Being There
Raymond James
By Jeffrey Saut
May 29, 2012
“As long as the roots are not severed… there will be growth in the spring.”
. . . Chance “the gardener” in the book Being There
With the recent slowing of economic momentum, grumbles have surfaced again from various stock market gurus about another
recession. To those groans this morning I reference the book “Being There” by author Jerzy Kosinski. The story revolves around a
simple-minded man named Chance “the gardener,” who knows only gardening and what he sees on television. Indeed, for his
whole adult life Chance has not ventured outside the grounds of his employer’s Washington D.C. manor. Eventually, however, the
employer dies and Chance is cast out onto the streets, where through a mishap he encounters the wife of a D.C. powerbroker.
Thinking her car was the reason for the mishap, she insists that Chance “the gardener,” who she interprets to be Chauncey Gardiner,
come with her to her husband’s estate. Benjamin Rand (the husband) is completely taken with Chauncey’s simple, direct approach,
and mistakenly attaches profundities to Chauncey’s ramblings about gardening. Viewing him somewhat as a savant, Rand
introduces Chauncey to Washington’s elite, including the President. In one verbal exchange regarding the current economic
condition Chauncey remarks, “As long as the roots are not severed there will be growth in the spring.”
To be sure, it’s spring again and instead of the typical shouts of “As long as the roots are not severed there will be growth in the
spring,” many Wall Street pundits are worried about economic growth. Their worries center on our dysfunctional government, the
housing/real-estate situation, and Euroquake. Speaking to the government, since the mid-term elections I have suggested the Tea
Party surfaced what Adam Smith wrote about in the book “The Wealth of Nations.” My prose read, “The Tea Party has surfaced
what Adam Smith described as the ‘political corruption that prevents prosperity’.” And that’s exactly what we’ve got; the best
Congress (Senate and House) money can buy. However, my sense is this is changing because if you parse the backgrounds of the
newly elected members of Congress you find that many of them are not professional politicians. Moreover, if you speak to them
they will tell you they really don’t want to be in Washington, but they think our country is off course and they want to fix it. I think
this is one of the reasons the S&P 500 (SPX/1317.82) rallied 16% following the 2010 mid-term elections into its May 2011 high. This
year the SPX is also following the presidential-year script, as can be seen in the chart on page 3. Hopefully, this correlation will
continue, driven by the bullish theme of more practical leaders.
As for housing, our fundamental real estate team writes:
“Last month, we shifted our tactical investment position on the homebuilders in a positive direction following trips to
key homebuilding markets in Florida and Arizona. We believed (and have since confirmed) order results for the public
builders would reflect surprising strength and a sharp acceleration in activity. We believe demand has remained strong
in recent weeks as MDC (MDC/$28.87/Outperform) recently reported that April orders rose ~30% y/y (moderating
from +51% y/y in 1Q), even as it lapped a big promotion event from last year. Also of note, Ryland (RYL/$22.83/
Outperform) reported that net orders (from continuing operations) increased 37% y/y in April. [Further] the average
home price rose 5.1% to $282,600 from $268,900 last year. Relative to March, sales increased in three regions, with
the breakdown as follows: Northeast (up 7.7%), Midwest (up 28.2%), South (down 10.6%), and West (up 27.5%).”
Of course, such improving metrics have been telegraphed for months by the S&P 1500 Homebuilders and lumber futures, as can be
seen in the attendant chart on page 3 from Ed Hyman’s sagacious ISI organization, whose mutual funds we embrace. Then there
was this quip from Fiserv, “Average U.S. home prices – down by a third since 2006 and still falling – will rise almost 4% a year for the
next five years.”
Last week, however, those two worries were again overshadowed by Euroquake as rumors swirled that Greece was going to pull out
of the EU and Spain’s second largest mortgage lender, Bankia, was on the verge on insolvency. To those apprehensions I repeat my
belief of the past 12 months. To wit, having worked in Washington I have a good understanding of politicians, bureaucrats, and
bankers. Unsurprisingly, they are the same in Europe as they are here in that they do not want to lose power; and if the EU fails they
all lose their power. So my hunch is, and has been, the powers that be will continue to “paper over” the Euroquake situation and
hope that time will provide a solution. That said, I can envision a scenario whereby the weakest countries could leave the EU while the stronger members stay. In fact, such a “partial break-up” might just be part of the solution and not the total disaster many
expect. If so, not only could this prove positive for the EU, but the rest of the world as well.
Such worries continue to leave investors profoundly underinvested in U.S. equities, as well as why the SPX trades at a P/E multiple of less than 13x this year’s estimate. With consensus earnings estimates centered around $103, and $119 for 2013, a return to the SPX’s mean P/E ratio of 16.2x implies decent upside from here. Further, this is one of the longest periods of time equities have been below their 50-year average valuation levels since 1973 – 1974. Back then the worries du jour were about the OPEC Oil Embargo and the resulting oil prices, Watergate, President Nixon’s resignation, the collapse of Franklin National Bank, the near bankruptcy of New York City, well you get the idea. From that grim news backdrop, the D-J Industrial Average (INDU/12454.83) made its nominal price low in December 1974 at 577.60. While the Industrial’s valuation low didn’t arrive until August 1982, at 776.92, most stocks made their generational low prices in December of 1974.
Fast forward and recall that on March 2, 2009 we stated the stock market would bottom that week and likened said bottom to the
nominal price low of December 1974. Since October 4, 2011 we have additionally opined that “low” was probably the valuation low,
which bring us to 2012. Our work suggested the “buying stampede” ended on January 26th and subsequently we recommended
raising cash in anticipation of a 5-8% correction. While it took longer than expected, the correction finally arrived in April – May,
culminating on May 18th with an intraday low of 1291.98 for the SPX. At the time ALL of the oversold indicators we use were
at/near historic readings and we recommended judiciously recommitting some cash to select stocks. Regrettably, since then the
SPX’s action has not been all that impressive. Indeed, the SPX has not even been able to claw its way back to our first target level of
1338, much less into the critical 1356 – 1366 zone. Yet, there is still time for this recovery to occur provided the SPX does not break
decisively below 1290, for that would trigger a danger signal for further price erosion.
The call for this week: I am out of the country seeing institutional accounts, so these may be the only strategy comments for the
week. In my absence the stock market will likely resolve its near-term directionality because the “selling stampede” is now 18
sessions long and such stampedes tend not to last for more than 17 to 25 sessions. Despite the decline, by my work there has been
no Dow Theory “sell signal,” although there are some Wall Street wags who are using very short-term pivot points and believe
otherwise. Still, the downside skein has left all of the indicators I monitor extremely oversold, suggestive of at least a near-term
bounce. Such a rally would tell us a lot about the health of the market going forward in time, but if 1290 is violated I will need to
rethink my bullish stance. Interestingly, all of the indices I track were up on the week with the economically sensitive D-J Transports
(TRAN/5079.84) fairing the best with a 4.23% gain. Likewise, all of the macro sectors improved for the week with best being
Materials (+3.72%). Surprisingly, the upside surge in Corn and Wheat stopped, but the driver of this duo’s rally remains as
temperatures soared into the 90s across the corn and wheat belt accompanied by the Iowa’s lowest rainfall in 40 years. That caused
the U.S. Agriculture Department to lower its rating for wheat in Kansas by nine points for the sharpest one-week ratings drop since
2007. This weather point is not unimportant, for if the warmest winter on record is followed by the hottest summer on record there
are all kinds of investment ramifications for water stocks, fertilizer stocks, air conditioning stocks, utilities, etc.
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