We’re in the worst of the four years of a Presidential administration–who’d have noticed?–according to history stretching back to 1900.  Next year will be the third year, which has historically been the best.  (It’s also the year when some say we meet the Four Horsemen of the Apocalypse, but we can worry about them when we see ‘em.) 

As to seasonality, it has tended to be pretty mild in year 3, although it does suggest a lower low in September.  Based on the lousy year so far, though, that’s only a 6% move lower.

For now, our thinking is that we stick with the consensus of our various services, which is to be modestly over-weighted to equities, but it would be hard to fault one who raised cash in anticipation of a lousy September/October.  After all, it’s easier to make up for lost opportunities than it is to make up for lost losses.

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I’ve pasted in a little bit about the firm from its website, and below that is the interview. You can find the firm’s website here.

Read on

Strategas Research Partners is a leading institutional broker-dealer focused on investment and sector strategy, macro-economics, policy research, and technical analysis. The firm seeks to provide timely and insightful research on the global equity and debt markets to institutional investors around the world.

Founded in 2006 by Jason Trennert, Nicholas Bohnsack and Don Rissmiller, Strategas is an independent, private partnership committed to providing superior research and client service in the old Wall Street tradition. Its motto, bonitas, probitas, fides – class, integrity, faith – guides both the management of the Firm and its commitment to its clients, its associates, and its vendors.

The Firm employs 30 research analysts, institutional salesmen, and sales traders, at its offices in New York, Washington DC and Geneva, and is fortunate to count among its clients some of the world’s largest mutual funds, investment advisors, pensions and endowments, and hedge funds.

1.  How do you view the markets?

The best way to describe myself is by saying that I’m basically a top-down investor, so I start with both the business cycle and the credit cycle to make a determination of how aggressive I want to be in equities. And, in addition to that, I’m a monetarist, so I believe that money growth has a lot do with the level of financial assets. Those are the two things I’m starting with to determine which sectors and how aggressive I want to be in terms of my exposure to equities.

2.  How would you describe your outlook for 2010?

The phrase we’ve been using–and we’re sticking with it for now–is bullish until the bill comes due, and we’ve had that view for a little less than a year. It’s worked well until relatively recently because now there are questions as to whether the bill is coming due right now.

The two most important pieces of the bill are higher taxes and higher interest rates.

One of the ironies of what’s happening in Europe is that it probably delays both of those bills. It takes long-term interest rates down here in the States, strengthens the dollar, and makes it less important for the Fed to tighten meaningfully any time soon. At the margin it tends to benefit U.S. equities.

When you refer to the bill, is that the bill for the largess of the U.S. and other countries for bailouts and the like?

Exactly. It’s the bill for the massive infusion of fiscal and monetary stimulus that we’ve used to forestall deflation.

The good news is that it looks like–until very recently– we’ve done a pretty good job of doing that. The bad news is that we’ve got to pay for it. You’re going to have to pay for it by higher interest rates to attract foreign capital or you’re going to have to raise taxes to put a dent in the deficit.

3.  What is your biggest worry for the short term?

I would say it’s more of a policy error and it clearly now has to be a policy error in Europe. The policy error to me is that the Euro just blows apart, and that would be so deflationary in the short term that it would probably take asset prices down in the U.S. and bring in the possibility of additional deflation.

I don’t see that as likely, though, mainly because I don’t see how that’s in anyone’s best interest. The Euro breaking up would be the financial equivalent of World War I in a weird way–it’s one of those irrational things that no one thought it could happen, yet for a variety of cultural and nationalistic reasons it happened anyway.

So, how would you handicap the odds of the Euro currency going to parity [with the dollar]?

The odds of the Euro going to parity or losing a lot of value are very high–like 100%.

[GPS - Given the high odds Jason assigns to this happening and the low odds of the Euro “blowing apart,” Jason’s clearly worried about something much worse than just a 20% slide in the Euro.]

4.  How about a long-term worry?

The longer-term fear I have for the U.S., specifically, is simply the size of the deficit and the debt. What worries me more about that is not only the level we’re at now; it’s also the fact that there hasn’t been much evidence to suggest that anyone has any interest in being serious about deficit reduction—there’s no political will to cut spending. Again, that’s going to mean higher taxes or higher long-term interest rates, or, potentially, much higher inflation.

5.  Alright, so how about a bullish factor for the short term?

The most bullish factor is that there are enough cyclical drivers in place that are likely to lift economic growth, and those would be the following.

First, there’s a fair amount of delayed fiscal stimulus that was passed last year; so only one-third of the spending part of that has been used. There’s also a fair amount of pent-up demand for cap-ex [capital spending by companies] so that’s also going to lift economic growth. Second, I also think that for the longer-term perspective—especially for large-cap stocks—I think the most interesting thing—the biggest positive is valuations. Stocks aren’t trading at multiples that are so high that earnings can’t surprise people on the upside. Put it another way: there’s a fair margin of safety in equities, especially relative to Treasuries, and that makes me somewhat optimistic.

6.  What about the longer term, what’s the most positive thing to consider there . . . anything?

The most positive thing is that we might somehow grow so quickly that we—that the overall issuance [of government debt] is going to come down some. That’s a positive, but it’s very difficult to get a whole lot more bullish than that.

The other thing you could say –the other hopeful sign–is that the electorate will get involved and demand changes from elected officials. That is the hopeful thing. We have a very dynamic political system here, and, generally speaking, you don’t drive right off the cliff; things change. Our political system is designed to change.

7.   What’s your guess as to the best-performing asset class over the next several years?

I think it’s large-cap growth equities in the U.S., and that’s mainly because I think that, first, the valuations are very positive. Secondly, they should be able to take advantage of global growth because of the strength of their global brands. It’s not just what’s going to happen in the U.S.—but the growth in China, the growth in India, the growth in the emerging world. You’re not spending a lot—take a company like Apple; the stock’s trading for 19.5x next-year’s earnings—or even Microsoft, which is trading at 14x earnings. These are not untoward multiples.

Large-cap growth equities is a longer-term guess. In the shorter term, I also like gold, and I still think there’s plenty of room in it.

 What’s a single bullet point to support your gold position?

It’s a lack of faith in fiat currencies and a debasement of currencies. One of the things that is interesting is the idea of—the U.S. has an enormous advantage in that its currency is a major reserve currency—if it didn’t have that status it would be having many of the same problems as the rest of these currencies. The problem about that is that [as a reserve currency] you lose some of the market signals that could be longer-term beneficial for you—short term painful, but longer term beneficial—because at least Europe now has to face up to its problems right now. In the U.S. we can so easily fund the debt because we’re a reserve currency, and because of that we have a tendency to compound the problem.

#8.  What’s a favorite sector for right now?

Technology satisfies so many of the things that I like. One is that there’s been a pent-up demand for cap-ex. Tech is a very attractive way for companies who want to increase cap-ex to do so. It’s relatively cheap and can result in productivity gains. The second part is that the balance sheets are such that they’re not dependent on the credit markets really at all—they’re loaded with cash and that gives them great flexibility to either pick up other companies or to pay special dividends, or to buy back stock.

#9. How would you characterize the outlook for commodities?

Generally speaking, if one’s bearish on paper currencies, one should be bullish on hard assets, especially hard assets that China needs and wants, which is pretty much all of them. It seems to me that China is, essentially, the marginal buyer of commodities, and I don’t see that they need to slam on the breaks [to slow down its economy.]

#10.   Are there any regions that seem especially attractive now?

Emerging Asia has to be where one has to be excited and it’s mainly because of the size of the populations and the stage of development—or lack of development—they’re in right now. There’re just clearly a lot of opportunities there now.

#11.  Do investors need to have exposure to alternative assets—lesser correlated assets?

I don’t have a strong view because I think you can get some of that exposure through equity-type products without pioneering. I do think that commodities, or commodity-related equities should be a bigger part of the asset allocation then it would have been in much of the ‘80s and ‘90s.

#12.   Is buy-and-hold a viable strategy or has its time passed?

I’m not particularly fond of that idea right now. The reason why I’m not is that I generally think that the economic cycles are going to be shorter because you don’t have endogenous cyclical forces—let’s say pent-up demand for consumer durables—that are driving the cycles—that mainly the cycles are being driven by government spending, which, again, requires you, eventually, to pay for it. You want to be long equities when there is fiscal accommodation and you want to get more defensive when there’s fiscal contraction.

Does that include monetary policy?

Absolutely, but I’m more worried about fiscal contraction than I am about monetary contraction, but I very much subscribe to the view that monetary policy, at the margin, is more important, but I’m not convinced that the Fed is going to have to slam on the brakes any time soon, so I’m not particularly worried about monetary policy over the next year or so.

Thanks, Jason

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David Kotok, of Cumberland Advisors, did some work on this phenomenon and discovered that the determining factor–make that A determining factor–is monetary policy, or whether the Fed is easing, tightening, or neutral on the monetary gas pedal–mostly measured by interest rate policy. 

• If it’s tightening, one should sell in May and go away
• If it’s easing, one should not sell in May, but stay invested, ceteris parabis
• If the Fed is neutral–and this seems to be a key, but unstated, conclusion from Cumberland’s work (see the original at the link below)–there are other factors that explain seasonality

Here’s Cumberland’s conclusion:

So, what do we do in 2010?

The Fed is unlikely to raise the targeted Fed Funds rate between May and October this year. They cannot lower it, since it currently is between zero and a quarter of one percent. Therefore, the application of the results of our historical study is hampered by the existence of the zero-interest-rate lower boundary. For this reason, we have to assume the Fed is either neutral or easing, and cannot be sure which applies. We have no history to guide us.

The same logic applies to other markets of the world. When we survey central banks, we find that Japan is unlikely to raise its targeted policy interest rate. It is currently near zero. The UK is also unlikely to raise its policy interest rate. In Europe, we are witnessing a massive easing of credit as the European Central Bank and the European Union create their version of a crisis response. Their policy may be likened to our American TARP and Federal Reserve activities following the failure of Lehman Brothers.

The Federal Reserve’s expansion of international swap lines appears to us to be a form of easing. Granted, it comes in response to the European crisis and the ECB initiative. However, easing is easing, no matter what form it takes.

As a result, we enter the May-October period with the working assumption that the G4 central banks are collectively easing. This should neutralize the negative seasonals in 2010. That is bullish for stock prices.

Here is the complete article.

Ned Davis Research is one of our key investment strategy providers.  (I should probably call them something like a key investment strategy partner, but who’s kidding who:  we write them a check; they send us e-mails).  Every year, NDR puts together a composite of how the year might unfold based on three historic studies:

• Four-year Presidential cycle
• 10-year (decennial) cycle
• Annual seasonality.

Here is a link to the chart.  (Just kidding, Ned & Co. if you’re out scanning the internet for copyright violations).

To avoid getting a hand-slapping from the fine folks at NDR, let me just describe the chart:  sell in May and go away.  The twist that they put on this is that they “don’t fight the tape,” which is to say that they allow their strategy to be guided by various readings and indicators.  They don’t sell just because the calendar gets flipped from April to May.

So far, however, the market seems to be holding the un-edited script that says sell in May and go away.  If we decide to go with this thinking you’ll be the first group–okay, second–to know.  First, we sell out our client accounts, then we put something on the blog.  If you want to be in the first group, you know how to find us.  Click here for starters.

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Volatility seems troublingly low

Implied volatility is at levels that, in the past, have suggested trouble for markets, and there seems plenty to worry about.  What’s more, stock markets have moved strongly higher, including something like 30+ days without a correction in the S & P 500.  Volatility is now investable with the advent of iPath S & P 500 VIX Short- (VXX) and Medium-term (VXZ) Futures Exchange Traded Notes (ETN).  Basically, they’re like ETFs in a different guise.  When volatility rises, their prices go up, and vice versa.

Here’s the chart.

A slam-dunk sell, right?

Not so fast, Tiger.  While dips below 20 have also been decent long-term indications of trouble ahead, it was painfully wrong, for a long time, as shown below, and a return to those levels would produce a very painful loss in either of the volatility ETNs.  And, as difficult as it has been to spot mini-tops since the bear market bottom a year ago, one has to be especially careful of using single indicators to suggest bailing.

The weekend “rescue” of Greece by the other European Union nations is only a short-term fix.  The rest of the PIGS–including Greece–are not done squealing.

I haven’t come across much to counter this line of thinking.  Seems to me these are big risks that have been papered over.  Here’s an excerpt from an update from David Kotok of Cumberland Advisors.  He’s a sharp knife, and he thinks the situation in Europe will be resolved okay.

We believe there will be a Greek version of the “hunkering down” outcome. We saw the Baltic version of this process recently in Latvia, where an austerity program cut the deficit in half last year and markets immediately resumed functionality.

Furthermore, we believe the euro will not only survive this test but emerge stronger and more reliable after it. The other EU countries are already moving to improve their fiscal process.

For the present we are underweight Europe in our global portfolios and we are watching carefully before taking a bullish position on the euro. Notwithstanding the recent news, it is still too soon to buy. But when the buying opportunity comes it will come fast, and the nimble will benefit. Surviving this crisis and successfully improving the internal European banking system are the key to the euro emerging as a battle-tested reserve currency.

What we see happening in Greece and in the euro zone is monumental in monetary history.

Maybe one of our bullish datapoints is becoming less bullish.

We’ve had this idea of a bubble in bonds as front and center amongst our bullish data points.  The idea is that, with a record amount of flows into bonds and bond funds by investors fleeing–following a shellacking in stocks in 2008–to safety–the first minus sign in a bond fund investor’s account statement, along with a continued rise in stock prices, and those flows will reverse back to stocks.

Today’s Barron’s had an article titled, “Accentuating the Positive, at Last,” with a sub-title that read,

“Retail investors are finally warming to U.S. stocks, as worries about a double-dip recession subside.  Good news:  one analyst sees the S & P 500 rising another 10% to 15% over the next six months. ”

That article also pointed out that retail (i.e. non-institutional) flows into equity funds were positive for four weeks straight.  And mutual fund managers aren’t letting that cash sit around, which would be a source of buying power.  Recently, Ned Davis mentioned that equity fund mutual funds have their lowest levels of cash–even adjusting for the ultra-low cash yields (which raises the opportunity cost of holding cash)–ever.

What’s more, in at least the 10-year Treasury futures pits, the speculators–this is the group traditionally left holding the bag when markets turn–have their largest ever short position.  They’re very bearish toward the 10-year, and that’s a pretty good proxy for bonds, in general.  I think it’s hard to find a bond bull.

Earnings expectations are high.  Stocks are set to disappoint.

That’s my worry; it’s not the company line. 

Analysts really have high expectations for companies.  According to the consensus of analysts surveyed by Bloomberg, earnings for fiscal 2010 are expected to be 19.9% for the S & P 500 excluding financials; 15.8% for 2011.  In 2010, Financials are expected to show growth of 99.1%; Energy 44.0%; Technology 34.2%.

According to Ned Davis Research, those estimates are in a zone that has, historically, produced per annum returns of minus (-) 3.4%.  Contrarians won’t be surprised to learn that stocks perform best when estimates are the worst.

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Marc Faber speaks with an accent (always cool), has a ponytail (uh, the ’90s are over, but he’s probably a renaissance man and it’s okay), wears a vest with his suit, and probably wears Prada loafers.  He does, however, sport buttondown collars, which strikes me as a little too casual–a spread collar would be a better choice.  He also publishes the Gloom Boom & Doom Report, which is the real reason for including the clip, below.  In it, Mike Santoli, of Barron’s, interviews him at Barron’s Successful Investing Conference.  In it, Marc presents the case for emerging market stocks.

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When volume does not–as technicians say–confirmthe price action, a divergence is said to have occurred. You’ve probably heard this in the context of Dow Theory, one of the oldest technical measures, which says that highs in the Dow Industrials should be confirmed by highs in the Dow Transports, with the original thinking being that if the Industrials are doing well, the transporters of the goods should be doing well since they’re shipping stuff to the ones making the stuff.

So here is a sampling of stocks from the sectors that have been the hottest since Armageddon (i.e. March 6).  Each has the same pattern:  rising prices and falling volume.  The lower volume means that fewer and fewer (and fewer?) buyers are responsible for pushing the stocks up.  Tops–of varying magnitudes–are not made of a bunch of astute sellers, but, rather, a lack of buyers.

We could be in for a bit of a pullback, but one that shouldn’t be as severe as some in the past.  Maybe the S & P 500 will drop to the 800 level before resuming the rally.  That’s just 4.6%, and that might not be worth standing aside from.

Here are the charts:

Also, the tenor of banking news has definitely gotten better–maybe too better, such that expectations have been pushed to high.  That was, perhaps, evidenced in the reaction to Goldman Sachs’ Monday night early release of earnings.  Despite doubling estimates, the stock sold off with a vengeance on Tuesday–on strong volume.

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Here are the bullet points from the report, all verbatim:

• Now overweight equities for first time in more than two years .
• Now underweight bonds.
• Now favoring small-caps over large-caps.

One last quote from the report:  “We are also continuing to emphasize emerging markets, which are overweighted by our Six-Way Global Equity Allocation Model.” 

We haven’t yet had a chance to sit down and discuss how we’ll act on this, whether to wait for a pullback or begin to average in, but we will shortly.  Stay tuned.

The chart below compares the price performance amongst the MSCI Emerging Markets index (yellow), the Russell 2000 Small-cap index (orange), and the S & P 500 (green), all indexed to 100 at the beginning of the year. 

With respect to BCA Research, that firm has yet to come around to the idea of overweighting stocks.  Their primary model, which is designed for capital preservation, still argues for 0% stocks, although they have overridden that signal in recent weeks.  In contrast to NDR, they find the prospects for bonds to be quite appealing and suggest that investment-grade bonds could outperform stocks over a 12-month time horizon.

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In reverse order, the seasonal cycle is that which plays out over 12 months.  One essence of it is captured in a cliche like “Sell in May and go away.”  Cyclical is generally thought of as taking place over four years, and it fits nicely with a Presidential term.  Secular  is a time frame that encompasses several four-year cycles.  The Kondratieff wave is a50-54 year cycle named after a Russian economist Nicolai Kondratieff.  Each trend has a random or noise element to it. Whereas the other cycles can be approximated–or fitted–with a curve or line, the random influence can not.  Those are the definitions.  Now let’s get to the title of this gig.

As can be seen in the chart below, since 1928–the earliest data we have available, the Dow Jones Industrial Average has experienced five secular trends.  Two were of the bullish variety; three–including the one we’re in now–were of the bearish variety.  Notice that stocks do not need to experience end-to-end declines to be considered bear markets; they merely need to go . . . well, nowhere.

By using the powerful tools of our Bloomberg terminal, specifically the very cool Cycle Finder (green humps), we find that the cycles have averaged almost exactly 16 years.  We found this by focusing on the period from 1965 – 1981, a period in which we knew that stocks went nowhere from end to end.  No, 16 years isn’t perfect, but it comes awfully close.  It missed the 1929 peak by a couple of years, but, hey, this hocus-pocus stuff isn’t supposed to work at all.

Extending the 16-year cycle into the future can give us a clue as to when the current secular bear market might end.  The chart below does that.  Naturally, the “12/31/15″ gives a false sense of precision, so we need to be vigilant for signs that might indicate the next secular bull market is beginning.  Even applying the Great Depression whiff of three years to that date, though, suggests that 2012 could still find us in a sideways, bear market.

16-year cycle projected

A later post will take a look at what signs we can look for to tell us that a new bull market is about to begin.

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