"There You Go Again" (Saut)

“There You Go Again”

by Jeffrey Saut, Chief Investment Strategist, Raymond James

June 6, 2011

“There you go again, was a phrase spoken during the 1980 presidential election debate by Ronald Reagan to incumbent President Jimmy Carter. Reagan would use this line in a condescending way intended to disarm his opponent. The phrase has endured in the political lexicon as a way to quickly refer to various candidates bringing certain issues up repeatedly during debates. The one debate between Reagan and Carter of the 1980 presidential year was held a week before the election. As Carter went on the offensive against Reagan's record regarding Medicare, Reagan replied with ‘There you go again.’ In 1984, Reagan's opponent Walter Mondale came prepared with a reply in case Reagan used the line, which he did. However, Reagan disarmed Mondale with yet another line, in which he took the issue of his own age off the table by saying he wouldn't hold Mondale's ‘youth and inexperience’ against him.”

... Wikipedia (as paraphrased by me)

And, “There you go again” surfaced on the Street of Dreams last week, epitomized by John Taylor, Chairman and CEO of hedge fund “FX Concepts.” In his appearance on CNBC Mr. Taylor stated, “We’ll be in a recession by the end of the year.” He went on to conclude – the first half of June is when the market will tank with the recession starting in December. Of course, those views were trumpeted by a host of other pundits as last week’s economic reports worsened. Fair enough, so we decided to look at some of Mr. Taylor’s past predictions. In July 2010 the headline reads, “John Taylor calls the top: the rally is ending.” From there the S&P 500 (SPX/1300.16) would subsequently rally ~33% by February 2011. Or, how about this – in March 2009 Reuters asked John Taylor, “Are stocks at a bottom?” He replied, “We are not at the bottom. Stocks may emblematize at their two-to-three lifetime bottoms; but even so, rush lower. I am sticking to my 500 - 550 forecast for the S&P 500.”

Now, people who live in glass houses should not throw rocks. Lord knows I have had my share of bad predictions over the past 50 years. Calling the Beatles a “one hit wonder,” questioning why anyone would pay for a bottle of water, and stating that nobody would ever use the Internet are but a few of my more embarrassing “calls.” However, writing investment letters about stock market “crashes” and impending “depressions” seem a bit reckless to me. Even when I was in Barron’s, in September 1987, I didn’t use the word “crash,” but rather stated there was a “waterfall decline” coming. Nevertheless, the media was replete with negative nabobs last week as the economic news got worse over the course of the holiday-shortened week. I know the media is “long” volatility because volatile market action breeds more viewership, but for the life of me I have NEVER understood why the public is so quick to embrace the negatives. Moreover, I don’t get why investors didn’t anticipate softer economic numbers.

Ever since the Japanese tragedy (Fukushima) I have been writing about how the subsequent supply chain interruptions were going to cause economic dislocations. Combine that with the weird weather (one of my better predictions), the latest Easter in 68 years, soaring fuel prices (back in April), and is it any wonder the economy has slowed?! But consider this, the sales-to-inventory ratio for U.S. businesses is below where it was during the depths of the 2008 recession, as can been seen in the first chart on page 3. To me, this suggests the stage is set for another inventory rebuild cycle, which should help strengthen the economic numbers going forward. That view is reinforced by another new all-time high in U.S. corporate profits (see second chart on page 3). Manifestly, the way the world works is that corporate profits expand, which drives an inventory rebuild cycle. That, in turn, fosters a capital expenditure cycle where companies spend money on plant and equipment. Subsequently, people get hired and consumption improves. I see no reason that sequence won’t play this time.

That said, the SPX broke below its 50-day moving average (DMA) eight sessions ago. I commented on that event at the time and stated it needed to recapture the 50-DMA quickly, which it did. However, I have repeatedly said that for me to get really aggressive the SPX needed to close decisively above the 1340 level. The 1340 level was not arrived at arbitrarily. It was derived from some proprietary work, which pegged 1340 as a strong attractor/repeller level. For the record, by “decisive” I mean that I use a 0.005% trading envelope meaning the SPX would have to close above 1346.7 for a “decisive” upside signal to be registered (1340 x 0.005 = 6.7 points, or 1346.7). Regrettably, last week’s high closing price was 1344.79. Obviously, the 1340 level turned into a “repeller,” causing the SPX to fall back below its 50-DMA (1331.39). More importantly, it violated the 1316 – 1320 zone I have been using as a “fail safe” point for trading types. Accordingly, we raised some more cash late last week even though we still expect the 1295 – 1300 level to provide meaningful support for stocks. However, if that level is “decisively” breached, there isn’t much visible support until 1250 – 1230.

Last week’s action caused the D-J Industrial Average (DJIA/12151.18) to lose 2.33%, marking its fifth consecutive weekly loss. It was the Dow’s first five-week losing skein since July 2004 (the SPX has had five such skeins since July 2004) when it was in the process of forming a bottom around 9700 for a rally that would carry it into its October 2007 all-time high of 14093.08. Alas, the “weekly wilt” left the senior index below its April 18, 2011 reaction low of 12201.59. For the D-J Transportation Average (TRAN/5220.25) to confirm the Dow’s downside would require the Trannies to violate their April 18, 2011 closing low of 5211.81. Therefore, this week could be setting up for a short-term downside non-confirmation. Yet even if the Transports confirm the downside in the short-term, it would still not be a Dow Theory “sell signal.” For that to occur would require both Averages to break below their respective March 16, 2011 intermediate “closing lows” of 11613.30 and 4950.00 and I just don’t expect that.

The reason I don’t believe a Dow Theory “sell signal” is in the cards rests on the fact that earnings estimates continue to improve, short-term funding markets are improving, lending standards are easing, commercial and industrial loans are rising, consumer credit is reviving, and the money supply is increasing. Importantly, President Obama and Fed Head Bernanke are determined to see a stronger economy. Verily, I think the economic recovery has become self-sustaining despite the recent anticipated soft patch. Accordingly, I will repeat what I have said for over a year, “You can get cautious, but don’t get bearish.” To me it currently feels eerily similar to what happened in the February – March decline of this year. At the time I was opining that any decline would likely be contained in the 7 – 10% range. I still feel this way and would note that as of last Friday’s close the DJIA is off ~6% from its intraday high of 12876.

The call for this week: Last Wednesday (-279.65 DJIA) was a 90% Downside Day, meaning 90% of the total points lost, and 90% of the total volume came on the downside. Typically, such Downside Days are followed by two- to seven-session “upside” rebounds. Clearly, that did not happen, bringing into view the SPX’s April intraday reaction “low” of 1294.70. Violating that would imply 1250 and then 1230. While I don’t think that is what will happen, the stock market doesn’t care much about what I think. Hence, the SPX had better hold above the April reaction “lows” or we will be forced to raise even more cash. Remember what Benjamin Graham said, “The essence of investment management is the management of risks, not the management of returns. Well managed portfolios start [and end] with this precept.” We continue to invest, and trade, accordingly ...

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