Jeff Saut: Making a Case for the Bulls

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This post is a guest contribution by Jeffrey Saut, Chief Investment Strategist and Managing Director of Equity Research at Raymond James & Associates.


I believe “income” will be a profitable investment theme for the foreseeable future. Indeed, the baby boomers are retiring; and, the yields afforded them via Treasury securities, money-market funds, and certificates of deposit (CDs) won’t supplement their retirement account incomes enough to support them in the style to which they have become accustomed. Enter stocks, which since 1926 have averaged a total annualized return of 10.4%.

Interestingly, roughly 5% of that return has come from earnings growth, 0.9% has come from price-to-earnings (P/E) multiple expansions – but 4.5% of said return was derived from dividends. More than 40% of long-term investment returns have been driven by dividends. Furthermore, if investors buy non-dividend-paying stocks, and the overall stock market declines, they tend to be at the “directionality” of the stock market.

However, the shares that investors purchase of dividend-paying stocks, whose share price subsequently declines, actually own an asset that is becoming more valuable as its dividend yield rises, provided the dividend is maintained.

While some contend that aggregate corporate dividends have been reduced, and/or eliminated, due to the maelstrom in the financial complex, I have recommended avoiding financials for the last 5 years, and therefore have been relatively unaffected by those dividend reductions.

Excluding the battered financials, however, most corporate balance sheets appear in relatively good shape. Yet companies remain hesitant to commit more money to capital expenditures in this weakened economic environment. Therefore, I think it reasonable to expect corporations will use dividends as an increasingly valuable strategy for distributing excess cash.

To be sure, non-financial balance sheets are in better shape than the financial complexes’, suggesting that dividends, and dividend increases, should be a favored corporate strategy going forward — rather than share repurchases — since for the last 18 months most share prices have traveled lower, making share repurchases a value-destroying strategy.

To this point, most companies have two avenues for cash: They can either plow back/re-invest in capital expenditures, M&A activities, and/or working capital initiatives, or they can pay/increase dividends, repurchase shares, and/or reduce debt. My analysis suggests that managers will probably pursue shareholder-friendly initiatives after meeting internal/external objectives. This implies they will likely pay, and/or increase, dividend streams.

This is a not unimportant observation, since the retiring “boomers” seem to be moving toward the mantra scribed in the first paragraph, of the first chapter, of Ben Graham’s book The Intelligent Investor: “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”

Note that Dr. Graham uses the word adequate, not spectacular, when speaking of investment returns. Plainly, secure dividends tend to cushion a portfolio and enhance total returns. Dividends also provide, at least to some degree, the “margin of safety” Ben Graham speaks of in the last chapter of his book: To wit, if you own a stock with a 7% yield, those shares can decline by 7% over the next 12 months, and you won’t have lost any money. Consistent with these thoughts, I have employed Graham’s investing matrices to our investing strategy for more than 40 years. That’s why I constantly reiterate the theme of “dividend yields.” I continue to invest this way, and would note that, in Bespoke’s dividend-yielding stock list, there are 5 companies from the Raymond James research universe of stocks. Those issues are: 8.8%-yielding Realty Income (O); 7.3%-yielding Polaris Industries (PII); 5.5%-yielding NYSE Euronext (NYX); 4.8%-yielding Hudson City Bank (HCBK); and 4.8%-yielding Aflac (AFL).

And while they are not on Bespoke’s list, additional yielding names from Raymond James’ “Analyst Current Favorites” report include: Republic Services (RSG); Johnson & Johnson (JNJ); Allstate (ALL); Inergy (NRGY); Home Depot (HD); Essex Property Trust (ESS); and New York Bancorp (NYB).

Speaking to the equity markets, I was pretty bullish between the psychological/capitulation stock market “low” of 10/10/08 (where 93% of the stock traded on the NYSE made new yearly lows), as well as the subsequent “price low” of November 20, 2008, often commenting that the stock market was in a bottoming process on a short/intermediate-term basis. Furthermore, I was adamant that participants should favor the upside into mid-January 2009 where a correction would be due. I also opined that the stock market’s internal metrics (advance/decline, upside versus downside volume, new highs versus new lows, etc.) in that decline would tell us a lot about the future direction for stocks.

Accordingly, I became increasingly defensive as the “ides of January” approached. Since then, I’ve been monitoring the market’s internals, but so far they are telling us nothing. The picture should become clearer if the DJIA (8000.86) can either confirm the breakdown by the D-J Transports (TRAN) of their November 20, 2008 “low” with a like breakdown below the Dow’s November 20, 2008 closing-low of 7552.29 (so far, what we have is a downside non-confirmation, which is bullish); or, if the DJIA and the TRAN can better their January 6, 2009 reaction highs of 9015.10 and 3717.26, respectively, which would be a Dow Theory “buy signal.”

Until then, I continue to take the market’s temperature. Indeed, sometimes me sits and thinks; sometimes me just sits. That said, I continue to think it’s a mistake to get too bearish, because of the bullish case that can be made.

1. If forward earnings estimates are anywhere close to the mark, stocks in the aggregate are cheap;

2. Nominal interest rates are zero and real interest rates a negative;

3. Money is the “oil” that makes the economic engine run, and money is being printed like wallpaper;

4. Oil prices have collapsed, which is tantamount to a huge tax cut;

5. The authorities are pulling-out ALL the stops;

6. The official recession is now 13 months old, with the typical one lasting 18 months;

7. If past is prologue, the fourth quarter of 2009 will end the recession;

8. The stock market tends to stop going down 6 months prior to recessions’ end;

9. So far the TRAN has broken below its November 2008 low without the DJIA doing the same (read: downside non-confirmation; and

10. If the DJIA and the TRAN rally above their respective January 6, 2009 closing highs, it would be a Dow Theory buy signal.

As well, I have seen this play before. As Dennis Gartman wrote last week:

“There is no question that this is the worst economic time since the Great Depression”… Sluggish economic growth this year will cap the worst 3-year period centered on a recession since the Great Depression… Forecasts for a weak recovery in 1992 suggest the period since 1990 will be the worst for the economy since the Great Depression… The banking industry has plunged to its lowest point since the Great Depression… “This is the worst retail sale period on record since the Great Depression… This recession is hitting white-collar workers more heavily than any since the great Depression of the 1930s.”

Those media quips were taken from various newspapers during the recession of 1990-1991.

The call for this week: At down 8.5%, the S&P 500 just had its worst January in history. That swoon flashed cautionary signals from not only the January Barometer (so goes January, so goes the year), but the December Low Indicator as well. Moreover, in the past 3 weeks, there have been 3 90% Downside Days (points lost versus points gained AND downside volume versus upside volume were skewed more than 90% to the downside), suggesting that the sellers have not yet been exhausted. The result left most of the market averages I follow below their respective 10-, 30-, and 50-day moving averages, indicating a full downside retest of the November lows is likely in the works.

Whether that retest will be successful remains to be seen, but I’m hopeful, because my proprietary oversold indicator is just about as oversold as it can get. In the interim we are cautiously sitting and waiting until the stock market speaks.

Source: Jeff Saut, Minyanville, February 2, 2009.


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8 comments to Jeff Saut: Making a Case for the Bulls

  • Paul C Sandison

    Interesting and very useful points and a wonderfully crafted article. Erudite. A pleasure to read.

  • Clearly the best written article I have read in recent time. The case for a balance in our thinking as investors is well made.

  • Cavalier

    Now that stock market’s average return that Mr Staut is talk about, is that arithmetic average or geometric average?

  • Cavalier: I guess it is geometric. I calculate the number to be 9.2% p.a. going back to 1871.

  • Sigmund

    I would be very cautious going long in the current environment. The Dow and the S&P are both showing signs of establishing a base. The current PE is something like 17.5 times in an environment that suggests that earnings will be declining for at least another year. Clearly large dividends will be under pressure, SO, the quality of the forecast becomes critical.

  • Jack Gallagher

    You’ve got to be kidding. He recommended avoiding ALL financials for the past five years? So, for total return customers of his, he missed the opportunity in a company like Goldman Sachs (GS) from about $100 per share (2003) to $234 per share (in 2007), and, during that stretch GS mostly “hugged” its 50 day moving average (MA) and almost never broke below its 200-day MA. Remind me never to take advice from Raymond James.

    I take issue with several of his numbered (1-10) “bullish” points, but there are even more obtuse gems in this article, my favorite of which is:

    “However, the shares that investors purchase of dividend-paying stocks, whose share price subsequently declines, actually own an asset that is becoming more valuable as its dividend yield rises, provided the dividend is maintained.”

    A stock whose share price subsequently declines after one buys it has NOT become more valuable. The dividend yield rises only for those who purchase the stock at that lower price – the yield did not increase for the person who bought the stock prior to the decline in price. Also, that “higher” yield can be argued to represent an escalation in the risk of holding the stock (and extremely so in times like these). Then there’s that wonderful qualifier at the very end “…provided that the dividend is maintained.” Yes, that’s the trick isn’t it. Risk of reduction in dividends is REAL – and not limited solely to financials – witness Motorola.

    I found this article to be most unhelpful as it was full of the usual conflation of fundamental/anecdotal points with just a smattering of technical analysis.

  • Frank W

    I really think that this article rather than being excessively bad is better characterized as being fairly mediocre. It’s true that Saut does say some incredibly stupid things like a dividend paying stock becomes more valuable to the holder as it declines in price! I mean even if the dividend remains the same, you’ve lost capital. Rule number one is don’t lose any money. As I recall, it is also Rule number two. The only thing that I can fault Jack for in his criticism on this point is failing to advise all bloggers with less than half a brain that ANY ASSET that declines in price does not become more valuable to the holder. I would also like to mention that the more a dividend paying
    stock falls in price the more the dividend yield increases. It is a well known fact that small companies that are insolvent often advertize astronomically high dividends. Of course, they never pay them. They go bankrupt instead. Finally, it is hard to believe that dividends are going to rise or even stay stable in a recession. Dividends more or less follow earnings which reflect GDP. GDP falls in a recession. One other thing. I would bet that many companies are going to behave like the banks are doing and horde their retained earnings rather than pay increased dividends. Most of Saut’s other advice is common knowledge. Also, a good deal of his advice is not cutting edge.
    For example, he warns us not to be overly bearish. I certainly agree with him on this point. The market is going SIDEWAYS not down as many investors think and has been doing so since the end of November 2008. If you don’t think so, have a reality check. Look at the numbers! So when Roubini, Sedacca, Edwards et al tell you that blood is running in the streets, and lead you to believe
    that now is a good time to slash your wrists, I suggest that you use a very dull razor blade. The advice Saut gives which is that recessions normally last a year and a half is fairly useless. This is not an ordinary recession. It is a financial crisis. Financial crises on the basis of the few pieces of evidence, that we have, last longer. In Saut’s defence, I note that he does pick the last quarter of 2009 as the end of the recession. This would make it about average length for a financial crisis.
    Also, the market does not always begin rising 6 months before the end of a recession. Sometimes the differential is much smaller. And then there is the last recession when the market didn’t start
    rising until AFTER the recession was over. I vaguely recall that it lagged 9 months, but I may not have gotten this number right. The more I read on finance the more I wonder why investors are happy to pay someone fat fees for delivering bland advice that you can get anywhere for nothing. The other thing that I wonder about is Saut’s penchant for sitting. He says he sits and he thinks. At other times he just sits. Wonderful! I don’t know about you, but I sure wouldn’t pay someone fat fees just to sit on his ass. Saut would be better off, if he read Prieur’s blogs, while he’s sitting and not thinking. As to where the market is going in the short term — Who knows? It could continue going sideways as it has been doing. Or it could do what Sedacca suggests in his “Coiling” article — that it will sooner or later fall off a cliff. Or it could be doing what one of Hussman’s articles suggests. He tells us that in about half the recessions since WWII the market bottomed early, went sideways
    for a while and then rose. You need to keep your mind open in times like these. Things should get clearer as the recession progresses. Declaration: I have been completely out of the stock market
    since early January 2008.

  • Keith - Hermosa

    Your top two dividend yielding stock picks are a retail REIT and a company that makes ATVs. You are insane if you think these are good picks. They are potentially so bad that it’s not even worth going into the details.

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