Still Cautious, But Downside Is Measured

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 |  Includes: DIA, FTPLF, QQQ, SPY
by: Jeffrey Saut

Excerpt from Raymond James strategist Jeffrey Saut's latest essay (published Monday, August 16th):

...[T]he 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.

...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 (OTC: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." He continues, "So I've come here to give you a hand, and lead you into the promised land”.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.”

...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.