Seismic Window (Saut)

March 21, 2011

7 minute read

Seismic Window

by Jeffrey Saut, Chief Investment Strategist, Raymond James

March 21, 2011

At the risk of sounding like a kook, I began writing about the weird weather in September of last year. The text read like this:

“I revisit the coal theme this morning because the La Niña weather pattern, combined with numerous volcanic eruptions that put large amounts of ash into the atmosphere, has allowed the Tropic of Cancer and the Tropic of Capricorn to expand. The result has brought increased hurricane activity, soaring temperatures, Asian floods, droughts (Russia has lost 30% of its wheat crop), and the list goes on. While the current focus is on the unusually warm weather, don’t expect this to continue as the Northern Hemisphere faces an upcoming VERY cold/wet winter due to massive amounts of volcanic ash in the atmosphere. Energy stocks, therefore, should be over-weighted in portfolios with the biggest ‘bang’ going to the Exploration & Production stocks (E&P), as well as coal stocks.”

Again, at the risk of sounding like a kook, this morning I offer another topical view from Jim Berkland, a geologist that has a decent record of targeting potential timeframes of increased earthquake activity. Know that Mr. Berkland correctly forecast San Francisco’s Loma Prieta earthquake (aka, “The World Series” earthquake) that occurred on October 17, 1989 right before the third game of the World Series. He did so by using a combination of tidal tables, lunar/gravitational phases, animal behavior, beached whales, and a keen sense of the “Pacific Ring of Fire.” That prediction caused a suspension from his job as County Geologist for Santa Clara, California on fears that future predictions might cause mass hysteria. Also know that many of his predictions never came to pass and consequently he too is considered a kook by some.

That said, his interview with Neil Cavuto begins (see it here: http://www.youtube.com/watch?v=xQXDt4VdS0E) with Jim stating that the months of October, March, and April are the most dangerous for earthquakes in the San Francisco Bay area. He further opines that March 19th’s full moon, where the moon made its closest approach to Earth until 2016, coincides with the equinoctial tide. While some folks are familiar with ocean tides, most are unfamiliar with Earth tides (caused by the Sun and Moon’s gravitation), as well as groundwater tides. Accordingly, all three tides will be at their zenith during what Jim terms the “seismic window” between March 19 and March 26. He continues by citing the recent million dead fish in Redondo Beach and the “beaching” of whales. His claim is that the Earth’s magnetic fields change dramatically right before earthquakes; since most fish/animals have magnetite in them to navigate those magnetic fields, said fish/animals become confused by the change. As a sidebar, magnetite (or lodestone) is the most magnetic of all naturally occurring minerals on the planet. Jim cites such events happening shortly before the 1989 World Series quake, the 2004 Indian Ocean earthquake, the 1964 Alaska earthquake, etc. He concludes with the fact that the Alaska’s 9.2 Richter scale quake occurred with a full moon.

While I certainly don’t want to ride into history as the Joe Granville of my era, I do find it unsettling that Chile’s 8.8 earthquake has been followed by New Zealand’s 6.2 quake and now Japan’s 9.0 tragedy in what appears to be a series of events occurring in a clockwise rotation around the Pacific Ring of Fire. If so, the next target should be either Alaska (the Aleutian Trench), or our west coast (the Juan de Fuca Subduction Zone, see chart). Joe Granville, by the way, hit the peak of his stock market career with his faulty prediction in April 1981 that a major earthquake, “would make Phoenix waterfront property during the week of April 10, 1981.”

Yet it is not really the threat of earthquakes that keeps me cautious on the stock market. Despite the fact that we still have not had more than three consecutive down days since September 1, 2010, and therefore the Buying Stampede remains intact, I can’t shake the feeling it actually ended on February 18. If that subsequently proves correct, we are at session 20 of a Selling Stampede. Recall, stampedes (both up and down) typically last 17 – 25 sessions before they exhaust themselves. A few have extended for 25 – 30 sessions, but it is rare to have one last for more than 30 sessions. Indeed, previously the longest stampede chronicled in my notes was a 52-session upside skein, of course that is until the September 2010 to February 2011 affair, which if ended on February 18 was legend at 117 sessions. If not, today is session 137 in the upside stampede.

Another thing that keeps me cautious is that the U.S. is going to find it increasingly difficult to finance its enormous debt given that our primary lenders are going need more of their capital at home. Think about it, the Chinese are now running a trade deficit, the Japanese are going to have a huge “call” on their capital, Europe is facing larger and larger bailouts for the PIGs, the petro-dollar nations (Middle East) are trying to buy-off dissidents, and the Federal Reserve is slated to stop QE2 in June. Unless the Martians start lending us money it is difficult to see how our cost of capital is not going to rise.

As for Japan, it is a strange feeling to attempt considering how investors should position themselves in light of this tragedy. As stated, I have thought Japanese stocks were cheap for quite some time. They obviously got cheaper last week given the Nikkei 225’s 20% decline from its March 9 high into last Wednesday’s intra-day low before firming late week. Plainly, this weakness caused a concurrent drop in the two investment vehicles I have been using since May 2009, namely Japan Smaller Capitalization Fund (JOF/$8.70) and WisdomTree SmallCap Dividend Index (DFJ/$41.55). These funds are now back to the levels I originally recommended them. Those wanting to invest in Japan should consider said vehicles using last week’s intra-day low as a failsafe point. I also think Japan will use more liquefied natural gas (LNG) and consequently I have recommended 6%-yielding Teekay LNG Partners (TGP/$39.98/Strong Buy) for investment accounts. Obviously, the nuclear nightmare had an equally deleterious impact on nuclear stocks. Hereto, a buying opportunity may be at hand. Accordingly, investors should consider the Global X Uranium ETF (URA/$14.85), which is a fund that holds a basket of more than 20 uranium stocks. I would use last week’s intra-day low of $13.25 as an “uncle point.”

While I remain cautious on stocks in the short-term, I am steadfast in my two-year belief that the equity markets are in an “up” phase for reasons often scribed in these reports. Last Friday the insightful folks at Minyanville gave me yet another reason to be constructive. To wit:

“The current myth is that it is ‘all one market.’ This was true from ~2005 to 2009 (according to the DeMark Indicator) in what people called the ‘grand reflation’ or ‘reflation trade’ and subsequently went bust. All stocks, virtually all risk assets really, had identical DeMark counts. If you covered up the name and price of the stock, and nearly all commodities, it was impossible to tell what you were looking at. They all looked alike, which in my universe is the same as saying correlations went to 1.0, which is what happens during bear markets. At the onset of bull markets the correlations break down and things begin to diverge once again. That has been happening for over a year now. It is not apparent in indexes due to their capitalization weighting, but in individual stocks it is. People now treat every company as if it were AIG or Lehman Brothers. But some companies actually have good business models and are making money despite the ongoing housing collapse and economic stress.”

The call for this week: Minyanville’s insightful CEO (Todd Harrison) had this to say on Minyanville’s must have “Buzz and Banter,” late last Friday, “A confluence of elements have come together today, including a potential ‘blink’ in Libya, relative calm in the Mid East and optimism regarding the nuclear situation in Japan. One other item bears mentioning and that’s the news the Fed says some banks can resume dividends after the stress test. That news has poked the ‘piggies’ back through the $52 level for the KBW Banking Index (BKX/$52.09) and lent a ‘bid’ to the (overall) tape.” Recall, after avoiding banks for ~10 years, I turned constructive on them last November when the bank index began outperforming the S&P 500 (SPX/1279.20). While I have not recommended the money center banks, I continue to embrace many of the regional banks often mentioned in these letters. I also remain an energy bull and offer 6.8%-yielding LINN Energy (LINE/$38.80/Strong Buy) for your consideration. LINN has a 20-year reserve life, a 100% ROI on drilling, 30% organic growth, a 7% cost of capital, is 95% hedged, and has a 50/50 mix of oil to natural gas. As for the stock market, for weeks I have suggested that any correction should be contained in the 7% - 10% range. On cue, the SPX declined 7.06% from its intra-day high of 1344 to last week’s intra-day low (1249), begging the question, “Is that it?” While I would like to think so, I just don’t believe it since we have had two 90% Downside days and two nearly 90% Downside since the February 18 high. However, that opinion could change if the SPX can hold above 1280 combined with a 90% Upside Day.

Click here to enlarge