Me, Lord Marlboro and the Dow!? (Saut)

Me, Lord Marlboro and the Dow!?

May 9, 2011

by Jeffrey Saut, Chief Investment Strategist, Raymond James

Reminding me of the current equity market is an anecdote about the Sport of Kings that took place in London:

“An American race horse owner, while parading his entry in the paddock just before the event, fed the horse what appeared to be a white tablet. Noticed and challenged by an English track official, Lord Marlboro, the American was informed that his horse would have to be disqualified. Protesting vehemently that he only gave the horse a sugar cube, the owner popped one into his mouth and offered Lord Marlboro a cube as proof. The English official tasted and swallowed the cube. He agreed with the owner that it was a harmless sugar cube and waived the disqualification. Just before the race horse was to enter the gate, the American signaled his jockey, instructing him to keep his horse clear of trouble near the start and try for the lead early since his horse was sure to win. ‘In fact,’ he told the jockey, ‘Only two have a chance to beat our horse.’ ‘What two?’ asked the jockey? The American owner replied . . . ‘Me and Lord Marlboro!’”

... Anonymous

I recalled the “Me and Lord Marlboro” quip as I watched the running of the Kentucky Derby over the weekend. Evidently, someone fed Animal Kingdom the proverbial “sugar cube” as this 20:1 long shot won the Derby by 2¾ lengths. Likewise, someone fed the D-J Industrial Average (INDU/12638.74) a “sugar cube” Friday morning as the senior index “galloped” 176 points higher on the better than expected employment numbers. Friday’s fling “saved” the index from a fourth session in a row on the downside, leaving the “buying stampede” intact at a now legendary 178 sessions. Indeed, the Dow has not experienced anything more than a one- to three-session pause/pullback since September 1, 2010, making this skein the longest stampede ever chronicled in my notes of over 40 years. Surprisingly, however, despite all the snorting and animal spirits, the investing public is largely AWOL (absent without leave) as reflected by the dearth of “bulls” in the sentiment figures. Even professional money managers tend to be “paranoid bulls,” having waited for a 10% - 20% correction to buy into for months. Yet, as repeatedly stated, I just don’t see anything more than a 7% - 10% pullback given the current earnings momentum. To be sure, I don’t think “sell in May and go away” is going to play this year. In fact, I think the averages are going to stay pretty perky until the end of the quarter when QE2 ends, which should make July the first month with the potential for a decent correction.

That said, while the intermediate/long-term internal stock market energy remains fully charged for a move higher, the market’s short-term energy still needs some time to rebuild. This probably means another week, or two, of consolidation and/or attempts to sell stocks down before we begin another leg to the upside. Even so, I don’t think any selling will gain much downside traction, implying the zone between the S&P 500’s (SPX/1340.20) 50-day moving average (DMA) at 1320 and the 1340 level should provide support for stocks.

Speaking of moving averages, for the past few weeks I have suggested most commodities were stretched on the upside with crude oil ~30% above its 200-DMA, while silver was an eye-popping ~83% above its 200-DMA. Last week some of the excess got corrected with oil declining 14.7% for the week, while silver lost 26.43%. In the process, both broke below their respective long-term uptrend lines, as well as their 50-DMAs, and were lower in all five sessions. For those wondering, Bespoke Investment Group writes:

“Silver has had 84 five-day losing streaks since 1975, and its average change over the next five days has been +0.16%. Oil has had 98 five-day losing streaks since 1983, and its average change over the next five days has been +0.65%.”

Despite these historic figures, I still find it difficult to believe silver and crude oil will rally much this week. Indeed, just like a heart attack patient doesn’t get right up off of the gurney and run the 100-yard dash, I doubt silver and oil will do that either.

Accompanying the “commodity crack” was an “MLP Melt” (master limited partnership) as rumors swirled that any new tax law would eliminate the MLPs’ advantage of “pass through” taxation. As MLPinvestor notes:

“In an MLP investors who invest directly in LP units only pay taxes on the cash distributed to them. That is, taxes are not paid at the entity level only at the investor unit level. This is often referred to as ‘pass-through’ taxation, and is a huge advantage for MLPs.”

We think the odds of such legislation passing are de minimis and therefore view the MLP pullback as a buying opportunity. To reiterate a few of our favorite names: LINN Energy (LINE/$37.63/Strong Buy); Enterprise Products Partners (EPD/$41.36/Strong Buy); Teekay LNG Partners (TGP/$35.10/Strong Buy); EV Energy Partners (EVEP/$54.50/Outperform); and Atlas Pipeline (APL/$32.74), which is followed by our research correspondent with a favorable rating.

Clearly the Osama Bin Laden news, and the “commodity crack,” were the big new events of the week. However, a burgeoning story would be the continuing weird weather. Since last August I have been writing about the building La Niña weather pattern, combined with more volcanic ash in the atmosphere than anybody can remember, which has caused the Hadley cell winds to expand toward “the poles” (North and South). Recall the Hadley cell winds dominate the tropics, carrying hot equatorial air up into the troposphere where atmospheric circulation carries them north and south. The air eventually sinks back to Earth. Where the air rises, the atmospheric pressure is low, causing heavy rains and storms (tropical). When it sinks, it produces high pressure areas characterized by deserts like the Australian outback. Unsurprisingly, the Hadley cell winds’ outward shift has played havoc with the trade winds producing droughts in otherwise moist parts of the world and monsoons in previously dry locales. Said “shift” has allowed tropical zones, and deserts, to expand dramatically. It has also fostered hurricanes, tornado, floods, etc. This is not an unimportant observation because the changed weather patterns have major implications for agriculture and the world’s soil bank. Such insights sparked this question from one of our more thoughtful financial advisors:

“Jeff, from somebody on the ground in Memphis, the word ‘epic’ to describe the current situation seems woefully inadequate. My thinking is that we need to be thinking about the ‘what if’s.’ What if the entire flow of the Mississippi river migrates west into the Atchafalaya Basin? What would be the impact on all the natural gas storage and infrastructure in the area, not to mention the other implications? It remains a much more likely possibility than people understand.”

The call for this week: Both the Reuters Commodity Research Bureau and the Goldman Sachs Commodity Index look to have formed double tops in the charts and surrendered 8.04% and 11.15% for the week, respectively. This suggests a period of convalesces for our beloved “stuff stocks,” but it is unlikely the secular bull market is over for stuff. The quid pro quo is that the Dollar Index may have put in a short-term bottom, a view that would gain credibility if the Dollar Index (75.18) can break out above its 50-DMA at 75.61. As for the catalyst for the commodity crack, opinions varied from emerging markets interest rate ratchets, silver margin increases, rumors Soros was selling gold/silver, weaker economic data, profit-taking, you pick it! I still expect that the Fed’s zero interest rate policy will continue to boost commodity prices over the long run. Accordingly, my strategy is to continue accumulating fundamentally sound stocks, preferably on weakness, and manage the downside risk. In addition to the names mentioned in these missives over the last few weeks, our friends at Bespoke have listed “Top Triple Plays,” which focuses on companies that have beaten earnings and revenues estimates and raised guidance. Four from the list covered by Raymond James include: Select Comfort (SCSS/$16.60/Strong Buy); Polaris (PII/$103.70/Strong Buy); Plexus (PLXS/$35.86/Strong Buy); and Arrow Electric (ARW/$44.67/Outperform).

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