Jeffrey Saut: "Alpha, Beta!"

May 22, 2013

5 minute read

“Alpha, Beta!”

by Jeffrey Saut, Chief Investment Strategist, Raymond James

May 20, 2013

I had a somewhat lengthy conversation with Rich Bernstein last Friday. I have been on TV with Rich over the years, but have never really had a one-on-one talk with him. Recall that Richard Bernstein was the Chief U.S. Strategist at Merrill Lynch for years before becoming the eponymous captain of Richard Bernstein Advisors (RBA). I was speaking with Rich because I have developed an interest in a few of the funds he manages for various entities. Rich began by stating he is extremely bullish, believing we are in one of the biggest “bull markets” ever. He commented that individual investors have “selective memories” and they think things should “feel good” when the stock market is going up. That is clearly not the case now. Things don’t feel very good, which is why investors don’t understand why the equity markets are so buoyant. Rich therefore opines we are likely only in the 4th or 5th inning of this bull market and when things start to feel good, and investors return in droves, the market will be in its 8th or 9th inning. Of course. that is the historic psychological cycle of the market, as can be seen in the chart on page 3.

Turning to emerging markets (EMs), Rich is shunning them, noting that while the U.S. economy is improving, and Europe is bottoming, there are debt, currency, economic, etc. issues in most of the EMs. For example, India has the highest inflation rate of any large economy in the world and yet its Central Bank is lowering interest rates. In China, he observes a banking problem, with non-performing assets (NPAs) rising rapidly. Hence, Rich is very underweight the EMs with only a 1% exposure. He continued, “I am very bullish on U.S. domestic companies with indexes like the S&P SmallCap 600 estimated to grow at more than twice the projected rate of most EMs.” He did say his funds bought Japan last fall, which luckily was right before “quantitative easing” was announced. Like me, Rich is a big believer in the American Industrial Renaissance and noted that to his knowledge he is managing the only “pure” industrial renaissance fund in this country. Also, like me, he is a big believer in energy independence for our country by 2020. We concluded our discussion with Rich stating, “We are Beta managers, and not Alpha managers, because correct asset allocation is the key to outperformance in the markets.”

I revisit Rich Bernstein this morning because I am hosting a “conference call” with him this Thursday at 4:15 p.m. (800.369.1922) where some of the underlying themes we will discuss include: 1) U.S. labor costs are becoming more competitive; 2) Lower Energy costs, both for natural gas and gasoline, making U.S. supply and distribution chains more efficient than those in EMs; 3) The U.S. has greater political stability, including respect for the rule of law; 4) U.S. companies are already gaining market share in many cases; 5) The American Industrial Renaissance (AIR); 6) Why there could be some problems with EMs, and anything else y’all want to talk about. Worthy of mention is that the AIR theme presently comprises about 10% of the Eaton Vance Richard Bernstein Equity Strategy Fund (ERBAX/$12.95) and a commensurate proportion of the equity sleeve of the Eaton Vance Richard Bernstein All Asset Strategy Fund (EARAX/$12.16). Because RBA is a macro- and quantitative-based firm, it has invested in a basket of approximately 50 companies fitting such investment themes. As with all of the firm’s theme-based investing, no one stock dominates a theme in order to help reduce the risk of the theme to the overall fund. I suggest listening to this call because Rich is one of Wall Street’s best.

Last week I hosted another call with my friend Troy Shaver, portfolio manager of the Goldman Sachs Rising Dividend Growth Fund (GSRLX/$17.80). Like Rich and I, Troy noted the low cost of energy is the key to a resurgence of the reshoring of industrial production back to this country. Troy began the discussion with, “Ten years ago we were importing 14 million barrels of oil a day and now it’s down to 7 million. In fact, last year we surpassed Kuwait’s crude oil production.” Referencing the Bakken, Troy mentioned that only 8,000 wells have been drilled so far, but before it’s over 36,000+ wells will be drilled. Moreover, the resource we are currently drilling is only 35 inches thick, but there is another resource under that (the Three Forks Formation) that is 4,000 feet thick and is estimated to have more than 7 billion barrels of oil.

Switching gears, he stated that over the past 40 years the leading space for stock performance has come from “dividend growth” stocks, with “dividend payers” being the second best performing group. Currently, he stated the “growth dividend payers” are more cheaply valued than the “dividend payers” and noted, “McDonalds (MCD/$101.54/Market Perform) has a 10-year average dividend growth record of 29% per year.” Another name he owns from Raymond James’ research universe is EOG (EOG/$135.25/Outperform). Troy considers EOG the best integrated energy company in the world. In Troy’s view, EOG is the most efficient E&P company on the plant, it has consistently increased reserves, possesses a huge ROI, owns its own sand/water/trucks/rigs/rail cars/ hoppers/etc., and has increased its dividend for 10 years by 10%+ per year. Another name mentioned was Polaris (PII/$91.46/Strong Buy), which is the leader in all of its seven categories. Troy went on to say he currently has no Utilities or bank stocks in his fund, but does have a 20% position in master limited partnerships (MLPs), which I actually like. His “sell discipline” is if a company “cuts” its dividend, if the 10-year dividend growth rate falls below 10% per year, or if there is a fundamental change in the company’s strategic direction. His fund has a low turnover ratio of 20%, a three-year Beta of 0.7, and an upside capture ratio of 0.9%.

Speaking to the stock market, last week‘s action was no surprise, even though we are now at session 97 in the longest “buying stampede” I have ever seen. As noted, this stampede is legend, eclipsing the now second longest stampede of 53 sessions by nearly twice. Last week’s “win” lifted the S&P 500 (SPX/1667.47) by 2.07%, but the real star was the economically sensitive D-J Transportation Average (TRAN/6549.16), which gained 2.72%. Unsurprisingly, such strength left all the macro sectors higher for the week with Financials being the strongest (+3.32%). Also unsurprising, currently all of those macro sectors are way overbought. Of course in “bull moves” markets can stay overbought for a lot longer than most think. And, that’s what I believe is going to happen as I expect the SPX to trade to 1700 into the end of the quarter before a polarity flip occurs sometime in the July/August timeframe, leaving stocks susceptible to a low double-digit decline.

The call for this week: The negative nabobs that continue to call this rally just a “tactical rally” in an ongoing “secular bear” market, as they have for more than four years, should consider this. The equally weighted S&P 500 (SPXEW/2590.60) made a new all-time high in April 2011; and made another new all-time high in March of last year, and has been pointing the way higher ever since (see chart on page 3). I, like Rich Bernstein, think this “bull” has a lot further to run. I do, however, think the equity market will become vulnerable to a decent pullback in the July/August timeframe.

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