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Daily Commentary
Buying Opportunity
David Goldring
Monday, June 09, 2008

A stunning rise in the price of oil torpedoed the major indices Friday. As we reached the underside of the 200 day moving averages at the beginning of May we conjectured that we would see a period of consolidation and then a relatively sharp drop lower as the price of oil went into a parabolic climatic top formation. We went on to say that the end of bubble moves are the sharpest and most perpendicular and it would be at this time that we should buy the broader market as oil prices would be setting a very long term top. While admittedly Thursday’s bullish break out action has us second guessing this original scenario, Friday’s action brought it back to center stage. We have been comparing today’s market to the rhyme of 1990/1991, and this recent correction is very similar to early January 1991. The S&P 500 (1360.68) would have to fall to 1328 and the Nasdaq (2474.56) to 2387 to mirror the percentage decline in 1991 just prior to the explosive three month rally that followed. Back then, the S&P 500 soared 26% and the Nasdaq 45% in a three month move off the January low and into April. While nothing repeats exactly, we expect a strong 2H rally and a final popping of the commodity bubble that has held the broader market hostage over the past four years. The Dow (12209.81) has given up over 900 points since the May 19th high and yet the Nasdaq has given up only 3% during that time. While the Dow is up only 2% since the March 17th low the Russell 2000 (740.37) has gained 14%. The point here is that the broader market remains strong and this is especially true in technology which is holding on to a 19% gain since March 17th. We believe that new leadership is forming and that once we see a correction in the price of oil, we will see a powerful and sustainable rotation back into traditional growth sectors. We said at the beginning of May that we could enter the “silly season” for commodities as we set a climatic top, and the major investment houses are coming up with their array of targets on the price of oil. $150, do I hear $200 etc etc. This is very reminiscent of $400 Amazon (AMZN) or $1000 Qualcomm (QCOM) back in the late 90’s as perception and reality became increasingly distorted. Americans drove 11 billion fewer miles in March 2008 than in the previous year or a 4.3% drop, which is the steepest yoy decline in history. Demand is falling and fuel inventories are at 14 month highs. The insatiable demand we keep hearing out of China, is 6% growth, not 15% or 20% that the headlines would make you believe, but 6%. There is plenty of oil in the world, and unlike the 1970’s we don’t have lines around the gas station, what we do have, is lines around the trading desks filled with buy orders. This is Nasdaq 5000, and the end result will be the same. The important thing is that when this irrational distortion from reality gives way to the inevitable correction, it will in turn unshackle a stampede into stocks. The Dow is now trading at less than 12x next year’s earnings estimates (with the exception of General Motors) to give a mean earnings yield of 8.44% relative to ’09 earnings! So the 10 Yr Treasury is yielding 3.93% and the mean Dow stock 8.44%; there has never been a time in history when stocks have been this undervalued in relationship to Treasury yields. This has been the worst decade for stocks since the 1930’s, and we have read studies recently that show how the inflation adjusted return for growth stocks is worse this decade than the 1930’s! The bears bemoan the fact that we are less than 15x from are all-time high, but we have been through four years of tremendous p/e multiple contraction. Stocks are dirt cheap and in the absence of any real deterioration in earnings, it is hard to imagine much downside. As an example, take Disney (DIS – 33.01); we ridiculed the downgrades on the basis of falling theme park attendance due to a weakening economy, and what happened? They blew the cover off the ball beating estimates by 7cents. DIS has tripled earnings since 1998, and yet its stock is down over 20% from its 1998 high. It would be one thing if interest rates had risen sharply during this time, but they have done the reverse and fallen dramatically. This is the age and politics of fear. DIS yielded an earnings yield of a little over 3% during the 1990’s in a 6-7% interest rate world. Today we have the complete opposite, and DIS yields over 7% in a sub 4% world. We could go on and on through so many traditional growth stocks and the message is exactly the same. Stocks have never represented so much relative value. The grand rotation out of growth and into basic material, commodity and industrial stocks started in January 2004 and will end with a top in the price of oil. DIS stock topped at $28 in Jan ’04 and despite tripling earnings the stock has added only $5. You can only continue to grow so long before the market wakes up and recognizes the fact that there is an abundance of value. This will happen when oil prices top, and given the parabolic nature of the recent rise, we believe this is close at hand.

S&P 500 (1360.68) broke our Up trend line off the March 31st and April 15th lows, and closed right at the 20 week moving average. This is the test we had been looking for and are adding long side exposure. The mid-point of our rally off the March 17th lows is 1349 and it was incorrectly reported in Barron’s this week that no bear market low had been made when the ensuing rally gave up more than 50% of its gains in the past five decades. In Jan 1991 the S&P 500 gave up 61% of its gains off the Oct 1990 low, and yet that Oct 1990 low was the mother of bear market bottoms. A lot of attention will be paid to the 1350 area, and any subsequent break below it will be heralded as confirmation that we have just had a secular bear rally and we are going lower. We don’t believe that is the case, and feel a move below 1350 will garner sufficient fear and shake out enough stops, as to pave the way for a strong rally, similar to our move off the March 17th low.

Nasdaq (2474.56) would expect any early strength to fade, and would look for a potential 50 day average test to play out this week. The 50 day is at 2430 and coincides with recent support. The index has been relatively very strong, and we expect this leadership to continue and for the up sloping 50 day average to offer strong support. Earnings drive stocks, and despite all the doom and gloom scenarios, earnings for Technology have surpassed even our own projections. 70% of Tech stocks are lower now than they were January 26th 2004 and multiples have never been this low. We expect a top in the price of oil to coincide with a strong rotation back into this sector.

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