Investment Strategy by Jeffrey Saut
“The Bull, the Bear, and the Boar”
I was on CNBC’s Kudlow & Company show last week along with two other pundits. John Rutledge was clearly “the Bull” with his rosy economic and stock market outlook, citing such metrics the S&P 500’s earnings yield (earnings / price) being below the yield on the 10-year T’Note (aka, the Fed Model). While I have issues with Fed Model, since it doesn’t work with many of the international markets and doesn’t take into account the business cycle, that is a discussion for another time. “The Bear” had to be Vahan Janjigian, due to his views of waning earnings momentum and rising interest rates. Consequently, I guess I was invited on the show to play “the Boar” given my ambivalence on the major market indexes, despite the fact that I own an awful lot of stocks. Larry Kudlow’s questions went something like this (as paraphrased by me):
Larry: Besides high earnings and low/moderate interest rates, the global spread of capitalism is very bullish, the world’s central banks hate inflation, low tax rates in the U.S., Europe, and even China all explain the worldwide stock market boom. Jeff Saut, what do you think? You’re a skeptic aren’t you?
Me: Not (a Skeptic) on the worldwide stock market boom. We have been unwaveringly bullish on the foreign markets for the past 6½ years and remain so. There will be growth scares where they think China, India, Vietnam, etc. are going to slow, but we think these pullbacks are for buying and remain steadfastly bullish on the international markets.
Larry: Okay, so what’s your problem with the U.S.? Earnings are rising and interest rates are slipping down in the short-end of the market. You heard Bob Pisani; the leaders today were commodities, industrials, and energy. First of all, those are all pro-cyclical / pro-economic growth stocks. Secondly, we had a very good factory orders report today that suggests business capex is moving out of the doldrums. So, what’s wrong with the U.S.?
Me: I own a lot of stocks in the U.S. I am very bullish on a lot of sectors and individual companies within those sectors. For the aggregate indices, however, I tend to use the ValueLine Index of 1700 stocks, because I think it is the best proxy for the average stock, and the ValueLine Index’s median P/E is back close to where it was at its “peak.” As well, by most of the valuation metrics that Ben Graham teaches us in the book “The Intelligent Investor,” stocks are optimistically priced.
When I returned to my office following the show I was greeted with this email, “Hey Jeff, while you didn’t mention it tonight, you did pose the question on CNBC last week – are stocks going up or is the measuring stick (AKA, the dollar) going down? – and your insight did not go unnoticed, as can be seen in the following piece from “Investment Quality Trends” by Kelly Wright. To wit:
“Proper Street etiquette during party mode requires market participants to refrain from questioning the catalyst(s) of the current revelry unless one wants to be perceived as a party pooper. Imagine my surprise then when I actually head an intelligent question asked on television the other day: ‘Are equities rallying, or is the measuring stick (the dollar), weakening?’ Hmmm, a great question; let’s take a look. Well, well, well; since the beginning of 2002, the S&P is up 29% while the dollar is off 30%. Correlations must exist for a reason.
If you don’t conduct any business outside the U.S. you probably don’t give tinker’s diddle if the dollar is going up or down. In fact, Americans have been living off the kindness of strangers for years. This is to say that we owe more than $3 to the holders of our Treasury bonds for every $1 we produce in goods and services. I know, this stuff is exhilarating and just keeps you on the edge of your seat with excitement. For foreigners who invest in dollar-denominated assets, however, this is a big issue. They don’t invest to see their capital erode in value with no end in sight. Someday they will reach their pain threshold and head for the exits. When that day will come is anyone’s guess, but when it does come many dollar-denominated assets will suffer. As for the big party currently underway on Wall Street, well, it sure is fun right now and right now is what Wall Street is all about.”
And “party on Garth” was the cry from the street of dreams as the S&P 500 moved ever closer to its all-time intraday high of 1552.87. The recent surge has carried the S&P higher in 23 of the last 26 sessions for a skein that has not been seen since the year 1944. We don’t know how big a standard deviation event that is, but obviously it’s historic. One thing we do know is that the upside march has lifted the ValueLine Index’s median P/E multiple back to near where it was at “the peak.” When we combine this with the loss of leadership from the small capitalization sector it continues to leave us ambivalent on the S&P 500 even though its all-time high is so close it will probably be bettered.
Despite our index ambivalence, we are still having a pretty good year with names like Whirlpool (WHR/$111.21/Strong Buy), Harsco (HSC/$51.98/Strong Buy), Laperriere & Verreault (GLV.A/C$40.16), and Schering Plough (SGP/$32.96/Market Perform) up substantially. And last week another one of our holdings came to life when Chesapeake Energy (CHK/$35.54/Strong Buy) reported its quarterly numbers. As with Schering Plough, we have used Chesapeake’s convertible preferred in the investment account because we like dividends. Consistent with our re-balancing strategy, however, we are selling partial positions in these names to keep their portfolio weightings in-line with the portfolio’s original objectives. For example, if you bought 1000 shares of Chesapeake’s convert around $90, where it was yielding 5%, the idea of selling 300 or 400 shares at $103 makes portfolio sense to us.
In conclusion, two other of our investment account companies reported last week. Covanta (CVA/$24.62/Outperform) reported an in-line quarter, yet revenues were better than anticipated. Covanta’s story continues to hinge on free cash flow generation and the earnings leverage it provides for debt paydowns and/or numerous, likely-more-accretive growth opportunities, both domestically and abroad. One that has not worked for us has been Intermec (IN/$22.81/Outperform), which reported a really ugly quarter last week, yet the shares didn’t really go down in price. We take that as a pretty positive sign and continue to invest and trade accordingly.
The call for this week: We are in New York City this week at our Canadian Oil Sands Conference, our Uranium Conference, and seeing portfolio managers. Consequently, these will be the only strategy comments of the week. And the “call” is for the S&P 500 to follow the other averages to new all-time highs.
May 7, 2007
- superfluo dire che io non vado in bicicletta, troppo pigro 
