The S&P's Tragic Rise Will Continue

by: Emmet Kodesh

Equities coughed October 15 on news of further complexity on a debt and spending deal. It was clear, however, indeed it was predictable before the storm began to blow that the House would yield and that Senate leaders would give a green light to more deficit spending and debt service. Exhilarated by a deal that ignited a surge when its tentative shape was released Wednesday, and fueled by QE and eagerness to ride to glory, equities resumed their run to higher highs and higher lows. This rise has a tragic undertone for its substance is damaging the economy. One must make hay while the sun shines.

Let's examine what to expect and how to position yourself for maximum gains and protection in the mid to long-term. Turbulence in the short term will pass for the markets but socio-economic stresses

require that one's holding be placed in the strongest castles.

In the past five years, from 876 on October 20, 2008 till today the S&P is up 95% unadjusted for inflation. Since that autumn of TARP, $7 trillion in debt has been created. The markets have gobbled it up and, in due course, yield suppression kindled a small but welcome housing recovery whose fragility was demonstrated during the four months of taper talk. As I have several times noted, ending QE will crush the major asset classes. This is unlikely before 2015 although a base built on massive debt is unsteady.

From the week of April 25, 2011 till February 20, 2012, for ten months, the S&P failed to make a new high although the lows of July 2011 never fell to that of June 28, 2010. QE 2 began in November 2010 but its impact faded and the indices flattened, surged and again plodded. It was only when the Fed formally announced QE 3 on September 13, 2012 that the markets spiked and took us to the run of consistently higher nominal highs we have been enjoying and whose artificial basis has troubled many observers.

Stephen Roach, a Fellow at Yale's Jackson Institute for Global Affairs pointed out August 26 that many economies are in a "pre-crisis" mode, investing more than they are saving and running enormous account deficits. The failed attempt to cap or limit Federal deficit spending was swimming against markets that banks have addicted to debt while economies flounder. "Asset and credit bubbles," Roach wrote, "have been treated as sources of economic growth" by the current and former Fed chairs. "The QE sugar trap [is] a failed policy" Roach concludes. It is a failure if you want to grow the economy: it is a success if your goal is to addict markets it to artificial stimulus from a Central Bank that thus gains life-or-death power over a nation, indeed, over many nations. That is the macro-context one must accept.

The alternative asset class of PMs (precious metals) has been subjected to repeated short selling episodes that have suppressed prices. This suppression is the inverse of the inflation in equity, bond and reflated real estate prices and has made PMs strong value plays on fundamentals like supply and demand and devalued fiat currencies. However, it is difficult to see an end to suppression of PM prices in a civilization that runs on the manipulation of narratives and devaluation of all values. As lying becomes a universal principle (Kafka, The Trial, chapter 9), wealth protection becomes increasingly difficult.

Let us then consider a three-part investing strategy that should enable most people to ride the rip tides of these markets and crazed policies and anchor themselves to companies adapted to the new America, and world that is taking shape.

1). Identify the best companies in the PM sector, take a position at major lows like late June or the present and at a significant rise, take profits, retaining a stake in companies that continue to show favorable profitability, growth and good management at multiple sites. The price action in First Majestic (NYSE:AG) and Yamana Gold (NYSE:AUY) on October 15, holding ground and then rising strongly indicates their intrinsic strength although it was not a turning point in PMs. The apparent basing of Endeavour Silver (NYSE:EXK) in the $3.75 - 3.95 area suggests the 2013 low already may be in for this outstanding company whose 3Q results were very impressive as noted in my previous pieces.

To take two examples of lack or true pricing in PMs: EXK and AG in the past week reported outstanding 3Q results, growing output, cutting costs, increasing profitability in a very challenging context. One would expect their prices to surge on the news. Instead, they each are basing at depressed levels. By fundamentals, they are among the market's strongest buys but the price action remains erratic.

At current prices, investment in a bullion ETP like Sprott Physical Silver (NYSEARCA:PSLV) which has had only a thirtieth of the outflow of iShares Silver (NYSEARCA:SLV) or Spider Gold (NYSEARCA:GLD) should bring profit and also buying bullion coins. Consider, however, that it is impossible to predict the future conditions for turning the latter assets into liquid exchange.

2). Find the strongest sectors in a political-economy such as we are developing and the best companies in them as measured by profitability, growth and ties to trends in culture and governance. The best sectors are Health, Consumer-related, the sub-industry of big media and aerospace - defense. The Vanguard Health Care Fund and the ETF (NYSEARCA:VHT) it mirrors is anchored in big pharma (46%), bio-tech (13%), health care providers (12%), supplies, equipment and related consumer goods. The Fidelity Select Bio-Tech fund (MUTF:FBIOX) is, as its name suggests, all bio-tech and 99% American companies while VHT is 78% American and 22% foreign companies. FBIOX is +57% YTD and 71% in a year. The funds complement each other, sharing only one company, Amgen, in their top ten.

Among the companies I have identified and discussed as meeting criteria noted above for mid to long-term viability in what is going to be a difficult economic period for most people are, in industrials, Boeing (NYSE:BA), United Tech (NYSE:UTX), Honeywell (NYSE:HON) and General Dynamics (NYSE:GD). In media-entertainment, CBS (NYSE:CBS), Time Warner (NYSE:TWX), Disney (NYSE:DIS) and Comcast (NASDAQ:CMCSA) look best to me and most analysts. Consumer-related winners should be Starbucks (NASDAQ:SBUX), Whole Food Markets (NASDAQ:WFM), TJX (NYSE:TJX), Home Depot (NYSE:HD) and Dunkin' Brands (NASDAQ:DNKN). The growth, ROE and socio-economic positioning of DNKN set it up for the long haul. All these companies have out-performed since I began recommending them two months ago and should thrive long-term.

3). Under-weighting but not exiting bonds probably is best along with an over-weighting to cash which, hopefully, you began to deploy to some of the above companies as I suggested three weeks ago here. On PMs one must be able to tolerate great volatility and often irrational price action. There is, however, the possibility that as QE-supported assets begin to flag from over-stimulation, PMs will see steadier accretion. The news October 14 on China demanding a "de-Americanized" world monetary system (while their sole aircraft carrier, not yet operational, is in California for training) is a hint that the world reserve system is in a process of transition. Xinhua also called for "a new international reserve currency." Perhaps this is part of what led mainstream market veteran, Art Cashin who does a daily overview with CNBC recently to write an article about the timeliness of recalling the inflation experience of Weimar Germany. The above points suggest that every investor include PMs in their allocation. The USD is being weakened in part to make way for the "inevitable" inclusion of the Yuan in a global reserve currency with substantial gold backing. This is bullish for PMs, if and when it occurs.

The S&P closed Wednesday at 1722 (rounded up), its high for the day. With a deal on the debt ceiling in place, the index, barring a major crisis, is unlikely to see the underside of 1684. The lows of February 25, June 24, August 30 and October make a floor near 1660 but while a lapse from today's jubilee is likely, the September 18 intraday high at 1730 should be passed soon. The closing highs of May 21 and August 2 point to 1750 for the up channel that QE and increasing debt should attain. This surge has an unsteady and tragic undertone but the strategy outlined above should leave your holdings in good shape even if socio-economic basics crumble. That is the set up for the odd optimism of our times of a mature and hollow bull market.

Disclosure: I am long SBUX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.