Jeffrey Saut: Where to Invest as the Rally Continues

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 |  Includes: COGT, EVEP, IOC, PARR, SGP
by: Jeffrey Saut

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

[We] recommended select investment positions, the most recent being Strong Buy-rated Schering Plough (SGP), except in this case we are using the 7.7%-yielding convertible preferred “B” shares. While this preferred is a relatively new one, we think the risk/reward metrics are similar to the last Schering Plough convertible preferred we owned, which provided us a total return of nearly 30% per annum over our two-year holding period.

Like before, the common shares of SGP have recently been devastated because of the fallible “Enhance” study on Vytorin. Our doctor, as well as our analyst, suggests this study encompassed far too small a sample of participants and that Schering Plough’s Vytorin is still a good drug. As always, the terms of the convertible preferred should be checked before purchase.

Other recent investment recommendations were 8%-yielding EV Energy Partners (NASDAQ:EVEP), Delta Petroleum (DPTR), Interoil (NYSE:IOC), and Cogent (COGT), all of which have some kind of upcoming news that we think might provide an upside catalyst.

Do these recommendations mean we think the difficult market environment is over? Not really, but we do believe the Fed, the banks, the politicians, et all, have a vested interest in preventing a recession and are pulling out all of the tools at their discretion. Whether they will be successful remains to be seen, but in the near term it looks like the various markets believe they will.

As to how far the rally extends is anyone’s guess, but it looks to us like there is scaled-up overhead resistance beginning at current levels for the DJIA and the S&P 500 (see nearby chart). Moreover, a lot of our shorter-term finger-to-wallet ratios are overbought, so it would not surprise us to see some kind of attempt to sell stocks off this week. Still, we think the near-term lows are “in” even if the economy spills over into a recession.

To this recession point, as I sit here in Jackson Hole staring out at the Grand Tetons from my friend’s house, we are discussing business. Mark owns a specialty steel company. When I asked him how business was he responded, “What recession?!” “Indeed,” he continued, “Our business is smoking. I even asked our sales people to canvass our customers and their business is also smoking! It’s the dollar,” Mark opined, “because of the dollar’s decline we have become by default the low cost supplier of specialty steel products.” To aficionados of our strategy reports these comments should come as no surprise, yet it is not just such anecdotal gleanings that keep us of the opinion there will likely be no recession.

Plainly, the manufacturing sector is improving. This trend was reflected in the recent stronger than expected durable goods report. As well, the manufacturing book-to-bill remains elevated, buoyed by strong foreign demand due to the dollar’s drop. In fact, the astute GaveKal organization observes, “Manufacturers’ order books look better than at any other point in the last 10 years – unfilled orders equal to nearly US$2 for every US$1 of current shipments.”

Indeed, if one deducts housing, inventories in the U.S. look exceedingly lean. Clearly, the recent crash in interest rates is also going to help ameliorate the housing situation. But just for insurance, it looks like the politicos are going to raise the “mortgage cap” for conventional/conforming mortgages from $417,000 to $730,000. Previously, any mortgage over $417,000 was considered to be a jumbo mortgage with an attendant interest rate that was roughly 1% higher than conventional mortgages. Manifestly, this is potentially a plus for housing.

As for employment, despite Friday’s downer numbers, employment is not a disaster. Even if the unemployment rate were to rise by 20% to the 6% level, 94% of the country would still be working! And, don’t forget that everywhere we look there are negative “real” interest rates, which have always sown the seeds for economic growth. Consequently, we continue to feel the “recession call” is premature.

The call for this week: Since 1949 every government-sponsored stimulus package has worked. Consequently, we are inclined to think this one will as well. Whether the powers that be can create another “bubble” for the overspent/under-saved U.S. consumer is debatable. Our sense is that if there is another bubble to be blown, it will likely be in emerging markets’ equity prices following their recent correction. If you have not followed our lead for the past seven years of investing some of your assets internationally, we suggest using the recent weakness to position yourself accordingly.

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