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collegio dei patafisici
Investment Strategy
by Jeffrey Saut
“Listening to good news”
“The actual private object of most skilled investment today is to ‘beat the gun.’ As Americans so well express it, to outwit the crowd and to pass the bad, or depreciating halfcrown, to the other. For it is, so to speak, a game of Snap, of Old Maid, of Musical Chairs – a pastime in which he is the victor who plays ‘snap’ neither too soon nor too late, who passes the old maid to his neighbor before the game is over, who secures a chair for himself when the music stops. Or to change the metaphor slightly, professional investment may be likened to those newspaper competitors in which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors, as a whole; so that each competitor has to pick not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view. We have reached the third degree where we devote our intelligences to anticipating what the average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth and higher degrees.”
“The General Theory of Employment, Interest, and Money,” John Maynard Keynes, 1935
Shakes off bad news and listens to good news! And, that was how last Friday’s markets began as participants interpreted Friday’s “backward-looking” GDP report as good news and not bad news. Why a slowing economy (GDP +2.5%), accompanied by an inflationary 4% jump in Prices Paid and a PCE of +2.9%, is “good news” is a mystery to us, but there you have it. Clearly the mantra of “one and done” drove Wall Street’s emotions as once again folks anticipated a cessation in the Fed’s rate hikes, but we have heard that cry repeatedly ever since Richard “eighth inning” Fisher stated that the Fed’s rate-ratchets were in the “eighth inning” some 14 months ago. I guess some of Friday’s euphoria can also be attributed to the Bush/Blair press conference where “peace in our lifetime” reigned. However, Friday was the second such “peace rally” of the past two weeks as memories are short on the “Street of Dreams” with participants forgetting that the previous week’s Condi Rice peace-rally (+213 DJIA) proved to be a false start. Yet Friday’s economic figures smacked of “stagflation” to us and stagflation has historically not been a particularly pleasant environment for stocks. Nevertheless, Friday’s “cry” was, “the FED is nearly done so BUY stocks;” and the rest, as they say, was history. Still, the difference between perception and reality is where investors’ opportunities lie and history shows that the final rate-rise has typically been followed by an equity market sell-off.
Nevertheless, in this business what you see is what you get and Friday’s Fling left the S&P 500 (SPX/1278.55) challenging its early-July reaction high of 1280. We had suggested this might be the case and noted that if 1280 was surpassed it would likely bring into view a full upside-retest of the 1290 – 1298 level. As we said on CNBC, on June 13th, “we think a trading-low is at hand, hopefully within a bottoming sequence.” That sequence typically consists of a trading low followed by a throwback rally and then a subsequent retest of the trading lows. We were buyers of stocks/indexes on June 13th and 14th and subsequently sold those trading positions into the early-July throwback-rally highs. Unfortunately, we were NOT buyers of trading positions into the mid-July downside retest of the June lows since our proprietary indicators were not nearly as oversold as they were at the June bottom.
That said, we did recommend adding to positions in the investment account with particular emphasis on energy. That view was reinforced by our visit last week to Alberta, Canada, where activity in oil sand projects remains amazing. Bear in mind that most of the oil exporting nations hate America. Therefore, investments in politically secure, oil exporting countries like Canada make sense to us. Manifestly, for the past three years our favorite energy stock has been Outperform-rated, 3.3% yielding Canadian Oil Sands Trust (COSWF/$31.95), which owns 35% of the Tar Sands’ Syncrude project. Interestingly, COSWF rallied nearly 11% last week versus the Oil Index’s (XOI/1194.67) 2.7% gain. Our analysts think the dividend distribution on these shares will continue to be increased over the next few years and that the Athabasca Oil Sands’ stocks remain an excellent investment theme. Another Canadian name we have been using for awhile is Strong Buy-rated, 7.8% yielding Trinidad Energy Services Income Trust (TDGNF/$15.87), which is a growth-oriented income trust that trades on the TSX under the symbol TDG.UN. Trinidad owns roughly 100 oil drilling rigs and its drilling fleet is one of the most adaptable and competitive in the industry. Hereto our analysts expect the dividend distribution to increase over the next few years. Both of these companies are followed by our Canadian energy team and as always “Blue Sky” laws should be checked by U.S. investors.
While the Canadian energy complex has done pretty well recently, many of the U.S. energy stocks have not fared nearly as well, including some of the Strong Buy-rated names from Raymond James’ universe of energy stocks we recommended a few weeks ago. This is surprising given crude oil’s perkiness, natural gas’ move back above $7.00/mcf, and a $5.00 per megawatt hour leap in U.S. spark spreads. Obviously, natural gas, as well as the spark spread, was driven by the country’s unseasonably hot weather. We remain convinced that natural gas has bottomed and consequently continue to favor the strategy of scale-buying fundamentally sound companies in this complex. For ideas, see the nearby chart that shows the companies that are the best allocators of capital as defined by production growth per debt adjusted share.
Click to enlarge
As for the “spark spread,” clearly last week helped our long position in the only publicly traded electric transmission grid company we know of, namely 3.3% yielding ITC Holdings (ITC/$31.40), which is rated Overweight by our research correspondent Lehman Brothers.
Other “measured risk” investments for your consideration are Schering-Plough’s 5.6%-yielding convertible preferred (SGP+M/$53.40) and Marshall & IIsley’s 6% yielding convertible preferred (MI +B/$27.18). While everyone knows what Schering-Plough does, Marshall & IIsley is not so well known. MI is a mid-capitalization bank that owns a large, fast-growing, processing business. The company’s P/E ratio is in-line with its peers, but it has a more attractive investor base, is less interest rate sensitive because its business is primarily asset-based, and has a superior credit history relative to its peers, all of which should shield the company even if industry trends deteriorate. Both of these situations are followed by our fundamental analysts and are rated Strong Buy.
In the way of a follow-up, he wrote, “Haven't heard much on Briggs & Stratton in some time. I believe the thinking a year ago was; here is a company with a virtual monopoly, a low P/E, and a good dividend. I may have missed some comments, but we (Research) have it at an Outperform. I have had some inquiries lately on what’s going on with BGG since the clients that didn't stop-out are now down 20-30%.” I replied:
“For the past seven years my mantra has been to not let ANYTHING go more than 15% - 20% against you. In this biz you are not going to make a 4.0 like in ‘B’ school. The trick in this business is to sell your mistakes quickly. Plainly, BGG has been a mistake. BGG gave a huge sell-signal when it broke below its October 2005 closing low of $31.52, and despite our analyst's rating, I am gone from BGG. I can come back from a 15% - 20% loss. However, once losses become more than that, the ‘climb out’ is difficult. While I realize it is tough to get clients to ‘buy into’ limiting losses, that is indeed the key to overall portfolio performance. I continue to manage the risk accordingly.”
The call for this week: Last week the S&P 500 pushed above both its 50-day moving average (DMA) at 1257, as well as its 200-DMA (1266). However, the S&P 400 Mid Cap Index did not. Meanwhile, the 10-year T’Note yield dipped below 5%, vaulting the D-J Utility Index to within sneezing distance of its all-time high. Yet, almost unnoticed has been the silent “crash” in the D-J Transportation Average (DJTA), which despite Friday’s Fling (+109 points), is off more than 11% from its July 3rd high. This is not insignificant because if the markets are a discounting mechanism, the economically sensitive DJTA is telegraphing serious economic slowing ahead, confirming what is occurring in the real estate complex.
July 31, 2006
by Jeffrey Saut
“Listening to good news”
“The actual private object of most skilled investment today is to ‘beat the gun.’ As Americans so well express it, to outwit the crowd and to pass the bad, or depreciating halfcrown, to the other. For it is, so to speak, a game of Snap, of Old Maid, of Musical Chairs – a pastime in which he is the victor who plays ‘snap’ neither too soon nor too late, who passes the old maid to his neighbor before the game is over, who secures a chair for himself when the music stops. Or to change the metaphor slightly, professional investment may be likened to those newspaper competitors in which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors, as a whole; so that each competitor has to pick not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view. We have reached the third degree where we devote our intelligences to anticipating what the average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth and higher degrees.”
“The General Theory of Employment, Interest, and Money,” John Maynard Keynes, 1935
Shakes off bad news and listens to good news! And, that was how last Friday’s markets began as participants interpreted Friday’s “backward-looking” GDP report as good news and not bad news. Why a slowing economy (GDP +2.5%), accompanied by an inflationary 4% jump in Prices Paid and a PCE of +2.9%, is “good news” is a mystery to us, but there you have it. Clearly the mantra of “one and done” drove Wall Street’s emotions as once again folks anticipated a cessation in the Fed’s rate hikes, but we have heard that cry repeatedly ever since Richard “eighth inning” Fisher stated that the Fed’s rate-ratchets were in the “eighth inning” some 14 months ago. I guess some of Friday’s euphoria can also be attributed to the Bush/Blair press conference where “peace in our lifetime” reigned. However, Friday was the second such “peace rally” of the past two weeks as memories are short on the “Street of Dreams” with participants forgetting that the previous week’s Condi Rice peace-rally (+213 DJIA) proved to be a false start. Yet Friday’s economic figures smacked of “stagflation” to us and stagflation has historically not been a particularly pleasant environment for stocks. Nevertheless, Friday’s “cry” was, “the FED is nearly done so BUY stocks;” and the rest, as they say, was history. Still, the difference between perception and reality is where investors’ opportunities lie and history shows that the final rate-rise has typically been followed by an equity market sell-off.
Nevertheless, in this business what you see is what you get and Friday’s Fling left the S&P 500 (SPX/1278.55) challenging its early-July reaction high of 1280. We had suggested this might be the case and noted that if 1280 was surpassed it would likely bring into view a full upside-retest of the 1290 – 1298 level. As we said on CNBC, on June 13th, “we think a trading-low is at hand, hopefully within a bottoming sequence.” That sequence typically consists of a trading low followed by a throwback rally and then a subsequent retest of the trading lows. We were buyers of stocks/indexes on June 13th and 14th and subsequently sold those trading positions into the early-July throwback-rally highs. Unfortunately, we were NOT buyers of trading positions into the mid-July downside retest of the June lows since our proprietary indicators were not nearly as oversold as they were at the June bottom.
That said, we did recommend adding to positions in the investment account with particular emphasis on energy. That view was reinforced by our visit last week to Alberta, Canada, where activity in oil sand projects remains amazing. Bear in mind that most of the oil exporting nations hate America. Therefore, investments in politically secure, oil exporting countries like Canada make sense to us. Manifestly, for the past three years our favorite energy stock has been Outperform-rated, 3.3% yielding Canadian Oil Sands Trust (COSWF/$31.95), which owns 35% of the Tar Sands’ Syncrude project. Interestingly, COSWF rallied nearly 11% last week versus the Oil Index’s (XOI/1194.67) 2.7% gain. Our analysts think the dividend distribution on these shares will continue to be increased over the next few years and that the Athabasca Oil Sands’ stocks remain an excellent investment theme. Another Canadian name we have been using for awhile is Strong Buy-rated, 7.8% yielding Trinidad Energy Services Income Trust (TDGNF/$15.87), which is a growth-oriented income trust that trades on the TSX under the symbol TDG.UN. Trinidad owns roughly 100 oil drilling rigs and its drilling fleet is one of the most adaptable and competitive in the industry. Hereto our analysts expect the dividend distribution to increase over the next few years. Both of these companies are followed by our Canadian energy team and as always “Blue Sky” laws should be checked by U.S. investors.
While the Canadian energy complex has done pretty well recently, many of the U.S. energy stocks have not fared nearly as well, including some of the Strong Buy-rated names from Raymond James’ universe of energy stocks we recommended a few weeks ago. This is surprising given crude oil’s perkiness, natural gas’ move back above $7.00/mcf, and a $5.00 per megawatt hour leap in U.S. spark spreads. Obviously, natural gas, as well as the spark spread, was driven by the country’s unseasonably hot weather. We remain convinced that natural gas has bottomed and consequently continue to favor the strategy of scale-buying fundamentally sound companies in this complex. For ideas, see the nearby chart that shows the companies that are the best allocators of capital as defined by production growth per debt adjusted share.
Click to enlarge
As for the “spark spread,” clearly last week helped our long position in the only publicly traded electric transmission grid company we know of, namely 3.3% yielding ITC Holdings (ITC/$31.40), which is rated Overweight by our research correspondent Lehman Brothers.
Other “measured risk” investments for your consideration are Schering-Plough’s 5.6%-yielding convertible preferred (SGP+M/$53.40) and Marshall & IIsley’s 6% yielding convertible preferred (MI +B/$27.18). While everyone knows what Schering-Plough does, Marshall & IIsley is not so well known. MI is a mid-capitalization bank that owns a large, fast-growing, processing business. The company’s P/E ratio is in-line with its peers, but it has a more attractive investor base, is less interest rate sensitive because its business is primarily asset-based, and has a superior credit history relative to its peers, all of which should shield the company even if industry trends deteriorate. Both of these situations are followed by our fundamental analysts and are rated Strong Buy.
In the way of a follow-up, he wrote, “Haven't heard much on Briggs & Stratton in some time. I believe the thinking a year ago was; here is a company with a virtual monopoly, a low P/E, and a good dividend. I may have missed some comments, but we (Research) have it at an Outperform. I have had some inquiries lately on what’s going on with BGG since the clients that didn't stop-out are now down 20-30%.” I replied:
“For the past seven years my mantra has been to not let ANYTHING go more than 15% - 20% against you. In this biz you are not going to make a 4.0 like in ‘B’ school. The trick in this business is to sell your mistakes quickly. Plainly, BGG has been a mistake. BGG gave a huge sell-signal when it broke below its October 2005 closing low of $31.52, and despite our analyst's rating, I am gone from BGG. I can come back from a 15% - 20% loss. However, once losses become more than that, the ‘climb out’ is difficult. While I realize it is tough to get clients to ‘buy into’ limiting losses, that is indeed the key to overall portfolio performance. I continue to manage the risk accordingly.”
The call for this week: Last week the S&P 500 pushed above both its 50-day moving average (DMA) at 1257, as well as its 200-DMA (1266). However, the S&P 400 Mid Cap Index did not. Meanwhile, the 10-year T’Note yield dipped below 5%, vaulting the D-J Utility Index to within sneezing distance of its all-time high. Yet, almost unnoticed has been the silent “crash” in the D-J Transportation Average (DJTA), which despite Friday’s Fling (+109 points), is off more than 11% from its July 3rd high. This is not insignificant because if the markets are a discounting mechanism, the economically sensitive DJTA is telegraphing serious economic slowing ahead, confirming what is occurring in the real estate complex.
July 31, 2006
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