Investment Strategy
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Jeffrey D. Saut,
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November 16, 2009Investment Strategy__________________________________________________________________________________________
`Tis the Season?
‘Tis the season . . . except in this case we haven’t quite yet entered the Christmas season. However, we have entered the best sixmonths of the year for the equity markets. Clearly, history demonstrates that the November through April periods have on averageshown superior stock market performance to that of the May through October half of the year. As our South African friend Dr.Prieur du Plessis notes, “(since 1950) the ‘good’ six-month period of the year shows an average return of 7.9%, while the ‘bad’ six-month period only shows a return of 2.5%.” This performance can be seen in the first chart on page 3.In addition to the aforementioned seasonality, there are some equally compelling shorter-term metrics. To wit, over the past 12years the DJIA has always shown a profit between November 11th and December 5th. Additionally, since 1976 the DJIA has posted apositive return between October 26th and January 1st every year except 2007. As for those that suggest the markets have ralliedtoo far too fast, we offer these comments from the always insightful folks at “The Chart of the Day.”“To provide some perspective to the current Dow rally that began back in March, all major market rallies of thelast 109 years are plotted on today's chart. Each dot represents a major stock market rally as measured by theDow. As today's chart illustrates, the Dow has begun a major rally 27 times over the past 109 years whichequates to an average of one rally every four years. Also, most major rallies (73%) resulted in a gain of between30% and 150% and lasted between 200 and 800 trading days (9.5 months to 3.2 years) -- highlighted in today'schart with a light blue shaded box. As it stands right now, the current Dow rally would be classified as both shortin duration and below average in magnitude.”To us the real question is not whether this is a counter-trend rally in an ongoing bear market, but rather is this the beginning of anew secular bull market, or a bull market within the confines of the trading range we have been in for the last nine years? In pastmissives we have often reminded participants that since 1900 there have been only three secular bull markets. They were from1921 – 1929, 1949 – 1966, and 1982 – 2000. Following each one of those secular bull market peaks the DJIA has been “range-bound” for a period of years. Using the 1966 bull market peak as an example, the Dow was mired in a trading range for 16 yearsbefore embarking on the next secular bull market. Of course, those of us that lived through the 1966 – 1982 debacle know thatthere were a series of bull and bear markets within the confines of that trading range. In fact, there were at least ten 20%+ ralliesand/or declines in that ongoing range-bound market. Accordingly, investors had to have a more proactive strategy for theirportfolios, much like we have had to use for the past number of years.While NOBODY can answer our proposed question, what we can attempt to do is position portfolios in a manner that deals with thecurrent environment as we see it. To that point, since last April we have been using the stock market’s chart pattern from 2003 as atemplate for this rally. Recall that the S&P 500 bottomed in March 2003 and rallied sharply into to June. From there itflopped/chopped around for a few months, but never gave back much ground, and then it took off on the second leg of the rally,rising into the first quarter of 2004. The first “leg” of the 2003 rally was driven by liquidity, much like 2009’s first leg (March – June).The second leg of the 2003 rally was driven by improving fundamentals and earnings, just like 2009’s “July through now” rally.To be sure, we have turned cautious a couple of times since the March “lows,” but we have never turned bearish. Most recently, wewrongfully turned cautious at the beginning of October, worried that the July – September upside vacuum created by the melt-upmight get “filled” to the downside once quarter’s end window dressing was over. Obviously, that was wrong-footed because all themarkets have done is work off their pretty overbought condition at the end of September into a very oversold condition a few weeksago. We chronicled that oversold condition in our report of November 2, 2009, but regrettably didn’t act on it. Accordingly, wecorrected that cautious “call” last week by adding some “long” index positions to the trading account. While we would have feltbetter adding those positions if the markets had pulled back, or if the S&P 500 (SPX/1093.48) had rallied above its potential double-top of 1100, in this business you have to take what the markets give you. Whatever the resolution in the short term, we continue tobelieve the major market indices will trade higher into the first quarter of 2010.Plainly, we agree with the astute GaveKal organization in that the normal economic cycle is for corporate profits to increase, whichdrives an inventory rebuild and subsequently capital expenditure cycle, and then comes employment expansion that revivesconsumption. Currently, corporate profits are surging at their largest ramp rate since mid-1975. According to ISI, “profits have
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