by Jeffrey D. Saut, Saut Strategy LLC
Desperately Seeking Susan is a 1985 American comedy-drama film directed by Susan Seidelman and starring Rosanna Arquette and Madonna. Set in New York city, the plot involves the interaction between two women – a bored housewife and a bohemian drifter – linked by various messages in the personal column of a newspaper. We recalled the movie, and its title, while talking to a 70-year-old contemporary who told us that in this low interest rate environment he is, “Desperately seeking savings.”
Wow, what a clever twist of words and it made us think of an old friend and mentor, Stan Salvigsen. Stan cut his teeth in this business as the strategist for C.J. Lawrence. Later he moved on to be the number one rated strategist on Wall Street at Merrill Lynch. Eventually, Stan broke with Merrill and teamed up with Michael Aronstein and Charles Minter to form Comstock Partners, which wrote some of the most colorful strategy reports ever on Wall Street.
It was Stan who first opined, “Before the bond bull market is over (lower interest rates) retirees in Florida will be fishing golf balls out of the golf course water hazards to supplement their retirement income.” Well, here we are!
So, what does my generation do for income in the current interest rate environment? Most of you know that one of the vehicles I personally have opted for is the midstream Master Limited Partnerships (MLPs). They are cheap, have decent yields, those dividend distributions have a very favorable tax treatment (much of it tax deferred), and everybody hates them because they got killed with the upstream MLPs.
Those folks lost a lot of money because they did not follow investment rule number 1, “Manage the risk and do not let anything go very far against you.” Our friend, and the best MLP centric portfolio manager I know, Eric Kaufman of VE Capital, told me some 8 years ago to not own any upstream MLPs because they have too much price sensitivity to crude oil. Boy, did that prove to be good advice!
So, I called Eric last week to ask, “With the 10-year T’note yielding roughly 1.5%, and the Alerian Index (AMZ) yielding over 8% should not that spread narrow over the coming years?” Here was his response:
Currently the capital markets are experiencing much lower bond market returns which have evolved rapidly over the last 10 months from a high yield on the 10 Year Treasury of 3.259% on 10-9-18 to a 1.44% yield on 8-26-19. Many countries are even experiencing negative yields on both sovereign and some corporate debt.
The reasons for this phenomenon abound aplenty from trade war concerns with attendant supply chain disruptions to the Central Bank accommodation to stimulate growth. Perhaps, some of these factors are merely a trigger for what is possibly a much different and simpler explanation. Consider the following possibility. Perhaps a new period of protracted low bond yields has at its core the aging of the Baby Boom Generation. What if low yields become the norm? In that case persistent ultra-low bond yields will likely force the huge cohort of under-saved Baby Boomers into equities as they search for sufficient returns. Such a situation has at its roots a shift in patterns of consumption due to aging from one of accumulating stuff. Generally speaking, when a large population exhibits acquisitive behavior, it inflates the value of whatever is being accumulated. In the years ahead, perhaps it will be equities, and
especially those where a significant percentage of hoped for total return is comprised of cash, such as dividends/distributions. Likewise, as the Boomers stuff is sold off (downsizing) the economic result, is deflationary. This result may be somewhat balanced by normal consumption of other demographic groups, thus producing a long-term sub-optimal rate of inflation (probably well below the Feds current preferred stated level of 2%) and should support below average interest rates for many years. A cursory review of the Japanese experience since the 1990's could be instructive here.
The search for income-producing assets will most probably accelerate as the Baby Boomers continue to age, which should propel the equity markets for some time, perhaps into the mid/late 2020's. If we agree with the thesis that equity bull markets come in 3 stages: Stage 1, mean reversion; Stage 2, the accumulation stage; and Stage 3, the speculative bubble phase; we are now right in the middle (Stage 2) of a Long-Term Bull Cycle (secular bull markets tend to last 15 -20 years). This backdrop may be instructive from the standpoint that just around the late 2020's millennials should begin to have some real funds for investments. The increasing preeminence of the upwardly mobile millennials, and the decline of the aging boomers’ economic influence, probably sets the stage for the last phase of the then aging bull market. If we review the general behavior pattern of the millennials, the one piece which stands out from their tech world upbringing is the need for immediate gratification rather than long-term strategic thinking. This fits nicely with a speculative end to the bull market probably somewhere in the mid/late 2020s or early 2030's. Beware the millennials giving hot stock advice at that time.
P.S. - This is a gross simplification of an extremely complex matter and is meant to pique your curiosity and deep thought.
Eric
Saut Strategy would add that Stage 1, Mean Reversion, was from March 2009 through May 2015. Stage 2, Accumulation began in February 2016 and is still at play. Stage 2 is usually the longest and strongest stage. When it will be over is unknowable, but when it is, we should see another upside consolidation like the May 2015 to February 2016 period where nearly everyone got bearish right before Stage 2 began. Enter stage 3, which is the “speculative stage” that puts the froth on the top of the beer mug. To size that for you Stage 3 of the 1982 – 2000 secular bull market began in late-1994 and lasted into the spring of 2000.
Another vehicle I am personally using is managed by the firm I have become associated with, namely Naples, Florida-based Capital Wealth Planning (CWP). Our association was fated. Many of you know I came into this business in 1971 of a trade desk making markets in options (puts and calls) before there were any option exchanges (the CBOE began in 1973). In fact, covered call writing kept me in the business in the horrid stock market period of 1973 – 1974 (the Dow lost ~50% of its value). During that time, I would come to Florida and show retirees how they could supplement their retirement income by investing in blue-chip dividend-paying stocks and selling covered calls against those positions. Fast forward, my wife’s financial advisor opened an account with CWP and when they saw my name on the account, they said we have been reading Jeff’s strategy reports for years and we need to talk to him. So, Kevin Simpson (founder, CEO, lead portfolio manager) and I hooked up. When I heard about their investment model I said, “This is exactly what I need, and it is what millions of my contemporaries need.”
To be sure, at Capital Wealth Planning we buy large-cap prominent blue-chip stocks with growing dividends and then “strategically” sell short-term out-of-the-money call options against those stocks (we do not sell calls immediately like most option writing funds) in an attempt to get index like returns with about two thirds of the stock market volatility while generating a 5% to 7% income distribution for our clients. Historically, CWP gets ~90% of the upside capture in the stock market with only ~60/70% of the downside capture. Our track record speaks for itself. For investors of my generation that are seeking reasonable returns, with diminished volatility and an income stream, our investment strategy is a great investment model.
The call for this week: Last week on CNBC and Fox Business we said:
We identified the selling climax low on August 5 and deem it to be THE low. Since then that low has been retested three times with no violation of that August 5 low at ~2822 basis the S&P 500 (SPX/2926.46). Subsequently, there have been three 90% Downside Days meaning 90% of the total volume traded came in on the downside; and two 90% Upside Days. Ladies and gentlemen, such volatility is how bottoms are made! Accordingly, we have repeatedly stated “the lows are in.” That said, our internal energy model shows there is some negative energy due to arrive this week, but any pause/pullback should not be all that great unless the tweets get out of hand again. Moreover, if the S&P 500 can get above the 2940 – 2950 level new all-time highs should be in the offing.
This morning the envisioned negative energy blast is here (ESUs off 19-points) as additional tariffs go into effect on China, Dorian heads towards Florida, and Yemen’s Houthis claim attacks on Saudi airport.
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