The Closing
The Bottom line
Statistical Summary
Current Economic Forecast
2007
Real Growth in Gross Domestic Product (revised): 2.0- 2.5%
Inflation: 2 - 2.5 %
Growth in Corporate Profits (revised): 6-8%
2008
Real Growth in Gross Domestic Product (GDP): 3-3.25%
Inflation: 1.75-2%
Growth in Corporate Profits: 7-9%
Current Market Forecast
Dow Jones Industrial Average
2007
Current Trend:
Medium Term Uptrend 13133-14719
Long Term Uptrend 11757-23751
Year End Fair Value (revised): 13250
2008 Year End Fair Value (revised): 14250
Standard & Poor’s 500
2007
Current Trend:
Medium Term Uptrend (?) 1455-1585
Long Term Uptrend 1225-2400
Former Long Term Trading Range (?) 750-1527
Year End Fair Value (revised): 1525
2008 Year End Fair Value (revised): 1640
Percentage Cash in Our Portfolios
Dividend Growth Portfolio 9%
High Yield Portfolio 30%
Aggressive Growth Portfolio 8%
Economics
The economy is a positive for Your Money. There was a dearth of much clarifying economic data this week: there was little on housing, the consumer statistics were so confusing as to be worthless, though employment remains strong which is good, industrial numbers were mildly disappointing but the trade and budget deficits showed improvement and inflation is under control. Bottom line, I believe that the data continues to support the ‘soft’ landing, moderating inflation scenario.
(1) housing: the only data point was weekly mortgage applications which were up 2.4% after having fallen for the prior two weeks. This is a secondary indicator; so I take little comfort from this first bit of good housing news in some time.
(2) data on the consumer was mixed and a bit confusing:
(a) the International Council of Shopping Centers reported that the weekly sales of major retailers were unchanged--for the second week in a row; while year over year, they were up 2.1%. Redbook Research reported that month to date retail chain store sales rose .3% versus the comparable time frame in September and 2.0% versus the similar period in 2006,
(b) September same store retail sales were reported up 1% by Lazard Capital Markets--a disappointing number; however, the Commerce Department reported September retail sales [a broader measure than the Lazard number] rose .6% versus expectations of an increase of .4%; ex autos, sales were up .2% versus estimates of up .4%. Most important, the year over year increase in sales was 5%; ex autos and gasoline, it was up 4.6%,
(c) perhaps contributing to the confusion over retail sales numbers over the last year is another Commerce Department report that apparel prices have fallen 3% over the last 12 months; if accurate, that suggests retail unit sales have been quite strong.
(d) weekly jobless claims fell 12,000 versus expectations that they would remain unchanged; this is a strong bounce back after last week’s slightly disappointing number--employment is strong.
(e) finally, the initial October University of Michigan index of consumer sentiment came in at 82.0 versus estimates of 84.2 and the final September reading of 83.4--a discouraging sign for future consumer spending.
(3) industry:
(a) August wholesale inventories rose .1% versus expectations of an increase of .3%; importantly, wholesale sales were up .4%. The wholesale inventory to sales ratio was unchanged versus July but down versus August 2006.
(b) August business inventories grew .1% versus expectations of a rise of .3%; unfortunately, business sales fell .4% following July’s strong 1.1% increase: another data point in the strong--July--weak--August--net--positive--two--month--growth pattern seen earlier in the durable goods orders and factory orders.
Both inventory numbers reflect tight financial management--a positive.
(4) macro economic trends:
(a) the September trade deficit shrank more than expected to $57.8 billion as a result of surging exports; remember that an improving trade balance has the effect of adding to the gross domestic product number.
(b) the
(c) September producer price index [PPI] rose 1.1% versus expectations of an increase of .5%, propelled primarily by a 4.1% jump in oil prices; however, the core PPI was up .1% versus estimates of up .2%. Year over year the core PPI came in at 2%--the top end of the Fed’s comfort range. Inflation remains under control.
The Economic Risks:
(1) the economy is weaker than expected.
(2) Fed policy (reading the data correctly).
(3) a disruption in global oil supplies (It is not the price of oil but its availability that will cause severe economic dislocation.).
(4) protectionism (Free trade is a major positive for world and
(5) fiscal profligacy (Government spending as a percent of GDP is too high and the looming explosion in entitlement expenditures will make it worse. There is no good solution save spending discipline.).
(6) a rising tax and regulatory burden (Government has never proven that it could solve economic problems efficiently or satisfactorily.)
Politics
Both the domestic and international political environments are negatives for Your Money. When I read (1) every statement from the primary Democratic Presidential candidates which generally contain a proposal for a new entitlement program, (2) the polls pointing to a likely Democratic Presidential victory as well as an increase in their majorities in both Houses, and (3) the polls showing Republican voters are opposed to free trade, my concern about higher secular inflation and shrinking corporate profit margins--neither of which are good for Your Money--increases.
On the other hand, the near silence from the main stream media and the Democratic Presidential candidates on
http://www.powerlineblog.com/archives/2007/10/018733.php
The Market
Technical
The DJIA is in an up trend defined by the approximate boundaries of 13133 and 14719. The S&P remains above the 1527 resistance level and is in an up trend defined by the boundaries of 1455 and 1585.
Fundamental
The DJIA (14083) finished this week more than 5% over valued (13781) while the S&P (1561) is somewhat (about 3%) above Fair Value (1513).
I have stated several times that the recent Fed easing was in response to the liquidity freeze up in the credit markets not a too weak economy; and, therefore, in anticipating the Fed’s action at its October meeting, those conditions that will prompt a further Fed easing are (1) the inability of the credit markets to clear non sub prime transactions and/or (2) a marked weakening in economic activity. Since it appears that the credit markets are functioning once again and the economy continues to grow albeit at a slower rate, I think that the odds of a Fed easing are fairly low.
I make this point because while the bond market is not pricing in a further Fed easing in October, far too many of the stock gurus think it likely. If the bond market is right, that could lead to disappointment among equity investors. Coupled with the current over valued level (at least as calculated by the SSI Valuation Model) of the Market indices, my inclination is towards caution, the value of cash, in my opinion, rises and explains why our Portfolios have not been aggressively Buying stocks when they drop into their Buy Value Ranges.
Our investment strategy is:
(1) use our Price Disciplines to take advantage of the ongoing heightened volatility to upgrade the quality of our Portfolios by Selling our weakest holdings and to take profits in those stocks rising into their Sell Half Range when prices spike to the upside and buying the stocks of great companies when opportunities present themselves [and the Markets dip],
(2) insure that our Portfolios can ride out any further turmoil brought on by trouble in the credit markets
DJIA S&P
Current 2007 Year End Fair Value 13250 1525
Fair Value as of
Close this week 14083 1561
Over Valuation vs. 10/31 Close
5% overvalued 13781 1589
10% overvalued 14438 1664
Under Valuation vs. 10/31 Close
5% undervaluation 12469 1437
10%undervaluation 11812 1361
The Portfolios and Buy Lists are up to date.
Company Highlight:
Citigroup is a diversified financial services firm with operations in consumer and corporate banking (Citibank), insurance (Travelers), investment banking and asset management (Smith Barney). The company recently took a large earnings write off tied to the sub prime mortgage market. With this problem hopefully behind C, there are numerous positives that should drive profits to higher levels including strong international banking and investment banking returns as well as a recently implemented expense control program. The company has consistently earned a 17%+ return on equity and grown profits and dividends at an 8-10% annual pace. Its stock yields 4.7%.
EPS: 2006 $4.25, 2007 $4.30, 2008 $4.95; DVD: $2.10 YLD 4.7%
http://finance.yahoo.com/q?s=C
Steve Cook received his education in investments from Harvard, where he earned an MBA, New York University, where he did post graduate work in economics and financial analysis and the CFA Institute, where he earned the Chartered Financial Analysts designation in 1973. His 38 years of investment experience includes institutional portfolio management at Scudder. Stevens and Clark and Bear Stearns, managing a risk arbitrage hedge fund and an investment banking boutique specializing in funding second stage private companies. Through his involvement with Strategic Stock Investments, Steve hopes that his experience can help other investors build their wealth while avoiding tough lessons that he learned the hard way.
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