by Jeffrey Saut, Chief Investment Strategist, Raymond James
it doesn't matter how many of its leaves fall,
it still adorns its boughs with more.
it doesn't matter how many storms try to make it bow and bend down,
it still stands tall and clings firm on its ground.
it doesn't matter how alone and lonely it stands,
it still keeps nesting wild sparrows in its motherly arms.
it doesn't matter how hot the sun burn through its time,
it still remembers to look up and worship the Great One above.
...Thoughts Under The Sequoia Tree by Cristone Benavente
I stopped my rental car in the middle of a cluster of giant sequoia trees while driving to one of my speaking engagements in northern California last week. I have always been overwhelmed with these beautiful “beasts” and last week was no exception. As I lay supine at the base of the behemoth the visual fallacy actually made it look like this monster was indeed growing to the sky. The surreal sensation brought to mind the old stock market axiom, “Trees don’t grow to the sky!” Yet, the stock market’s action since the intraday low of March 6, 2009, at the surreal 666 “mark of the devil” basis the SPX, certainly gives the impression that trees can truly grow to the sky. Most recently, we have seen this “trees to the sky” effect over the past few weeks.
Recall, just two weeks ago the S&P 500 (SPX/2096.99) completed a third “bonk” against its downside support level of 1990, causing me to utter the old stock market saw, “Triple bottoms rarely hold.” Well, the news backdrop changed and those “bonks” proved to be a rare triple-bottom as the SPX spurted a cool 100 points from its intraday low back into its longstanding overhead resistance zone of 2060 – 2080. Hereto, the SPX “bonked” three times against that resistance zone, triggering another market mantra, “Triple-tops rarely hold.” The implication is/was that while there are numerous examples of double-tops stopping rallies, typically when you see a triple-top the stock, or index, in question breaks out to the upside; and that was the case last week. Moreover, as stated for weeks, I have not seen such a huge buildup of internal energy on my proprietary indicators for the equity markets in years. Two weeks ago I thought that energy was going to be released on the downside (as a sidebar, the indicators do not tell you which way the energy is going to be released, but rather that there is a lot of energy to drive a big move in either direction). Obviously, some of the internal energy has been released on the upside since the February 2nd intraday low of ~1981. However, what is amazing to me is there is still a large amount of internal energy left. So while I am chagrinned to put this in writing, if last week’s upside breakout to new all-time highs by the SPX sustains, and if it is a true upside breakout and not a fake out, my models suggest a move to 2200+ on the SPX is possible in the short/intermediate term. I know that sounds improbable, and maybe even impossible, but that is what the models are saying.
Speaking to Dow Theory, first let me say to all the false prophets of Dow Theory that rang the Dow Theory “sell signal” bell two weeks ago, while the D-J Industrials (INDU/18019.35) and the D-J Transports (TRAN/9034.06) have not registered new all-time highs, they are certainly close to doing so. If the Industrials can close above their December 26, 2014 closing high of 18053.71, combined with the Transports closing above their respective closing high of 9217.44 on December 29, 2014, it would yet be another of the long string of Dow Theory “buy signals” chronicled in these missives since our “it’s the bottom call” of March 2, 2009. So what are we as investors, and or traders, to do at this juncture?
Well, I will repeat what I have said ad nauseam for nearly six years, “It’s a bull market and in bull markets all the surprises come on the upside!” Accordingly, while Andrew Adams and I have made some “trading calls” to raise cash from time to time, those “calls” have ALWAYS been within the context of a secular bull market that likely has eight to nine years left in it. To be sure, secular bull markets historically last 14 to 15 years and compound at a 16% average annual rate of return. Since we are nearly six years into this one, if past is prelude, we should have another eight to nine years left in this secular bull market. And, if the 16% average annual compounding return holds true, the SPX will be substantially higher in the early 2020s than it is now.
That said, the SPX’s breakout to new all-time highs, which is as of yet unconfirmed with a Dow Theory “buy signal,” leaves us at a unique spot in time. If the Industrials and Transports fail to confirm the SPX on the upside, the huge buildup of internal energy could still be released on the downside. Right now, I think said energy will be released on the upside, but a few weeks ago I wrong-footedly thought it would be released on the downside. Therefore, this week is critical in the short-term scheme of things. Nevertheless, there are some interesting events that occurred last week with some of our stocks. Years ago, with the arrival of Obamacare, we determined the big winners would probably be the drug store chains and featured our fundamental analysts’ favorable thoughts and ratings on the group. Particularly featured were CVS (CVS/$102.63/
Outperform), Rite Aid (RAD/$8.34/Outperform), and Walgreens (WBA/$78.73/Market Perform). Last week Rite Aid made an interesting acquisition and our fundamental analyst wrote this:
We reiterate our Outperform rating on shares of Rite Aid… following the acquisition of EnvisionRx, a leading independent pharmacy benefits manager (PBM). Management expects Envision to generate $150-160 million in CY15 EBITDA, implying an 11.1x purchase multiple (versus CTRX at ~12x and ESRX at ~10x), net of $275 million in net operating losses. The $2 billion acquisition will be financed with a combination of new unsecured debt ($1.8 billion) and stock (27.9 million shares issued to the seller); the transaction is expected to close by September 2015 at the latest. We believe the pursuit of an integrated model is more important than initial accretion (we estimate ~3% accretive to FCF per share in year one) and the favorable purchase price. Three key factors make the integrated model work for Rite Aid: 1) lower drug acquisition costs for EnvisionRx via MCK (included in the $25 million initial synergy estimate); 2) adding a captive retail network to EnvisionRx's offerings; and 3) ‘soft steering’ retail traffic to Rite Aid stores a la ‘Maintenance Choice,’ the CVS model. The CVS retail/PBM model has certainly stood the test of time.
The call for this week: This week we find out if trees can really grow to the sky; indeed, breakout or fake out. Speaking to crude oil’s action, amid Citi’s call for $20 per barrel oil last week, all I can say is where were such oil bears when rude crude was breaking down at $100 a barrel?! The only folks I know that had a bearish “call” at the time were the energy analysts at Raymond James. Now our team thinks oil is bottoming and they are not the only ones, as referenced in an article titled “Bottom Fishers Play Energy Angle” in last Friday’s Wall Street Journal. The first line of the article read, “The oil slump is drawing interest from some of the savviest bargain hunters on Wall Street.” And then there was this this from the chief of Royal Dutch Shell, who said he expected crude demand would grow faster than supply this year, which caused crude to pop ~3% last Friday. Of course all of this dovetails with what I wrote months ago following my visit with David King, portfolio manager of Columbia Flexible Capital Income Fund (CFIAX/$12.35), who said, “Jeff, you are getting a once in a lifetime opportunity to buy the ‘broken debt’ of some of these smaller energy companies.” Plainly I agree, but if you don’t have the skill sets to drill down into the balance sheets of such companies, you can just buy David’s fund. This morning the futures are flat as Greek talks stall, the Ukraine truce fades, U.K. inflation falls to the lowest on record, China’s defense budget defies an economic slowdown, and crude oil is up ... again.
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