Constructive on Stocks: Selling Some Financials, Shorting Energy

Jul.29.08 | About: ProShares Ultra (DIG)

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

Late last week, however, stocks fell out of favor again as profit-taking reigned after the previous week’s huge rally. Also clouding the environment were shockingly weak economic figures from Europe, worse than expected U.S. home sales, and a prediction by PIMCO’s Bill Gross that U.S. bank losses will be at least one trillion dollars. We have warned investors that the U.S. dollar to euro exchange rate was having deleterious effects on Europe, so last week’s news should have come as no surprise.

As for homes sales and Bill Gross’ prediction, the statement– that the financial disaster won’t improve until housing prices stabilize – is now legion. Lost in the noise, however, is that while existing home sales have indeed collapsed, median prices have actually been moving “up” for the past four months ($215,100 in June versus $195,600 in February)! Whether this marks “the turn” for the economy is questionable, for while we don’t think the news will get a whole lot worse, we also have a difficult time believing it will get materially better either.

Meanwhile, the long-standing “trade” of shorting the financials and going long materials/energy has unwound rather dramatically over the past few weeks. To be sure, various financial indices rallied more than 30% in just six trading sessions, while crude oil is off 16% and natural gas has crashed 30%. We think the ferocity of the sector rotation is overdone in the near-term, which is why we recommended selling some of the financial indices we tranched into for trading purposes a few weeks ago. The quid pro quo is that last week we also recommended buying energy stocks for a short-term trade. Our vehicle of choice was the ETF ProShares Ultra Oil & Gas (NYSEARCA:DIG).

The call for this week: According to Richard Russell, On 7/24/08 "Lowry's Selling Pressure Index rose to within one point of its July 15 all-time high. That tells me that big money has been selling into all rallies, and that's just plain bearish. Selling Pressure should be declining rapidly when the market rallies. That's not what is happening.” Still, as long as the S&P 500 (SPX/1257.76) remains above 1240, we are constructive on stocks.