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): 0-1.5%
Inflation: 1.75-2%
Growth in Corporate Profits: 3-5%
Current Market Forecast
Dow Jones Industrial Average
2008
Current Trend:
Short Term Trading Range 11600-12511
Medium Term Trading Range 11600-14203
Long Term Trading Range 7100-14203
Year End Fair Value: 14050
2009 Year End Fair Value: 14471-14893
Standard & Poor’s 500
2008
Current Trend:
Medium Term Uptrend 1269-1722
Medium Term Trading Range 1062-1527
Long Term Trading Range 750-1527
Year End Fair Value: 1615
2009 Year End Fair Value: 1663-1711
Percentage Cash in Our Portfolios
Dividend Growth Portfolio 17%
High Yield Portfolio 22%
Aggressive Growth Portfolio 20%
Economics
The economy is a neutral for Your Money. There was lots of economic data reported this week, most of it mixed but with one devastating number--a very soft February non farm payroll report. This was the second decline in as many months. As you know, one of my favorite observations over the last year has been that we can’t have a recession when everyone has a job (income)--well, we now know that January’s payroll number wasn’t an aberration and that my favorite observation carries a lot less weight, suggesting that the economy is weaker than my current forecast. As a result, I am lowering (again) my expectations for 2008 real economic growth to 0-1.5% versus the current 1-2% projection. This reflects a slowdown in the first half of 2008 with a feeble recovery in the second half.
For the moment, I am leaving the inflation estimate unchanged though as you know I am growing increasingly concerned that it may be too low; I am also not revising my 2008 corporate profit number. Given the current excellent state of company balance sheets, including the lack of excess inventory, as well as strong global demand, I think that my forecast is still reasonable.
This week’s data points included: no real meaningful information on housing; only one bit of macro economic news which was the release of the Fed’s latest Beige Book showing a slowing economy but rising price pressures; consumer statistics that included a mixed picture of retail sales but also the aforementioned disappointing jobs report; industrial activity figures that were largely down, though in most cases better than forecasts.
Bottom line: the economy will ‘muddle through’ though at a very slow rate which could dip modestly into negative territory. Unfortunately I am also growing more worried about rising inflationary pressures (note the poor unit labor cost number as well as the commentary in the Beige Book) and the declining dollar. As a result, the Fed will almost certainly be forced to tighten monetary policy quickly once the liquidity crisis has passed and that suggests a weak recovery.
(1) the only housing related stat was weekly mortgage applications [secondary indicator] which rose 3%--the first increase in several weeks,
(2) all the consumer related data, save the retail sales numbers, focused on employment: [a] weekly jobless claims fell 22,000 versus expectations of a 8,000 decline, [b] on the other hand, February non farm payrolls dropped 63,000 versus expectations of being down 5,000; in addition, January non farm payrolls were revised from down 17,000 to a decrease of 22,000, [c] the unemployment rate at the end of February came in at 4.8% versus expectations of 5.0% and January’s reported 4.9%--but don’t get too excited; experts attributed the decline to a rising number of people dropping out of the labor pool, [d] finally, the International Council of Shopping Centers {ICSC} reported weekly sales of major retailers fell .6% while rising 2.1% on a year over year basis; Redbook Research reported month to date retail chain store sales declined 1.3% versus the comparable period in January while they increased a paltry .5% over the similar timeframe in 2007; the ICSC also reported that February retail sales {+1.9%} came in better than expected {0.5-1.0%},
(3) industry data contained both good news and bad news: [a] January construction spending fell 1.7%, in line with expectations, [b] the February Institute for Supply Management’s {ISM} manufacturing index came in at 48.7 {anything below 50.0 signifies contraction} though it was better than estimates of 48.0, [c] while the February ISM non manufacturing index was reported at 49.3 versus expectations of 47.2 and January’s 44.6 reading, [d] fourth quarter productivity was up 1.9% versus estimates of up 1.8%, [e] fourth quarter unit labor costs rose by 2.6% versus forecasts of an increase of 2.1% {remember in January, they fell 1.9%}, and [f] January factory orders declined 2.5% versus expectations of down 2.2%,
(4) only a single macro economic data point: the Fed released its latest Beige Book which basically said most geographic regions of the country and most economic sectors were experiencing weakness but price pressures were starting to increase.
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.
The Market
Technical
The DJIA (11893) is in a short term trading range defined by 11622 /11900 (the January intra day low/the January low close) and 12722 (the November 2007 intra day low). With the S&P (1293) I am watching the boundaries of the up trend off the 1982 low (circa 1282-1735), the 750-1527 2002-present trading range and the short term trading range comparable to the DJIA range (1269-1406).
I was hoping for an emotional sell off of Friday; and while stock prices were down (the DJIA closed ever so slightly below its January low close), there just wasn’t the kind of panic that exists when the Market bottoms (or tests a bottom). That likely means more agony early next week. Given that I believe that the Market is attempting to bottom, if we get an emotional flush, I will probably put a little money to work.
Fundamental
The DJIA (11893) finished this week about 11.5% below Fair Value (13449) while the S&P closed (1293) around 16.5% undervalued (1548).
Equity values were challenged this week by not only enhanced fears of recession (most specifically the February jobs report) but by concerns of the lack of liquidity in the financial system (the on again, off again Ambac re-cap; the margin calls at Thornburg and Carlyle). Given investor response to economic reports, it seems like the near term risks of recession have for the most part been discounted; it is the health of the banking institutions that appears to be causing investor heart burn. That said even though we got a daily dose of bad news on the credit markets, there was also news of financial institutions, corporations and the government taking action to address the crisis issues--not the least of which was the Fed’s announcement on Friday that it was increasing its credit facility to (liquidity impaired) banks. The $32,000 question is, are these measures sufficient enough to allow our financial system to manage and innovate its way out of the current very difficult situation or does it collapse on itself? with the $64,000 question being how much of either scenario is currently in price of stocks?
I, of course, have no clue. My back stop to this ignorance is our Price Disciplines, which will protect our Portfolios from large losses while keeping them in a position to benefit when, as and if investors realize the worse case is not going to happen.
Our investment strategy is to:
(a) use any price declines to buy positions in great quality companies whose stocks have either remained within their Valuation Range or have briefly traded below it but quickly rebounded (but keeping a minimum cash position of 15%),
(b) insure that my research on the Valuation Model especially for those stocks that have broken below or are near their Stop Loss Price is up to date and the Values generated by the Model reflect the current economic reality,
(c) build our Buy Lists, drawing largely from stocks on our Watch Lists as we review their financials and gain confidence in their Value Range [see (a) and (b) above],
(d) use positive days in the Market to Sell stocks that have traded into that ‘no man’s land’ between the lower boundary of their
(e) be mindful that the Market may very well not have bottomed; so our Stop Loss Discipline and a large cash position [see Percentage Cash in Our Portfolios above] remain critical,
(e) on a longer term basis, 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.
DJIA S&P
Current 2008 Year End Fair Value 14050 1615
Fair Value as of 3/31//08 13449 1548
Close this week 11893 1293
Over Valuation vs. 3/31 Close
5% overvalued 14121 1625
10% overvalued 14794 1703
Under Valuation vs. 3/31 Close
5% undervalued 12777 1471
10%undervalued 12104 1393
15%undervalued 11431 1316
20%undervalued 10759 1238
The Portfolios and Buy Lists are up to date.
Company Highlight:
Pfizer is a major producer of pharmaceuticals, hospital products and animal health lines. The company has earned a 20%+ return on equity and grown profits and dividends at a 14%+ rate for the last 10 years. PFE is facing patent expiration of over one half of its drug sales by 2011; because of that the stock has experienced lack luster performance over the past year and at current price yields over 5.5%. Nevertheless, PFE has a huge drug research program, is currently building it biotech business and will likely make acquisitions--all of which should mitigate its drug expiration problem. In addition, the company is likely to continue to grow its dividend at a 5%+ annual rate which when coupled with its current yield provides a competitive total rate of return. PFE is rated A
++ by Value Line and has only about 10% of its capitalization as debt.
http://finance.yahoo.com/q?s=PFE
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.
