Jeffrey Saut: Scaling Into Veriphone, Motorola, Avnet

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

...[T]he recent economic data clearly shows the economy is slowing and that the mortgage/housing situation is worsening. In our opinion, this leaves the Federal Reserve with little choice other than to reduce short-term interest rates until the yield curve steepens. A steepening yield curve should help financial institutions recapitalize and ameliorate some of the financial contagion.

Recently, the markets seem to be telegraphing this outcome with the price of crude oil, gold, commodities, etc. all trading higher. The last time the Fed reliquidfied the system like this, equities were over valued, while bonds, commodities, and real estate were under valued. Today the opposite is true.

Indeed, using the Fed Model, which compares equities “earnings yield” (earnings ÷ price) to the yield of the 10-year T’note, shows equities’ “earnings yield” is more than 4% greater than the benchmark T’note’s yield (according to a study of 29 various countries compiled by Lehman Brothers). The last time such a wide dispersion occurred was back in September 1974 right before the equity markets rallied strongly.

...[I]t is worth noting the Fed Model’s current valuation in light of the probability of lower short-term interest rates. We mention the Fed Model this morning for while we are cautious, we think it’s a mistake to become too bearish.

As for our recommendation on Outperform-rated Verifone (PAY), we recommended buying a one-third tranche of PAY on its initial price collapse to under $20/share back in early December. We are considering buying a second tranche, and then still another one-third tranche somewhere in the future, to complete this investment position.

A similar strategy may be employed with Motorola (MOT) and Avnet (AVT). As always, we never buy, or sell, an entire position all at one time. This strategy has served us well over the years, as can be seen with our tranche “in,” and partially tranched-out, approach to Monsanto (MON), which was recommended in the mid-teens four years ago as part of our agricultural theme.

The call for this week: We think that this is a critical week! The Transports [DJTA] are 106 points below their November low, while the Industrials [DJIA] are 57 points above their November low (a potential non-confirmation). Moreover, the DJIA has traced out a head-and-shoulders “top” formation in the charts and has fallen below both its 50-day moving average [DMA] at 13340, as well as its 200-DMA (13366).

Additionally, last week the Dow’s 50-DMA crossed below its 200-DMA and thus, by our interpretation of moving averages, is negatively configured. Further, for the past few weeks new daily lows have vastly exceed new highs. We have learned over the years that it is extremely difficult to make money in the equity markets when new lows are expanding over new highs.

Consequently, we remain cautious. Recall, this is the same strategy that we began 2007; and, it worked. The Analysts’ Best Picks for 2007 returned 30.5% last year, while the Focus List gained 10.7%. Hopefully, this same risk-adjusted approach to the markets will treat us as well in 2008.