Investment Strategy by Jeffrey Saut Investment Strategy
The “bible” of technical analysis for stocks, namely the book titled Technical Analysis of Stock Trends, describes a climactic top as, “A sharp advance, accompanied by extraordinary volume, i.e., much larger volume than the normal increase, which signals the final 'blow-off' of the trend, followed by either a reversal, or at least by a period of stagnation, formation of consolidation pattern, or a correction.” And an upside blow-off is what we suggested was currently in the works for the DJIA in all of our strategy comments last week. To reprise our written comments, “The next event participants should be watching for is a reversal in the bond market on the perception of an economic pick-up. Given the leverage currently being employed by the hedge funds in their long bond positions, said sell-off in the bonds could be vicious. Initially, that might produce a downside hit for stocks. However, the upside might be another asset allocation rotation, out of bonds into stocks, driven by the aforementioned perception of an economic pick-up and therefore better earnings. If true, that 'into stocks rotation' should provide the upside blow-off to the rally that began on March 12th as the trading range environment continues.” We further opined that said blow-off should produce a “look” above Dow 9000.
To get a sense for what a potential upside blow-off looks like, we suggested participants scrutinize the D-J Utility's (DJUA) recent action. To wit, after bottoming in February of this year (at 185), the utilities have been steadily rising into last week's intraday high of 250. That's an amazing three-month gain of roughly 35% for what are typically considered rather stogy stocks! What is more amazing, however, is that said rise turned in to an absolute upside “tear” the past few weeks, which lifted the utility average an amazing 11% in just nine sessions on much larger than normal volume, thus presenting a potential upside “blow-off.” Moreover, that recent surge drove the DJUA to the top of its 10-week 10% Exponential Trading Band, a level that has historically tended to represent at least an intermediate trading-top. Consequently, we recommended that participants that followed us into our purchases of utility names like American Electric Power (AEP/$29.04) either sell a portion of their shares, or hedge those portions by selling some “call” options. Clearly, the utilities' stunning performance has been driven by the passage of the recent tax package and its favorable tax treatment of dividends.
Similarly, we think the tax bill, and the consensus “call” that all the stimulative efforts will finally produce a robust economic rebound, is also driving the recent re-acceleration of the equity markets, which like the DJUA commenced on May 21st. Interestingly, the favorable tax treatment of dividends has made the after-tax dividend yield on the DJIA more attractive than the after-tax return of the 2-year T'Note, assuming a 35% tax bracket. Furthermore, the tax-package is more stimulative than we first thought. As Ed Hyman notes, “First, of the $210 billion in tax cuts for FY03 and FY04, $187 billion is traditional demand stimulus (for example, child credit and state aid), i.e., only $23 billion in tax cuts for dividends and capital gains. Second, the $187 billion in traditional demand stimulus tax cuts are spread out over just 16 months, i.e., four months of FY03 and 12 months of FY04. This works out to a $140 billion annual rate of stimulus. Third, the $187 billion in traditional demand stimulus tax cuts are split $57 billion for FY03 and $130 billion for FY04. However, because FY03 has only four months left, the $57 billion hits June-September at a $170 billion annual rate. (And) Fourth, the $187 billion traditional demand stimulus tax cuts are greater than those requested in the larger tax-cut provisions that were rejected – that's because the provisions passed are concentrated over a few years instead of 10 years (sneaky, and probably effective).” We would add that clearly the tax package is VERY front-end loaded.
Apparently, the equity markets sensed that as well last week and responded accordingly with a +2.9% Dow Wow, which was easily eclipsed by the NASDAQ's 5.7% leap, as technology stocks were again the trading “chips” of choice. That technology triumph left the technology complex once again selling at nose-bleed valuations despite virtually no revenue growth, and the weak demand of the first quarter, as demonstrated by Applied Material's (AMAT/$15.56) P/E multiple of 105x estimated 2003 earnings per share. Further, as Ingram Micro's (IM/$11.02/Outperform) CEO Kent Foster said, “There are people who are expecting, or hoping, for an upturn in the second half of the year, but I don't see any sign of that and I talk to people every day in almost every segment of the economy.” Reinforcing those comments was a report from a major brokerage firm suggesting that technology sales would be down 14% this year. Another report intimated that the capex expenditures of the Fortune 100 companies would be off 5% this year and 1% next year. Additionally, they suggested that when an IT capex cycle finally plays, it will NEVER be close to as robust as it was a few years ago since the headcount at most the major companies has been dramatically reduced.
Still, the markets are currently enthralled by the recovery rumors and the media's pronouncements that “XYZ” company's share price is “up” 30% from its recent lows, causing one old Wall Street wag to lament, “If a stock falls 70%, say from $100/share to $30, and then rallies to $39, while that 30% gain sounds good, the shares are still down 61% from their peak!” Nevertheless, perceptions are two-thirds of the short-term trend and the current perception is that the short-term trend is higher. Consequently, we are still looking for an upside blow-off above Dow 9000, on outsized volume, before this current rally ends. Sure, the risk/reward ratio is high, but we think the upside momentum will overcome reason, which is why we have been recommending trading positions in the ETF of your choice. As for our individual trading recommendations, AmeriTrade (AMTD/$7.83/Outperform) still looks higher to us, even though we don't like the brokerage group for fundamental reasons. Likewise, our trading “buys” on Coca Cola (KO/$45.57) and Kimberly Clarke (KMB/$51.93) seem to be working.
As for our investment positions, the recent addition of the Phelps Dodge's (PD/$36.45) 7% yielding convertible preferred (PD preferred A) rallied last week on our economic recovery/re-flation theme, despite the precious metals' sell-off on the same theme. However, we still like the 5% yielding Anglogold Ltd. (AU/$29.12) on the premise that the dollar is in a bear market irrespective of our sense that a substantial “throwback” rally is due. Also rising to a new recovery high was one of our casual dinning recommendations, namely Applebee's (APPB/$30.15/Outperform). Another long-standing recommendation in the regional banking complex also “tagged” a new reaction high last week as SouthTrust (SOTR/$28.84/Market Perform) rose 5% for the week, yet sill yields 2.9%. Similarly, our vent toward the energy complex continued to reap rewards with many of our yield-oriented names like Exxon (XOM/$26.40), BP (BP/$41.89), and Chevron (CVX/$70.94) registering new reaction highs. Also tagging along were Raymond James' Strong Buy-rated Comstock Resources (CRK/$13.71) and Key Energy (KEG/$11.88), which also recorded new recovery highs last week. We continue to like the energy complex with particular emphasis on the natural gas sector.
The call for this week: A raging bull invaded the opening session of Yemen's newly elected legislature over the weekend and injured three people. Similarly, a raging bull is currently rampaging on Wall Street. Our bet is that the short-sellers get gored before the upside blow-off is complete.
Many thanks to Les Horowitz who as far as I know posted this first over at SI on the News and Links thread:
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