The document discusses an investment strategy by Jeffrey Saut. It summarizes that the winter solstice marks a turning point with the sun appearing to stand still before gradually setting later each day. While the solstice is a natural yearly cycle, the stock market saw a turning point in March 2009 towards recovery. However, challenges lie ahead in 2010 as stimulus ends, taxes rise, and earnings comparisons become more difficult. The strategy favors quality large cap stocks and advises that stock selection and active management will be key to returns.

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Investment Strategy by Jeffrey Saut
Turning Point?
December 21, 2009
Winter officially begins today with the arrival of the Winter Solstice. Recall that solstice means “standing-still sun;” and on December
21st at 5:47 p.m. (EST) the sun will “stand still” over the southern Pacific Ocean (Tropic of Capricorn). At that time the sun’s rays
will be directly overhead, giving the impression that the sun is truly standing still. This phenomenon occurs twice a year (winter
solstice and summer solstice), for as Earth orbits the Sun the north-south position of the Sun changes due to the Earth’s changing
“tilt.” The dates of maximum tilt to the Earth’s equator correspond to the winter and summer solstice, while the dates of zero tilt are
termed the vernal and autumnal equinox. In these latitudes most people “frame” the winter solstice as the shortest day of the year. The
quid pro quo is that the French consider it the longest night of the year! No one is quite certain how long ago humans recognized the
winter solstice, and began heralding it as a turning point, but a turning point it is since the sun will set a minute or two later each day
from here into the summer solstice (June 21st), which just happens to be the shortest night of the year.
While the Winter, and Summer, Solstice have marked the “turning points” of the annual cycle of the year since Neolithic times, this
year’s stock market “turning point” came the week of March 2nd; and we were bullish. Since that time investing has been pretty easy.
To wit, given the fact that the equity markets were at generationally oversold levels (three standard deviations below norms), all you
had to do was invest in the riskiest assets you could find and wait for things to regress to the mean (read: normalize). To be sure, in
March investors gleaned that the financial system was not going to implode into another Great Depression and began to buy stocks.
That sense was sparked when “the authorities” made it clear there would be no more Lehman Brothers, and flooded the system with
liquidity, which drove the first leg of rally.
We have often spoken of that “leg,” comparing it to the 2003 bottom whereby the S&P 500 (SPX/1102.47) bottomed in March and
rallied sharply into June. From there it “chopped” around into August, but never gave back much ground, before beginning “leg 2” of
the uptrend that carried the SPX higher into the first quarter of 2004. The first leg of that affair was driven by liquidity, while the
second leg was spurred by improving fundamentals. If that sounds familiar it should because it is eerily similar to what we are
currently experiencing. As we approach 2010, however, “things” could become more difficult, requiring stock selection, as well as
market timing, to produce decent portfolio returns.
So what makes us think things are going to become more difficult in the New Year? Obviously, the 68% rally from the intra-day
“lows” to the recent intra-day “highs” has reduced some of the “margin of safety” that Benjamin Graham spoke of in his legendary
book “The Intelligent Investor.” Yet, there are other headwinds. To name a few, we will lose some of the “sugar high” from the
stimulus monies, taxes are likely going to rise, there will be more government intrusion into corporate America, earnings comparisons
will become more difficult, inflation should start to pick up, which should raise interest rate fears, there will be election worries, and
the U.S. dollar should continue to strengthen.
Speaking to the dollar’s strength, given negative “real” interest rates, and a declining dollar, the U.S. dollar “carry trade” has become
ubiquitous. Simply stated, the U.S. dollar “carry trade” is a strategy of borrowing cheapening dollars (versus other currencies) at
nearly zero interest rates, leveraging those dollars, and investing in markets with a higher interest rate and/or a rising currency. Of
course, with the resurgence of financial engineering, practitioners of the “carry trade” have come to speculate in ANYTHING that
was/is going up (read: emerging markets, commodities, etc.). However, using leverage, when the dollar starts to rally, the profitability
of those leverage trades erodes quickly. Since the beginning of December the Dollar Index has rallied more than 5%, which is a huge
move for a major currency, causing the “carry trade” crowd to begin “unwinding” some of their carry-trades; and asking the question,
“Is the dollar rally just a counter-trend move in an ongoing bear market, or is it a new trend?”

2. While nobody knows the answer to that question, for months we have opined that despite the media’s beating of the buck “like a
rented mule,” the Dollar Index still resided above the lows made in the spring/summer of 2008. Moreover, the U.S. dollar is cheap on
a purchasing power parity basis; and economic growth is improving, not just here, but around the world, which is dollar friendly. Then
too, interest rates will eventually rise. As our friends at the brainy GaveKal organization opine:
“Underweighting US equities is likely to become a risky bet. Indeed, in a rising US Dollar environment, companies with positive US$
cash flows will benefit, which obviously gives US equities an edge. The biggest winners will be low-leverage companies with very
visible US$ cash flows (e.g., US staples and industrials). Which brings us to the next issue, namely emerging markets? For the past
nine months, it made sense to own companies with high US$ debt leverage combined with foreign exchange earnings. This included
not only foreign companies that have a lot of US$ debt, such as Chinese property developers or Korean utilities, but also some global-
oriented US firms, such as banks. Naturally, if the US$ keeps rising, these assets will be hurt. At the same time, heavily commodity-
weighted emerging markets will also lose some shine as a higher US$ generally spells weaker commodities. This in turn should
benefit manufacturers and exporters, whose margins have recently been caught between the rock of weak US demand and the hard
place of rising material costs. In other words, a reversal in the weak US$/strong commodity trend would likely trigger a rotation away
from 'price monetizers' towards 'volume monetizers’. As the US$ rallies, it is clear that the investment environment that has prevailed
for past nine months is changing. If one believes the US$ trend is here to stay, as we do, then it makes sense to realign portfolios
rapidly, especially away from foreign firms that earn in the local currency, but pay debt in the US$. Reversals of carry trades are
always quite painful...”
As for the other themes as we enter the new year, our sense is the U.S. will experience 3.5% GDP growth in the first half of the year
and then slow to 2.5%. Consequently, global growth in 2010 should be uneven. Near term, advanced economies should experience a
bounce in activity that will last into the first half of the year. Following that, monetary policies will vary. Emerging markets will need
to tighten much sooner than the G7. We do expect interest rate hikes from the ECB and the Bank of Japan in 2010. However, we also
think participants are wrong in expecting interest rate hikes too early given the fragile economic environment. Further, in 2010 we
think investors should be positioned for: Sovereign balance sheet risk (potential defaults: Venezuela, Ukraine, Argentina, Pakistan,
Latvia, etc.); increased geopolitical threats; Asian urbanization; a potential commercial real estate crisis; rising
taxation/inflation/regulation; the emerging and frontier market consumer; rising global growth, free cash flow beneficiaries; energy
and alternative energy; infrastructure plays (electricity, water, etc.); technology (read: volume monetizers); U.S. exports and business
spending; dividends; and a return to active portfolio management. Indeed, stock selection, and active portfolio management, are likely
to be the key drivers of portfolio returns in the year ahead. As for style, while we always like special situations, from a macro
perspective we favor quality growth, dividend yield, positive earnings revisions, and large capitalization stocks.
As for last week’s stock market action, we were manifestly disappointed, having believed the SPX was poised to surmount its 50%
retracement level at 1115 (measuring the decline from October 2007 to March 2009), triggering upside targets between 1160 and
1200. Alas, it was not meant to be as the index tried, and failed, for the fourth time to breach 1115, setting the stage for potentially a
fifth downside test of the 1085 level. While we remain constructive, history shows that the fifth test of a support level typically doesn’t
hold. Therefore, in Friday’s verbal strategy comments we concluded, “We think it’s pretty important that the equity markets build on
this morning’s opening strength.” And while that didn’t happen, the markets did stabilize following the “Thursday Tumble” (-133
DJIA). Still, with market valuations below their 20-year mean valuation, surging earnings and low interest rates, we remain
constructive.
The call for this week: These will be the only strategy comments for the week since we are leaving for Washington in an attempt to
bring the promised transparence to a now completely opaque healthcare bill. As James Capretta writes:
“Senate Majority Leader Harry Reid is running the same play again. He unveiled the latest version of his reform legislation this
morning, filled to the brim and outrageous payoffs to buy the votes of holdout Senators. Virtually no one else has seen the bill before
today, much less had a chance to give it the scrutiny it deserves. And certainly the public has not had a chance to weigh in. No matter,
Senator Reid has simultaneously set in motion the procedures necessary to force a vote on his new health-care plan in a matter of
hours, not weeks.”
Accordingly, we will pay tribute to this year’s “turning point” (Winter Solstice) by facing the sky and screaming at the top of our
lungs. It will be one of many such screams emitted as we watch our Congress “fiddle” while “Rome burns.” Indeed, we marvel at the
mendacity currently swirling inside the “beltway” and are reminded of John Adams’ statement (1788), “No man’s life, liberty, or
property is safe while the legislature is in session.” Season’s greetings everybody...