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 13030-14592
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
2008 Year End Fair Value: 1625
Percentage Cash in Our Portfolios
Dividend Growth Portfolio 9%
High Yield Portfolio 30%
Aggressive Growth Portfolio 5%
Economics
The economy is a positive for Your Money. The data continue to portray an economy that is slowing but not descending into recession:
(1) the housing stats were once again terrible: weekly mortgage applications fell 2.7% while the August pending previously owned home sales fell 6.5% versus expectations of a decline of 2.1%, Nothing good here; however, I remind you, as I occasionally do, that housing accounts for only about 5% of gross domestic product,
(2) the consumer continues to muddle through:
(a) the International Council of Shopping Centers reported weekly sales of major retailers unchanged but up 2.7% year over year. Redbook Research reported month to date retail chain store sales up .3% versus the similar period in August and up 2.0% versus the comparable 2006 period,
(b) September auto sales declined 3% but that was in line with expectations,
(c) weekly jobless claims rose 16,000 versus expectations of an increase of 14,000; however, September non farm payrolls [the key data point of this week] rose 110,000 in line with expectations but a huge comeback from the initially reported 4,000 decline in August [as an aside as it turns out, the August decline was a seasonal adjustment fluke related to the timing of teachers’ return to work and it was revised to up 89,000]; the unemployment rate rose slightly to 4.7% versus 4.6% at the end of August but in line with expectations,
(3) the industrial sector results were mixed:
(a) the Institute for Supply Management [ISM] reported its September manufacturing index at 52.0 versus the August reading of 52.9; the ISM non manufacturing index came in at 54.8, in line with expectations and versus 55.8 recorded the prior month. Two points: [i] remember anything over 50.0 signifies growth and [ii] while the manufacturing index may be slightly disappointing, both indices connote slowing economic growth not recession,
(b) on the other hand, August factory orders fell 3.3% versus expectations of a 2.4% decline; ex transportation, orders dropped 1.7%. This number is not dissimilar to last week’s durable goods orders data, i.e. the weak August numbers followed very strong July statistics [+3.7%]. If the two are averaged, the trend is still up.
Bottom line: the ‘soft’ landing forecast is in tact. The most important takeaways this week are (1) the improvement in the credit market psychology as witnessed by major financial institutions ‘coming clean’ about the extent of their exposure to sub prime mortgages--which I covered in several of this week’s blogs, (2) the return of liquidity to as measured by the successful completion of several large private equity buyouts and the return of the industrial sector’s ability to finance its operating needs in the commercial paper market [see The Market, Fundamentals below] and (3) the very positive September payrolls number.
They are important because they suggest that the Fed’s expansion in the monetary base, the 50 basis point reduction in both the Fed Funds rate and the discount rate appear to have been successful in unfreezing the credit markets and thereby (hopefully) diminishing the risk of recession. Since this crisis stemmed not from poor economic numbers but rather the loss of liquidity in the financial markets, I believe that means that, assuming the economic data continues to reflect a ‘soft’ landing, no more Fed rate cuts are necessary [and as an aside, it means that my harsh criticism of Bernanke at the peak of the crisis was premature--he is to be complimented for Fed’s handling of the sub prime problem].
http://article.nationalreview.com/?q=NDQxNWFiMTA2MjdmZmZhMjE0NDQ1ODQ0ZWRhZDQyMmU=
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. Re-read the article in Thursday’s WSJ, linked in Friday’s blog, if you doubt.
The Market
Technical
The DJIA is in an up trend defined by the approximate boundaries of 13105 and 14676. The S&P has remained above the 1527 resistance level for enough time that I have to at least acknowledge the likelihood that it is now in an uptrend. If so, that trend is defined by the boundaries of 1455 and 1585. Based on the inability of this index to hold the 1527 on five prior occasions, I am cautious about assuming that it will this time.
Fundamental
The DJIA (14066) finished this week more than 5% over valued (13781) while the S&P (1557) is somewhat (about 3%) above Fair Value (1513).
A couple of points:
(1) I discussed one result of the Citigroup announced earnings write off in Tuesday’s blog: improved investor psychology as major financial players own up to the extent of their exposure to the sub prime problem. There is another result: because of Citigroup’s heavy weighting in the S&P index, its write off has the affect of reducing the third quarter year over year earnings growth expectation for the S&P by one half.
I have made the point in prior discussions that short term earnings short falls don’t have much impact on the SSI Valuation Model; however, other investors may be adjusting expectations which could suggest some downward pressure on the S&P valuation. Given that this index as well as the DJIA is somewhat overvalued in the SSI Valuation Model, lower prices would simply move these indices to Fair Value--in other words, don’t be surprised if equity prices give back some of their current advance.
(2) this week the commercial paper market was able to not only roll over all maturing issues but finance new paper. As you know, one of my biggest concerns through this liquidity problem had been the inability of businesses to finance their day to day operating needs. This week’s activity suggests that the industrial sector of the refinancing market is returning to normal--that is a huge positive.
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,
(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 14066 1557
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:
Alliance Resource Partners L.P. produces steam coal, leases and operates a coal loading terminal on the Ohio River, resells coal directly and indirectly to utilities and provides mine products and services including the design and installation of underground mine hoists for transporting mine employees in and out of mines, design of systems for automating and controlling various aspects of industrial and mining environments and the design and sale of mine safety equipment. This partnership has earned a return on partners’ capital in excess of 100% over the last five years and has grown earnings and dividends at a 10%+ rate for the same time period. Environmental concerns notwithstanding, coal represents a major source of energy for the US and its sales should continue to grow at an attractive rate. The LP’s debt/equity ratio of 32% and its stock yields 5.1%.
EPS: 2006 $3.03, 2007 $3.75, 2008 $3.32; DVD: $1.92 YLD 5.1%
http://finance.yahoo.com/q?s=ARLP
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.
