2011: The Year of the Banks

 |  Includes: IBKC, PBCT, WMT
by: Jeffrey Saut

Excerpt from Raymond James strategist Jeffrey Saut's latest essay (published Monday, December 6th):

While created by writer Dan O’Keefe, Festivus was lionized on the hit TV series Seinfeld. The holiday’s celebration includes the “Airing of Grievances,” and “Feats of Strength,” all accompanied by an unadorned aluminum pole instead of a Christmas tree. In December 2007 the Minyanville organization adopted the concept and held its first Festivus event... I revisit Minyanville this morning because last Friday was the annual celebration of Minyanville’s Festivus. In attendance were many of Wall Street’s “best and brightest.”

I arrived around 5:00 p.m. and had a chance to chat with a number of other early arrivers before the official festivities began. First was David Stockman. Recall, David was the former federal budget director under President Reagan. His take was – it is different this time; and, it will take a decade just to get back where we were in December 2007 unless things change. The heart of his argument was about middle class jobs. I too have written about this, scribing that roughly 2.4 million high-paying manufacturing jobs were lost in the first part of this decade. Yet, those losses were masked because many of those folks found jobs in the construction industry. When the bubble burst in construction, however, the structural unemployment situation became glaringly apparent. David also noted that for the first time in history governmental jobs (Federal and State) are shrinking as more than 250,000 jobs have been shed during the past year. Additionally, he believes most governments are broke and offered the following solution:

1) Raise revenue across the entire population by a large magnitude to pay our government’s bills; probably a half trillion dollars a year.

2) Social Security and Medicare: Cut benefits for better-off retirees by $100 billion a year through a means test for retirement entitlements.

3) Reduce defense spending by at least 20 percent from planned levels (by 2015), which is projected at about $800 billion.

4) Cut domestic discretionary spending by $100 billion – transportation, national parks service, education, farm subsidies, business subsidies (such as ethanol plants).

Next I had a conversation with Dr. Gary Shilling. The last time I spoke with Gary was last spring when we were both on a panel at John Mauldin’s conference. Gary’s views have not change all that much since then. He still thinks the 10-year Treasury’s yield is going to be zero before our bout with deflation is over. Standing next to Gary was Peter Schiff, who was so negative I had to walk away. Then there were the constructive types like my friends Tony Dwyer (Strategist for Collins Stewart) and Smita Sadana (CEO of Sunrise Capital).

Of course there were many other positive pundits, yet most of their arguments resembled the thoughts expressed in these missives over the last six months. To wit, there will be no double-dip recession, earnings momentum will continue, the resulting profit explosion leads to a strong inventory rebuild (whose ramp rate is now slowing) followed by a capital expenditure cycle boosting hiring and then consumption should increase. To this consumption point, there is roughly a 90% correlation between a rise in the stock market from September through December and stronger than expected Christmas retail sales. Accordingly, for three weeks I have urged investors to consider retail stocks, the largest market cap one being Wal-Mart Stores Inc. (WMT/$54.62/ Strong Buy).

While in the city I also spoke to numerous institutional accounts, most of whom are underperforming their respective benchmarks. To be sure, this has been an extremely tough year, consistent with my mantra of December 2009, “The trick in 2010 is likely to be keeping the profits accrued to portfolios since the March 2009 bottom” (aka, “The Year of the Hangover”). The fact of the matter is that you only had to get two things right this year. You had to avoid the May – June swoon and then stay constructive on stocks. Unfortunately, a lot of investors didn’t do that and are therefore underperforming. One such portfolio manager (PM) told me that he was not going to be able to catch-up with “The Joneses,” the Dow Joneses, and subsequently had “flattened out” his portfolio and is calling the year over. Most of the PMs, however, were in desperate search of stock ideas that would help their performance into year-end. I think there is a distinct message there.

As stated, I have learned the hard way that it is tough to break stocks to the downside during the ebullient holiday month of December. While it has happened, it is still a fairly rare event, occurring only 29% of the time over the last 100 years. This year, I have argued, it should be particularly difficult due to the aforementioned underperformance; and, the fact many PMs are sitting on too much cash. Hence, driven by performance risk, bonus risk, and ultimately job risk, PMs should be inclined to buy the “dips.” And that, ladies and gentlemen, is why I have repeatedly stated that any pullback should be contained in the 5% to 8% range. So far that has been an okay “call” since the November stock stumble was contained at 4.4%, leading to the best start of December ever, albeit only three days into the month.

Interestingly, since Thanksgiving the best performing groups have been (in descending order) Retailers, Consumer Durables, Semis, Transportation, Capital Goods, and Technology. Last week, the star sectors were Materials (+5.70%), Energy (+4.96%), and Financials (+4.92%). That weekly performance, however, pales in comparison to Cotton (+19.01%), Wheat (+15.61%), and Natural Gas (+10.77%). Plainly, such action was positive for my portfolio recommendations. Importantly, Energy should continue to be a major portfolio focus given my views this will be a much colder than expected winter.

The worst performing sectors since Turkey Day have been Banks and Financials. Readers of these reports know that I have avoided the banks for some 10 years. I missed them going down and have missed them going up. However, select banks finally appear to be comfortable with their capital ratios such that they should begin raising dividends in 2011. Verily, there should be widespread dividend increases next year as most of the top 50 banks have minimal payout ratios when compared to historic levels. Accordingly, I am thinking of terming 2011 “The Year of the Banks” as “The Year of the Hangover” sunsets. Whether I embrace that mantra remains to be seen, but I still would offer 4.8%-yielding Peoples United Financial (PBCT/$12.96/Strong Buy), as well as 2.5%-yielding IBERIABANK Corp. (IBKC/$53.84/Strong Buy), for your consideration. Please see our fundamental analyst’s most recent comment on these companies for more insight.

The call for this week: Festivus is alive and well, and the “Airing of Grievances” should be particularly loud since 2010 will go down as the worst year of underperformance by active money managers in memory. That will leave many of the pros unloved in the new year. Also unloved are the Financials, and consequently under owned, which if 2011 does turns out to be “The Year of the Banks” might explain why the Financials were up 4.92% last week. The Dow’s weekly-win of 2.6% broke the senior index out of its two-week trading range driven by last Wednesday’s 90% Upside Day. It was the seventh such 90% Upside Day since the beginning of September versus only one 90% Downside Day. That speaks to the strength of the underlying rally and continues to put underinvested PMs squarely in the crosshairs of the performance derby. That performance anxiety could increase if Lowry’s Buying Power Index travels above the Selling Pressure Index, which could happen this week. That said, the stock market is once again over bought so it would not surprise me to see a pause and / or pullback in the short-term. Nevertheless, I still expect the trend of buying the “dips” to continue. Watch the Financials; they may be the key to the stock market’s near-term directionality.