this thought, it is worth noting that in July retail investors liquidated $23 billion worth of U.S. stock mutual funds for the largest liquidation since October 2008’s $27 billion. My sense is even more liquidation is taking place this month.

Yet, it is not just mutual fund liquidation indicating the selling skein is over. Corporate insiders are buying shares at the highest rate since the March 2009 bottom; at last week’s lows the dividend yield on the S&P 500 (SPX/1178.81) exceeded the 10-year T’note’s yield (read: historically bullish for stocks); and if you believe 2012’s consensus earnings estimates, last Monday the SPX was trading at a PE under 10x with an Earnings Yield of ~10%, leaving the Equity Risk Premium around 8%. Ladies and gentlemen, those are valuation metrics not seen in years. To that value point, since the first Dow Theory “sell signal” of September 1999, I have opined the equity markets were likely going into a wide-swinging trading range akin to the 1966 – 1982 affair where an index fund made you no money for 16 years. In December 1974 the D-J Industrial Average (INDU/11269.02) made its “nominal” price low of 577.60, but its “valuation” low (the cheapest the INDU would get on a PE, book value and dividend basis) didn’t occur until the summer of 1982. Fast forward, I have argued the “nominal” price low for this 11-year range-bound market took place in March 2009 and have added, “I don’t know when the ‘valuation’ low will come.” But maybe, just maybe, if next year’s estimates are right, and we don’t go into a recession, we may have made the “valuation” low over the past few weeks.

Whether that “valuation low” thought is correct or not, I am fairly confident the selling squall has compressed stocks so much a short-/intermediate-term bottom has been, or is being, made. To wit, over the past week I have repeatedly stated the equity markets were epically “oversold.” To be sure, finding a session as bad as last Monday’s, when less than 2% of all the stocks traded closed “up” on the day, one has to go back to May 1940. At that time, the markets believed the world was ending when the Germans punched a ~60 mile wide hole in the Maginot Line and poured into France. Another way to look at last Monday is to measure how far the SPX is below its 50-day moving average. While not as massively compressed as in the 1987 Crash’s 5.5 standard deviation, at 4.3 the SPX is very oversold as can be seen in Figure 2 on page 3 from our brainy friends at Bespoke Investment Group. Additionally, the astute Lowry’s organization writes:

“This week will go down in the record book as one of the most manic of all time, with four alternating negative and positive 90% Days, each generating changes in the DJIA of more than 400 to 600 points. There is nothing even close to this frenzy in the 78 year history of the Lowry Analysis. The causes of the week’s mass confusion will be debated for years to come, but the immediate question is, what should investors do now?”

Lowry’s concludes:

“As of Friday’s market close, all of the requirements of Buying Control No. 1 were completed, calling for a 25% invested position. The 2nd stage of the buying program will be completed if Buying Power rises ten points to 391 or higher, confirmed with a ten point drop in Selling Pressure to 358 or lower.”

While we agree with Lowry’s, and have recommended the cash raised last February/March gradually be recommitted to stocks, we think there will be a bottoming process over the coming weeks. In all my talks last week, I likened the current decline to those of October 1978 and October 1979 (Figure 1 on page 3). Both of those “stampedes” came out of the blue with no fundamental reasons. Following the initial selling-climax low, there was a sharp rally that peaked with a subsequent retest of those “climax lows.” The 1978 bottoming process took seven weeks to complete, while in 1979 it took only four weeks. Still, while the stock market’s bottoming process should take weeks, many individual stocks have probably already bottomed. That sense was reinforced last week with our fundamental analysts’ comments on names like: Linn Energy (LINE/37.86/Strong Buy), EV Energy Partners (EVEP/$66.21/Strong Buy), Healthcare REIT (HCN/$45.88/Outperform), First Potomac Realty (FPO/$12.99/Strong Buy), CenturyLink (CTL/$34.61/Strong Buy) to name but a few.

Tags: Candlestick Chart, Chart Formation, Chief Investment Strategist, Cnbc, Exchange Traded Funds, Hft, International Institutions, jeffrey saut, Options Futures, Portfolio Managers, Retail Investors, Rise Of The Machines, Selling Stocks, Technical Analyst, Term Positions, Terminator 3, Terminator 3 Rise Of The Machines, Ubiquitous Question, Valid Question, Wikipedia
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