Global Outlook

“The Turtle?”

Contributed by Raymond James

By Jeffrey D Saut

“We are suffering just now from a bad attack of economic pessimism. It is common to hear people say that the epoch of enormous economic progress which characterised the century is over; that the rapid improvement in the standard of life is now going to slow down; that a decline in prosperity is more likely than an improvement in the decade which lies ahead.”

... John Maynard Keynes, 1930

I recently reread the aforementioned quip from John Maynard Keynes (as paraphrased by me). While it sounds like it was written in the past year, it was actually penned in 1930 and titled Economic Possibilities for our Grandchildren. I revisit Keynes’ prose this morning because I did a video conference with a large U.K.-based institutional account last week where I repeatedly stressed that while I guess the U.S. could talk itself into a recession, as I read the tea leaves the economy looks to be in a self-sustaining economic recovery. Subsequently, our London institutional sales manager sent the following message to that account:

    “There may be no value in drawing comparisons with past market patterns, but I find it irresistible. In 1994 I was a U.S. portfolio manager and the debate of the day was whether the U.S. economy would succumb to recession. If my memory is correct, the term ‘double-dip’ was coined at this time as the U.S. was still suffering the hangover from the Savings & Loan crisis that had exacerbated the 1991 recession. Despite this background of doom and gloom the S&P 500 advanced by 34% in 1995.

    Lest you think there was much less to worry about back then, here are some of the headlines:

    Nov 1994 - Norwegian voters decide not to join the European Union.

    Dec 1994 - Boris Yeltsin orders troops into Chechnya.

    Dec 1994 - Mexican Tequila Crisis – ‘unleashing the Tequila effect on global financial markets.’ The U.S. agrees to a bail-out.

    Jan 1995 - Kobe Earthquake in Japan.

    Feb 1995 - Barings collapses due to speculative trading by Nick Leeson.

    Apr 1995 - Oklahoma City bombing kills 168 people.

    Jun 1995 - Iraq disarmament crisis.

    ... you get the picture - plenty to worry about - plus ca change.

    So a prudent man may have been tempted to hold back from investing in early 1995, but that would have been foolish. The market rose in 7 of the first 8 weeks of the year. By the end of February the S&P 500 was up 6%, and then rose nearly 3% in March, another 3% in April and over 3% in May. By the time most of the Cassandras were re-evaluating their position the S&P 500 had advanced ~20%.

    That’s my point: don’t stand back and deny the move; participate. I was the prudent man.”

Fast forward to today, there are certainly plenty of reasons to be bearish. Amidst all of this, I have been sticking my neck out since the day after Thanksgiving, believing the Santa rally was beginning and the economic data was improving. Despite that backdrop the S&P 500 (SPX/1289.09) went absolutely nowhere last year, although it did rally nearly 12% from Thanksgiving into the first trading day of this year. Indeed, in 2011 the SPX was down 0.003% for the second flattest year in history (1947 was the flattest at 0.000%). Speaking to that, the must have Bespoke Investment Group writes:

    “Looking at the prior years where the S&P 500 saw small changes, there was only one year where the index saw a move of less than +10% the following year, and the S&P 500 was positive seven out of nine times. Although the S&P 500 went nowhere in terms of price [in 2011], earnings were impressive. While the fourth quarter numbers have yet to come in, based on estimates the S&P 500 is on pace for EPS growth of 16% [last] year. This would put earnings at a record level of $97.10, eclipsing the prior record of $87.70 from 2006.”

Think about that, while earnings have grown by about 16% the SPX’s valuation has plunged by about 17% on a forward P/E basis (from a P/E multiple of roughly 16x at the start of 2011 to a forward P/E multiple of 13.3x today). So as our London sales manager implies, investors were so mesmerized by the headline du jour (Euroquake, tsunamis, nuclear disasters, etc.) they were frozen into inaction.

While I have been somewhat inactive since January 3rd’s Dow Wow, I have continued to suggest all we would see is a modest pullback and/or a sideways consolidation. As stated, the stock market’s “emotional peak” felt like it occurred the first trading day of the new year when the DJIA (INDU/12422.06) “gapped” 262 points higher, only to close up 179 points. The nominal price peak, at least for me, happened on 1/10/12 with an intraday high of 12514.69. Since then the senior index has been consolidating. In that consolidation the short-term overbought condition is being worked off and the market’s internal energy is being rebuilt.

Meanwhile, 4Q11 earnings season began last week punctuated by Friday’s solid report from JP Morgan (JPM/$35.92/Strong Buy). This is not an unimportant earnings report since approximately 26% of this year’s SPX earnings estimate ($106.81e) comes from the Financials. Clearly, the banks are anticipating decent earning this year given their year-to-date sector outperformance of +9.08%, which has left all of the Financial indices I track either near, at, or above their respective 200-day moving average. In business school they teach you that investing is all about earnings, and while I think fear, hope, and greed play a role in the investing equation, over the long term earnings indeed play the dominant role. Realizing this, the good folks at Bespoke have assembled a list of companies that have consistently reported the strongest earnings since March 2009 that report between now and February 24th. Names favorably rated by our fundamental analysts making said list include: Citrix Systems (CTXS/$64.85/Outperform); Devon Energy (DVN/$63.10/Outperform); and Tempur-Pedic (TPX/$58.94/Strong Buy).

The call for today: The turtle makes no progress until it sticks its neck out; I have been sticking my neck out since Thanksgiving, believing the Santa rally was beginning. I stuck with that strategy until the first day of trading this year, which felt like a short-term emotional trading peak. A short-term price peak occurred on 1/10/12 at 1296.46 basis the SPX, as chronicled in these missives. The only question in my mind was whether we were going to get a pullback into the 1230 – 1240 support zone, or if we would experience a sideways correction as the overbought condition was worked off and the market’s internal energy was rebuilt. So far it’s been a sideways correction, leaving the NYSE McClellan Oscillator not overbought, but not oversold either. In fact, it is hovering around the neutral line. Meanwhile, the stock market’s internal energy is almost fully recharged. And this morning we are greeted with better than expected Chinese GDP growth (+8.9% vs. +8.7%E), a worldwide interest rate easing cycle, the largest jump in German investor confidence ever, a decent Spanish bond auction, and hints of another round of quantitative easing. The result has the pre-opening S&P 500 futures up double digits, precious metals sharply higher, crude oil back above $100/bbl., and a lower U.S. dollar. Accordingly, while I would have liked to see more of a pullback to a minimum of 1250 – 1260, I’ll say it again – I think it is a mistake to become too bearish ...