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): -1.0 - +1.05%
Inflation: 2-3%
Growth in Corporate Profits: 0-5%
Current Market Forecast
Dow Jones Industrial Average
2008
Current Trend:
Short Term Downtrend 10090-11477
Medium Term Downtrend 10658-12605
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 Downtrend 1122-1273
Medium Term Downtrend 1155-1374
Long Term Trading Range 750-1527
Long term Up Trend 1317-1797
Year End Fair Value (revised): 1533-1577
Percentage Cash in Our Portfolios
Dividend Growth Portfolio 22%
High Yield Portfolio 24%
Aggressive Growth Portfolio 22%
Economics
The economy is a neutral for Your Money; and, as we have been discussing, it is apt to stay that way for a long time. Our outlook is for the economy to progress at a -1% to +1% pace for the next 12 to 18 months. Unfortunately in the midst of this no growth/slow growth environment, in particular in its later stage when a recovery starts to have visibility, the Fed is likely to have a very difficult time balancing the removal of the enormous amount of money that has been pumped into the US financial system (which has major inflationary implications) with need to be sure that sufficient funds remain so that the appropriate level of credit is available for normal (non-speculative) needs--not a situation that’s apt to engender broad consumer or investor optimism. So my bottom line remains: a slow growth/no growth economy with the threat of inflation near term being minimal but accelerating dramatically as the economy begins to recover.
Last week’s economic statistics were of little informative value because (1) there weren’t that many of them and (2) many were influenced by Hurricane Ike. Housing data remained dismal with existing and new home sales as well as weekly mortgage applications considerably below estimates. On the consumer front, weekly jobless claims were disappointing. Likewise, the only statistic on industrial activity was durable goods orders which came in well below forecasts. Last, the final second quarter gross domestic product (GDP) numbers were released with growth recorded at +2.8% (below expectations of 3.3%), the price index at +1.1% versus expectations of +1.2% and corporate profits down 7.1% on an annualized basis. Again, save the second quarter GDP stats, most of the other data were negatively influenced by the effects of Hurricane Ike.
Of course, whether or not these results were of any significance pales in comparison to the real issue this week: the necessity of coming up with a fix to the financial system. Our Morning Calls provided a blow by blow account of developments on this front, so no need to repeat them here.
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.
You only had to be breathing this week to appreciate just how potentially negative our domestic political environment can be. I try to avoid voicing my personal political views (which are conservative and largely republican) in this commentary; but McCain’s behavior (hubris, self righteousness and total economic ignorance) and the partisan politics exercised by the democrats this week revealed just how poor the choices the electorate has this November.
Dick Morris who I have a lot of respect for and knows a whole lot more about politics than I do, disagrees totally with my views on McCain:
The Market-Disciplined Investing
Technical
Amazing as it is, both indices (DJIA 11143; S&P 1213) closed above their July 2008 lows (DJIA 10809; S&P 1198) leaving them in what I postulated last week as a trading range (DJIA 10809-11866; S&P 1198-1311). Given what transpired this week that technical conclusion today I think would be somewhat misleading because (1) investors have basically remained on the sidelines this week afraid to do anything ahead of clarity on the enactment [or lack thereof] and contents of Paulson’s rescue plan and (2) as of the close Friday, we still don’t know details of (1) yet and (3) consensus appears to be that once we do know, stocks will move big one way or the other. Bottom line: ordinarily I would be pleased with the technical condition of equities as of the close Friday and would be prompted to put additional cash to work; but I think that ahead of any clarity on the Paulson plan, any trend defining Market direction is suspect.
Fundamental-A Dividend Growth Investment Strategy
The DJIA (11143) finished this week about 17.7% below Fair Value (13549) while the S&P closed (1213) around 21.5% undervalued (1547).
This week has been all about how our government, in particular the political process, deals with the freeze up in the credit markets; and, of course, it is not over. If Paulson, Bernanke and some pretty astute investors are correct about the consequences of a failure to enact a rescue plan (i.e. that it would be economically catastrophic), a solution is needed and soon; and it is incumbent on those opposed to Paulson’s plan to offer an alternative or specific modifications.
That seems to be the process that our political class has been going through this week. To say that they have made it high drama (and not a small amount of hubris [McCain] and dishonesty [name someone who wasn’t]) is an understatement. (And as an aside in my opinion, we should all be ashamed for their behavior.)
Certainly, Paulson et al could be wrong in their analysis of the consequences of not acting; but to date I have seen only one expert argue that point of view with any cogency and none of the other naysayers have come to his support. My bottom line is that unless and until there is a reasoned opposition from a chorus of dissenters, the most practical thing to do is assume that Paulson et al are correct.
Here is the state of the negotiations as of
http://kudlowsmoneypolitics.blogspot.com/2008/09/paulson-cantor-plan-is-win-win-for.html
That this process would lead to stock price volatility is not astonishing, although I am actually surprised that the Market gyrations this week were as modest as they were. Certainly, the historically high level of the volatility index the entire week would have suggested much wider swings in stock prices. The only explanation I have for why this didn’t happen is that most investors were afraid to do anything which was reflected in unusually low volume.
How does this all bear on investment strategy? Following the introduction of Paulson’s plan two Thursdays ago, on the thesis that (1) it was comprehensive enough that it would work, (2) our elected representatives would respond to it in a responsible and mature fashion and (3) the Market technically had bottomed, I changed our investment strategy from ‘defense’ (protect profits, avoid losses) to managing our cash position between 15-20%. By the Market close on Wednesday, our Portfolios had acted accordingly and taken their cash from 30%+ to circa 19-20%.
Then Thursday, partisan politics got injected in the negotiations process, raising, it seemed to me, for the first time the real possibility that the plan could be derailed. When coupled with a dramatic rise in credit spreads (meaning basically that banks had ceased extending credit), I frankly for the first time lost confidence in my operating assumption for the preceding two weeks: that the system had to be fixed and, therefore, intelligent, responsible leaders would be sure that it was fixed.
As a result, our investment strategy returned to defense (protect profits, avoid losses) and our Portfolios immediately went to 22% in cash. Did I set our Portfolios up to be whipsawed if we get a rescue plan this weekend? Clearly. Will they be? I hope so because the alternative is worse. Bottom line: for the moment, i.e. Friday, our investment strategy is defense and will remain so until our political class comes to its senses and begins acting like adults.
However, assuming the enactment of a workable plan, we will go back to the less defensive strategy of managing our Portfolios’ cash positions between 15-20%. Underlying this strategy, I re-print a quote from last week: ‘.....as the outline of the Treasury’s RTC-redux plan becomes clear, it will at the least allow equities to find a valuation level absent the fear of financial collapse but commensurate with an economy with a crippled but in tact financial system that is likely to grow at a below average pace for some time. Hence, it doesn’t solve all our economic problems nor does it bring any clarity to the long term issue of the impact of a potential shift in the political landscape and what that shift might mean economically. But based on our Valuation Model, those problems were in the price of stocks at higher levels.’
http://www.capitalspectator.com/archives/2008/09/another_bailout.html#more
DJIA S&P
Current 2008 Year End Fair Value 13650 1555
Fair Value as of 9/30//08 13549 1547
Close this week 11143 1213
Over Valuation vs. 9/30 Close
5% overvalued 14226 1626
10% overvalued 14904 1701
Under Valuation vs. 9/30 Close
5% undervalued 12872 1469
10%undervalued 12194 1392
15%undervalued 11516 1315
20%undervalued 10839 1238
25% undervalued 10161 1160
The Portfolios and Buy Lists are up to date.
Company Highlight:
Marathon Oil is an integrated oil company though its refinery capacity is higher than its oil production. The company has grown its profits in excess of 20% over the last 10 years on a 15-20% return on equity. Dividend growth has been less than one half that pace though its expected rate of increase should rise above 10% annually over the next 5 years. Both earnings and dividends will be driven by several large projects in which the company is investing:
(1) expansion of its
(2) the acquisition of Western Oil Sands (a development in the Canadian oil sands),
(3) production projects in offshore
MRO is rated A+ by Value Line, has a 29% debt to equity ratio and its stock yields 1.7%.
http://finance.yahoo.com/q?s=MRO
9/08
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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.
