Me, Lord Marlboro And The Dow!?

Me, Lord Marlboro And The Dow!?

By Jeffrey Saut | 18 May 2009

Reminding us of the current equity market is an anecdote about the Sport of Kings that took place in London:

An American race horse owner, while parading his entry in the paddock just before the event, fed the horse what appeared to be a white tablet. Noticed and challenged by an English track official, Lord Marlboro, the American was informed that his horse would have to be disqualified. Protesting vehemently that he only gave the horse a sugar cube, the owner popped one into his mouth and offered Lord Marlboro a cube as proof. The English official tasted and swallowed the cube. He agreed with the owner that it was a harmless sugar cube and waived the disqualification. Just before the race horse was to enter the gate, the American signaled his jockey, instructing him to keep his horse clear of trouble near the start and try for the lead early since his horse was sure to win. "In fact," he told the jockey, "Only two have a chance to beat our horse." "What two?" asked the jockey? The American owner replied… "Me and Lord Marlboro!" …Anonymous

We recalled the "Me and Lord Marlboro" quip as we watched the running of the Preakness over the weekend. Evidently, someone fed Rachel Alexandra the proverbial "sugar cube" as she won the Preakness by beating "Mine That Bird" to become the first filly to win said event since 1924. Likewise, someone must have fed the D-J Industrial Average (DJIA/8268.64) a similar "sugar cube" 10 weeks ago, as the major averages have "galloped" from a generational oversold reading into the longest "buying stampede" of my lifetime.

Indeed, the stampede is now legend at 48 sessions without anything more than a one— to three-session pause/correction. Surprisingly, however, despite all the snorting, cheerleading, and animal spirits, the last tranche of index positions we sold in mid-April are virtually no higher now than they were back then. And, ladies and gentlemen, that is as it should be, for history shows that if a stampede is able to extend for more than the typical 17 - 25 sessions, the "momentum peak" tends to come between the 25th and 30th session; it is extremely rare for a stampede to extend for more than 30 sessions. In this case it appears the momentum peak came on April 17th with the S&P 500 at 876. Currently, the S&P 500 (SPX/882.88) resides only 6 points above that level.

Accordingly, we have counseled for caution over the past four weeks; and despite our renewed "hate mail" (for being too cautious), we don’t think a whole lot of money has been made since the April 17th momentum peak, which just so happened to be session 29 in the stampede. That said, as often repeated in these missives, we can find NO instance where the equity markets spring from such a generational oversold reading into a straight-up six-week buying stampede and then come right back down and test, or break, the previous reaction price low, in anything less than 12 weeks (three months). It is just the nature of the beast in that most participants "missed" the lows, have been sitting with too much cash, and are 'forced' by the performance derby to commit that cash, which is why the "dips" are being bought.

Indeed, ISI’s survey of hedge funds shows that their net exposure to equities is still well below benchmarks. And that is why the pauses/corrections have been shallow and fleeting. Three months [along] into the skein, however, the environment could change, setting up the potential for a "June Swoon". That would also be in keeping with the astute Dines Letter that observes, "April has been a month with a pivotal reversal of the March trend 67% of the time since 1963; and, at least a semi-important TOP has been reached in virtually every April or May since then". And don’t look now, but the early May "highs" felt pretty toppy to us.

So far any downside correction, since the early March lows, has been contained to between 5% and 6.4%. That suggests any correction of more than 6.4% could imply more of a correction than any we have seen since the demonic S&P 500 low of 666. Measuring from the May 8th closing high of 929.23, a greater than 6.4% price decline yields a "failsafe point" of slightly below 870 on the SPX. If that level is violated, it would suggest a decline to at least 830 (the 50-DMA is near 832) and maybe more. Moreover, last Wednesday’s "wilt" (-184 DJIA) was a 90% Downside Day, meaning that more than 90% of Downside vs. Upside Volume, as well as Downside vs. Upside total points lost, were both skewed more than 90% to the downside.

So what does all of this mean on a short/intermediate term basis? Well, after nine weeks of straight-up rally for the NASDAQ, the tech heavy NASDAQ (1680.64) took a breather last week. This is noteworthy because other than the Financials, the Techs have been the market leaders. Further, as the good folks at Bespoke Investment Group write, "The most noticeable difference about (last) week’s sell-off is that it is the first decline in years that wasn’t due to ‘troubles’ in the financials."

They go on to observe, "In fact, even though the S&P Financial sector has declined by 13% since May 8th, default risk has also had its biggest decline in months. During prior market selloffs, our CDS Index (Credit Default Swaps) has spiked sharply (higher) on fears of systemic problems. Now, that’s not the case, as our CDS index is near its lows of the year."

Inferentially, at least to us, last week’s action set up the potential for a more enduring decline than that which we seen since the March lows. Accordingly, we think participants should reduce/hedge their exposure to early-cyclicals, which have outperformed since our "buy ‘em" call of March 2nd. We also think those freed up funds should be shifted to agricultural investments.

In past missives we have mentioned numerous investment vehicles, which have rallied nicely, such as 9%-yielding Archer Daniels Midland convertible preferred "A" shares (ADM, A/$33.54), and 6%-yielding Bunge’s convertible preferred (BGEPF/$78.00) both of which are followed on a research basis by our affiliates. We continue to embrace the agricultural theme and have added the exchange-traded fund (ETF) iPath AIG Live Stock Total Return Index (COW/$30.02), as well as 3%-yielding Claymore Clear Global Timber Index (CUT/$13.06), to stocks for your consideration.

Congressman Waxman appears willing to give away credits to industries in support of the "climate change" bill. This should be a positive for electric utilities. While we don’t like the utilities right here for numerous reasons, their dividend yields and geographic positioning make some of them worthy of consideration.

Our caution on the utilities stems from the interest rate complex, where the 30-year Treasury bond has broken down in the charts (read: higher interest rates), leaving the yield above 4% for the first time since November 2008. Indeed, on April 29th the long bond broke below its 200-day moving average (DMA), thus completing what looks to be a massive top formation. Surprisingly, because higher interest rates should be supportive of a firmer U.S. dollar, the Dollar Index has also broken down and continues to reside below its respective 200-DMA.

Meanwhile, gold has traced out what appears to be a giant reverse head-and-shoulders bottom in the charts; and, we remain bullish. To be sure, bonds, the dollar, copper, and crude oil remain supportive of the "reflation trade". We have been bullish on crude oil since its mid-January "price lows," believing crude oil was making a bottom. We are still bullish, but would note that after its rally from those mid-$30s "price lows" in January, to its recent high of around $60, crude is now extremely overbought in the near-term. Consequently, we would be more cautious on crude oil stock positions; and, would actually consider hedging some of those positions to protect their gains.

The call for this week: I am leaving for Europe this coming Friday to see institutional accounts and do some seminars. Consequently, while I will continue to do verbal comments for the balance of this week, there will be no Monday letter for the next two weeks. Hopefully, I will have some insights from my travels upon returning. Nevertheless, last week felt like a trend change to me with the S&P 500 (equal weighted) losing more than 8%, the Russell 2000 surrendering some 7%, and the D-J Transports shedding nearly 9%.

Moreover, Thursday was a 90% Downside Day. As the Lowry’s service notes, "A likely key factor in determining the extent of a market pullback in the weeks ahead would be the occurrence of additional 90% Down Days. Thus far, in the rally since mid March, 90% Down Days have been isolated events, quickly followed by a renewed uptrend. However, a series of 90% Down Days could indicate the sort of sustained, heavy selling consistent with a deeper and more sustained market set back". And, as the always insightful Helene Meisler writes, "Keep your eyes on the Russell 2000 since it is the only index that has rallied back to the underside (or just about) of its broken channel line. A failure here would confirm my view that we’re in the midst of a correction."