The Summer Wind (Saut)

The Summer Wind

August 29, 2011

by Jeffrey Saut, Chief Investment Strategist, Raymond James

“The summer wind came blowin’ in from across the sea. It lingered there to touch your hair and walk with me”

... Frank Sinatra, lyrics by Johnny Mercer

Irene “came blowin’ in” over the weekend for the first hurricane to hit the East Coast in years. In fact, New England has not experienced a hurricane since “Bob” attacked in 1991. For over a year I have been commenting about the weird weather that was surely coming. Since then we have experienced the anticipated extremely cold wet winter, tornados in the Midwest of historic proportions, floods around the world, hurricanes, and droughts. Indeed, in Russia droughts destroyed 40% of the grain crop, sparking an attendant rise in grain prices. The same drought caused 30 foot deep “cracks” to appear in the farmlands north of China’s Inner Mongolia Autonomous Region, keeping farmers out of the fields. Meanwhile, other parts of China have been experiencing floods and mudslides. In this country certain regions have seen 100-year floods, while places like Texas have had 100+ degree temperatures for months with no rain. I could go on, but you get the idea -- the weather has turned undeniably weird.

To be sure, I have commented that while to some degree the environmentalists are right about the climate change being attributable to “man,” undeniably the weather is also being compounded by a La Niña weather pattern coupled with more volcanic ash in the atmosphere than anyone can remember. That combination has allowed the Tropics to expand as the Tropic of Cancer and the Tropic of Capricorn have moved toward the Poles. Well, that’s not factually correct because the Tropics can’t really expand since they are defined as being 23° 16’ 16” above and below the equator. What has expanded is the “reach” of the Hadley cell winds, which have moved closer to the North and South Poles. Recall the Hadley cell winds dominate the Tropics carrying hot equatorial air up into the troposphere where atmospheric circulation carries that air north and south. The air eventually sinks back to Earth. Where the air rises, the atmospheric pressure is low, causing heavy rains and storms. Where it sinks, it produces high pressure areas characterized by deserts like the Australian Outback. The shift in the Hadley cell winds has played havoc with the trade winds, producing droughts in otherwise moist parts of the world and monsoons in previously dry locals. Said “shift” has allowed tropical zones, and deserts, to expand. This is not an unimportant event because the changed weather patterns have major implications for agriculture and the world’s soil bank.

To wit, much of the world’s topsoil is eroding and therefore declining in nutrient quality. According to wiseGEEK:

“Topsoil is the upper surface of the Earth's crust, and usually is no deeper than approximately eight inches. The Earth's topsoil mixes rich humus with minerals and composted material, resulting in a nutritious substrate for plants and trees. It is one of the Earth's most vital resources.”

Unfortunately, topsoil erosion is occurring much faster than nature can replace it. In addition to the weather, modern agriculture techniques have hastened the erosion, as has row crop planting (corn, soybeans, cotton, tobacco, etc.) since row crops erode soil much faster than sod crops. Regrettably, once soil is gone, you can’t get it back! Plainly, this has grave implications because as I have stated for years, “When per capita incomes rise, the first thing people want is clean water, the second is a better diet.” With per capita incomes rising rapidly in emerging countries, the burgeoning food demand has left global grain consumption exceeding production; and over the next few decades the situation is likely to get worse because food production needs to expand by some 50% just to meet the estimated demand. Ladies and gentlemen, this means an additional ~6 billion acres of land is needed to meet the upcoming food demand, but only ~2 billion acres of good land is available. Thus, farmland should be a good investment and there are select public companies that play to this theme. Also of interest are ag-centric “technology” companies that hopefully can ameliorate some of the upcoming food shortfall.

I revisit the weather, water, and agriculture themes today not only because they have been three of my long-standing themes, but to emphasize why they should continue to be viable investments going forward. Importantly, water is by far the most undervalued asset I know of, yet it is difficult to find water-centric investments. Not so with agriculture.

As for the stock market, recently the most ubiquitous question has been, “Was that the bottom?” My response has been, “I think so.” Verily, if one has been using the October 1978 and 1979 bottoming patterns as a template, the correlation, at least so far, has been pretty remarkable. If that R² continues, it suggests the “selling climax” lows occurring on August 8 and 9 should prove to be the lows. However, that does not mean we can’t spend a few more weeks in “bottoming mode.” As stated, the October 1978 bottoming sequence took 6 – 7 weeks, while the 1979 sequence encompassed only 4 – 5 weeks. The ideal chart pattern would be what a technical analyst terms a “wedge” formation (see chart below). According to StockCharts.com:

“Wedge: A reversal chart pattern characterized by two converging trendlines that connect at an apex. The wedge is slanted either downwards or upwards demonstrating bullish or bearish behavior respectively.”

While a “wedge” bottoming formation should take a few more weeks to complete, many stocks have likely already bottomed. In past missives we have used some of the names our fundamental analysts believe have bottomed. Names like: EV Energy Partners (EVEP/$65.85/Strong Buy), LINN Energy (LINE/$36.97/Strong Buy), Health Care REIT (HCN/$48.62/Outperform), Campus Crest (CCG/$11.35/Strong Buy), Abbott Labs (ABT/$50.15/Outperform), and CenturyLink (CTL/$34.44/Strong Buy) to name a few. Last week, however, our energy team upgraded Chevron (CVX/96.85) to a Strong Buy and it is therefore worth your consideration. For further information on any of these, please see our analysts’ comments.

The call for this week: Just like the surfer interviewed over the weekend who grabbed a board and leapt into the Irene-induced waves, investors need to “grab a board” and catch a wave if they want to achieve investment success. But to do that, first you need to get into the water! The time to stand on-shore was months ago, not after a ~20% decline in the S&P 500 (SPX/1176.80) from its intraday high on May 2 to its intraday low on August 9. While we have been pretty conservative in our stock recommendations over the past three weeks, we would become more aggressive if the SPX can break out above the recent rally-high of ~1208. And while the odds of a recession have clearly increased (to 30%), my hunch remains we will avoid it. Accordingly, I will leave you with this quip from our restaurant analyst, “Every casual dining company that has spoken to Wall Street has said they have seen no evidence of behavior change despite all the scary headlines of the past six weeks or so. If we have a recession, this would be the first one in my 25 years as an analyst that was not foreshadowed with weakness at full service (the most discretionary) restaurants.”

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