Jeffrey Saut: "Bizarro World"

“Bizarro World”

by Jeffrey Saut, Chief Investment Strategist, Raymond James

June 16, 2014

We stood up for what was right. We fought for moral reasons. We passed laws, struck down laws for moral reasons. We waged wars on poverty, not poor people. We sacrificed, we cared about our neighbors, we put our money where our mouths were and we never beat our chests. We built great big things, made ungodly technological advances, explored the universe, cured diseases, and cultivated the world’s greatest artists and the world’s greatest economy. We reached for the stars, acted like men, we aspired to intelligence, we didn’t belittle it, and it didn’t make us feel inferior. We didn’t identify ourselves by who we voted for in the last election and we didn’t scare so easy. We were able to be all these things and do all these things because we were informed, by great men, men who were revered.

... Jeff Daniels, delivering a biting soliloquy on American decline (HBO’s The Newsroom)

I recalled this quip by Jeff Daniels from HBO’s hit series The Newsroom while taking last week off to think about recent events because I feel like I am living in Bizarro World. First named "Bizarro World" in DC Comic books, the term has come to mean a situation or setting that is weirdly inverted or opposite of expectations. I mean we’ve had the ATF’s Fast & Furious where we sold guns to Mexican smugglers. The NSA is spying on us. The IRS is using its power to target select groups and now the IRS claims it has lost 28 months of Lois Lerner’s emails. Benghazi. The Department of Justice going after the Associated Press and Rosengate. The Veterans Administration horror. Last week it was tens of thousands of children crossing our southern border combined with the ISIS blitzkrieg in Iraq. To top it all off, there are reports of Iranian troops in Iraq, as well as some Russian tanks moving into Eastern Ukraine. But the situation in Iraq is by far the most serious. Just look at the map on page 3 of what ISIS (the Islamic State of Iraq and Syria) wants to create. They want to carve out an Islamic state they would use as a terrorist staging area that would destabilize the region. Plainly, Jordan and Kuwait could not defend themselves against such a state.

Accordingly, I wrote this in last Friday’s Morning Tack:

The worry is that if Baghdad “falls” the entire Middle East could degrade into a holy war. Armed with those worries I made some calls to folks familiar with the situation. I was told to understand Iraq one has to know that it is a sectarian nation with the Shiites controlling the government, the Sunnis out of power, and the Kurds to the north. Evidently the Shiites have repressed the Sunnis to where they felt hopeless and had nothing to lose, thus the insurrection. The folks I talked to do not believe the Sunni-controlled ISIS will attack Baghdad because most of the population there are Shiites and they will fight and never surrender to ISIS. Moreover, there are a few hundred thousand troops in Baghdad. What they could do is to surround Baghdad and attempt to cut it off from supplies.

Over the weekend ISIS continued its onslaught toward Baghdad, prompting Iraq’s supreme cleric (Grand Ayatollah Ali al-Husseini al-Sistani) to issue a call to arms to defend the city. This is just another sign of how critical the crises is, and while clearly the right thing to do, it does run the risk of plunging Iraq into a sectarian war between the Shiites and Sunnis. As of this writing reports have it that thousands of folks have responded to the cleric’s call.

One thing that has materialized from the current Iraqi conflagration is a rise in the price of gasoline (see chart 2). A further price rise could become a serious headwind in the U.S. economic recovery. Recall that every penny rise in the price of gasoline represents a $1 billion “hit” to the purchasing power of American consumers and last week WTI crude tagged a nine-month high. However, if we don’t get a big spike in gasoline prices many of the recent economic numbers are looking better. While last week’s retail sales disappointed, real retail sales for 2Q14 are on track for a large +6.6% quarter/quarter annualized run rate. The U.S. Small Business Optimism Index has broken out to a six-year high. U.S. railcar loadings are at a 10-year high, U.S. bank loans are at a six-year high, the U.S. Financial Conditions Index is at new highs, and the list of positives just keeps going. So, why did every index I follow decline last week, as did every sector except Energy (+1.66%)?

The media trotted out a number of reasons for the weekly wilt, but how about this. The equity markets were stretched pretty far above their various moving averages and needed a rest. And last week’s “rest” did correct the McClellan Oscillator’s overbought condition. It also brought the number of stocks in the S&P 500 (SPX/1936.16) above their respective 50-day moving averages (DMAs) down from 86.4% to 66.3%. In last Monday’s letter I noted, for various reasons, in the near term the upside is going to be very difficult. Well, the overbought condition has to a large degree been corrected. My internal energy indictors, however, are nowhere close to rebuilding any strength. Now, I had thought the initial 1930 – 1940 support level for the SPX would not hold and that the real battle would come at 1920, as stated repeatedly last week. Unfortunately, the low “print” for the week came on Thursday at 1925.78 so I never got to see how the SPX would handle the 1920 level. Therefore, I begin this week still in cautious mode on a trading basis. On a trading basis the SPX would need to close over last Thursday’s intraday high of 1943 to impress, and then trade out above the all-time high 1955.55, but I have my doubts that is going to play this week. Longer-term I remain bullish given the S&P 500’s earnings yield (E/P) of 6.2% for this year, and 7.1% for 2015 based on bottom-up and operating earnings estimates of $119.65 and $137.30, respectively, for the S&P 500. Also on a positive note, one of my proprietary indicators remains “greened up,” as it has been since December 2012, and green is good. In fact, it has not given any intermediate sell signals since turning green on December 7, 2012 (see chart 3). The only thing I have attempted to do is call the shorter-term trading moves, finesse moves if you will, with the knowledge that sometime this year we are due for a 10% - 12% pullback based on historic precedent. And, then there was this from the eagle-eyed Jason Goepfert of SemtimenTrader fame:

The spread between the Smart Money and Dumb Money Confidence has now widened to negative 38% (see chart 4). This is the 8th time it has done so since the bull market began in 2009. All 7 prior instances saw stocks give back any further shorter-term gains when looking out several months, and 4 of them coincided with the exact peak or within days of it, while 3 instances saw stocks run another 1-2 months before peaking (March 2010, December 2010 and November 2013).

The call for this week: As of late Sunday night the aircraft carrier USS George HW Bush had been moved into the Arabian Gulf, we were evacuating some of our personnel from the embassy in Baghdad, the Iraqi military had claimed to have stopped ISIS short of Baghdad and stated they were on the offensive, this morning Saudi Arabia rejects any foreign intervention in Iraq, then there is “got gas” in the Ukraine as Russia shuts off their natural gas flow, there has been no word of the three teenagers abducted in the West Bank, there is no movement on the U.S. Marine who took a wrong turn into Mexico and was arrested for possession of pistols; indeed, “Bizarro World!” In fact, what’s going on everywhere reminds me of the last scene in the movie Bridge Over the River Kwai where the camp doctor sits on a stump overlooking the blown-up bridge and a bunch of dead people repeating the word, “madness, madness ...”