Market Strategy: Lean Against the Wind

by: Jeffrey Saut

Excerpt from Raymond James strategist Jeffrey Saut's latest essay:

We have often referred to investors’ long-term investment desires by quoting Benjamin Graham who wrote, “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.” Note that Mr. Graham uses the term adequate return, not spectacular return. Unsurprisingly, our discussions with investors suggest they are looking for consistent, “adequate,” risk-adjusted returns, not spectacular returns, because they know that spectacular returns require undue risk...

Along these lines, for months we have been counseling clients to “lean against the wind” [LAW] by reducing risk in portfolios as stocks rallied and building outsized cash positions. Our concerns centered on the fact that we couldn’t figure out if the economy was going to slow dramatically into a recession, continue to muddle forward, or reaccelerate. Additionally, we were worried by the straight-up/unnatural rally that had taken place since August 2006, increasingly optimistic valuations, waning earnings momentum, rising gasoline prices (again), spreading mortgage problems, and the list went on. Still, stocks traveled higher. However, by our pencil the upside stock momentum began to wane when Japan raised interest rates, the Japanese yen firmed, the ubiquitous Japanese carry-trade began unwinding, and the rest, as they say, has been history. The result was a “global gotcha” on February 27th, which also saw the DJIA shed 416 points that day, and the name of the game ever since has been “defense”...

Despite all of the hand wringing, the DJIA, the S&P 500 and the NASDAQ 100 have not yet even tested their 200-day moving averages at 11832, 1351 and 1675, respectively. Our sense is that eventually they will, as economic slowdown worries intensify into the spring, leaving equities on the defensive with participants pondering more negative corporate earnings’ guidance. Moreover, we think “risk appetites” have peaked, providing another headwind for stocks.