By Jeffrey Saut
December 5, 2011
I spent last week in New York City seeing accounts and doing the media “thing.” On Thursday I went to CNBC’s Englewood Cliffs studio to see some friends and do a TV “hit” with my friend Brian Sullivan. Much to my surprise, Brian began the show by talking about the “Sauta Clause” rally, not only because I was on the show, but because I have been suggesting that the Santa Clause rally had already begun. Indeed, in my commentary of November 28, 2011, titled “The Oath,” I wrote:
“Last week’s wilt brought the ‘selling stampede’ to session 19, as well it punctuated the now ~8.2% decline by the senior index since the Dow Jones Industrial Average closing reaction high of October 28, 2011 (12231.11). Recall that such stampedes typically last 17-25 sessions with only one- to three-session pauses, or rally attempts, before they exhaust themselves. In addition, the S&P 500 has experienced seven consecutive sessions on the downside, and markets rarely go that many days in a row in any one direction. Moreover, as of last Friday the selling skein has left the McClellan Oscillator as oversold as it was at the August 8 and 9 ‘lows.’ Therefore, the stage is set for some sort of tradable bottom.”
Since then the stock market has rallied some 7% as measured by the DJIA. Despite that surge the McClellan Oscillator is not in overbought territory, although it has traveled into neutral ground, as can be seen in the chart on page 3. Still, I think the equity markets will continue to work their way irregularly higher. The driver for that view should be multifaceted. This week’s causa proxima will likely be the Sarkozy – Merkel “hook up” slated for today, followed by Friday’s European Union Summit. I believe some sort of progress will be made in buying time for the Club Med countries. To that point, last week I was asked by numerous accounts why I have been somewhat optimistic about Euroquake. After listing the litany of reasons so often scribed in these missives, I said, “The ECB, as well as the bureaucrats surrounding it, do NOT want to lose their power. If the Euro falls apart they most assuredly will lose power. Additionally, in my 41 years in this business when something absolutely had to happen, it typically happened; remember in 1974 when NYC was broke?”
This week’s aforementioned duo of events will be followed by next week’s Fed confab. Parsing recent comments from various Fed Governors suggests there is the potential for a QE2 type of announcement from the December 13th FOMC gathering. To wit, Fed Governor Yellen recently said, “The Fed continues to provide highly accommodative monetary conditions to foster a stronger economic recovery in a context of price stability." She further opined, “The scope remains to provide additional accommodation through enhanced guidance on the path of the federal funds rate or through additional purchases of longer term financial assets." While Janet Yellen is considered “a dove” on policy, history shows Fed members choose their words extremely carefully. The inference is that she would not be using such language unless something was afoot. Other Fed members have been uttering similar thoughts. Accordingly, I think there is the potential for a trifecta of positive announcements over the next two weeks, which might have positive ramifications for the equity markets, especially with so many folks underinvested.
Manifestly, most of the hedge funds I met with last week were actually hoping the equity markets would decline because they are underinvested. Unfortunately, they are not alone. To be sure, only 23% of stock-fund managers are outperforming the S&P 500 (SPX/1244.28) this year, while most endowment funds are performing just as badly because they too are underinvested in U.S. equities. If these “thin reed” insights become weaved into an “investment bouquet,” I believe the ensuing “performance anxiety” will force such investors to chase stocks irregularly higher into the end of the year. If that’s correct, the question then becomes what do you buy on a risk-adjusted basis.
Firstly, looking back at the past few years we have found that coal stocks tend to outperform in December. This can be attributed to several factors including higher seasonal demand in the winter, depletion of coal stockpiles at utilities, and relatively weak performance during the summer months. Although the strong December performance may be a challenge this year, given the sharp rally on November 30, we thought it worthwhile to point out the historical trends that might work in favor of the sector this year, especially given the horrendous year-to-date performance. All in, with recent positive economic data points improving investor sentiment, we would expect the high beta nature of coal stocks to lead to outperformance if we see continued strength in the markets. Interestingly, the best performing stock in the S&P 500 last week was a coal stock, as Alpha Natural Resources (ANR/$24.11/Strong Buy) rose by 28.2%. A potentially better risk-adjusted coal stock for your consideration is Rhino Resources (RNO/$19.22/Outperform), a diversified met and steam coal producer with reserves in Central Appalachia, Northern Appalachia, the Illinois Basin, and Western Bituminous regions. As our fundamental analyst writes in a company comment published November 9, 2011 (please see the comment for the full story, including the justification of the stock’s price target):
“RNO’s valuation remains attractive for yield-focused investors, despite a weaker than expected quarter. The company boasts a robust 10.4% yield and given the strong (dividend) coverage ratio, and reiterated 2012 guidance, we stand by our Outperform rating while slightly lowering our target price to $25.50. Based on Tuesday's (11/8/11) closing price of $18.50, we estimate RNO offers a nearly 50% total return; 38% per unit upside to our target price plus a very attractive 10.4% yield.”
Another risk-adjusted name is Rayonier (RYN/$40.64/Outperform), a leading international forest products company with three core businesses: timber, real estate, and performance fibers. Hereto, our fundamental analyst writes in a company comment published October 26 (again, please see the comment for the full story):
“Currently, RYN shares trade at a 12% discount to our $45.64 NAV estimate. In comparison, our REIT coverage universe trades at a 7% premium to NAV. Moreover, we also find shares yielding an attractive 4.0%, 40 basis points above our REIT coverage universe average. Our $49.00 price target reflects shares trading at a 7% premium to our NAV estimate, which we believe is warranted due to 1) rising demand and strong earnings growth we anticipate in performance fibers, and 2) healthy international demand for U.S. timber and lumber products.”
For mutual fund investors, we continue to like The Goldman Sachs Dynamic Allocation Fund (GDAFX/$10.36), which attempts to manage the risk by targeting the volatility for the fund to about half that of the S&P 500. Another exchange-traded fund (ETF), while not actually managing volatility but does have the characteristic of capturing ~100% of the stock market’s upside and only ~65% of the downside, is WisdomTree’s Dividend ex-Financials Fund (DTN/$50.86). I had lunch last week with DTN’s portfolio manager (PM) and was duly impressed. I am also impressed with my friends at the GaveKal organization and think the recent weakness in The GaveKal Platform Company Fund (GAVIX/$10.71) should be used to buy a second tranche. For fixed income investors I would also use the recent weakness in The Putnam Diversified Income trust (PDINX/$7.30) to purchase another tranche; and the same can be said for The Lord Abbett Bond Debenture Fund (LBNDX/$7.57). I spent time last week’s with Chris Towle, the PM of LBNDX, and continue to think he adds value in the fixed income space. In fact, I spent four hours with eight different PMs at the Lord Abbett organization last Friday and came away quite impressed. My last visit of the day was with Tom O’Halloran, captain of The Growth Leaders Fund (LGLAX/$14.41). About halfway though his discussion I began shaking my head and was subsequently asked, “What’s wrong?” My response was, “Tom is giving my exact presentation.” Indeed, as Tom discussed his themes I felt like it was me talking to me!
The call for this week: December has been the best performing month of the year over the past 100 years with positive returns 73% of the time. And while last week’s 7.39% romp (basis the SPX) will likely not be duplicated quickly, the path of least resistance remains “up” according to our work (as an aside, the real winner of the week was the Russell 2000, which was up 10.08% last week, while Natural Gas rallied 11.63%). That said, while the DJIA bettered its 200-day moving average (DMA @11946.18) last week, the SPX and D-J Transportation Index did not. Consequently, a divergence currently exists that could lead to some sort of pause and/or pullback. Therefore, look for opening strength this morning followed by attempts to sell stocks back down with the final hour being a toss-up. Still, with improving economic numbers (see the second chart on page 3), the potential for positive news out of the aforementioned trifecta, a profoundly underinvested “crowd,” and the upside seasonal bias, pullbacks should be contained and the upside should continue to be favored.
(c) Raymond James