My December 2010 Comments & Jeff Saut – 08/08/11 © ™
- Short Term
- July 7, 2011 – Present
- Step 2 Down Underway
- Action Status – Sold
Today the stock market continues to make lower lows and lower highs and it is doing this without any sign of massive volume. In fact the volume is drying up. Friday had much more volume than today. Perhaps the current decline will end with a whimper instead of a bang. Whimper means a decline ending on low volume. As I write this the market is drawing close to the lows made early this morning. Wouldn’t it be nice if we bounced off of those lows. Regardless, we are on the sidelines. The DJ Industrials are down 330 points at 12:36 EDT.
Jeff Saut is the stock market investment strategist for Raymond James and he is VERY GOOD. I never fail to read/listen to his comments. It isn’t often that we disagree and there have been a few moments recently where we have diverged. I have included his entire column for Monday August 8, 2011.
In a bear market, oversold means nothing as the market just keeps going and going until it has worn itself out. We’ll see what scenario we have going, wear itself out or rally soon.
Begin Jeff Saut quote.
Rumours
August 8, 2011
“Rumours,” yet I am not talking about the 1977 smash album by Fleetwood Mac, but rumors that I heard while watching last Thursday’s Tumble. The two most credible were: 1) A major rating agency is going to downgrade the U.S. credit rating; and 2) A major institution is in trouble and is being forced to liquidate its portfolio. Obviously, one was right and the other wrong as late Friday Standard & Poor’s downgraded our nation’s debt rating to AA+. And, “There is no joy in Mudville – mighty Geithner has struck out,” as our Treasury Secretary has repeatedly declared, “There is no chance the U.S. will lose its top credit rating.” Such statements have left a bevy of cries for Secretary Geithner’s removal fostering at least the illusion of a shakeup in the country’s financial course. While it is doubtful Timothy Geithner is even marginally responsible for our debt debacle, in politics it is all about “illusions.” In fact, the current national malaise reminds me a lot of President Jimmy Carter’s 1979 “Crisis of Confidence” speech. If you have five minutes, click here: (http://www.youtube.com/watch?v=1IlRVy7oZ58).
So what are the implications of Friday’s downgrade? While it will likely take weeks for that question to be answered, as of this writing the answer seems to be “not much.” That “consensus call” is based on what happened to Canada, Australia and Japan when they lost their AAA status. The result was only a minimal economic impact in those countries. That said, we are not so certain that will be the case here given our nation’s reserve currency status and the fact there are so many other financial instruments geared to U.S. Treasuries. As our economist Dr. Scott Brown writes:
“It should go without saying that nobody knows precisely how things will unfold from here. One issue is that while S&P downgraded, Moody’s and Fitch have not. Some have suggested that a downgrade would lead to higher borrowing costs for the U.S. However, we haven’t seen much of an increase in bond yields in other cases where sovereign debt was downgraded. Treasuries are still considered to be the “safe” asset – so, I wouldn’t expect a big increase in Treasury yields. The bigger concern will be second and third round effects through the financial markets. Downgrades to agency debt (Fannie Mae, Freddie Mac), a number of states, and municipalities will follow on Monday. Money market outflows are likely to increase (as people move to insured bank deposits). The Fed is likely to move to support the money markets (as they did during the financial crisis) and may set up other liquidity facilities. In issuing guidance to banking organizations for risk-based capital purposes, the Fed indicated that risk weights for Treasuries and agencies will not change. Still, a number of banks have large holdings of agency debt and may be inclined to increase capital and tighten loans for consumers and businesses. We’ll have to wait to see how markets react and what the expectations are for U.S. equities.”
Accordingly, we wait to see the economic impact of recent events while contemplating Soren Kierkegaard’s sage words, “Life can only be understood backwards; but it must be lived forwards.”
So what do we think we know about “living forwards”? Well, while I didn’t believe it was going to happen, the D-J Industrial Average (DJIA/11444.61) confirmed the D-J Transportation Average (TRAN/4693.59) last week when both of those indices broke below their respective March 16, 2011 closing reaction “lows,” thus rendering a Dow Theory “sell signal.” It was the first such “sell signal” since November 21, 2007. Unlike the November 2007 “sell signal,” this one came at much lower valuation levels and following a nearly 11% decline since the selling stampede began on July 8, 2011. Recall, however, that selling stampedes typically last 17 – 25 sessions with only 1 – 3 session pauses/corrections before they exhaust themselves. Last Friday was session 21 in the selling skein making this decline long of tooth. Also of note is the Dow’s Dive has left the NYSE McClellan Oscillator more oversold than it has been in years; likewise the percentage of stocks above their 10-day moving averages dropped to 0.79%, the lowest reading (most oversold) since 1991. As the “must have” InvesTech Financial’s astute James Stack writes:
“On today’s close [8-4-11], our short-term Pressure Factor hit an extraordinary oversold -169 (normally, -80 is an ‘extreme’ oversold reading). There were only six occasions in the past 60 years when the Pressure Factor has dropped below -160… None of those instances saw the S&P even 1% lower one week later. Only one instance saw the market negative one month later – last summer which marked the correction bottom. And interestingly – perhaps coincidentally – 5 of the 6 saw the market up over 19% twelve months later. Such oversold extremes typically do not mark the beginning of a bear market.”
While I certainly hope Mr. Stack is correct, I must admit the Dow Theory “sell signal” concerns me. Still, the bone-crushing decline since early July has used up so much energy (read: extremely oversold) making it is reasonable to expect a “throwback rally” from some sort of stock market low. Indeed, just like you can only press down on a spring so far before you get a “boing” bounce back, the same is true in the equity markets. Moreover, I think the recent rout is more about the aforementioned “Crisis of Confidence” environment than the fundamentals. To be sure, as of yet there is no economic evidence the country is sliding into recession — slow growth, yes; recession, no. That view is reinforced by the Yield Curve, which has been one of the most reliable predictors of recessions. To wit, every recession for the past 50 years has been preceded by an inverted Yield Curve (short-term interest rates above long-term interest rates). Currently, the Yield Curve is very steeply sloped as can be seen in the chart on page 3 from our friends at the Bespoke Group. In fact, the U.S. has the steepest sloped Yield Curve of any I can find.
Meanwhile, we are wasting a terrific earnings season with 61% of the companies reporting beating estimates, while 68% beat revenue estimates. The result has left the S&P 500’s (SPX/1199.38) earnings estimates for this year nestled around $100 and pushing towards $114 for 2012. If those estimates prove correct, at last week’s intraday low (1168.09), the SPX was trading at a PE multiple of 10.3x next year’s earnings, with an Earning’s Yield of ~9.8% ($114 ÷ 1168), leaving the Equity Risk Premium for stocks at ~7.4% (Earnings Yield – 10 year T’note yield of 2.4%) for the highest ERP in a generation. This implies either earnings estimates are too high (I don’t believe it), the country will slide into recession (I don’t believe it), or stocks are undervalued (my position). Hence, if you did not raise some cash last February – March as recommended, I think it is a mistake to do so here since we should get some kind of rally either off of last week’s low, or a low early this week. In that rally, it will be important to monitor the market’s internal metrics with an eye towards pruning underperforming stocks from investment accounts. While my hunch is last week’s Dow Theory “sell signal” will prove false, like the one that occurred during May 6, 2010’s “Flash Crash,” I would still tread carefully “living forwards.”
The call for this week: For weeks I have stated that a credit rating downgrade was a fait accompli and possibly already discounted by the markets; this morning that doesn’t seem to be the case with the pre-opening futures down ~30 points. Whatever the various markets’ near-term reaction, the fact is that everyone is merely offering their intelligent guesses as to the outcome of this historic “downgrade” event. One thing I do believe is what I wrote last week, which is likely a catalyst for the downgrade (as paraphrased):
“While I don’t embrace the Tea Party, their ‘sea change’ is palpable. Nowhere is this more apparent than the current Debt Ceiling debate. The Tea Party seems to have surfaced our nation’s ‘political corruption,’ which hinders the proliferation of prosperity. Interestingly they are not the first, for such thoughts were first scribed by Adam Smith in his book The Wealth of Nations (1776). Whether you like, or hate, the Tea Party, there is definitely a palpable change afoot that over the long-term could be extremely bullish for the economy, the stock market and our country.”
In conclusion, I leave with these thoughts from legendary investor Jim Rogers:
When asked how he made his money, Mr. Rogers answered, “I sell euphoria and buy panic.” The way he determines that is to wait until prices are “gapping” in the charts. Gapping on the upside is “euphoria,” while gapping on the downside is “panic.” Currently, gold and Treasuries are gapping on the upside; and, stocks are gapping on the downside. The implication, even though I believe gold is in a secular bull market, suggests partial positions should be sold in precious metals and the freed-up cash should be used to “buy” fundamentally sound stocks with decent dividend yields. Obviously, the weeks ahead will determine if this is the correct strategy. All said, IMO it is too late to panic. The time to panic, and raise cash, was months ago (we did). Now it is time to selectively redeploy that cash into select equities.”
End Quote.
I reminded a friend this morning that the correction following large step 2 up from March 2009 would be of a significant nature. It would be large enough that most everyone would doubt that the validity of the bull market was intact. I also included myself in that category. Since we have arrived at that point in time, I thought I would find that email and reprint it today.
Begin quote from my December 20, 2010 email comments.
“Do you have the mental fortitude to accept huge gains?”
“This comment usually gets a hearty laugh, which merely goes to show how little most people have determined it actually to be a problem. But consider how many times has the following sequence of events occurred? For a full year, you trade futures contracts, making $1000 here, losing $1500 there, making $3000 here and losing $2000 there. Once again, you enter a trade because your (trading) method told you to do so. Within a week, you’re up $4000. Your friend/partner/acquaintance/broker/advisor calls you and, looking out only for your welfare, tells you to take your profit. You have guts, though, and you wait. The following week, your position is up $8000, the best gain you have ever experienced. ‘Get out!’ says your friend. You sweat, still hoping for further gains. The next Monday, your contract opens limit (down) against you. Your friend calls and says, ‘I told you so. You got greedy. But hey, you’re still way up on the trade. Get out tomorrow.’ The next day, on the opening, you exit the trade, taking a $5000 profit. It’s your biggest profit of the year, and you click your heels, smiling gratefully, proud of yourself. Then, day after day for the next six months, you watch the market continue to go in the direction of your original trade. You try to find another entry point and continue to miss. At the end of six months, your method finally, quietly, calmly says, ‘Get out.’ You check the figures and realize that your initial entry, if held, would have netted $450,000.”
“So what was your problem? Simply that you had allowed yourself, unconsciously, to define your ‘normal’ range of profit and loss. When the big trade finally came along, you lacked the self esteem to take all it promised . . . who were you to shoot for such huge gains? Why should you deserve more than your best trade of the year? Then you abandoned both (trading) method and discipline. To win the game, make sure that you understand why you’re in it. The big moves in markets only come once or twice a year. Those are the ones which will pay you for all the work, fear, sweat, and aggravation of the previous years. Don’t miss them for reasons other than those required by your objectively defined method. The IRS categorizes capital gains as ‘unearned income,’ that’s baloney. It’s hard to make money in the market. Every time you make, you richly deserve. Don’t ever forget that.”
… Robert Prechter – the Elliott Wave Theorist (1992)
“Do you sincerely want to be rich?!”
What a great question! It’s a question I ponder this time of year as I reflect on the year gone by. This year that question leaped out while studying the history of buying stampedes. Recall, the current stampede is now 77 sessions in length, which eclipses the longest such skein recorded in my notes of some 45 years. While reviewing the 1987 upside stampede, into the August 1987 peak, I rediscovered the aforementioned quote from Robert Prechter. It’s an excellent quip. Virtually everybody can identify with it. On the surface the question seems laughable; who can’t accept huge gains? But in order to set yourself up for such gains you have to possess the courage to take an oversize position and maybe even leverage it. That kind of risk takes stomach and fortitude. Many times I have waited for the right moment, the big move, and decided against it. Maybe it was because I chickened out. While I often rationalized the hesitation away, the real reason I did not act was the emotional strain.
Yet, I know myself and have learned that emotional actions are failures most of the time. What one has to do is be able to step outside of themselves in an objective fashion. When you do that, it’s kind of like seeing things in slow motion. You are calm, objective, and can see ahead, perceiving the proper sequence of events. You just know you’re right and you act. I admit it’s kind of eerie; and, it’s hard to explain to anyone who hasn’t had the experience. Years ago, I had the same kind of experience in golf. Now it happens occasionally in my writing, trading, and investing. You just feel it, you see ahead, and you get the “rhythm.”
I bring these thoughts up today because it’s very human to look back after this September 1st to December 18th “buying stampede” and say, “If I hadda . . . !” If I hadda bought that stock, that option, that index, in size, etc. . . . ! It’s painful. But, post mortems help you learn in this business. I’ve learned that history repeats itself in the financial markets, despite changing players and changing events. You have to identify the patterns, and then you have to possess the courage to act, to believe in your own discipline. “Do you sincerely want to be rich?” Know that’s a question with agonizing implications; and it may tell you more about yourself than you really want to know.
“Do you sincerely want to be rich?” To accomplish that goal, to make those “outsized” gains, you need to know one thing – in bull markets don’t lose your entire position! Certainly you can rebalance positions (read: sell partial positions) as the security in question rallies. However, never (repeat: NEVER) lose your entire position of a “bullish bet.” To be sure, you will hear a lot about how overbought the stock market, an individual stock, a bond, an index is; still, stocks can stay overbought longer than most participants think. And, that is why I have repeatedly stated – if you want to be cautious in the short-term that’s okay, but don’t get bearish. Case in point, it was March 2009 and I was pretty bullish. I was particularly attracted to emerging markets. Our annual institutional conference was in session and I had just listened to a very bullish presentation from one of the companies in our research universe, namely NII Holdings (NIHD/$45.30/Strong Buy). NIHD provides wireless communication services in South America (particularly Brazil). At the time the shares were changing hands around $12 and we were recommending purchase. Unsurprisingly, a number of accounts bought the stock. The problem was that a few months later many of those accounts sold the shares in the low-$20s and in turn asked me for additional “buy ideas.” My response was, “Why did you sell your entire position?” Their reply was, “Because we had a nice gain.” Subsequently, NIHD shares have traded substantially higher.
Ladies and gentleman, as Warren Buffett opines, “All you need is one or two good ideas a year.” Clearly, this year has been replete with good ideas, as demonstrated by the performance of our Analysts’ Best Picks List for 2010 (please see page 6 for more information). Still, a lot of 2010’s outperformance has been driven by getting two things right. First, you had to avoid getting “hammered” in the 17% May through June swoon. And second, you had to stay constructive on stocks from those June lows until now. I think the trick in 2011 is going to be much of the same since I believe the wide-swinging trading range stock market environment we have experienced for the past 10 years will continue unless our elected leaders can come together with simple, workable solutions to the nation’s problems. Manifestly, I don’t think the nation can stand two years of gridlock given the issues we are facing. As for themes, I continue to embrace no double-dip recession, slow economic growth, dividend yield, stuff (energy, agriculture, water, electricity, metals, etc.), emerging/frontier markets and their consumers (although the emerging markets are well overbought currently), technology, financials, active investment management over passive (indexing), and hedging portfolios to reduce the downside risk. And with that, Merry Christmas to all and to all a good night.
The call for this week: When I left the country last Tuesday the S&P 500 (SPX/1243.91) was trading at 1242 and my “call” was, “I think we are making a very short-term trading top here, but I don’t think any selling will gain much downside traction. All I think happens is the equity markets stall, and rest, while they rebuild their internal energy for another rally into the new year.” Well, I’m back in the country and the SPX is roughly 2 points higher than when I left and I still think we are setting the stage for another rally into the new year. That said, there are signs that the current rally is long of tooth, suggesting the potential for a January “air pocket.” Furthermore, there is precedent for that. In 1981 the SPX suffered a 5% downside “air pocket.” Again in 1990 there was a 7% “hit.” In fact, January 2010 saw a 4% hiccup. Accordingly, while I still believe the upside should be favored into year-end, I am starting to consider some downside hedge “bets” to reduce the risk in portfolios.”
Jeff Saut Investment Strategist Raymond James
The most bullish forecast that I can create is a bull market that won’t be complete for several more years. Using the wave count method, I say that a large step ended in April 2010 (the step began in March 2009). The step is labeled as a red “1”. We are presently in another large step up that is labeled as “in red step 2”. This step could last for many more months. At the conclusion of red “2” we will have a reaction that will be larger than anything we have seen since March 2009. I base this on the fact that the correction that follows step 2 is always larger than any of those corrections that had preceded it. This correction will make a lot of people believe the bull is dead (me included) but after it has run its course the bull will resume its upward move. I would think the lengthy correction could be caused by the FED waiting to see the results of QE2. When they have determined that the economy can’t survive without another stimulation (QE3), we will resume the third and final step up in the bull market.
All of this is predicated on the economy not falling back into recession. Presently there is no indication of that but there were signs last summer, which also caused the stock market swoon from April to July. I would think there will be another swoon in the economy after the effects of QE2 have worn off but the FED will be loathe to stimulate again. There slowness to act will cause the correction from step 2 up to be deeper and longer than anything seen since March 2009. But again the FED will ride to the rescue with QE3 and the result will be the final step up in the market. Obviously all of this will take place over a lengthy period of time.
The correction following step 2 will likely fall below the bottom made in July 2010 (about 9600) possibly ending on the red line drawn on the chart below.
I agree with Jeffrey that we could have an air pocket in January. I actually have been expecting it since Dec 1 but the season is too strong to create a downdraft in December. Now January is another story. History has many instances of bull and bear pockets taking place. January can have a lot of different looks to it. But a buying opportunity could present itself.
A couple of years ago I had wondered if the market following the top in 2000 would look like the top made in early 1966. The 1966 top was significant and was the end of the bull market following WWII. Following the 1966 top there were 3 bear markets and each was followed by a move back above the high made in 1966. I believe that is exactly what is taking place presently. The top in 2000 was followed by a bear market (step 1 down ending in 2003). After step 1 down the market rallied to a new high in 2007 and again another bear market took place (step 2 down ended in 2009). The market is presently rallying from the step 2 bottom, which occurred in March 2009. If things continue to play out as they did in 1966 to 1974, the market will rally to another new high (above Oct 2007, 14,300 Dow). This will be followed by step 3 down. Each of the downward steps ended lower than the preceding bear market and step 3 down was the worst of the three. This scenario is something that will play out over years possibly not ending until 2018.
The top in 2000 was a major turning point in the stock market just as the top in 1966. In 2000 sentiment was crazy and it was 1929 again. The shoe shine boy was giving tips in 1929. In 2000 it was your neighbor at a cocktail party. Everyone was a stock market genius as they could do no wrong. Never confuse genius with a bull market. After a major turning point in history like 2000, there is a lengthy repair process to complete. It is like a pendulum that has swung too far and now it must swing just as far in the opposite direction. When the correction is finished (2018???) it will be like 1933 or 1974 and you can do no wrong in buying any stock. They all will go up because they will have been beaten down too far for too long. That will be the time to buy a good company that has a high yield and good prospects for the future. You will buy and wait for 20 years (2040??) before you even think of selling (predicated on you buying a company with good prospects). I will be 100 years old when that happens.
There will probably be points where it doesn’t look like history is following this projection but sometimes you have to wait until all the parts of the puzzle are in place before deciding on what really happened.
End quote of my December 2010 comments.
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