Investment Strategy by Jeffrey Saut
“You Gotta Have Heart”
“. . . After the workshop, another student took us out to Claibourne, the thoroughbred farm where Secretariat was buried. He was one of the great racehorses of all time. We went to his grave. He was buried in an eight-foot mahogany coffin with a gold satin lining.
My student told me, ‘They don’t usually bury the whole horse, but he was special. Hundreds of people came to his funeral.’
‘Well, what do they bury if they don’t bury the whole horse?’ I asked.
‘Most horses they don’t bury at all. With real winners, they bury the head, the hooves, and the heart,’ she told me nodding.
‘The heart?’ I asked, astonished.
‘Yes, that’s what a horse runs with, his heart. That’s why they say, that horse has heart. If they’ve got heart, it makes up for other things, they can win,’ she explained.”
. . . Long Quiet Highway, by Natalie Goldberg
“Street Sense” was the odds-on favorite to win last Saturday’s Preakness Stakes. He was beaten, however, by the 7:5 odds horse Curlin. Similarly, the odds-on favorite to win the stock market’s derby is the S&P 500 – year-to-date (YTD) it has recorded a respectable 7.4% gain. Yet like “Street Sense,” the S&P 500 is being beaten by most of the foreign bourses. For example, while everyone knows of Shanghai’s stunning 177% YTD gain, few know that Malaysia is up more than 30% for the year. Even fewer know that the Tel Aviv 100 Index is up nearly 20%. As stated in previous missives, with central banks printing money at a double-digit pace, inflation running higher than the official figures suggest, and risk appetites as high as they have been in years, most asset classes should rise. However, some will rise faster than others. This has clearly been the case with most of the foreign markets.
For years we have been unwaveringly bullish on many of the foreign markets and have used MFS’s International Diversification Fund (MDIDX/$16.92) as one of the better ways to get at this theme. We have also used many country-specific closed-end funds and ETFs. Case in point, the Malaysia Fund (MF/$9.86). We have recommended the Malaysia Fund for the past few years thinking Malaysia’s economy was going to accelerate and that its currency would rise relative to the U.S. dollar. Accordingly, since the beginning of 2006 the Malaysia Fund has nearly doubled and we are using this strength to rebalance positions (read: sell partial positions even though we think MF is going higher). We are employing a similar strategy with our Brazil ETF (EWZ/$58.42).
Nevertheless, where you stand is a function of where you sit, and from our “perch” the U.S.-based Dow Jones Wilshire 5000 Index broke out of a spread triple-top in the point and figure charts last week as can be seen by going to stockcharts.com and keying in $WLSH. Since the Wilshire 5000 ($WLSH/15304.99) is the broadest-based index we know this is not an unimportant event. Using last Friday’s upside breakout yields a near-term price target for the Wilshire of 16000, which is roughly 5% higher than Friday’s close. If that target is achieved it would also “foot” with our sense that with the S&P 500’s (SPX/1522.75) all-time high of 1552.87 so close it would be surprising if the SPX didn’t follow the Wilshire to new all-time highs. While we don’t understand it, in this business what you see is what you get.
Yet, while everybody is focusing on the major market indices, there are some other things worth considering. Our first consideration is the following chart of the yield on the 10-year benchmark Treasury Note:
10-Year Yield Index (TNX)
As can be seen, the yield has broken out to the upside, lifting the yield on the 10-year T’note to its highest level since mid-February. Also of note is that the inversion in the yield curve between the 90-day T’bill and the 10-year T’note has disappeared as the yield curve steepened, implying higher interest rates going forward. And that sense seemed to put a “bid” under the Dollar Index ($USD/82.11) as it lifted from its recent multi-year low of 81.10. Obviously this was not good for our long trading position in Japanese Yen (FXY/$82.61) and if the Yen breaks decisively below 82.00 we will be stopped-out. Then too there are negative implications for commodities (gold, copper, grains, etc.), as well as P/E multiples, in a higher interest rate environment (read: P/E compression), but that is a discussion for another time.
Plainly, the potential for higher rates has not been lost on the REIT complex, as can be seen in the next chart:
Dow Jones Equity REIT Index (DJR)
The REIT Index (DJR/304.21) has broken below its rising trendline and accelerated on the downside. We think this has negative implications for investment positions in U.S.-based REITs. While we still embrace international REITs, we are “losing” (read: selling) many of our domestic REITs. Yet, “No spillover from the real estate debacle,” has been the cry from most economists, but something clearly happened in April to retail sales, as seen in the following data from Vicis Capital’s Scott Reamer:
Retail Same-Store Sales from 50 retailers:
Jan +3.9% / Feb +2.8% / Mar +5.7% / Apr -5.2%
Same-Store Sales (Revenue-Adjusted):
Jan +1.0% / Feb +2.4% / Mar +5.9% / Apr -2.1%
We don’t know if the negative “print” in retail sales was caused by housing’s slide, $3.00+ gasoline, April 15th tax payments, weather, Easter, etc., but it is a data point that bears watching.
As for individual stocks, we have mentioned Strong Buy-rated Edge Petroleum (EPEX/$13.64) before. We particularly like Edge’s 4.5%-yielding convertible preferred shares (EPEXP/$52.47). Last week we had the company on the road seeing institutional accounts. The story was pretty positive. Indeed, in the first quarter, Edge was busy hiring personnel to work on the newly acquired properties. The company has now hired all of the people that it believes are critical to exploit the acquired properties. In 1Q07, Edge drilled 11 new wells. The company plans to ramp up activity in 2Q07 and drill 20 to 25 new wells. Many of the properties are showing promising results. Still, the shares are trading at a large discount to their NAV of $21.59. Furthermore, the shares are also trading at a deep discount on an EV/EBITDA basis, currently 2.9x 2008 EBITDA vs. the small cap mean of 5.8x. Our analyst continues to believe that Edge represents one of the most attractive deep value opportunities in our E&P coverage universe.
The call for this week: We are off to the midwest this week to see accounts, conduct some seminars, and check out what really is happening in the Corn Belt and with ethanol in particular. We’ll be back the latter half of this week. Until then, we are continuing to favor the upside, but keep raising our stop-loss points on trading positions like the SPDR Financials (XLF/$37.82). We’ll speak to you again on Thursday . . .
May 21, 2007
