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-again)
Real Growth in Gross Domestic Product (GDP): -1.0 - +1.0%
Inflation: 2-3%
Growth in Corporate Profits: 0-5%
Current Market Forecast
Dow Jones Industrial Average
2008
Current Trend:
Short Term Up trend 11281-12052
Medium Term Downtrend 10809-12747
Long Term Trading Range 7100-14203
Year End Fair Value (revised): 13450-13850
2009 Year End Fair Value (revised): 13850-14250
Standard & Poor’s 500
2008
Current Trend:
Short Term Uptrend 1258-1332
Medium Term Downtrend 1173-1395
Long Term Trading Range 750-1527
Long term Up Trend 1317-1797
Year End Fair Value (revised): 1533-1577
2009 Year End Fair Value 1595-1635
Percentage Cash in Our Portfolios
Dividend Growth Portfolio 20%
High Yield Portfolio 20%
Aggressive Growth Portfolio 20%
Economics
The economy is a neutral for Your Money. As I suggested in Monday’s Morning Call, after reviewing the economic data from the prior two weeks, my conclusion is that we have reached the point that the accumulated weight of evidence suggests that the economy is likely in some sort of negative growth phase. The poor housing market aside, the rest of the economy is by no means a disaster or even indicating a significant slowdown; but employment has been frail long enough and rising inflation is diluting the nominal improvements in the statistical data sufficiently that I have to infer that the numbers will meet the Labor Department’s definition of recession.
As a result, I have (1) lowered the forecast for real growth in 2008 to -1% to +1% [versus prior estimate of .5-1.5%], (2) raised the projected 2008 inflation to between 2% and 3% [versus prior estimate of 1.75-2%], putting it squarely above the Fed’s comfort zone (3) but left our previously lowered corporate profit projections unchanged at 0-5%. [the assumption being that this minor shading in my forecast is probably not enough to impact corporate profits enough to warrant altering the current range of expected profit growth.].
I don’t think these revisions cause for major concern; that is, I don’t think that economic outlook has suddenly turned any bleaker than has been obvious for some time. Indeed, at this moment, conditions may be as bad as they are going to get. These changes are minor when viewed in a macroeconomic sense and are more of an intellectual exercise than the recognition that conditions are much worse than I had originally expected.
On the other hand, I have become convinced that the problems in financial institutions have crippled them enough that their ability to finance future economic growth has been impaired and that should negatively impact the underlying rate of secular economic growth for the next several years--I am lowering the assumed growth rate of the economy by 1% annually for at least the next three years.
Plugging the new numbers and assumptions into our Valuation Model, I am lowering the 2008 Year End Fair Values for the DJIA to 13650 [versus 13850] and the S&P 500 to 1570 [versus 1593] and initiating 2009 Year End Fair Values for the DJIA at 14050 and the S&P at 1617. Importantly, even though the 2008 forecasts have been lowered and the 2009 are below where they might otherwise have been, equities are still undervalued.
This week’s data mirrored the general pattern of the last several months--directionless consumer statistics and reasonably strong industrial activity numbers:
(1) the only housing number was weekly mortgage applications which were up 2.8%,
(2) consumer related data were mixed: [a] June personal income was up .1% versus expectations of a .3% decline and a 1.9% rise in May, [b] June personal spending increased .6% versus estimates of .5% decrease and +.8 in May, [c] however, the June personal consumption expenditure index rose .8% and was up 4.1% on an annualized basis, making both June real income and real spending negative, [d] the International Council of Shopping Centers reported weekly sales of major retailers unchanged but up 2.9% on a year over year basis; Redbook Research reported month to date retail chain store sales up 3.5% versus the similar timeframe in 2007, [e] weekly jobless claims rose 7,000 versus estimates of a 23,000 decline,
(3) industrial activity remains the source of strength in the economy: [a] June factory orders jumped 1.7% versus forecasts of a fall of .6% and .6% rise in May, [b] the Institute for Supply Management reported its July non manufacturing index at 49.5 versus expectations of 48.3 and 48.2 recorded in June, [c] second quarter productivity rose 2.2% versus expectations of an increase of 2.4%--which is great news with regard to inflation and only adds to the positive momentum currently being generated by falling commodity prices, [d] second quarter unit labor costs were up 1.3% versus estimates of up 1.7%, [e] June wholesale inventories came in at +1.1% versus anticipated results of +.6%; however, as has been the case for the last six months, wholesale sales were up even stronger at +2.8%, driving down the wholesale inventory to sales ratio to a record low.
(4) the Fed met this week and left the Fed Funds rate unchanged. As noted in our Morning Call, while the language that accompanied the announcement of this decision was more hawkish than prior statements, investors interpreted it as dovish. Bottom line: the likelihood of a rate hike is very low for the foreseeable future.
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.
http://pajamasmedia.com/claudiarosett/please-lay-off-the-kool-aid-mr-president/
John Bolton on negotiations with
http://online.wsj.com/article/SB121789278252611717.html?mod=opinion_main_commentaries
The Market-Disciplined Investing
Technical
As volatile as this week was, at its end both the DJIA (11734) and the S&P (1296) closed above the upper boundary of the May 2008 to July 2008 downtrend as well as their January 2008 intraday lows. If one is hoping that the July lows marked the bottom in stock prices, this is a positive development. However as you know, for me just closing above a resistance point doesn’t necessarily mean a trend reversal. Rather I tend to want to have a combination of both additional ‘time’ (price staying above the resistance level for several days) and ‘distance’ (price continuing to trade to higher levels) before believing that a change in trend is real.
With Friday’s close, I think we have the ‘distance’ part covered; and while a little more ‘time’ would be nice, I think that we should start analyzing the movement of the Averages primarily within the context of two easily identifiable trends: (1) a short term uptrend off the July 2008 low defined by DJIA circa 11334-12073 and S&P circa 1259-1339 and a longer term downtrend off their October 2007 highs defined by DJIA circa 10816-12759 and S&P circa 1172-1345.
In shifting our technical focus, I am not saying that bottom in this Market is in; I am saying that the probability of it being in has increased. Given that plus the fact that using either or both of the new trends, one can see upside in stock prices. Bottom line: strictly from a technical perspective, this week’s fine performance argues for shifting toward a lower cash position on a trading basis.
Fundamental-A Dividend Growth Investment Strategy
The DJIA (11734) finished this week about 13.2% below Fair Value (13516) while the S&P closed (1296) around 16.6% undervalued (1565).
It was all about the rising dollar and plunging oil/commodity stocks this week--and that is a good thing in that they both have positive implications for inflation and the real cost of living for Americans. And not to be ignored, the current economic malaise has voters no longer quite so positively disposed toward some of the more obvious anti-capital planks in the Democrats platform (no drilling, higher taxes) which has Obama shifting to His right, philosophically speaking.
I am not arguing that the Dems have changed their stripes; but it may be that the problems in the financial and commodity sectors could either (1) decrease the likelihood of November rout by the Democrats or (2) even if they do win all three houses, prevent enactment of the more noxious proposals in their agenda. (Again I want to emphasize that you may agree with the economic/social objectives of the Democratic platform; my point is that many of those objectives are in conflict with maximizing the return on Your Money).
Interestingly even though oil traded down big this week, many of the stocks of the large integrated oil companies were up. I can’t improve on my conclusion in Thursday’s Morning Call:
‘........... over the past year, oil stock prices never advanced as fast or as far as the price of oil; so it seems reasonable to assume that in this decline, oil stock prices will either bottom well in advance of oil prices or if they bottom simultaneously, oil stock prices will not decline as fast or as far as the price of oil. Yesterday could be a signal that oil stock prices have bottomed irrespective of oil prices. ‘Signal’ is the operative word; but if the next couple of trading days reinforce this conclusion, our Portfolios will likely re-start re-building its positions in oil and related stocks.’
The other development worth mentioning relates to another point I discussed in Thursday’s Morning Call: the performance of the financial stocks. Wednesday their pin action could be rated ‘fair’ in the face of the huge losses posted by Freddie Mac. I suggested at the time that maybe this was a sign that much of the bad news from the financial sector was already in the stocks. Then Thursday AIG’s lousy earnings report along with Citigroup’s settlement with the state of
Saying that this is all too confusing may be stating the obvious. Clearly Thursday’s action demonstrated that not all the bad news from the financial sector is in the stocks. But perhaps the Wednesday/Friday financial stock pin action suggests that much/most (?) of the bad news is.
Of course, ‘perhaps’ is not a proposition on which one constructs investment strategy. On the other hand, with an improving technical picture, progress on inflation, a seeming bottom in the oil stocks despite oil’s continuing price decline, a less dismal political outlook, ‘perhaps’ can count for something. My bottom line, I want to start moving back toward managing our cash positions--this time utilizing a 15-20% spread. That means selling cash (buying stocks) during sell offs and buying cash (selling stocks) when stocks trade up. I do want to be cautious at this point simply because I don’t want to chase stock prices after a 300 point up day. So with any weakness, our Portfolios will start nibbling cautiously at stocks again, recognizing that the maximum increase in our stock positions will be about 5%.
Our investment strategy is:
(a) defense is still the guiding principle. Focus our Sell Discipline on [i] those stocks trading between the lower boundary of their
(b) watch Market technicals for confirmation that a bottom has been made; and in the mean time on a short term basis, resume buying positions in great quality companies whose stocks are trading within their
(c) on a longer term basis, recognize that there remain 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.
DJIA S&P
Current 2008 Year End Fair Value 13650 1570
Fair Value as of 8/31//08 13516 1555
Close this week 11734 1296
Over Valuation vs.8/31 Close
5% overvalued 14192 1632
10% overvalued 14868 1710
Under Valuation vs. 8/31 Close
5% undervalued 12840 1477
10%undervalued 12164 1400
15%undervalued 11488 1322
20%undervalued 10813 1244
The Portfolios and Buy Lists are up to date.
Company Highlight:
Nike designs, develops and markets an extensive line of footwear, apparel and accessory products for athletic and leisure activities through approximately 18,000 retail outlets in over 180 countries. Over the past five years the company has generated a 20% + return on equity, growing earnings and dividends in excess of 15% annually while carrying a debt load of only 6%. NKE should continue this level of performance as a result of (1) strong growth in the global market and (2) continued product line expansion in many sports, e.g. its recent acquisition of Umbro, a major factor in the soccer market. The company is rated A+ by Value Line and its stock yields 1.7%.
http://finance.yahoo.com/q?s=NKE
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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