Microsoft word - saut101011_083400.doc

Investment Strategy
Published by Raymond James & Associates Jeffrey D. Saut, (727) 567-2644, [email protected]
October 10, 2011
Investment Strategy __________________________________________________________________________________________
"Undercut Low?"
“What do you mean by an undercut low?” was a question I received in numerous emails after last Tuesday’s verbal strategy comments. Well, for the past few months I have been talking about the similarities to the declines, and subsequent bottoming sequences, of October 1978 and October 1979. Yes, I know that back then the economy was better, the interest rate environment was different, politics were more settled, Europe was stable, etc., but I am referencing just the pricing action of the D-J Industrials (INDU/11103.12). As often stated, those aforementioned declines were just as severe, and just as quick, as what we experienced from the 7/27/11 intraday high of 12751.43 into the selling climax lows of August 8th and 9th. Following those extreme oversold lows the major indices have pretty much mirrored the 1978/1979 patterns by trading in a fairly tight range, rallying a few sessions and then declining for a few to the point where participants needed Dramamine! In those late 1970s sequences the INDU violated the selling panic lows twice with an undercut low so often referenced in these letters. An “undercut low” is when a much watched level, like the panic low of early August (1101.54 basis the S&P 500), is violated on the downside just enough to get everyone really bearish and cause them to sell out their portfolios. Subsequently, the indices turn up and rally, “locking in” a low. And, that was our bet last Tuesday when in that morning’s verbal strategy comments we recommended buying the index of your choice on the belief we were going to experience an “undercut low.” To be specific, I said to buy the trading vehicle of your choice and if we rallied into the afternoon hold on to that position for a trade. The quid pro quo was that if we were not rallying late in the day to sell said position and live to “play” another day. In retrospect, at least so far, the 1970s pattern continues to track. Now one particularly observant financial advisor (FA) asked last Friday if I thought last Tuesday’s low (1074.77) could be retested over the coming weeks. My response was, “Yes it could and that would still be in keeping with the October ‘78/’79 experiences.” A number of other FAs asked if last week’s collapse below 1101.54 meant we are going into another whole new “leg” to the downside toward minor support at 1050, or major support at 1020 – 1030. Speaking to that question, we have always said a “decisive” break below 1101.54 was needed on a closing basis to constitute the raising of even more cash than we already have. By decisive we have repeatedly stated 5-10 points on the S&P 500 (SPX/1155.46) was what was meant by “decisive.” Moreover, it has to be on a closing basis to be valid. Therefore, last Monday’s close of 1099.23 wasn’t enough; and, Tuesday’s intraday low of 1074.77 didn’t count because that day’s closing level was 1123.95. Yet another FA wanted to know if last week represented another Dow Theory “sell signal.” Asked and answered I replied, “By my pencil a Dow Theory ‘sell signal’ was recorded on 8/4/11 when the INDU broke below its March 16, 2011 reaction low, thus confirming a similar break by the D-J Transportation Average below its March reaction low.” At the time we wrote about the signal and have spoken of it numerous times since then. To get another Dow Theory “sell signal” would require a close below the July 2010 reaction lows of 9686.48 for the Industrials and 3906.23 for the Transports, at least by our method of interpreting Dow Theory. Regrettably, to get a Dow Theory “buy signal” under my methodology would require a close above the May 6, 2011 high of 12807.36 by the Industrials with a similar close from the Trannies above their July 7, 2011 high of 5618.25. Of course, some Dow Theorists would suggest a close above the August 2011 closing highs of 11613.53 and 4683.96 would do the trick, and I certainly hope they are right. Whoever is correct, we have been pretty cautious over the past two months, except for last Tuesday’s bullish trading “call,” believing that if we are going to err it is going to be by being too cautious. That’s why we have made very few trading recommendations and why we have concentrated on dividend-paying stocks with strong fundamentals that have favorable ratings from our analysts. All but two of those stocks hopefully made their respective “panic lows” back in early August. The two exceptions are LINN Energy (LINE/$35.21/Strong Buy) and The Williams Companies (WMB/$24.97/Outperform), both of which made new reaction lows early last week before recovering late in the week. Again this week we offer these names for your consideration. One of the reasons for the “painful ups and downs,” and new reaction lows referenced in last week’s letter, is that analysts are whacking forward earnings estimates. For example, according to our friends at Bespoke Investment Group: “Over the last four weeks, analysts have raised forecasts for 276 companies in the S&P 1500 and lowered forecasts for 780. This works out to a net of -504, or -33.6% of the index, and represents the lowest level since April 2009.” We have watched such shenanigans for nearly 50 years. When stock prices are rising analysts tend to raise their earnings estimates.
When prices are falling they lower estimates. Maybe a good current prism for investors would be to look at the 276 companies
where analysts are raising estimates.
Please read domestic and foreign disclosure/risk information beginning on page 3 and Analyst Certification on page 3.
2011 Raymond James & Associates, Inc., member New York Stock Exchange/SIPC. All rights reserved.
International Headquarters:
The Raymond James Financial Center | 880 Carillon Parkway | St. Petersburg, Florida 33716 | 800-248-8863
As for the economy, in last Monday’s missive we noted that 14 of the 18 economic reports issued in the previous week came in better than expected. That trend continued last week with 11 of the 16 releases showing better than estimated results. Of particular interest were better than anticipated numbers on employment, vehicle sales, vehicle production, construction spending, and manufacturing/non-manufacturing PMIs. In fact, the composite Purchasing Managers Index is consistent with +1.8% GDP growth for 3Q11. Additionally, U.S. Machine Tool Orders have soared, same-store sales for the average casual dining chain were up 2% in September (an acceleration from August) and railcar traffic trends for the past two weeks have been quite strong (particularly intermodal). All of this is inconsistent with an economy entering a recession. As stated, we guess people could actually talk themselves into a recession, but at the current time the metrics actually suggest the economy is marginally strengthening. To be sure, cyclical sensitive sectors, namely housing, has been so weak it is difficult to envision how much more it can contract. Household balance sheets have improved since the 2008/2009 “Financial Fiasco.” The trade deficit is likely to improve due to slower import growth and a decline in energy and commodity prices. Said price declines should also check headline inflation and lift households’ purchasing power. As for ECRI’s (Economic Cycle Research Institute) statement that a recession is “imminent,” while the folks at ECRI are very smart, they did call for a recession last year that never arrived. The call for this week: Amazingly, on October 3, 2008 the SPX closed at 1099.23, the exact same level as on October 3, 2011 right
before “Turning Tuesday’s” triumph. In observing the data, one can make the case that the U.S. stock market is cheaper today than
three years ago. Thanks to my friend Doug Kass for that insight. Also from Dougie, “The U.S. stock market, on a P/E multiple basis,
appears to be discounting 2011 S&P 500 earnings of about $78 a share, which I believe will turn out too low. (The current rate of
earnings is annualizing at $100 a share in third quarter 2011). But, given risk premiums (earnings yield less corporate bond yields),
the market is discounting 2012 S&P 500 profits of slightly under $60 a share, which to me, seems ridiculous.” Something else to
contemplate is that while the SPX briefly violated its intraday low of August 9, 2011, the Volatility Index (VIX/36.20) did not breach
its August 8, 2011 intraday high of 48.00, nor did the number of stocks making new annual lows exceed that of 8/8/11. Then too,
according to Ned Davis Research, since WWII quarterly losses exceeding 14% (3Q11 loss was 14.33%) have been followed by
rebounds the next quarter 89% of the time. The average gain during the next quarter has been +5.3%. More importantly, since the
1920s there have been 24 quarters when the SPX declined by 14% or more. The average rebound over the next 12 months was
~12%, while the average 12-month gain since WWII has been ~23%. The real question for this week is following last week’s
oversized near-term rally, “Can the SPX surmount its 50-day moving average at 1177.87 that has contained every rally attempt since
September 16, 2011?”
P.S. – A good example of a Brain Study: If you can read this you have a very strong mind – 7H15 M3554G3 53RV35 7O PR0V3 H0W 0UR M1ND5 C4N D0 4M4Z1NG 7H1NG5! 1MPR3551V3 7H1NG5! 1N 7H3 B3G1NN1NG 17 WA5 H4RD BU7 N0W, 0N 7H15 LIN3 Y0UR M1ND 1S R34D1NG 17 4U70M471C4LLY W17H 0U7 3V3N 7H1NK1NG 4B0U7 17, B3 PROUD! 0NLY C3R741N P30PL3 C4N R3AD 7H15. WE CONTINUE TO INVEST, AND TRADE, ACCORDINGLY, CONSISTENT WITH OUR RIGHT BRAIN, WHOLE BRAIN, INVESTMENT STYLE. 2011 Raymond James & Associates, Inc., member New York Stock Exchange/SIPC. All rights reserved. International Headquarters:
The Raymond James Financial Center | 880 Carillon Parkway | St. Petersburg, Florida 33716 | 800-248-8863
Important Investor Disclosures
Raymond James is the global brand name for Raymond James & Associates (RJA) and its non-US affiliates worldwide. Raymond James &
Associates is located at The Raymond James Financial Center, 880 Carillon Parkway, St. Petersburg, FL 33716, (727) 567-1000. Affiliates include
the following entities, which are responsible for the distribution of research in their respective areas. In Canada, Raymond James Ltd., Suite
2200, 925 West Georgia Street, Vancouver, BC V6C 3L2, (604) 659-8200. In Latin America, Raymond James Latin America, Ruta 8, km 17,500,
91600 Montevideo, Uruguay, 00598 2 518 2033. In Europe, Raymond James European Equities, 40 rue La Boetie, 75008, Paris, France, +33 1
45 61 64 90.
This document is not directed to, or intended for distribution to or use by, any person or entity that is a citizen or resident of or located in
any locality, state, country, or other jurisdiction where such distribution, publication, availability or use would be contrary to law or
regulation. The securities discussed in this document may not be eligible for sale in some jurisdictions. This research is not an offer to sell
or the solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be illegal. It does not
constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of
individual clients. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital
may occur. Investors should consider this report as only a single factor in making their investment decision.
Investing in securities of issuers organized outside of the U.S., including ADRs, may entail certain risks. The securities of non-U.S. issuers may not be registered with, nor be subject to the reporting requirements of, the U.S. Securities and Exchange Commission. There may be limited information available on such securities. Investors who have received this report may be prohibited in certain states or other jurisdictions from purchasing the securities mentioned in this report. Please ask your Financial Advisor for additional details. The information provided is as of the date above and subject to change, and it should not be deemed a recommendation to buy or sell any security. Certain information has been obtained from third-party sources we consider reliable, but we do not guarantee that such information is accurate or complete. Persons within the Raymond James family of companies may have information that is not available to the contributors of the information contained in this publication. Raymond James, including affiliates and employees, may execute transactions in the securities listed in this publication that may not be consistent with the ratings appearing in this publication. Additional information is available on request. Analyst Information
Registration of Non-U.S. Analysts: The analysts listed on the front of this report who are not employees of Raymond James & Associates,
Inc., are not registered/qualified as research analysts under FINRA rules, are not associated persons of Raymond James & Associates, Inc.,
and are not subject to NASD Rule 2711 and NYSE Rule 472 restrictions on communications with covered companies, public companies,
and trading securities held by a research analyst account.
Analyst Holdings and Compensation: Equity analysts and their staffs at Raymond James are compensated based on a salary and bonus
system. Several factors enter into the bonus determination including quality and performance of research product, the analyst's success
in rating stocks versus an industry index, and support effectiveness to trading and the retail and institutional sales forces. Other factors
may include but are not limited to: overall ratings from internal (other than investment banking) or external parties and the general
productivity and revenue generated in covered stocks.
The views expressed in this report accurately reflect the personal views of the analyst(s) covering the subject securities. No part of said person's compensation was, is, or will be directly or indirectly related to the specific recommendations or views contained in this research report. In addition, said analyst has not received compensation from any subject company in the last 12 months. Ratings and Definitions
Raymond James & Associates (U.S.) definitions
Strong Buy (SB1) Expected to appreciate, produce a total return of at least 15%, and outperform the S&P 500 over the next six to 12 months.
For higher yielding and more conservative equities, such as REITs and certain MLPs, a total return of at least 15% is expected to be realized
over the next 12 months.
Outperform (MO2) Expected to appreciate and outperform the S&P 500 over the next 12-18 months. For higher yielding and more
conservative equities, such as REITs and certain MLPs, an Outperform rating is used for securities where we are comfortable with the relative
safety of the dividend and expect a total return modestly exceeding the dividend yield over the next 12-18 months.
Market Perform (MP3) Expected to perform generally in line with the S&P 500 over the next 12 months.
Underperform (MU4) Expected to underperform the S&P 500 or its sector over the next six to 12 months and should be sold.
Suspended (S) The rating and price target have been suspended temporarily. This action may be due to market events that made coverage
impracticable, or to comply with applicable regulations or firm policies in certain circumstances, including when Raymond James may be
providing investment banking services to the company. The previous rating and price target are no longer in effect for this security and should
not be relied upon.
2011 Raymond James & Associates, Inc., member New York Stock Exchange/SIPC. International Headquarters:
The Raymond James Financial Center | 880 Carillon Parkway | St. Petersburg, Florida 33716 | 800-248-8863
Raymond James Ltd. (Canada) definitions
Strong Buy (SB1) The stock is expected to appreciate and produce a total return of at least 15% and outperform the S&P/TSX Composite Index
over the next six months.
Outperform (MO2) The stock is expected to appreciate and outperform the S&P/TSX Composite Index over the next twelve months.
Market Perform (MP3) The stock is expected to perform generally in line with the S&P/TSX Composite Index over the next twelve months and
is potentially a source of funds for more highly rated securities.
Underperform (MU4) The stock is expected to underperform the S&P/TSX Composite Index or its sector over the next six to twelve months
and should be sold.
Raymond James Latin American rating definitions
Strong Buy (SB1) Expected to appreciate and produce a total return of at least 25.0% over the next twelve months.
Outperform (MO2) Expected to appreciate and produce a total return of between 15.0% and 25.0% over the next twelve months.
Market Perform (MP3) Expected to perform in line with the underlying country index.
Underperform (MU4) Expected to underperform the underlying country index.
Suspended (S) The rating and price target have been suspended temporarily. This action may be due to market events that made coverage
impracticable, or to comply with applicable regulations or firm policies in certain circumstances, including when Raymond James may be
providing investment banking services to the company. The previous rating and price target are no longer in effect for this security and should
not be relied upon.

Raymond James European Equities rating definitions
Strong Buy (1) Expected to appreciate, produce a total return of at least 15%, and outperform the Stoxx 600 over the next 6 to 12 months.
Outperform (2) Expected to appreciate and outperform the Stoxx 600 over the next 12 months.
Market Perform (3) Expected to perform generally in line with the Stoxx 600 over the next 12 months.
Underperform (4) Expected to underperform the Stoxx 600 or its sector over the next 6 to 12 months.
In transacting in any security, investors should be aware that other securities in the Raymond James research coverage universe might carry a
higher or lower rating. Investors should feel free to contact their Financial Advisor to discuss the merits of other available investments.

Rating Distributions
Coverage Universe Rating Distribution
Investment Banking Distribution
LatAm RJA
Strong Buy and Outperform (Buy)
Market Perform (Hold)
Underperform (Sell)
Suitability Categories (SR)
For stocks rated by Raymond James & Associates only, the following Suitability Categories provide an assessment of potential risk factors for investors. Suitability ratings are not assigned to stocks rated Underperform (Sell). Projected 12-month price targets are assigned only to stocks rated Strong Buy or Outperform. Total Return (TR) Lower risk equities possessing dividend yields above that of the S&P 500 and greater stability of principal.
Growth (G) Low to average risk equities with sound financials, more consistent earnings growth, possibly a small dividend, and the potential
for long-term price appreciation.
Aggressive Growth (AG) Medium or higher risk equities of companies in fast growing and competitive industries, with less predictable earnings
and acceptable, but possibly more leveraged balance sheets.
High Risk (HR) Companies with less predictable earnings (or losses), rapidly changing market dynamics, financial and competitive issues,
higher price volatility (beta), and risk of principal.
Venture Risk (VR) Companies with a short or unprofitable operating history, limited or less predictable revenues, very high risk associated
with success, and a substantial risk of principal.
2011 Raymond James & Associates, Inc., member New York Stock Exchange/SIPC. All rights reserved. International Headquarters:
The Raymond James Financial Center | 880 Carillon Parkway | St. Petersburg, Florida 33716 | 800-248-8863
Raymond James Relationship Disclosures
Raymond James expects to receive or intends to seek compensation for investment banking services from the subject companies in the
next three months.
Company Name
Disclosure
Raymond James & Associates makes a NASDAQ market in shares of LINE. Raymond James & Associates lead-managed a follow-on offering of LINE shares in December 2010 and co-managed a follow-on offering of LINE shares in March 2011. Additional Risk and Disclosure information, as well as more information on the Raymond James rating system and suitability
categories, is available at Copies of research or Raymond James’ summary
policies relating to research analyst independence can be obtained by contacting any Raymond James & Associates or Raymond James
Financial Services office (please see or by calling 727-567-1000, toll free 800-237-5643 or
sending a written request to the Equity Research Library, Raymond James & Associates, Inc., Tower 3, 6th Floor, 880 Carillon Parkway,
St. Petersburg, FL 33716.
International securities involve additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets. Small-cap stocks generally involve greater risks. Dividends are not guaranteed and will fluctuate. Past performance may not be indicative of future results. Investors should consider the investment objectives, risks, and charges and expenses of mutual funds carefully before investing. The
prospectus contains this and other information about mutual funds. The prospectus is available from your financial advisor and should
be read carefully before investing.
For clients in the United Kingdom: For clients of Raymond James & Associates (RJA) and Raymond James Financial International, Ltd. (RJFI): This report is for distribution
only to persons who fall within Articles 19 or Article 49(2) of the Financial Services and Markets Act (Financial Promotion) Order 2000 as
investment professionals and may not be distributed to, or relied upon, by any other person.
For clients of Raymond James Investment Services, Ltd.: This report is intended only for clients in receipt of Raymond James Investment
Services, Ltd.’s Terms of Business or others to whom it may be lawfully submitted.
For purposes of the Financial Services Authority requirements, this research report is classified as objective with respect to conflict of interest management. RJA, Raymond James Financial International, Ltd., and Raymond James Investment Services, Ltd. are authorized and regulated in the U.K. by the Financial Services Authority. For institutional clients in the European Economic Area (EEA) outside of the United Kingdom: This document (and any attachments or exhibits hereto) is intended only for EEA institutional clients or others to whom it may lawfully be submitted. Review of Material Operations: The Analyst and/or Associate is required to conduct due diligence on, and where deemed appropriate visit, the material operations of a subject company before initiating research coverage. The scope of the review may vary depending on the complexity of the subject company’s business operations. This report is not prepared subject to Canadian disclosure requirements. Registration of Brazil-based Analysts: In accordance with Regulation #483 issued by the Brazil Securities and Exchange Commission (CVM) in October 2010, all lead Brazil-based Research Analysts writing and distributing research are CNPI certified as required by Art. 1 of APIMEC’s Code of Conduct (www.apimec.com.br/supervisao/codigodeconduta). They abide by the practices and procedures of this regulation as well as internal procedures in place at Raymond James Brasil S.A. A list of research analysts accredited with the APIMEC can be found on the webpage (www.apimec.com.br/ certificacao/Profissionais Certificados). Non-Brazil-based analysts writing Brazil research and or making sales efforts with the same are released from these APIMEC requirements as stated in Art. 20 of CVM Instruction #483, but abide by recognized Codes of Conduct, Ethics and Practices that comply with Articles 17, 18, and 19 of CVM Instruction #483. 2011 Raymond James & Associates, Inc., member New York Stock Exchange/SIPC. All rights reserved. International Headquarters:
The Raymond James Financial Center | 880 Carillon Parkway | St. Petersburg, Florida 33716 | 800-248-8863
Proprietary Rights Notice: By accepting a copy of this report, you acknowledge and agree as follows:
This report is provided to clients of Raymond James only for your personal, noncommercial use. Except as expressly authorized by Raymond James, you may not copy, reproduce, transmit, sell, display, distribute, publish, broadcast, circulate, modify, disseminate or commercially exploit the information contained in this report, in printed, electronic or any other form, in any manner, without the prior express written consent of Raymond James. You also agree not to use the information provided in this report for any unlawful purpose. This is RJA client This report and its contents are the property of Raymond James and are protected by applicable copyright, trade secret or other intellectual property laws (of the United States and other countries). United States law, 17 U.S.C. Sec.501 et seq, provides for civil and criminal penalties for copyright infringement. 2011 Raymond James & Associates, Inc., member New York Stock Exchange/SIPC. All rights reserved. International Headquarters:
The Raymond James Financial Center | 880 Carillon Parkway | St. Petersburg, Florida 33716 | 800-248-8863

Source: http://mclaughlingroup.org/documents/SAUT101011_083400.pdf