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Mark S. Young
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Investment Strategy by Jeffrey SautBoston!
August 30, 2010
I love Boston! My love affair with the city began in the late 1960s when I first heard the group “Beacon Street Union” playing on the banks of the muddy Charles. In 1971 I entered this business and the love affair grew into the early 1980s when we as “kids” whispered the names of legendary investors like Peter Lynch, Dean LeBaron, Paul Cabot, and David Babson while discussing markets at various Boston cocktail parties. Last week I again embraced Boston by spending time speaking at a national conference of stockbrokers and exchanging ideas with some of Boston’s best and brightest portfolio managers (PM). However, the mood was somber with one grey-haired PM waxing that maybe it is different this time because he has never seen the yield on the D-J Industrial Average (INDU/10150.65) above the yield of the 10-year benchmark Treasury. I responded by noting that I don’t believe in Pimco’s “New Normal.”
The state of mind at the conference was particularly glum where prior to my presentation I was asked numerous times if I had a-n-y-t-h-i-n-g positive to say. Accordingly, I began my discussion by stating that if one more person asked me about the Hindenburg Omen I was going to get sick. While it’s true under the simple interpretation of the indicator there have been two Omen signals in August, but it is also true that the success ratio of the indicator is spotty. Moreover, as stated in these missives, the Omen’s metric I have trouble with is the percentage of new 52-week highs and lows on the NYSE. Parsing August 16th’s New High/New Low list, as well as August 12th’s (the alleged other Omen signal), shows that the vast majority of “stocks” making new highs were interest rate sensitive closed-end funds, preferred stocks, or some other kind of fixed income product, which by my pencil are not stocks. Therefore I’ll say the same thing I have said for weeks, “I don’t think a Hindenburg Omen has been registered.” Still, with the stock market’s bête noire of September and October looming, retail investors appear comatose.
Speaking to the upcoming two-month two-step, this quip was recently scribed in the always observant “Dines Letter”:
“Labor Day: If the market declines in the four-day week following Labor Day (starting and including Tuesday, September 7th this year and ending on Friday, September 10th), one should postpone buying for one month. It worked splendidly in 1994, 1998, 1999, 2000, 2001, 2002 and 2008, when postponed buying provided buyers with prices near a bottom in all seven Octobers. On the other hand, if there is a gain in that four-day week, the market will probably keep going higher; true in 1993, 1995, 1996, 1997, 2003, 2005 and 2009 when the market posted a gain in the week after Labor Day and continued to rise in subsequent months. This did not work however in 2004, 2006 and 2007. No Indicator works every time, but those are the latest odds.”
Meanwhile, my intermediate trading indicator continues to counsel for caution as it has since the first week of May, which is why I have employed a timed trading strategy (see the attendant chart where red bars mean caution). Additionally, many negative divergences have developed since mid-August with indices like the S&P Small Cap 600 Index (SML/330.22) breaking below its early-July low. Despite these events, I was surprised to see the S&P 500 (SPX/1064.59) travel below the 1080 level because even though the economy is weakening, I don’t think it’s a double-dip. I also think stocks as an asset class remain attractive.
Consider this, while 70% of the U.S. economy is household consumption (and consumers are indeed tightening their collective belts), only 30% of GDP is retail spending. To be sure, the SPX is more exposed to business spending than retail spending, which is why I have emphasized select technology and industrial stocks. Furthermore, ~40% of SPX profits are from foreign operations with roughly 15% of those profits attributable to the emerging markets. Hence, I believe the “profits recovery” will continue, which suggests the earnings yield on the SPX should approach 9%. Finally, if the forward earnings estimates are correct the SPX is trading at a P/E ratio not seen in a long time. For these reasons I just do not see a whole lot of downside.
Unfortunately, my cautiously bullish stance was shared by only a few of the folks in Boston. That said, many of them were bullish on select themes. To name a few: Cloud computing; fish farming; the graying of America (assisted living); resource efficiency; green transportation; alternative energy; water; and commodities. One PM suggested that today’s portfolio “should not speak English,” obviously in keeping with my love of emerging and frontier markets. He went on to note that the healthcare, financial, and energy sectors are under regulatory attack, implying there might be some undervalued situation in those arenas. Most of the PMs agreed there are opportunities in distressed debt because you don’t need an “economy call” for that position to make money. The most vocal about the distressed debt position were the good folks at Putnam. Indeed, it wasn’t just the PMs running Putnam’s Diversified Income Fund (PDINX/$8.05) making that bullish “call,” but Putnam’s equity portfolio managers as well. For mutual fund investors I continue to like the idea of positioning equal dollar amounts of PDINX and some sort of equity-income mutual fund in portfolios and then trying to add Alpha by using individual special-situation stocks like Fortress Paper (FTPLF/$27.85/Strong Buy) and Cenovus (CVE/$26.42/Outperform), which are followed by our Canadian affiliate with the aforementioned ratings.
The call for this week: While the various markets can certainly do ANYTHING, it’s typically not the snake you see that bites you; and currently the media is replete with stories about the Hindenburg Omen. Ladies and gentlemen, when so many people are asking the same “Hindenburg Omen” question, it is typically the wrong question! Meanwhile, the Moody Blues have been playing on The Street of Dreams, and the song – Ride My See-saw – as the equity markets have been “dancing” to that song buffeted by deflationary worries from the bond market. The counterpoint to those lower bond yields is the metal with a Ph.D. on the economy, namely copper, which has broken out to the upside in the chart, suggesting no economic double-dip. Reinforcing that view is the Bloomberg Financial Conditions Index that has shown very little weakness, as well as the improvement in the LIBOR-OIS spread. All of this has caused the pre-open futures to see-saw from plus to minus; indeed, Ride My See-saw. However, over the last 16 mid-term elections the stock market has never made a new reaction low post election day. And don’t look now, but our energy analyst John Freeman’s proprietary model has registered a buy signal on the Exploration & Production (E&P) stocks (see chart).
Crowded Trade
August 23, 2010
“Our friend Percy Wong of Bank of America recently observed that the ‘only crowded trade was on the sidelines,’ which we felt summed up the current summer, and the mood amongst most of our clients, perfectly. Indeed, there is a lot to digest, what with a) fears for one's job/business following a tough past three years, b) very haphazard economic data, c) the emergence of new risks (e.g., sovereign bond risk amongst European signatures) and d) the new reality of global economic growth no longer being driven by the United States but instead by emerging markets. No wonder so many investors are looking to take cover, whether in the form of bonds (with US 2-year yields now at a record low 0.48%) for investors who believe that fiat currencies will hold their own, or gold for those more skeptical on the ability of paper money to withstand its value, even in a deflation.
“But all the confusion does not mean that there are no trends out there for investors to follow. For example, the current outperformance of South East Asian bond, equity and currency markets make fundamental sense and have yet to run their course. The same can be said for the outperformance of consumption-related stocks in China (a trend which should be given a further boost by the renewed wave of financial deregulation in China). With its very undervalued currency, it is hard to not like Korea's exporters and the overall Korean equity market. In Scandinavia, Switzerland and perhaps even the UK, we have governments with balance sheets that make sense or that are in the process of improving, while local central banks will be forced to maintain very easy monetary policy if only to prevent gains against a Euro which, structurally, should remain weak. From there, it is very possible to envisage an era of sustained outperformance of equity, bond and local currency markets. Undeniably, the overall macro uncertainty is much higher than we would have expected at this point in the cycle. Nevertheless, this does not mean that the trades that made sense six months ago no longer make sense today. There are alternatives to the sidelines.
...GaveKal
“Crowded trade?”... you bet; and, I have to admit I too am guilty of having a lot of cash currently. To wit, for investment accounts I have recommended having roughly 20% in cash, while for trading accounts I have been pretty much on the sidelines since recommending selling all of the downside hedges in late-May and early-June. Since then, while I have added some stocks to investment accounts, trading accounts have been relatively flat even though the McClellan Oscillator telegraphed the July rally. That tepid trading strategy is driven by the fact my intermediate trading indicator has been in cautionary mode since the first week of May as shown in last week’s report. Nevertheless, there are indeed alternatives to the sidelines. For example, last week one of our stocks was “bid for” as Intel (INTC/$18.91/Outperform) made an offer to acquire computer security company MacAfee (MFE/$47.03/Market Perform). Interestingly, the same hedge fund manager that gave me MacAfee a month ago now suggests the McAfee announcement potentially puts another of our stocks into play, namely Red Hat (RHT/$32.54/Outperform). Additionally, I was duly impressed with how some of our stocks held up last week. Names like Walmart (WMT/$50.22/Strong Buy), Johnson & Johnson (JNJ/$58.74/Outperform), Allstate (ALL/$27.75/Strong Buy), American Tower (AMT/$47.43/Strong Buy), etc. certainly resisted the stock market’s machinations. Yet, it is not just select stocks that afford an alternative to cash.
To be sure, I still like the idea of distressed debt. And this week I am off to Boston to meet with the good folks at Putnam, as well as a number of other institutional accounts. Recall, I have been recommending Putnam’s Diversified Income Trust (PDINX/$8.04) for the past few months after spending an hour with Rob Bloemker, who is the head of fixed income for the Putnam organization. With roughly a 10% yield, and duration of a little over 1 year, I think PDINX affords the potential for equity-like return over the next few years. Surprisingly (at least to me), while Rob has his own money in PDINX, he is also buying individual stocks. He reasons that with the S&P 500’s earnings yield (earnings/price) at its widest spread to Treasuries in decades, the combination of PDINX and stocks is an attractive strategy. Obviously, I agree. Reinforcing that strategy is this from Citigroup’s (C/$3.75/Strong Buy) Robert Buckland who found 10 prior divergences between global bond yields and stock prices. Six times stocks were proven right, two times bonds were right. The other two times there was no clear winner.
Last week, however, participants shunned stocks, worried about the softening economic statistics as the Philadelphia Fed report was shockingly weak, while Jobless Claims also negatively surprised. Accordingly, the S&P 500 (SPX/1071.69) failed to hold above the 38.2% Fibonacci level (~1080) I opined should hold. The failure arrived last Thursday when the SPX fell roughly 19-points and in the process knifed through the aforementioned level. The action also allegedly triggered the second “Hindenburg Omen” in the past two weeks. As a reminder, the five criteria (courtesy of Zero Hedge) of the Omen are as follows:
1) That the daily number of NYSE new 52 Week Highs and the daily number of new 52 Week Lows must both be greater than 2.2% of total NYSE issues traded that day.
2) That the smaller of these numbers is greater than or equal to 69 (68.772 is 2.2% of 3126). This is not a rule but more like a checksum. This condition is a function of the 2.2% of the total issues.
3) That the New York Stock Exchange (NYSE) 10 Week moving average is rising.
4) That the McClellan Oscillator is negative on that same day.
5) That new 52 Week Highs cannot be more than twice the new 52 Week Lows (however, it is fine for new 52 Week Lows to be more than double new 52 Week Highs). This condition is absolutely mandatory.
The metric I keep having trouble with is the percentage of new 52-week highs and lows on the NYSE. Parsing last Thursday’s New High/New Low list, as well as August 12th’s (the alleged other Omen signal), shows the vast majority of “stocks” making new highs were interest sensitive closed-end funds, preferred stocks, or some other kind of fixed income product, which by my pencil are not stocks. Therefore I’ll say the same thing I said two weeks ago, “I don’t think a Hindenburg Omen has been registered; and even if it has, its track record is spotty.” What largely went unnoticed, however, was the Demark “buy signal” that was recorded by the SPX late last week. In addition to the Demark signal, there are some other potentially encouraging developments. As stated, the McClellan Oscillator is approaching the oversold level of late June, ditto the Capitulation Index, the SPX closed at the low-end of the Bollinger Bands that have contained decline for over a year, the NFIB Hiring Plans Index just went into positive territory, and investors’ sentiment is bloody awful (read that as bullish). In fact, I have not seen retail investors so unwilling to talk about stocks since the fourth quarter of 1974!
The call for this week: While in my view we have not had two Hindenburg Omen “sell signals,” we have indeed experienced two 90% Downside Days, without a single 90% Upside Day, over the past two weeks. Recall to qualify as a 90% Downside Day, down volume must exceed 90% of total Up-to-Down Volume, as well points lost must be greater than 90% of points gained plus points lost. Nevertheless, I think it is a mistake to get too bearish here for the aforementioned reasons. I also think it is a mistake to get too bullish. Indeed, I believe the equity markets will remain mired in the envisioned wide-swinging trading range I spoke of following the first Dow Theory “sell signal” of September 1999. In such an environment, stock selection, combined with the ability to sell mistakes quickly, should be the key to portfolio outperformance. Moreover, I agree with the insightful folks at GaveKal who suggest there are reasonable investment alternatives to the sidelines.
“Promised Land?!”
August 16, 2010
The mountain is high
The valley is low
And you're confused on which way to go
So I've come here to give you a hand
And lead you into the promised land
... Edgar Winter Group, Free Ride
The Edgar Winter Group was playing on The Street of Dreams last week, and the song was Free Ride, as the equity markets have certainly been “confused on which way to go.” Indeed, the McClellan Oscillator became extremely overbought a few weeks ago, which is why I have followed a neutral short-term trading approach to the equity markets. That said, I believe the downside is “measured” given that the earnings yield on the S&P 500 (SPX/1079.25) is 8.1% (based on current forecasts), versus an 8.3% yield for the high yield bond universe, for the narrowest spread e-v-e-r! Such metrics should afford select blue chip, dividend-paying stocks an attractive risk/reward ratio for investment accounts. Interestingly, that is the current strategy of legendary investor Jeremy Grantham. As reprised in Steve Sjuggerud’s always insightful True Wealth newsletter:
“In plain English, Grantham's predicting a 24% rise in the overall stock market; (even though) he's predicting seven lean years for the U.S. economy. But he believes high-quality U.S. stocks will outperform every other asset class over the next seven years.
(Grantham) High-quality stocks were left very much behind in the great rally last year, which was the biggest and most speculative since 1932. Much more surprisingly, they have underperformed this year . . .
Grantham offers up several explanations why high-quality stocks have underperformed, including this one:
(Grantham) In the last 10 years, institutions and even ultra-rich individuals have, in general, been increasing the share of their portfolios that is invested in private equity and hedge funds, commodities, and real estate. And even within their equities, they have been increasing their share of foreign equities, including emerging markets and small caps...
So what is being liquidated to buy all of this new stuff? Old-fashioned blue-chip U.S. stocks. Quality stocks might possibly spend much of the next several years underpriced, but from time to time will bounce back to fair value. (and) This is all that patient investors need.”
Yet, many investors do not want to buy individual stocks. To address that issue Raymond James’ Asset Management Services Department (AMS) is introducing two new investment platforms. The first is slated to commence on September 1, 2010 and is an extension of the current Unified Managed Accounts (UMA) array, which I have embraced since their inception. The new UMA platform is more of a “flex” model. This model uses three separate account managers, housed within a single account. The flex model deviates from AMS’s other UMA offerings in that it uses managers who are less constrained than the typical “style box” manager. A third of the portfolio will be allocated to Lord Abbett Multi Cap Value, a third to Clearbridge Multi Cap Growth, and a third to ING Global Equity Dividend. Lord Abbett and Clearbridge are free to move up and down in market capitalization, depending on where they see opportunities. ING Global Equity Dividend provides the portfolio with high dividend income by investing in global blue chip, dividend-paying companies.
While I personally tend to be more of an individual stock-specific investor, I like these kinds of UMA vehicles for previously stated reasons. Additionally, while Jeremy Grantham is underweighting private equity, hedge funds, commodities, and real estate, I continue to like the idea of investing in a number of such non-correlated vehicles. Unfortunately, the typical retail investor does not have access to such investments because most of them have minimums of $1 million or more. Speaking to this dilemma, AMS has already introduced an alternative investment-focused product called the Alternative Allocation Managed Completion Portfolio. It is a fee-based, turn-key portfolio comprised of 14 mutual funds in the alternatives space. Some of the sectors represented are: Commodities, Long/Short funds, Managed Futures, Arbitrage, Global Macro, and Hedge Fund Replication. The goal is to provide portfolios with a lower correlation, and lower beta, compared to the broader markets. Comprised of 1940 Act mutual funds, the platform has daily liquidity, while the underlying holdings are reported by the mutual funds. Expected returns should be in the realm of a balanced, 60/40 portfolio (7-9%), with a standard deviation around 7. This structure should allow for participation in rising markets, while providing downside protection when the market declines. The minimum investment for this platform is $50,000. Keep in mind, however, this account cannot represent more than 20% of a client’s portfolio at the time of inception.
As for the directionality of the stock market, while my intermediate-term trading indicator remains in the same cautionary mode it has held since the first week of May (see chart where the red lines overlaid against the S&P 500 represent caution), I still don’t envision much downside from here. Indeed, the McClellan Oscillator traveled into oversold territory last week and is almost as oversold as it was at the end of June, as can be seen in the attendant chart. Recall, an oversold reading from the McClellan Oscillator telegraphed the July rally. Further, despite last Wednesday’s 90% Downside Day (-265 DJIA), Lowry’s Selling Pressure Index remains in a well-defined downtrend and Lowry’s Buying Power Index is in a well-defined uptrend. Meanwhile, the New High/New Low, and Advance/Decline, indicators are healthy; and, while many of the indices fell below their respective 50-day moving averages (DMAs) last week, the D-J Industrials (DJIA/10303.15) did not. Either the DJIA will follow the other indexes to the downside by violating its 50-DMA of 10266.14; or, what we could have is a downside non-confirmation.
Speaking to one of our special situation stocks, I have previously addressed Fortress Paper (FTPLF/$27.44), which is followed by our Canadian research affiliate with a Strong Buy rating. Fortress is a growth-oriented specialty paper manufacturer. Yet, the exciting part of the story began in April 2010 when the company acquired the Fortress Specialty Cellulose Mill from Fraser Papers Inc. The envisioned plan calls for a green electricity facility (co-generation with Hydro Québec) to power the mill’s dissolving cellulose operations (read: dissolving pulp). The project should be completed in mid/late-2011. Last week our Canada-based analyst (Daryl Swetlishoff) raised his price assumption for “dissolved pulp” to C$1,100 per ton (from C$1000/ton). Accordingly, FTP’s price target was raised to C$40, which equates to about 10x his 2011 EPS estimate of C$4.07. However, the company suggests it can sell its output of dissolved pulp for C$1,200/ton. Interestingly, the current “spot price” is C$1,580 per ton. If either of those prices proves achievable, FTP’s shares should do well. For further information please see last week’s report. As always, Blue Sky laws must be check by U.S. citizens before purchase.
The call for this week: Edgar Winter was right, “The mountain is high, the valley is low; and you’re confused on which way to go.” As for leading you into the Promised Land, I think that was done in March 2009 (I was very bullish); this year, however, my mantra has been, “the trick in 2010 is going to be keeping the profits accrued from the March 2009 lows.” I think the two new platforms from AMS have a good chance of accomplishing that, as well as potentially leading you into the Promised Land over the next few years. Last week, however, investors gave up on stocks, worried that Wednesday’s 90% Downside Day marked the end of the summer rally, punctuated by fears that another big decline was in the offing as we enter the dreaded months of September/October. While statistically those months tend to be the worst of the year, that wasn’t the way it played last year; and, I doubt that is the way it plays this year. While the equity markets may pull back, NONE of the characteristics that mark a major “top” are currently in place, including the one all of you folks “pinged” me about late last week; namely, the prematurely called “Hindenburg Omen.” The reporter that released that salacious indicator was clearly a headline seeker since not all of the metrics ascribed to said indicator have yet to be in place.
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