Jeffrey Saut: How To Position Your Portfolio in 2012

“The Ambergris Factor!”

by Jeffrey Saut, Chief Investment Strategist, Raymond James

March 12, 2012

“In the American whaling industry, which got underway during the eighteenth century, whalers slaughtered the giant sperm whale for sperm oil, which came from the head and blubber and was important as a fuel for lamps. Another type of oil, called spermaceti, extracted from the head, became the chief ingredient in candles. While boiling up the blubber and parts of the sperm whale, whalers occasionally noticed a very pleasant fragrance. It turned out this was a third oil-like substance, located in the intestines of the whales. Called ambergris, it became the basis for very expensive perfume. The problem was that the whalers found ambergris in very few of the whales they killed; nevertheless, the substance brought them a good income because the perfume manufacturers paid extremely high prices for it. So the whalers killed a lot of sperm whales looking for those chosen few who had the right intestinal stuff.”

... The Fall of First Executive by Gary Schulte

Investing is a lot like whaling. Investors are constantly searching for that whale of a stock with the “ambergris factor.” And, that is what I was doing last week at Raymond James’ 33rd Annual Institutional Investors Conference in Orlando, Florida. In attendance were more than 600 professional investors that were listening to presentations from CEOs and CFOs of some 330 companies. As stated, just like the portfolio managers (PMs) were there looking for stocks with the right stuff, so was I. But before I began that search, I had a meeting with two PMs from Switzerland that had 10 questions they wanted answered. The Q & A went like this:

1) Would you buy cyclical stocks or defensive stocks?

Answer: I would buy cyclicals because barring some major event I don’t embrace the view that we are going to see another recession in the U.S. for the near/intermediate future.

2) 2011 was a “risk on/risk off” year, so is it a “top down” or “bottom up” strategy for 2012?

Answer: Last year you only had to get two things right. You had to raise cash in March/April and put it back to work during the bottoming sequence of August – October. I did that and think a similar strategy will work this year as well. That said, one always needs to employ a “bottom up” strategy combined with a “top down” view.

3) Should we buy gold or gold stocks?

Answer: Both; but if I am forced to pick just one, I would buy gold stocks because they are well behind gold’s performance. Therefore, after the yellow metal’s consolidation is finished, gold stocks are likely to play catch up.

4) Homebuilders or Home Depot?

Answer: We think our early-year buy ‘em recommendation on the homebuilders based on the “hope trade” is waning and therefore prefer Home Depot (HD/$48.10/Strong Buy) at this stage.

5) QE3 or not?

Answer: My belief has been the economy is moving toward a self-sustaining recovery and consequently I don’t think QE3 will be needed. Nevertheless, if it looks like our economy is slipping back into recession, I do believe the Fed will use another QE (quantitative easing) to ameliorate the situation.

6) GDP this year, 1.5% or 3.5%?

Answer: Neither, but hereto if I have to pick one it would be the latter.

7) Treasury 10-year yields of 1.5% or 2.5% by year end?

Answer: 2.5%.

8) Obama or Romney?

Answer: Unless gasoline goes to $5.00 per gallon, or there is some other economic/geopolitical event, I just don’t see who can beat President Obama.

9) Made in China, or made in the U.S.A.?

Answer: One of my themes is, and has been, is that at the margin manufacturing jobs are being moved back to the U.S. Combined with this belief is another theme, namely the re-industrialization of America.

10) Iran?

Answer: I don’t think Iran’s mullahs, who are the ones that really have the power, will let Ahmadinejad do anything in the Hormuz Strait because that would give the world an excuse to “pound” Iran, which might affect regime change.

With those questions asked and answered, I was off to see various presentations. A few of the companies I saw that are favorably rated by our fundamental analysts and thus we offer for your consideration, include: Alere (ALR/$26.01/Strong Buy); Alliance Data Systems (ADS/$122.90/Strong Buy); Lumber Liquidators (LL/$24.01/Strong Buy); Maximus (MMS/$41.63/Outperform); National Oilwell Varco (NOV/$81.38/Strong Buy); Nuance Communications (NUAN/$25.86/Strong Buy); Rayonier (RYN/$45.04/Outperform); TMS International (TMS/$11.93/Strong Buy); Verifone Systems (PAY/$50.72/Strong Buy); and Vocus (VOCS/$14.16/Strong Buy). As always, for further information on these companies please see our fundamental analysts’ notes from last week’s conference, as well as the various webcasts.

Turning to the stock market, well it had to happen and it did last week. The S&P 500 (SPX/1370.87) finally experienced its first 1%+ down day of 2012 last Tuesday. It took 44 sessions for that to occur, making this the seventh longest beginning of the year such skein since 1928. Last Tuesday’s Tumble left the SPX oversold (see the attendant chart) for the first time since the Buying Stampede ended on January 26th. Tuesday also qualified as the first 90% Downside Day of the year, meaning that 90% of the total volume traded came in on the downside, as did the number of total points traded. Typically 90% Downside Days are followed by a rally lasting two to seven sessions, which became even more valid given last Tuesday’s oversold readings. Of course, we have now experienced a three-day rebound and accordingly it will be interesting to see how this week plays since today is session four from Tuesday’s Dow Dive (-203 points). Whatever the stock market’s short-term directionality, over the longer term there continues to be NO signs of a significant “top,” which is why I keep chanting, “You can get cautious, but do not get bearish!” And that remains my trading stance; cautious, but not bearish because late last week the SPX made a “throwback rally” toward its recent intraday reaction high of 1378.04 (recorded 2/29/12); and in the process, used up most of its remaining internal energy, at least in the near-term. The implication is that the SPX could be making a double-top. This week should tell the story if that is the case.

The call for this week: The past two weeks have been all about milestones. The week before last saw the D-J Industrials (INDU/12922.02) close above 13000 for the first time since 2008. During that same week the NASDAQ (COMP/2988.34) traded above 3000 for the first time since the turn of the century. Last week contained still more milestones as many of the exchange-traded products that track the homebuilding stocks traded to their highest levels since 2008, raising the question, “With auto sales perky, if the housing sales do better than expected maybe this really is a self-sustaining economic recovery!” And, what an appropriate question to ask on the three-year anniversary of the bull market, which began on 3/9/09 and I was bullish. To be sure, it was a really lonely stance on March 2, 2009 when I said on Bloomberg TV, “The bottoming process that began on 10/10/08, when 92.6% of all stocks traded made new annual lows, is complete this week and we are ‘all in’.” At the time I likened the March 2009 “nominal price lows” to those of December 1974 that marked the “nominal price low” of that 17-year, wide-swinging, trading range stock market. I also commented that the “valuation low” did not appear until the summer of 1982; and, that I hoped it would not take another eight years for this wide-swinging, trading range market to make its “valuation low.” Well, since last November I have been opining that the “undercut low” of October 4, 2011 could be such a “valuation low” with the SPX (at the time) trading below 10x forward earnings estimates with a 10%+ earnings-yield. That combination, when using the yield on the 10-year T’note as your risk-free rate of return, produced an equity risk premium of more than 8%. Such valuation metrics have not been seen in decades! Whether this is a new secular bull market remains questionable, but I am hopeful.

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