Jeffrey Saut: Go Against the Hysteria

Includes: DIA, QQQ, SPY
by: Jeffrey Saut

Excerpt from Raymond James strategist Jeffrey Saut's latest essay (published Monday, March 14th):

“... Look for hysteria to see if you shouldn’t go the opposite way, but don’t go the opposite way until you have fully examined it. Also, remember that the world is always changing. Be aware of change. Buy change. So many people say, ‘I could never buy that kind of stock.’ ‘I could never buy utilities.’ ‘I could never play commodities.’ You should be flexible and alert to investing in anything. ... Sometimes the chart for a market will show an incredible spike either up or down. You will see hysteria in the charts. When I see hysteria, I usually like to take a look to see if I shouldn’t be going the other way. ... Just about every time you go against panic, you will be right if you can stick it out.

. . . How do you pick the time to go against the hysteria? I wait until the market starts moving in gaps. ... Never, ever, follow conventional wisdom in the market. You have to learn to go counter to the markets. You have to learn to think for yourself; to be able to see that the emperor has no clothes. Most people can’t do it. Most people want to follow a trend. ‘The trend is your friend.’ Maybe that is valid for a few minutes in Chicago, but for the most part, following what everyone else is doing is rarely a way to get rich....

... Excerpts of interview with Jim Rogers, from “Market Wizards”

September 1, 2010 to February 18, 2011 was a pretty good “year” with the D-J Industrial Average (DJIA) gaining roughly 23.7%. Indeed, the “buying stampede” that occurred over those months is now legend, with today being session 132 without anything more than a one- to three-day pause / correction (recall it takes four consecutive down days to break the back of a buying stampede). Previously, the record stood at 52 sessions, and while the current stampede is not officially over, as stated three weeks ago – my hunch is it has ended.

I participated in most of last year’s rally, but turned cautious (not bearish) on just about everything coming into this year. In retrospect that was a good “call” on most developing markets, and not so good a “call” on developed markets, as professional money scrambled into a panic to keep up with the Jones, the Dow Jones that is. Yet as Jim Rogers states, “Just about every time you go against panic, you will be right if you can stick it out.” Accordingly, I stuck to my discipline of selling partial investment positions, allowing some long-term capital gains to accrue to portfolios, and increasing my cash positions in order to take advantage of investment ideas that have recently surfaced, like Williams Companies Inc. (NYSE:WMB).

To be sure, unlike many investors, I consider cash to actually be an asset class. To put this loathsome asset, i.e., cash, into perspective, Seth Klarman, an outstanding value investor, dissected the faulty rationale that “cash is trash” during an interview in Grant’s Interest Rate Observer. To wit:

“They compare the current yield on cash (lousy) to the current yield on longer-term bonds or (the) dividend yield from a stock. Cash nearly always loses in this comparison, and investors feel quantitatively justified in doing what career and client pressures cause them to do anyway. It makes no difference how overvalued these alternatives may be in an absolute sense.”

Further, I would note Seth’s point that investments be made “not because cash is bad, but because the investment is good.” I think some people lose sight of this fact.

Now, coming up to Seth’s key point, which is ignored by nearly everyone:

“One of the biggest challenges in investing is that the opportunity set available today is not the complete opportunity set that should be considered. Indeed, for almost any time horizon, the opportunity set of tomorrow, which could be greater, narrower, or similar in scope but different in specifics from today’s, is a legitimate competitor for today’s investment dollars. It’s hard, perhaps almost impossible, to accurately predict the volume and attractiveness of the future opportunities; but it would be foolish to ignore them as if they will not exist."

All of this brings us to the current state of affairs as expressed in this email from one of Raymond James’ financial advisors:

“Jeff, in light of what could be a historic meltdown going on in the Middle East, the latest being Saudi police firing on protesters if reports are true, how about addressing your thoughts on that in Monday's commentary.”

To which I replied, “N-o-b-o-d-y can predict how events will play out in the Middle East, but I will try to comment on a few current market-related items.” I think the recent stock market weakness is a routine consolidation in an uptrend, albeit within the confines of the wide-swinging trading range of the past 10 years often referenced in these missives. That belief is reinforced by the fact that despite many ongoing tensions the Ted-Spread (3-month LIBOR vs. 3-month T’bills) has not widened, and the yield curve remains very steep. This suggests no double-dip recession is on the horizon. Further, the monetary backdrop is favorable, earnings are strong, capital expenditures are increasing, chain-store sales have surged, ditto auto sales, and it looks to me like many of the stock indices in the developing markets have bottomed. Case in point, China’s Shanghai Composite Index.

The call for this week: Since September 1, 2010 the DJIA has not experienced anything more than a one- to three-day pullback / correction. Last Friday I received numerous calls asking if that would be the case here given Friday’s rally (+9.17 SPX). While markets can certainly do anything, I find it too convenient to have the S&P 500 (SPX/1304.28) stop its recent decline at the intra-day reaction low of 1294.26 recorded on February 24, 2011. To me, Friday’s rally looked like merely a retracement rally back up to the point of breakdown, following Thursday’s 90% Downside Day, rather than the start of a new uptrend.