The Closing
The Bottom line
Statistical Summary
Current Economic Forecast
2007
Real Growth in Gross Domestic Product (revised): 2.5- 3%
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 12922-14427
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 (?) 1449-1585
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 7%
High Yield Portfolio 30%
Aggressive Growth Portfolio 5%
Economics
The recent Market action notwithstanding, the economy is a positive for Your Money. However, as we indicated last week, the disappointing July housing statistics (starts and permits) prompt us to lower our economic growth forecast--which we have done (as you can see above), revising our outlook for real GDP growth in 2007 from 2.5-3% to 2-2.5%. It is also important to note that we have not altered (1) our inflation forecast; indeed, if the current credit crisis were to worsen, deflation not inflation would become one of our major concerns, (2) our outlook for economic growth in 2008; we may have to but we think that any revisions would be dependent [a] how the credit crunch resolves itself, [b] when and at what level of activity housing stabilizes, [c] the strength or lack thereof in consumer spending, (3) our 2007 estimate for corporate profits; in fact, as you may recall, we raised that number three weeks ago based on [a] first half 2007 corporate profits exceeding our forecast and [b] the continuing positive impact of global economic growth on US business earnings.
There were very few economic statistics released this week. Among them:
(1) in housing, some very contradictory data: weekly mortgage applications fell 5.5%--the largest decline in three months, while July new home sales rose 2.8% versus expectations of down 1.6%. Furthermore, new unsold home inventories dropped 1%.
The new homes sales number is by far the more important of the two data points, so net, net this has to be looked at as a positive. Does that mean that we are out of our mind to be lowering our 2007 economic growth forecast based on a lousy housing market at the exact moment conditions are improving? We clearly don’t think so because:
(a) the expectations for the July new home sales number were so low, a better than estimated report was still a dismal performance,
(b) even if we could say with assurance that the housing market bottomed today, the impact of the current turmoil on housing prices will almost assuredly influence future consumer spending plans negatively.
Remember we are not predicting a recession, just a slow down in the rate of growth.
(2) in the consumer sector more mixed though not terrible data: the International Council of Shopping Centers reported weekly sales of major retailers up .2% and up 2.7% year over year. On the other hand, Redbook Research reported month to date retail chain store sales fell .7% versus the similar period in July but rose 2.0% versus the comparable period in 2006. Consumer spending does not appear to be falling off a cliff as many are suggesting; but it remains worrisome.
Weekly jobless claims fell 2,000, in line with expectations--employment remains strong.
(3) more great news from the industrial activity: July durable goods orders jumped 5.9% versus expectations of up 1%; ex transportation orders [which are very volatile], the rise was 3.7% versus expectations of up .6%; this was the largest increase in two years.
In addition, the back log of unfilled orders rose 2.4%, the biggest increase since this data series has been measured.
(4) on the macroeconomic front, the leading economic indicators rose .4% in July, in line with expectations. This is positive not only because it bodes well for future activity but also because it reverses the declines in this index in two out of the last three months.
Bottom line: we are sticking with our ‘soft’ landing, moderating inflation scenario; although (1) our latest revision reflects that the slow down in growth will be greater than originally expected, (2) the continuing housing malaise plus a sluggish consumer sector raises the risk that the economy is weaker than expected and finally (3) the Fed policy (reading the data correctly) risk is morphing from concern about inflation to apprehension that it won’t respond properly to potential deflationary forces that would be unleashed if bankruptcies mount in the already strained financial sector.
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 domestic and international politics are a negative for Your Money. The good news is that Congress is in recess, so the political class’ penchant for mischief is for the moment limited; the bad news is that we are in the midst of a contest among the Presidential aspirants over who can best demagogue the credit crisis. Harsh as it may sound, lenders who made inappropriate loans and borrowers who assumed inappropriate loans need to suffer the consequences. The last thing that the economy needs is another layer of regulations strapped on to another industry.
On the international front, the good news is that American troops are executing General Petraeus’ strategy so well that former opponents are starting to crawfish on the odds of success of the ‘surge’; the bad news is that if the Iraqi leadership doesn’t get its act together and quickly, the US may once again be faced with the prospect of winning a war militarily but losing it politically.
The Market
Technical
The DJIA is in an up trend defined by the approximate boundaries of 12922 and 14427. The S&P is in its seven year trading range with boundaries of 750-1527.
Fundamental
At the risk of being premature, it does seem that the Markets with some help from the Fed are doing what needs to be done to isolate the sub prime problem to the borrowers and lenders that assumed inappropriate risk. To be clear, that doesn’t mean that there still aren’t institutions and individuals that are in precarious financial shape and could very well go into bankruptcy; but the non sub prime sectors of the credit markets are beginning to be able to price and execute transactions. Barring the collapse of a major financial institutions that has to date managed to hide its sub prime exposure and a resulting re-freezing of liquidity in the non sub prime markets, we think that the probability of a continuation of the decline in equity prices due to the sub prime problem is decreasing daily.
That, of course, is not to say that stock prices can’t go down another 1000 points; but it would probably be the result of some other ‘crisis’ (recession, deflation, an interruption in global oil supplies)--none of which loom immediate.
Those disasters aside, stocks at current prices have returned to roughly Fair Value (the DJIA slightly over valued; the S&P slightly under valued). Given that our investment strategy is:
(1) continue to average into the stocks in which our Portfolios have established partial positions,
(2) use our Price Disciplines in the ongoing heightened volatility to our advantage by taking profits when prices spike to the upside and buying the stocks of great companies when opportunities present themselves,
(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 13378 1479
Over Valuation vs. 8/31 Close
5% overvalued 13650 1570
10% overvalued 14333 1649
Under Valuation vs. 8/31 Close
5% undervaluation 12380 1421
10%undervaluation 11761 1349
The Portfolios and Buy Lists are up to date.
Company Highlight:
Federated Investors provides investment advisory, administrative and other services and products to its mutual funds (primarily money market funds) and separate accounts. The company earns an impressive 35% return on equity and has grown profits and dividends at a 9-10% pace over the last 10 years. This record should continue as assets under management grow, the company makes acquisitions and repurchases stock.
EPS: 2006 $1.80, 2007 $2.15, 2008 $2.40; DVD: $.80 YLD 2.3%
http://finance.yahoo.com/q?s=FII
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.
