"That Was the Week that Was"

January 11, 2011

6 minute read

TW3?!
January 10, 2011

by Jeffrey Saut, Chief Strategist, Raymond James

“That Was The Week That Was,” also known as TW3, was a satirical TV comedy first broadcast on the BBC in November of 1962. It subsequently moved to America, but remained hosted by David Frost. The program was radical in that it chronicled events of the previous week and broke new ground in lampooning the establishment. It was also the first show to demonstrate it was truly television by allowing the cameras and boom microphones to be seen, giving the program an exciting and modern feel. I revisit TW3 this morning because despite last week’s holiday-like environment there were some pretty amazing headlines. For example, here are 11 for the first week of 2011:

1) Swiss central bank refuses Irish debt as collateral
2) FAO’s World Food Price Index hits record highs
3) China’s Yuan may rise 10% in 2011 to fight inflation
4) Emerging markets continue to power world growth
5) Chile’s currency fell 4.5% against the U.S. dollar, its biggest one-day drop in 25 years
6) Forty-two states reported gains in tax collections in 3Q10
7) Some big U.S. banks are starting to boost lending to businesses
8) Bank lending has risen by $16.6 billion over the past three weeks – the biggest three-week gain since Lehman
9) Intuit data for small business shows hiring has increased by 1 million jobs from the 2009 low
10) Toyota’s CEO said the Yen needs to trade at 90 to keep Japan competitive
11) Australia’s record floods are causing catastrophic damage to its infrastructure

To be sure there were other headlines like “Auto Sales Are Booming” and “Shoppers Expanded Their Christmas Purchases By The Biggest Margin Since The Boom Year Of 2005;” yet the point is that such headlines have caused some to become more worried about the economy overheating than worried about a double-dip. I, however, am not one that embraces the overheated economy thesis. Nope, I think the equity, and bond, markets are merely re-pricing themselves based on the expectation for stronger global growth. Still, I remain concerned about the weird weather; and, it looks like that will continue this week as I attempt to fly into an ice storm in the Carolinas.

For months I have commented about the burgeoning La Niña weather pattern combined with more volcanic ash in the atmosphere than anyone can remember. That duo has caused the Hadley Cell Winds to expand toward the “poles,” fostering droughts in Russia and the Amazon. Meanwhile, Australia is flooding, shuttering most of its coal mines, which is obviously good for our investment positions in coal stocks. More specific to this country, I have opined that because of the shift in the “cell winds” the U.S. would experience a cold, wet, winter and consequently have been recommending an overweighting of energy stocks. I think the aforementioned weather trend will continue for the balance of the year with an attendant “hop” for the energy complex. That said, I can’t shake the feeling that in the very short-term stocks are making a trading top.

I also think Toyota’s CEO is correct about Japan’s Yen needing to trade at 90 to the U.S. dollar. Indeed, in my missive dated December 13, 2010 I wrote:

“If this scenario plays, and stronger economic growth in the U.S. materializes, the various markets should start discounting a normalization of Fed policy. All we need is a few good employment reports and the dollar, as well as interest rates, should rise. Interestingly, if interest rate differentials widen between the rest of the world and the much maligned Japan, Japan’s currency should fall, fostering a surge in Japan’s exports. I have been wrong-footedly bullish on Japan since June of 2009. And while I have not made much money there, I haven’t lost much money either. My investment vehicles have been two small-cap closed-end funds. Those names are Japan Small Capitalization Fund (JOF/$9.20) and WisdomTree SmallCap Dividend Fund (DFJ/$44.28). I continue to like them because Japan is ‘cheap’; and as my father says, ‘Good things tend to happen to cheap stocks.’ Moreover, as the sagacious GaveKal organization opines, ‘A continuation of the bond market meltdown would tell us to own stocks in the U.S., Japan, Korea, and Taiwan’.”

Manifestly, Japan is “cheap” with P/E ratios hovering near 1974 levels. And while I may be wrong about making money in Japanese stocks, I just don’t see how you can lose very much, especial if you adhere to my mantra of not letting ANYTHING go more than 15% - 20% against you.

Speaking of not letting anything go more than 15% - 20% against you, the yield on the 10-year Treasury Note has risen roughly 43% from its yield-yelp low of 2.33% on October 10, 2010. The 10-year’s yield now stands at 3.33% after hitting an intra-day high last Friday of 3.46%. That rate ratchet caused the T’note’s 50-day moving average (DMA) to cross above its 200-DMA last week. While I continue to think interest rate spreads will compress in the near-term, said “cross” is yet another technical indication that over the longer-term interest rates should rise. So I will say it again, long-term I expect interest rates to rise, but rise for the right reasons (an improving economy). Therefore, I think it is very important to position fixed income portfolio allocations in specialized vehicles. The three I have been recommending are: Putnam Diversified Income (PDINX/$8.15); Mainstay Floating Rate Fund (MXFAX/$9.49); and Pioneer Floating Rate Fund (FLARX/$6.93). As always, details should be vetted before purchase.

Driven by the rise in interest rates, as well as an improving economy, the Dollar Index has been rising from its corresponding October 2010 low of 74.60 to Friday’s closing price of 81.46. My hunch remains that the dollar will travel higher. The quid pro quo is that could spell trouble in the short-term for my beloved “stuff stocks.” Reacting to the dollar’s strength, the Reuters/CRB Continuous Future Index pulled back from its recent new all-time high to its previous all-time high recorded in 2008. It will be interesting to see if continued dollar strength will cause a pullback in the CRB Index, or if world demand for “stuff” wins out.

As for Friday’s employment data, our economist Dr. Scott Brown said it best:

“The payroll figure was a disappointment relative to expectations, but not a disaster (the upward revision to October and November takes some of the sting out of the miss). Moreover, the establishment survey data will undergo annual benchmark revisions next month. The drop in the unemployment rate was a surprise, and some observers may embrace this more favorable reading – but beware. The lapse in extended unemployment insurance benefits likely contributed to the reduced unemployment rate in December. The reported 556,000 drop in unemployment from the household survey does not mean anything (the household survey is good for measuring ratios, such as the unemployment rate, but not levels). At face value, the report is a negative for equities and a positive for bonds, but it will take markets some time to digest and there’s likely to be some confusion regarding the differing pictures from the two surveys.”

The call for this week: Herb Stein once remarked, “If something can’t go on forever, it won’t!” And, the current “buying stampede” is now 90 sessions long, making it the longest one ever recorded in my notes of more than 40 years. Combine that with many other “finger to wallet” indicators suggesting caution and I am currently just sitting. Indeed, sometimes me sits and thinks and sometimes me just sits. As the astute Lowry’s organization opines, “Our last short term sell-signal for aggressive traders was triggered on December 30th, when the 14-day Stochastic indicator dropped from overbought levels and crossed below its moving average. A conventional short term sell-signal, for culling selective stocks [from portfolios], was registered as of today’s market close (last Friday), when our Short Term Index dropped a total of more than 6 points from its recent high of 104.”