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-again)
Real Growth in Gross Domestic Product (GDP): .5-1.5%
Inflation: 1.75-2%
Growth in Corporate Profits: 0-5%
Current Market Forecast
Dow Jones Industrial Average
2008
Current Trend:
Short Term Trading Range 11634(?)-13133
Medium Term Trading Range 11600-14203
Long Term Trading Range 7100-14203
Year End Fair Value (revised): 13650-14050
2009 Year End Fair Value (revised): 14050-14893
Standard & Poor’s 500
2008
Current Trend:
Short Term Trading Range 1325-1439
Long Term Trading Range 750-1527
Long term Up Trend 1317-1797
Year End Fair Value (revised): 1570-1615
Percentage Cash in Our Portfolios
Dividend Growth Portfolio 15%
High Yield Portfolio 14%
Aggressive Growth Portfolio 12%
Economics
The economy is a neutral for Your Money. The data this week were generally discouraging: housing continues to look like death warmed over (though in the sharply declining housing starts number lies improvement in home inventories), signs of strength in the consumer sector were nowhere to be found, business activity did little to help, only the broader indicators of the economy (positive surprises on the core producer price index and leading economic indicators) provided any up beat news. If this week’s reported results reflected similar statistics to prior weeks, I would be concerned. However, because they didn’t, I am a bit more sanguine. Nevertheless, they do suggest that my forecast is not a forgone conclusion and that I need to continue to re-evaluate it. Bottom line: No change in my assumption on economic growth or my rising concern about inflation.
(1) the housing statistics looked horrible though plummeting housing starts should help alleviate excess inventories: [a] May building permits fell 1.3% versus expectations of a 1.8% decline, [b] May housing starts dropped 5.5% in line with estimates, [c] weekly mortgage applications {secondary indicator} resumed their decline, falling 8.8%,
(2) consumer data were mixed: [a] the International Council of Shopping Centers reported weekly sales of major retailers rose .2% and +2.1% on a year over year basis; continuing to record counter trend results, Redbook Research reported month to date retail chain store sales down .9% versus the comparable period in May but up 2.1% versus the similar time frame in 2007, [b] weekly jobless claims fell 5,000 versus expectations of a 7,000 decline,
(3) measures of industrial activity were disappointing: [a] May industrial production fell .2%, in line with forecasts, and as compared to April’s .7% decrease, [b] May capacity utilization came in at 79.4 versus expectations of 79.7 and 79.6 recorded in April, [c] and two secondary indicators: the NY Fed reported its June manufacturing survey index at -8.68 versus estimates of -1.5 and -3.2 recorded in May; the Philadelphia Fed reported its June business activity index at -17.1 versus forecasts of -11.0 and -15.6 recorded in May,
(4) the macroeconomic numbers were modestly positive: [a] the May producer price index {PPI} rose 1.4% versus estimates of a 1.0% increase; while the core PPI was up .2%, in line with expectations, and [b] May leading economic indicators were up .1% versus forecasts that they would be unchanged.
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.
In last week’s Closing Bell, I commented that ‘.. the more I read and listen to the Presidential candidates define their positions, the more I worry...’. As you may recall, I was addressing the prospect of increasing penalties on capital resulting from a changing national economic agenda and their impact of stock valuations. This week both candidates demonstrated how little they understand about the commodity markets (they both want increased regulation) and the energy crisis (they are both bashing oil company profits and supporting restrictions on drilling in ANWR).
Here is an excellent article debunking the nonsense about commodity speculators:
And this is not to mention Obama’s willingness to treat as a criminal matter the risks that radical Islam poses to the safety of the lives and property of US citizens and McCain’s unwillingness, at least to date, to aggressively challenge the historical inaccuracies, the constitutional inconsistencies and the unnecessary risks of such a position if implemented.
In the same aforementioned Closing Bell, I stated that despite my concerns I was not going to alter our Valuation Model (again) yet. However, on Wednesday morning, I did take a material step in recognizing my worries by having the Aggressive Growth Portfolio start re-building its position in gold. As you know earlier this year, it had reduced its holding to about one third of a normal sized position (about 1% of the total Portfolio) when gold was near its highs. This latest move takes the
This is a small start. I hope that I am wrong and that the Aggressive Growth Portfolio has to Sell this position at a loss. But in my opinion, it is time to start creating a bigger hedge against a decided turn toward greater constraints on capital and a greater inflationary bias in government policies.
The Market-Disciplined Investing
Technical
As you know, this week the DJIA’s (11842) price action served to remove its April 2008 low as a support level (12263). It leaves open the question as where it will find support. Just looking at the charts, its January 2008 low (11634) seems the most likely. As an alternative, a number of technicians I talk to have been looking at 12000--among some, there is a lot of emphasis on the big round numbers as critical levels of support and resistance; but Friday’s DJIA performance makes that thesis suspect, at least this time around. My best guess at the moment is that the DJIA is indeed in a trading range but searching for a support level. The top to that trading range is DJIA 13133.
The primary driver of my ‘trading range’ conclusion lies with the S&P (1317). While it closed Friday below the lower boundary the long term up trend off its 1982 low (circa 1321) and its April 2008 low (1323), it was trading right on those levels 15 minutes before the Market closed--the point being that a last minute rush for the exit before the weekend is not the best indicator of future Market direction and, therefore, even a minor bounce Monday morning will put the S&P back above 1320 and at least for moment leave the aforementioned as support levels. Of course, even if it fails to do so, its January 2008 low (1269) would still remain as a potential major support level.
All that said, lurking in the weeds as a possible alternative trend is the very short term down trends of both indices from their May highs which could become longer term ones (boundaries DJIA circa 11857-12218; S&P 1311-1374).
Bottom line: even though there is no clear trend, I think the burden of proof is on the bears who will have to drive stock prices through the January/March lows to turn this trading range into a down trend.
Fundamental-A Dividend Growth Investment Strategy
The DJIA (11842) finished this week about 12.6% below Fair Value (13550) while the S&P closed (1317) around 15.2% undervalued (1553).
We are not short of reasons for this week’s whackage:
(1) continued carnage in the housing related [credit market] markets, though with the narrower spreads in the credit markets and the positive announcements from several regional banks on write-offs [or lack thereof] and dividends [raising them], it would appear that the banking system continues to heal itself,
(2) worries about higher oil prices, this week represented once again as an oil shortage resulting from a potential Israeli/Iranian showdown--the Israelis conducted war games rumored to mirror an attack on Iranian nuclear facilities. Lost in the hoopla was that those Israeli military maneuvers were a couple of weeks ago, roughly in the same time frame as the statement from the Israeli transportation minister threatening war with Iran—which, if you remember, also took stock prices down big time. Do we discount the same saber rattling twice?
(3) inflation. I voiced my confidence last week that Bernanke would hang tough and take the necessary steps to quell inflationary forces. Then this week, he made a couple of statements that could be interpreted as waffling. Further, several of the forward looking inflation indicators [real interest rates, the TIPS spread, the price of gold] are in their red zone. That has goosed up the rhetoric from the inflationistas; and quite honestly, their concerns can’t be disregarded. It would appear that the Market isn’t ignoring them and that’s one of the reasons stock prices are down [it raises the rate at which corporate earnings are discounted, i.e. lowers the price earnings ratio]. The good news is that the Fed meets next week and we will get a Fed policy statement to parse. Hopefully, it will firmly state the Fed’s resolve to fight inflation; otherwise I may have to retreat from my aforementioned faith in the Fed,
(4) See Politics above.
All that said, the question is, how much of the above is already in the price of stocks? Part of the answer is clearly that with the indices trading 12-15% below Fair Value, some of it, at the very least. Another part is that we never know where the bottom is until we look back.
Of course, it would be easy enough to point to my concerns about inflation and the election, point to our larger position in gold and do nothing. But I have (attempted to) priced a lower rate of return on capital into our Valuation Model and stocks are still undervalued; and the gold position is nothing more than a hedge against the worse case. So while both may argue for lower equity valuations, we already have that or at least some of it.
The point being that it is for times like these [i.e. when stocks are down big, uncertainty abounds and the Market action makes you want to puke] that our Price Disciplines were designed.
So Monday morning, our Portfolios will nibble (operative word) on those stocks that have remained in their
My final thought being that if I am wrong, our cash position and our Sell Discipline are there to protect our downside.
Our investment strategy is to:
(a) use any price declines to buy positions in great quality companies whose stocks are trading within their
(b) 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 [i] there remains an outside chance that the Market may not have bottomed and [ii] that notwithstanding, a number of our Holdings have traded into their Sell Half Range, so our Sell Disciplines remains critical,
(d) on a longer term basis, recognize that there are 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 13850 1593
Fair Value as of
Close this week 11842 1317
Over Valuation vs.6/30 Close
5% overvalued 14228 1636
10% overvalued 14905 1714
Under Valuation vs. 6/30 Close
5% undervalued 12872 1480
10%undervalued 12195 1402
15%undervalued 11518 1324
20%undervalued 10840 1246
The Portfolios and Buy Lists are up to date.
Company Highlight:
Cato Corp. operates 1,318 women’s fashion specialty retail stores in
http://finance.yahoo.com/q?s=CTR
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.
