Jeff Saut: Short-Term Market Rally May End but Equities Will Remain Bullish – NASDAQ

On October 10, 2008, with the
S&P 500

(INDEXSP:.INX) at 839.80, the bottoming process began when 92.6% of
all stocks traded on the NYSE made new annual lows. That’s a six
standard deviation event, which is supposed to occur only twice in
a lifetime. At the time, many investors were liquidating their
portfolios because they did not heed Benjamin Graham’s advice in
his epic book

The Intelligent Investor

: “The essence of investment management is the management of
risks

, not the management of
returns

. Well-managed portfolios start with this precept.”

Consequently, investors who failed to respect the Dow Theory “sell
signal” of November 2007 ended up incurring substantial losses into
the beginning of the October 2008 bottoming process. Moreover, they
continued to liquidate their portfolios right into the S&P
500’s ultimate intraday bottom of 666.79 on Friday, March 6, 2009.
Surprisingly, I was on Bloomberg TV that Monday (March 2, 2009),
stating, “The bottoming process that began last October is complete
this week and we are ‘all in.'” I have been pretty constructive on
equities ever since.

I did, however, recommend raising cash in the spring of 2010, 2011,
and 2012, on a tactical trading basis, with the strategy of putting
that cash back to work during the summer months; that is all you
had to get right in those years to produce decent equity returns.
This year, my mantra has been that “sell in May and go away” is not
going to work as I targeted the mid-July through mid-August
timeframe as the first window for a meaningful decline to begin. To
be precise, it was the timing/quantitative models (not me) that
gave the exact date of July 19, 2013 for the stock market’s
internal energy to be totally exhausted. Yet I have been the one
taking the heat for that “call” because the SPX made a few marginal
closing highs above the July 19 high of 1692.

Nevertheless, the fact of the matter is that the stock market’s
internal energy was indeed used up in mid-July with the various
averages virtually going sideways and then pulling back 4.1% over
the past three weeks (intraday high to intraday low).
Interestingly, this recent pullback is remarkably similar to the
May 22 to June 6 decline of this year (see chart below). That
initial decline was roughly 5% and left the NYSE McClellan
Oscillator extremely oversold. The SPX subsequently rallied 3.5%
into its June 18 peak before resuming the decline into its June 24
low. The entire pullback encompassed 7.5%. If that chart pattern
repeats this time, it would suggest that the rally attempt that
began last Thursday should peak between 1684 and 1696. Personally,
I don’t think that the SPX has the energy to make it back through
my 1684 “pivot point.” On the downside, I still think the SPX has
an appointment into the 1530 (April low) to 1560 (June low) zone.

Click to enlarge

Of course, I continue to think such pullbacks are within the
context of a bull market since my confidence remains high that we
are in a new secular bull market. Last week, I carried that message
to Nashville where I spoke with institutional accounts and
presented at events for my firm’s financial advisors and their
clients. Regrettably, most of them think you need a “feel good”
environment for a bull market to exist. But when you get that “feel
good” environment, it tends to be late in the game. Ladies and
gentlemen, the equity markets do not care about the absolutes of
good and bad; they only care about whether things are getting
better or worse. And things are definitely getting better! To
emphasize that point, in my presentations, I always discussed the
American Industrial Renaissance (onshoring) whereby manufacturing
jobs are coming back to America. To wit, chemical companies are
expanding into the US because of our low natural gas prices. Airbus
just broke ground for a massive new plant in Mobile, Alabama; VW is
expanding its facility in Tennessee;
Samsung

(OTCMKTS:SSNLF) is spending $4 billion in Austin, Texas; Michelin
is investing $750 million in South Carolina;
Denso

(OTCMKTS:DNZOY) is spending $750 million in five different states;
and the list goes on.

Next is the energy independence theme, with the US becoming the
largest natural gas producer in the world in 2015 and likely going
to be energy independent in the 2020 – 2025 timeframe. Yet most
importantly, I think the 2010 midterm election marked a turning
point in the political arena whereby over the next five years, we
are going to elect smarter policymakers and therefore get smarter
policies. Unsurprisingly, for that view I have been termed naive.
In my presentations, I talk about numerous reasons for that belief.
Unfortunately, there is not enough space in this missive to go into
much detail on this theme. I will, however, offer some quips from
last Thursday’s
Wall Street Journal

article titled “A New Law to Liberate American Business” by Thomas
G. Stemberg, founder of
Staples Inc.

(
SPLS

), as an example of “smarter policies.” The author begins by
noting:

There are so many government impediments to business today that
the next Staples – and its 50,000 jobs – might never get off the
ground. Chief among those roadblocks: the blizzard of bureaucratic
red tape that buries businesses and stifles job creation. These
include the additional 16 million hours that vending machine and
chain restaurant business owners must spend complying with new food
regulations each year. But there is also the license that magicians
require to do a rabbit disappearing act, which mandates an annual
fee, surprise inspections, and a rabbit disaster plan. All told,
American business faces 46,758 pages of rules to live by in the
Federal Register…. [Job] creators know that regulatory relief
can’t come soon enough. In 2010, the Small Business Administration
pegged the annual cost of complying with regulations at $1.75
trillion. The SBA report covered 2008 and the burden has certainly
grown since. A May 2013 report by the Heritage Foundation, “Red
Tape Rising,” found that new regulatory costs added in 2012 totaled
$23.5 billion.

Wow, no wonder job creation has been slow to recover. But help may
be on the way because of Senators Angus King and Roy Blunt. Their
bill, “The Regulator Improvement Act of 2010,” would create a
bipartisan Regulatory Improvement Commission whose purpose is to
recommend cuts in the regulatory regime. Those recommended cuts
would require a mandatory up-or-down, nonamendable, vote by
Congress. The King-Blunt concept has already worked as seen with
“The Defense Base Realignment and Closure Commission” (BRAC), which
has been responsible for the closure of 121 major military bases
since 1988.

As the
Wall Street Journal

article states:

In short, the BRAC Commission gave politicians what they crave
most: cover. Nobody back home could blame them for losing a
military base. The King-Blunt proposal will give representatives
the same cover with regulations. The bipartisan Regulatory
Improvement Commission – with members appointed by the president
and congressional leaders – would tackle one area of regulation at
a time. Its members would be charged with finding regulations that
are duplicative, like the 642 million hours employees will spend
complying with redundant regulations this year, according to the
American Action network. The panel also will try to identify
obsolete regulations, maybe resembling the arcane rules the Federal
Communications Commission leverages to achieve whatever regulatory
aims the commissioners desire.

I happen to believe that all of this is pretty bullish over the
longer term. But in the near term, I remain cautious for all of the
stated reasons.

The call for this week

: The initial leg down from the May 22 peak ended on June 6, which
left the McClellan Oscillator very oversold (see chart below), and
was followed by an ensuing 3.5% rally into the July 2 top of
709.67. Subsequently, the secondary decline began on June 16 and
ended on June 24, taking another 94 points off of the SPX. The
current chart pattern looks very similar to that of the May 22 to
June 6 drop, and if that pattern repeats, it suggests the current
rally attempt should peter out in the 1684 to 1696 zone, followed
by a secondary decline that carries the SPX into the prescribed
1530 – 1560 zone where a trading bottom should be anticipated.