“I can calculate the movement of the stars, but not the madness of men.”
… Sir Isaac Newton, after losing a fortune in the South Sea bubble
In 1711 the Earl of Oxford formed the South Sea Company, which was approved as a joint-stock company via an act by the British government. The company was designed to improve the British government’s finances. The earl granted the merchants associated with the company the sole rights to trade in the South Seas (the east coast of Latin America). From the start the new company was expected to achieve huge profits given the believed inexhaustible gold and silver mines of the region. It was anticipated the company would ship British goods to the South Seas where they would be paid for in gold and silver. Rumors swirled that Spain was going to give free access to its ports in Chile and Peru for a share of the South Seas stock and share prices soared. Sir Isaac Newton was an early investor in the stock, investing a decent amount of money into the shares. He exited those shares a number of months later with a good profit, leaving him a happy investor. Subsequently, the shares soared into bubble proportions, and as Newton saw his friends getting rich, greed overtook fear and Newton took most of his cash and re-bought the shares. Not long after that, the share price peaked, and then crashed, leaving Sir Isaac Newton broke (see chart).
I revisit the South Seas bubble, which is chronicled in Charles MacKay’s epic book, Extraordinary Popular Delusions and the Madness of Crowds, not because I think the equity markets are in a bubble (I don’t), but as an example that even one of the most brilliant men in history was overcome by greed at exactly the wrong time. As my father used to say, “In the long-term it is all about earnings, but in the short/intermediate-term the stock market is fear, hope and greed only loosely connected to the business cycle.” He also taught me that cash is an asset class, unlike many in our business who don’t believe it. As the brilliant investor Seth Klarman espouses (as paraphrased by me), “To assume the investment opportunity sets that are available to you today are as good (or better) than those that will present themselves next week, next month, next quarter is naive and you need to have cash to take advantage of those new investment opportunity sets.” For those of you that don’t know who Seth Klarman is, he is an American billionaire who founded Baupost Group, a Boston-based private investment partnership. He is also one of the best money managers on the planet and has the track record to prove it. He authored a legendary book that sits on my desk titled Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor. Recently Seth spoke at James Grant’s investment conference. Here are some of his comments, as paraphrased by me. To wit:
Of the $30 billion we have under management, $14 billion resides in cash because we don’t see a lot of compelling investment opportunities currently. The ones we find, we pull the trigger on and purchase. We worry about things from a “top down” standpoint, but pick our investments on a “bottoms up” (fundamental) basis. We think inflation is likely and view gold at these levels as the best hedge against a worst case environment. However, we only have a couple of percent of assets positioned in gold. We own some commercial real estate in Japan and a few equities, as well as some investments in Russia.
In viewing Seth’s purchases I found it interesting that Baupost recently took a significant position in one of Raymond James’ Strong Buy rated stocks, namely Micron (MU/$20.19/Strong Buy). Along this individual stock investment line, in last week’s Morning Tack I mentioned if we get some kind of pullback in the weeks ahead, investors should consider purchasing stocks with strong “power ratings.” I have received numerous emails for such a list. So this morning I give you a number of those stocks, which not only have strong “power ratings” and Outperform ratings from our fundamental analysts, but also screen positively on my proprietary trading system. The list includes: Amerisource Bergen (ABC/$70.02), CVS (CVS/$66.68), Delta (DAL/$28.60), Federal Express (FDX/$137.07), McKesson (MCK/$163.61), Lincoln National (LNC/$50.48), Bard (BCR/$139.85), and Old Republic (ORI/$17.36). Like stated last Monday, put these stocks on your “watch list” for potential purchase.
This week, we enter the holiday-shortened week of Thanksgiving and I will be in New Orleans and then the Washington D.C./Richmond, Virginia areas. The history of the week is generally positive having averaged a gain of 0.65% since the mid-1940s about 62% of the time. It will therefore be interesting to see if the historic precedent takes control, or if my timing models prove correct and a moderate pullback commences. One thing for sure is that Wall Street attendance will be limited as the “pros” desert the Street of Dreams for the holiday. Also of interest will be how the equity markets react to the first substantive Iranian nuclear deal in a long time. Indeed, for the second time in three months, our President has pulled a rabbit out of his hat. First it was the Syrian solution, thank you, Vladimir Putin. Last weekend it was the deal struck between Iran and six of the world’s nations. The deal places qualitative/quantitative restrictions on Iranian nuclear enrichment for the next six months. Following that, a longer-term agreement is to be negotiated. Strategically, one would think said deal might take some of the geopolitical risk premium out of world oil prices. Tactically, however, the world’s Iranian oil embargo remains in place. According to the White House, “In the next six months, Iran’s crude oil sales cannot increase.” Consequently, Iran’s oil exports will remain capped (cut by ~1.5 MMbpd since 2012), which is neutral for near-term oil market fundamentals, according to our fundament analysts. Yet this morning, crude prices are noticeably lower.
The call for this week: The divergences of the past few weeks continued last week. For example, the number of new 52-week highs on the NYSE has diminished over the past three weeks. Additionally, the Advance/Decline Lines for most of the small-cap complexes have not made new highs. NYSE stocks above their respective 50-day moving averages continue to decline, many of my overbought/oversold indicators are currently overbought, the S&P 500 is at the top end of its Bollinger Band (read: caution), bullish sentiment is at a decade high (read: caution), interest rates are rising, housing is stalling because mortgage rates have risen and affordability is diminishing, real final sales are sluggish, the global economy is under pressure, yet the Federal Reserve still has the peddle on the metal. And that, ladies and gentlemen, has been able to trump any of the natural forces suggesting a pullback. While I recommended recommitting some of the cash raised last June when the Syrian Solution arrested the anticipated decline at 6% versus my expectation of a 10% decline in August/September, I still have too much cash at a 25% recommendation given what the markets have done. Hopefully, we can still get some kind of pullback into early December setting up the fabled “Santa Rally.” As stated, the first support zone exists between the upper pivot point of 1784 and the previous reaction highs of 1775. Falling below that brings into view the 1750 – 1760 level, which if violated would suggest a 5% - 7% correction. This morning, however, world markets are celebrating the Iran deal with the preopening futures better by about 5 points. Yet, as the world likes the deal, two of our staunchest allies, the Israelis and Saudis, are fuming. Hereto, it will be interesting to see what happens to oil prices if the Saudis decide to make their displeasure felt.
© Raymond James