The Closing
Note: As you know, Thanksgiving Day occurs next week. In addition to doing my share of the cooking (20 friends and family for Thanksgiving dinner), my dad has reached the age where he can no longer drive. So I will have to him pick up which will take most of Wednesday and return him which will take most of Friday. As a result, I won’t produce a Closing Bell next week; plus I will only write a Morning Call on Monday and Tuesday. As always, I will be checking prices and if action is needed will communicate via a Subscriber Alert. My best wishes to all for a Happy Thanksgiving Day.
Statistical Summary
Current Economic Forecast
2007
Real Growth in Gross Domestic Product: 2.0- 2.5%
Inflation: 2 - 2.5 %
Growth in Corporate Profits: 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 Trading Range 12850-14175
Long Term Uptrend 11757-23751
Year End Fair Value: 13250
2008 Year End Fair Value: 14250
Standard & Poor’s 500
2007
Current Trend:
Long Term Trading Range (?) 750-1527
Long Term Uptrend (?) 1225-2400
Year End Fair Value (revised): 1525
2008 Year End Fair Value (revised): 1640
Percentage Cash in Our Portfolios
Dividend Growth Portfolio 15%
High Yield Portfolio 30%
Aggressive Growth Portfolio 17%
Economics
The economy is a positive for Your Money. The economic data reported this week were not as constructive as the prior two weeks. Indeed, I would characterize them as negative. Housing statistics looked good as did the macro economic statistics save the core consumer price index; the consumer and business activity numbers were mixed to negative. Especially disappointing was the release of third quarter S&P earnings which were down. Bottom line: I am sticking with my forecast that a ‘soft’ landing and moderating inflation remains the most likely economic scenario though this week’s data did little to support that view.
(1) two secondary housing indicators were both positive: weekly mortgage applications were up 5.5% to the highest level since December 2006; September pending home sales rose .2% versus expectations of a decline of 2.5%,
(2) the consumer data was once again mixed:
(a) the International Counsel of Shopping Centers reported weekly sales of major retailers fell .5%, another dramatic reversal from the +1% recorded last week--similar to the pattern of a couple of weeks ago; year over year sales were up 2.7%. Redbook Research reported month to date retail chain store sales up .3% versus the comparable period in October and up 2.4% over the similar timeframe in 2006. Finally, the Commerce Department’s report on October retail sales showed them up .2%, in line with expectations; however, ex autos, those sales were up .2% versus estimates of +.4%,
(b) weekly jobless claims rose 20,000 versus expectations of an increase of 3,000; Labor Department officials believe that the entertainment industry writers’ strike negatively impacted the reported number.
(3) industry data was mixed to negative with big disappointments coming in a lower industrial production report and down third quarter earnings:
(a) October industrial production fell .5% versus expectations of an increase of .1% [given the poor October ISM manufacturing report, this was not that big a surprise],
(b) October capacity utilization came in at 81.7 versus expectations of 82.0 and 82.1 reported in September,
(c) September business inventories rose .4%, in line with expectations; business sales increased .6%--this left the business inventory to sales ratio unchanged,
(d) two regional [secondary] November manufacturing surveys were quite positive: the New York Fed manufacturing index was reported at 27 versus expectations of 19; and the Philadelphia Fed index came in at 8.2 versus estimates of 5.0 [in both surveys anything over 0 signifies growth],
(e) finally, S&P released the composite third quarter earnings for its various indices and they were down plus or minus 8%. Not surprisingly, most of the decline was recorded in the housing-related and financial sectors. Strength remained in the industrial, technology, consumer staple and health care industries’ earnings.
I have stated numerous times that you can’t have a recession when corporate profits are booming; and clearly, they are not booming. To the point, companies have a tough time growing if earnings are shrinking. Nevertheless if the current profit woes remain largely contained in the housing and financial sectors, a ‘soft’ landing can still occur--flat to slightly down corporate profits are not inconsistent with 2% real economic growth especially if the path to that lower rate of growth is erratic. That said, this definitely increases the probability that the economy is weaker than expected.
(4) macro economic indicators were generally positive:
(a) the October producer price index [PPI] was up .1% versus much higher expectations of up.4% and the +1.1% reported in September; core PPI was unchanged versus estimates of a rise of .2% [a more complete look from Barry Ridholz]:
http://bigpicture.typepad.com/comments/2007/11/fasb-buncha-bit.html
(b) the October consumer price index [CPI] rose .3%, in line with expectations; the core CPI was up .2%, also in line with estimates. Note--the year over year increase stands at 2.2%, outside the Fed’s comfort zone,
(c) the government’s October budget deficit came in at $55 billion, in line with expectations but up from $49.3 billion in October 2006,
(d) on Wednesday, the Fed announced that it was inaugurating a new communication process with the public, the net effect of which will result in its decision making and thought processes becoming more transparent. My take is that more information is always better; however, I caution that in the short term, there is likely to be a learning process [i.e. increased opportunity for confusion] for both the Fed and experts/investors as the rules and protocols of this new system are established.
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 negative for Your Money though the outlook for economic/political stability in Iraq continues to improve (a positive) while domestically our elected representatives by and large give every indication that they want to raise our taxes (Charles Rangel’s tax bill), raise their spending (Water Bill, Farm Bill, Health and Education Bill) and increase economic regulation (Barney Frank’s mortgage industry reform bill).
This on the AMT:
http://article.nationalreview.com/?q=NjFlODZhYTExNjk4M2M1M2EzNzY1ZjA1NmFmYjNlNjc=
The Market
Technical
Despite the Market rally this week (Tuesday), the DJIA remained below the lower boundary of the uptrend off the July/August low--though it did get close, then fell away. I am now using a trading range as the dominant trend: the lower boundary being somewhere between 12500 (August intraday low)-12850 (August closing low) and the upper boundary 14187.
The S&P did manage to trade back into the boundaries of its uptrend off the July/August low; however, it only stayed there for one day, then again retreated below the lower boundary. In my opinion, 750-1527 is the current operative trend.
Fundamental
The DJIA (13176) finished this week, right on Fair Value (13187); the S&P (1458) is almost 4% undervalued (1519).
The most important fundamental development this week was that the financial institutions appeared to have at least started the arduous task of defining the depth and breadth of the sub prime problem. Several major institutions disclosed losses none of which were large enough to impair that institutions lending/financing capability. To be sure there are plenty more shoes to drop, perhaps even from those same institutions--BUT the process seems to now be in full swing, helped along by FASB 157 (see Thursday’s Morning Call) which went into effect Thursday.
While it remains impossible to quantify with any accuracy the ultimate size of sub prime write offs or the extent to which they will damage the US financial system’s ability to meet the credit needs of businesses and consumers, the fact that the disclosure (of losses) process has begun in earnest means that the gap between what are now known losses and what will be the ultimate magnitude of sub prime losses has begun to shrink--indeed Wall Street analysts apparently now have done enough work/gotten enough information that they are willing to go in print estimating what those total sub prime losses will be, witness the Goldman Sachs report linked in Friday’s Morning Call which lays out for all the bear case for losses and their economic consequences.
My point here is that every time investors get more information from financial institutions and additional analytical reports born of that additional information (i.e. bad news), the closer we get to having total sub prime losses (the bad news) discounted in stock prices, i.e. it reduces the downside risk in stock prices related to the sub prime problem. I am not arguing that further sub prime problems don’t pose a risk to equity values, I am arguing that that risk is diminishing. This prompted our Portfolios’ stock purchases on Wednesday and Friday and will continue to drive the process of averaging into the stocks of high quality companies.
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 averaging into stocks of great companies when opportunities present themselves [like the current 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
Close this week 13176 1458
Over Valuation vs. 11/30 Close
5% overvalued 13846 1595
10% overvalued 14506 1670
Under Valuation vs. 11/30 Close
5% undervaluation 12528 1443
10%undervaluation 11868 1367
The Portfolios and Buy Lists are up to date.
Company Highlight:
Brinker Int’l develops and operates several ‘concept’ restaurants: Chili’s Grill and Bar, Romano’s Macaroni Grill, On the Border, Maggiano’s, Rockfish and Corner Bakery. The company has earned approximately 20% return on equity over the last five years while growing profit per share between 13-14%. Current corporate plans should contribute to a continuation of that record; they include increasing (higher margin) franchise units relative to company owned stores, raising prices, upgrading current restaurants to improve comparable store sales growth and continuing the company’s aggressive stock buy back program.
EPS: 2006 $1.46, 2007 $1.76, 2008 $1.95; DVD: $.40 YLD 1.4%
http://finance.yahoo.com/q?s=EAT
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.
No comments:
Post a Comment