Excerpt from Raymond James strategist Jeffrey Saut's latest essay, (published Monday October 19th):
In Greek mythology Sisyphus was the son of Aeolus, who was the King of Thessaly. Noted for being sly and evil, this cunning knave waylaid travelers and murdered them. After betraying the gods, Hades himself intervened and as punishment required Sisyphus, for all of eternity, to roll a huge stone to the top of a hill only to have it plunge back down just as it was about to reach the crest. According to the dictionary, Sisyphus means “endless and unavailing, as labor or task.” Since mid-September there is little doubt investors have felt the same frustration Sisyphus did as the media trumpeted the D-J Industrial Average’s (DJIA/9995.91) failed assaults on 10,000. Last week, however, Sisyphus succeeded as the senior index legged it past the 10,000 mark for the first time in over a year, causing one Wall Street wag to ask, “Is this a breakout or a fake out?”
Nevertheless, many people continue to view the stock market’s advance with skepticism. As our technical analyst, Art Huprich, pointed out at Raymond James’ Vancouver conference last week, “both Jeff and I continue to get questions about DJIA 2700, or in some cases DJIA 400, as is being forecast by certain pundits.” Worth considering, however, is that these same pundits have been forecasting those downside targets for 10 years. Still, the media trots them out and subsequently Art and my phones light-up with the question, “do you really think this is a rally in a bear market; and, can the DJIA really go to 400?”
To us it is interesting that despite the monstrous rally in stocks, accompanied by extremely strong advance/decline statistics (Art showed a great breadth chart of this at the conference, which is attached), the negative nabobs continue to call this a bear market “sucker’s rally!” While it’s true that markets can do anything, the real “suckers” have been the bears who didn’t employ adaptive asset allocation and consequently have “sat” out the seven-month rally. Clearly, we disagree with the bears’ assessment, having maintained the view that this is a new bull market since April.
Moreover, participants got the Dow Theory confirmation of that “bull market” strategy either in July, or August, depending on which levels you used for the Dow and the Transports. Whether the current rally turns out to be a tactical bull market within the longer-term confines of a trading range market, or the first “leg” of a new secular bull market, remains to be seen. But, as we told our friend and founder of the “must have” minyanville.com website, “does it really matter?!” Indeed, as the title of Ned Davis’ legendary book reads, “Being Right or Making Money?”
Obviously, we’ll opt for “making money.” To that point, we have argued that with credit spreads (Ted spread, OIS to Libor, etc.) back to pre-Lehman (OTC:LEHMQ) levels, there is no reason why the equity market can’t “fill” the downside vacuum visible in the charts created by the Lehman bankruptcy. In the S&P 500’s (SPX/1087.68) case this implies at least a 1200 upside target. To be sure, there will eventually be a healthy correction, yet there is little question the primary trend is “up.” As the good folks at Riverfront Investment Group scribed recently, “(even) a healthy correction will not alter the trend.” Plainly, we agree and would note what the astute Lowry’s organization wrote last Friday:
This week’s advance pushed most of the major price indexes to new rally highs in the primary uptrend dating from the March ’09 market low. But, perhaps an even more important indication of the internal strength of the market from a longer term standpoint is this week’s drop in our Selling Pressure Index to a new 12-month low. This persistent contraction in selling indicates that, despite occasional corrections, investors have become increasingly convinced that prices are headed higher in the months ahead.
“Occasional corrections?!”... well so far said corrections have been brief and shallow. We have often opined this is because many portfolio managers have too much cash and have therefore underplayed the “bull run.” Consequently, they now have performance risk, bonus risk, and ultimately job risk as they approach their fiscal year-end. Certainly, there will eventually be a healthy pullback, but our sense is it will be contained to somewhere between the 50-day moving average (DMA) and the 200-DMA. In the SPX’s case that currently targets the zone between 1038 (50-DMA) and 910 (200-DMA).
Still, there is nothing “saying” there has to be a pullback, which is why we have repeatedly exclaimed, “cautious – yes, bearish – no.” It is also why we have recommended not “disturbing” investment positions since we continue to believe stocks will be higher at year-end even if there is a near-term pullback. As ISI’s Francois Trahan writes,
the fourth quarter is seasonally the strongest of the year with average gains of 3.5%, a full 100 bp higher than the second seasonally friendly period: Q1... Indeed, since 1960, Q4 has finished in the black nearly 75% of the time.
As for the all the “doubters” we encountered last week, who keep pointing to the rising unemployment numbers, we reminded them that employment is at the back-end of the cycle. Nevertheless, their chant goes like this, “how can we have a durable economic recovery when consumers account for roughly 70% of the economy; and, unemployment continues to rise while consumers continue to leave their 'billfolds on their hips?'" Ladies and gentlemen, the typical economic recovery is driven by corporate profits, not consumption.
Tagging along with U.S equities markets on their new reaction high “hit parade” were the Goldman Sachs Commodity Index, Crude Oil (and the Energy sector in general), many of the precious metal indexes/stocks we follow, a number of “soft” commodities, most of the exchange-traded funds (ETFs) we have recommended that play to emerging and frontier markets, and the list goes on. We think there is a message there. Should the various markets continue to trade higher in the months ahead, our sense is the sectors/stocks that have been the best performers off the lows will continue to be the best performers into year-end.
Therefore, we would avoid playing the “laggards” in favor of the “leaders,” believing they will continue to “lead” if the equity markets trade higher. In addition to the aforementioned sectors, we would re-emphasize technology. Manifestly, tech is “cheap,” as well as being a second derivative play on the emerging and frontier markets. Moreover, technology companies tend to be “volume monetizers,” as opposed to “price monetizers,” a concept proffered by the sagacious GaveKal organization and often referenced in these missives. And we continue to invest, and trade, accordingly.
The call for this week: Since the March “lows” we have repeatedly argued that the equity markets were three to four standard deviations below “normalized” valuation levels. Since then, they have merely rallied back to “normalized valuations.” Indeed, the DJIA only trades at a P/E ratio of 16 times earnings (according to Barron’s) and the gap between companies’ free cash flow yields and bond yields is at the widest since the early 1990s. As the prescient QB Asset Management folks write,
As the Fed and other central banks have been inflating their respective monetary bases dramatically over the last year, it is logical that gold has appreciated in dollar terms. It is also logical that stock markets have risen. In monetary base terms, the S&P 500 would have to rise to 1300 just to match the real/March ’08 lows.