The Closing Bell

The Closing Bell

10/20/07

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 13201-14784

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 (?) 1459-1591

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 12%

High Yield Portfolio 30%

Aggressive Growth Portfolio 15%

Economics

The economy is a positive for Your Money though this week’s data was mixed at best. Most discouraging were the Fed’s Beige Book report, housing numbers plus the growing perception that progress in defining, isolating and correcting the problems in the sub prime mortgage market has not advanced as much as we thought. Indeed at some point the combination of sliding housing activity and the potential fall out from further deterioration in the sub prime markets could be so great as to do irreparable damage to the economy thereby negating the ‘soft’ landing scenario--the operative word in this statement being ‘potential’ because even though it appears that there are more problems to come in the sub prime area, it also remains clear that we simply don’t know their order of magnitude.

On the other hand, we did get some optimistic news this week in the form of the earnings reports from some major international firms--spotlighting the importance that global economic strength is playing in sustaining US industrial activity. Bottom line: the earnings performance of international companies notwithstanding, I would characterize this week’s economic statistics as increasing the likelihood of a recession; but I think more information is needed before altering the SSI scenario. I am, however, reviewing the SSI 2008 real gross domestic product estimate with an eye to lowering it.

(1) abysmal doesn’t accurately describe the housing statistics this week: while weekly mortgage applications rose .7% [the second weekly increase], it is still a secondary indicator; and unfortunately two primary gauges were terrible: September housing starts fell 10.2% versus expectations of a decrease of 3.8% and September building permits dropped 7.3% versus expectations of a decline of .7%,

(2) consumer spending was strong but the employment number was disappointing:

(a) the International Council of Shopping Centers reported weekly sales of major retailers jumped an impressive 1.0% after two prior sub par reports; year over year, sales increased 2.5%. Redbook Research reported month to date retail chain store sales up .1% versus the similar period in September and up 2.6% versus the comparable period in 2006,

(b) weekly jobless claims rose 28,000 versus expectations of a 7,000 increase.

(3) the industrial data was basically neutral:

(a) September industrial production rose .1%, in line with expectations; however, the August number was revised down to unchanged versus the original reading of +.2%--which is not particularly surprising given the poor August performance of durable goods orders, factory orders and business inventories,

(b) September capacity utilization came in at 82.1, in line with expectations, but down slightly from the 82.2 reading in August,

(c) the October Philadelphia Fed index of business activity was reported at 6.8 versus expectations of 7.5 and a 10.9 reading in September and 0.0 in August.

(4) the macro economic data was mixed:

(a) the September consumer price index [CPI] rose .3% ,in line with expectations; as with the producer price index last week, energy prices drove this number up; core CPI increased .2%, also in line with expectations; year over year, it is up 2.1%, slightly over the Fed’s comfort zone,

(b) the Fed released its latest Beige Book report [a once every six weeks anecdotal assessment of the state of the US economy] Wednesday; and while it concluded that the economy continues to expand, it was the most pessimistic report in four years,

(c) September’s leading economic indicators were up .3%, in line with expectations, though the August number was revised down from -.6% to -.8%.

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 US economic growth.).

(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 international and domestic political environments are negatives for Your Money. Pakistan--this is good news:

http://atimes.com/atimes/South_Asia/IJ19Df01.html

The Market

Technical

The DJIA is in an up trend defined by the approximate boundaries of 13201 and 14784. The S&P is in an up trend defined by the boundaries of 1459 and 1591; however, the S&P once again closed below the old 2000 high of 1527. The question, of course, is, is the aforementioned up trend dominant or has the old 2000-2007 trading range once again asserted itself? We’ll know more next week.

Fundamental

The DJIA (13522) finished this week about 3% over valued (13125) while the S&P (1501) is slightly undervalued (1513).

As alluded to above, one of the most notable developments this week was the acknowledgement by Paulson, Bernanke and financial institutions, particularly the banks, that the financial community either doesn’t know or hasn’t yet admitted the magnitude of the sub prime loan problem. Supporting this notion is that while this week’s total volume of refinanced commercial paper grew [which is a positive], the amount of paper related to sub prime mortgages that rolled over declined. As a result, it appears likely that the economy has more pain, perhaps a lot more pain, to be experienced than recently thought. That means a couple of things---I think:

(1) it was probably premature buying the positions in the Citigroup and Fifth Third Bancorp. As you know, the FITB has already been Sold. With Citigroup, potential management changes [which would be positive] could offset any negatives growing out of any additional exposure C has to the sub prime market. For the moment, the High Yield Portfolio is Holding its Citigroup position.

(2) the liquidity problems which prompted the dramatic easing by the Fed several weeks ago may return; that [along with a cascading housing market and this week’s rather somber Beige Book report] increases the likelihood of another Fed Funds rate cut--which, of course, is a mixed blessing: equity investors would love an easier Fed, but they may hate the economic impact of a deteriorating sub prime mortgage market.

(3) in a Closing Bell a couple of weeks ago, I noted that equity prices behaving so positively were [given their discounting function] inconsistent with a recession. Then comes this week. As discussed above, the economic news this week was not so bright and it would seem to be having its impact on investor psyche. Which raises the questions, was this week’s news the straw that broke the camel’s back so to speak, bringing recession, or the likelihood thereof, to the forefront of investor consciousness? and whether or not there is a recession, is this week’s Market performance indicative of that new awareness that the risks of one are mounting? and if it is, how low can stock prices go?

Before addressing those question, I think we have to remind ourselves that: [a] neither of the major indices have broken down technically and [b] I have been observing for weeks that the indices especially the DJIA were over valued, at least on the SSI Valuation Model; and the lousy performance this week notwithstanding, the DJIA is still slightly over valued. I have also pointed out that when reverting to Fair Value, it doesn’t really matter if stock prices drift back or they plunge. It could be that this time it is a plunge. The point here is that as of the close of business Friday, there is nothing related to either the technical performance of the major indices or their fundamental valuation that would suggest they are either discounting a recession or are rolling over into a major downturn.

That said, my bottom line is that whether or not a recession or a significant decline in equity prices lie ahead, it is hard to envision an upward trending Market in an atmosphere where whole sectors (housing, financials, consumer discretionary) of the economy are scorned by investors and where the slightest hint of bad news causes investors to stampede for the exit (Fastenal missed its third quarter earnings per share estimate by one cent and the stock sold off 10%) even from the darlings of the investment crowd (witness Caterpillar, Honeywell and 3M’s Friday stock price performance). This suggests extremely nervous investors with very short time horizons. Caution continues to be important.

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) pay very close attention to the Stop Loss Discipline, occasionally moving the Stop Loss price above its historic level,

(3) 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 10/31/07 13125 1513

Close this week 13522 1501

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:

ONEOK Partners engages in gathering, processing, storing and transporting natural gas in the US. This partnership has earned a 12-17% return on equity over the last five years and has grown profits and dividends at a 6% annual pace. It has a 48% debt to equity ratio which is conservative for an entity of this nature. The partnership should continue grow earnings and dividends at a modest pace as tariffs are increased. Coupled with a 6.2% yield, the total return on this stock makes it an attractive bond substitute.

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.