by Jeffrey Saut, Chief Investment Strategist, Raymond James
April 9, 2012
“When prices of pork products begin to rise, farmers naturally begin to increase the breeding of pigs, hoping to profit from the rising market. Each farmer considers himself astute and novel in concept, quite certain that prices will continue to rise. However, the same idea occurs to a large number of farmers simultaneously. It takes about one and one-half years for a pig to reach maturity, and the same one and one-half years for the market to become saturated with the flood of recently bred pigs. Inevitably, prices fall, farmers sadly take losses and reluctantly cut back production. Finally, as a result of the reduced breeding, shortages develop and the cycle begins anew.”
... Panic & Crashes And How You Can Make Money Out Of Them; Harry Schultz 1972
Harry D. Schultz wrote a book at the top of the massive secular “pork market peak” of 1972 titled “Panics & Crashes And How You Can Make Money Out Of Them.” He pointed out that business, and panic-to-pig cycles, follow pretty much the same pattern. The typical cycle consists of seven phases: 1) shortages, 2) the development of a concept, 3) profitable production, 4) overproduction and oversupply leading to losses, 5) losses, 6) cutbacks in production, 7) shortage and the start of a whole new cycle. Over the years Wall Street has also had a series of pig-to-panic cycles for those of us old enough to remember them. The sequence went something like this: bowling alleys, color TVs, conglomerates, Alaskan oil stocks, double knits, air pollution, CB radios, mobile phones, soft contact lenses, Wankel engines, one-decision growth stocks, gambling casinos, Internet insanity, eyeballs per minute valuations, and most recently social media stocks. The lesson throughout the decades is that shortages eventually lead to oversupply. Last week that observation came into plain view.
Indeed, last week the entire stuff-stock complex cratered. Recall, I have been bullish on “stuff” since China joined the WTO in December 2001 on the premise that when per capita incomes rise people consume more “stuff” (oil, gas, coal, water, electricity, timber, cement, agriculture, base/precious-metals, etc.). That has been the history of rising per capita incomes throughout history. We rode that theme until November/December 2007 when those investments grew into such large positions in portfolios that we recommended selling 30 – 50% of them to raise cash and allow long-term capital gains to accrue to portfolios as we entered 2008 very defensively positioned. Following the March 2009 bottoming sequence, however, stuff-stocks returned to prominence until April of 2011.
Since April of 2011 the Continuous Commodity Index (CCI/565.15) has been in decline having fallen from its high of ~691 into December 2011’s tax-loss selling “low” of ~546 as can be seen in the attendant chart. From there the CCI rallied into late February where it peaked and began selling off. The selling intensified last week seemingly due to the Federal Reserve’s inference that QE3 is effectively off of the table. With that, the U.S. dollar soared and the CCI plunged. That action caused one old market maven to exclaim, “Have commodities begun another ‘leg’ down, or was this just a pullback within the context of a new upward trend?” My sense is it is the latter, and I would invest that way using the Exchange Traded Product of your choice with last December’s “low” as a failsafe point.
As for ideas in the commodity complex, a good starting point might be the commodities that performed best in 1Q12. To this point, the insightful Minyanville organization notes (as paraphrased by me):
“For those looking for the next cheap buy, or commodities that have been on a tear, we outline some of the best and worst performing futures from the first quarter of this year: Soybeans (+24%), Soybean Meal (+17%), Gasoline RBOB (+21%), Canola Oil (+18%), Crude Brent Oil (+16%), and Platinum (+14%). And then there were the losers: Natural Gas (-30%), Coffee (-18%), and Milk (‘9%).”
For specific ways to play those select commodity themes, I suggest you contact our Exchange Traded Products research department.
Like commodities, stocks swooned on the Fed’s statement; and, that swoon accelerated on Wednesday as participants pondered a botched Spanish debt auction that showed decidedly higher funding costs for La Furia Roja (the red fury, aka Spain). The result left the S&P 500 (SPX/1398.08) lower by 10.39 points, but still above the first ledge of support often referenced in these comments between 1375 and 1385. Interestingly, all of the pullbacks in the SPX this year have been between 25 and 35 points. Accordingly, measuring from last Monday’s closing reaction high of ~1419 produces a level of 1394 for a 25 point correction, and 1384 for a 35 pointer. Importantly, anything more than a 45 point pullback would put the SPX below the bottom of our 1375 – 1385 support zone -- and suggest something has changed. It would also represent a breakdown below a spread triple-bottom for most of the major averages. While there is minor support at 1365, my hunch is that breaking below 1375 brings into view the 1320 – 1340 level.
This week should be the decision point for the market’s near-term directionality as this morning stocks will have to deal with Friday’s disappointing employment report. In last Monday’s letter I opined the employment report was anticipated to be disappointing; and, disappointing it was. Indeed, non-farm payrolls increased a very modest 120,000 for March versus consensus estimates for a 205,000 gain. The report was exactly half of the previous month’s gain of 240,000 and well below the December through February average payrolls increase of 246,000. Our economist, Dr. Scott Brown, had this to say about Friday’s report:
“Disappointing, but not a disaster. This is largely a weather story. Mild weather inflated payrolls figures for January and February and generated excessive optimism about the job market. The weather was still mild in March, but January and February were much milder than usual. The three-month average payroll gain, at +210,000, is not bad. The unemployment rate fell, but that was due to people exiting the labor force (likely as their unemployment insurance benefits expire).”
So, this week should be the test for stocks. My sense is that following this morning’s jobs-induced drop, the SPX will remain mired in the 1385 – 1425 consolidation zone I have been commenting on for the past few weeks. As stated, I think the SPX needs to convalesce while the short-term overbought condition is alleviated and the market’s internal energy is rebuilt. As seen in the nearby chart, the overbought condition has been corrected with the NYSE McClellan Oscillator back in oversold territory (Energy and Materials are the two most oversold sectors). Moreover, my daily internal energy indicator now has more than a full charge of energy. Unfortunately, the weekly internal energy indicator is nowhere near being fully recharged. The implication is that the downside should be somewhat contained, but the SPX is also not likely to break out above 1425 without spending some more time consolidating.
The call for this week: As stated, this is a key week for the equity markets and we continue to wait and see how the equity markets resolve themselves on a short-term basis, a trading stance we have been in for weeks. Meanwhile, for investors, I met with a portfolio manager last week whose investment style I think is suited for the current stock market climate. The investment style of Troy Shaver, PM of Dividend Asset Capital, sub-advisor to Goldman Sachs Rising Dividend Growth Fund (GSRAX/$15.05), is to invest in companies that increase their dividends by 10% per year on average for 10 years in a row. Accordingly, the fund seeks capital appreciation and current income. The other insight of the week was a conference call on the Yorkville High Income MLP ETF (YMLP/$19.85). YMLP is structured for an outsized current yield by investing in Master Limited Partnerships. Yet because of that structure no tax-cumbersome K-1 is issued. For further information please contact our Exchange Traded Product research department.
P.S. – I am traveling the balance of this week, and while I will try to do at least one strategy call, it is going to be pretty difficult to accomplish given my schedule. Accordingly, this may be the only strategy comment for the week.
