The Closing
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 (revised)
Real Growth in Gross Domestic Product (GDP): 2.0-2.5%
Inflation: 1.75-2%
Growth in Corporate Profits: 3-5%
Current Market Forecast
Dow Jones Industrial Average
2007
Current Trend:
Medium Term Trading Range 12523-14203
Long Term Uptrend 11757-23751
Year End Fair Value: 13250
2008 Year End Fair Value: 14050
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): 1615
Percentage Cash in Our Portfolios
Dividend Growth Portfolio 8%
High Yield Portfolio 28%
Aggressive Growth Portfolio 12%
Economics
The economy is a positive for Your Money although I have had to lower the 2008 real GDP growth forecast in recent weeks. The good news is that the economic data turned positive this week with upbeat statistics in the consumer and industrial sectors providing reassurance that recession remains unlikely and that inflation will continue to moderate:
Once again the only information on the housing sector was weekly mortgage applications (a secondary indicator) which rose an impressive 22.5%, led by strong mortgage refinancing activity. (As an aside, the impetus for the resurgence in refinancings is lower interest rates; and the result is that many adjustable rate mortgages are being replaced with lower interest fixed rate mortgages--a major positive especially in the current difficult housing/mortgage financing environment.)
The consumer related data were generally positive though not buoyant: (1) the retail sales numbers were okay with the International Council of Shopping Centers reporting poor [-2%] weekly sales of major retailers while Redbook Research recorded higher [+.3%] month to date retail chain store sales; November retail sales reported by Thomson Financial were up 4% versus expectations of +3.3% and +1.6% recorded in October, (2) employment data were also good--weekly jobless claims fell 15,000 though slightly less than expectations [-17,000] while November nonfarm payrolls rose 94,000 versus estimates of up 80,000 [though again the average increase in payrolls should run about 115,000/month to absorb all new entrants into the labor force] and the unemployment rate remained unchanged at 4.7% versus estimates of an increase to 4.8% and finally, (3) the December University of Michigan index of consumer sentiment came in at 74.5 only slightly below expectations of 75.0 and October’s 76.1 reading,
Business activity was a bright spot (1) the Institute for Supply Management’s two November indices were positive--manufacturing was 50.8 versus expectations of 50.7, nonmanufacturing 54.1 versus expectations of 55.0 [anything over 50.0 connotes growth], (2) October factory orders increased .5% versus expectations of being unchanged and (3) most important [for inflation], third quarter productivity was reported up 6.3% versus estimates of up 6.2% and unit labor costs dropped .2% versus expectations of decline of .1%.
The significance of the above data is (1) as noted above, they reinforce the ‘soft’ landing economic scenario versus one of recession and (2) the noninflationary implications of the strong productivity/paltry unit labor cost numbers coupled with the neutral November nonfarm payroll report provides flexibility to the Fed to further ease monetary policy in order to deal with the freeze up in credit markets.
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 a negative for Your Money though the international situation is becoming less negative (reconciliation between the Sunnis and Kurds in Iraq, the closing of the North Korean nuclear facility, the newest intelligence assessment that Iran may be further from developing a nuclear weapon than had been expected) and the domestic scene is somewhat mixed--the federal government is in vapor lock (that is the good news) but the post election prospect looms of higher taxes, higher government spending, increasing regulations and rising protectionism (the bad news).
The Market
Technical
The DJIA (13625) is in a trading range defined by 12523 (the August intra day low) and 14203; the S&P (1504) similarly is in a long term trading range of 750-1527 and a shorter term trading range (roughly comparable to the current DJIA trading range) of 1370-1573.
Fundamental
The DJIA (13625) finished this week about 3% over Fair Value (13250) while the S&P closed (1504) over 1% undervalued (1525).
The most notable developments that impacted the Market this week were (1) continued improved visibility of the magnitude and depth of the sub prime problem [excluding the political class’ attempts to impose a solution]--a positive, (2) upbeat economic data that belies concerns about a recession and reinforces the outlook for benign inflation--a positive, and (3) further evidence of a freeze up in the commercial paper market--a negative, though if it will almost assuredly prompt the Fed to provide additional liquidity to the system and that’s a positive.
Of course all these positives haven’t gone unnoticed--witness the DJIA is once again in overvalued territory. In addition, in the past two weeks five stocks in the Dividend Growth Portfolio (General Dynamics, Altria, Praxair, ExxonMobil and Proctor and Gamble) and two stocks in the Aggressive Growth Portfolio (Donaldson and Chicago Mercantile Exchange) traded into their
On the other hand, the S&P still lags which accounts for the large number of stocks on our Buy Lists. As you know this divergent behavior between the two major indices has existed for some time and is largely explained by the poor performance of housing, financial and consumer discretionary stocks which are more heavily weighted in the S&P. The net result is to place a premium on stock selection which only reinforces my reliance on our Price Disciplines.
So, our investment strategy remains:
(a) continue to use our Sell Price Discipline to take profits in those stocks moving into their
(b) recognize that there are both technical and fundamental factors that argue for caution and therefore to proceed carefully with our Buying, keeping a larger than normal cash position in anticipation of valuation and strategy changes that could result from a potentially new domestic economic agenda,
(c) continue to pay very close attention to the Stop Loss Discipline, occasionally moving the Stop Loss price above its historic level,
DJIA S&P
Current 2007 Year End Fair Value 13250 1525
Fair Value as of
Close this week 13625 1504
Over Valuation vs. 12/31 Close
5% overvalued 13912 1601
10% overvalued 14575 1678
Under Valuation vs. 12/31 Close
5% undervaluation 12588 1449
10%undervaluation 11925 1372
The Portfolios and Buy Lists are up to date.
Company Highlight:
American International Group is a holding company with operations in domestic property and casualty insurance, individual and group life and health insurance and risk management and agency services. The company has grown its profits at a 13% pace over the last 10 years and its dividend at almost twice that rate. Return on equity has been in the 13-15% range while AIG’s debt to equity ratio is about 26%. The company has faced a number of challenges in the past year including the resignation of its founder and investor concern about its investment portfolio’s exposure to sub prime mortgages. However neither of these issues is expected to impair AIG’s earnings and dividend growth.
EPS: 2006 $5.88, 2007 $6.25, 2008 $7.00; DVD: $.73 YLD 1.5%
http://finance.yahoo.com/q?s=AIG
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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