The Closing
Next Saturday is the
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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 9816-11176
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 1099-1250
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 26%
High Yield Portfolio 31%
Aggressive Growth Portfolio 33%
Economics
The economy is a neutral for Your Money; although right now the issue for Your Money I think is less about how bad the economy is going to get and more about investors’ mind set. My point being that if one were to assume that present investor psychology is an accurate indication of future economic events, then things are going to get much worse and I will have underestimated the severity of the upcoming downturn (let’s not forget that barring the last couple of weeks worth of economic data, the economy is now nowhere near recession as defined by the official statistics keepers). However, the problem, as I suggested in Friday’s Morning Call, is that I am not sure whether it is a rapidly deteriorating economy that is causing investor duress or lousy investor sentiment that is leading to dire economic forecasts.
Of course, either way stock prices are down; but that still leaves the question, is it the economy’s fault? And the answer is that I don’t think so but we will have a better feel after the third quarter GDP numbers are in. For the time being I am sticking with my forecast of an economy with little to no growth.
The other economic issue is inflation which right now is not a problem--witness falling (plunging, cascading; you get the picture) commodity prices. However, as I have previously suggested, the Fed is pumping an incredible amount of money into the banking system and sooner or later that has to come out to avoid upward price pressures (inflation = too much money chasing too few goods). So inflation remains a matter about which we need to be concerned; just not today.
All that said, the economic data points this week made for pretty crumby reading. Weekly mortgage applications (secondary indicator) plunged 11%, though August construction spending was unchanged (versus estimates of decrease of .5%).
Consumer retail sales were weak, auto sales were horrible, August personal spending was flat, weekly jobless claims rose more than expected and September nonfarm payrolls fell at a recession like pace. The bright spot was August personal income which grew .5% (versus expectations of a .2% increase); and if we are to believe that at least a part of the current economic malaise is a function of the consumer spending too much and not saving enough, then higher income and lower expenditures would seem the remedy.
The statistics from industrial sector which, as you know, has until recently been the major source of economic strength were again disappointing. The September Institute for Supply Management’s manufacturing index fell to 43.5 while its non manufacturing index was basically flat. August factory orders fell 4% though the September Chicago purchasing manager’s index came in better than forecast.
Finally on a positive note, the core personal consumption expenditure index (inflation) rose .2% in August, down from +.3% in July.
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.
Perhaps part of the explanation to the ‘is it a rapidly deteriorating economy that is causing investor duress or lousy investor sentiment that is leading to dire economic forecasts’ dilemma is terrible job the political class has done managing the upheaval in the financial markets (in other words, its psychology). I have commented ad nauseum about their disgraceful performance in our Morning Calls; but I will add one final note--$150 billion in earmarks attached to the rescue plan. How can one not be discouraged when the individuals the people elect to govern responsibly can’t act in a national emergency without being self serving?
The Market-Disciplined Investing
Technical
Both indices (DJIA 10329; S&P 1099) closed below [1] their July 2008 lows (DJIA 10809; S&P 1198) and [2] the lower boundaries of the August 2007 to present downtrend, leaving the only identifiable trend as the May/August 2008 downtrend (DJIA 9816--11176; S&P 1099--1250). There is identifiable technical support level at DJIA 9707 and S&P 1062.
Today, it sure looks like I was wrong that the July lows marked the bottom. Which means unfortunately that stocks remain in search of one; and if the traders I talk to are to be believed, there isn’t going to be one until the hedge funds are done puking out stock. A bell won’t ring when that moment comes, but we should be able to see it in the indicators that I mention daily in our Morning Calls: volume, volatility and panic. If history repeats itself, one day the Market is going to be down big on high volume as total capitulation occurs. In the midst of that day, you are going to have stomach cramps; but that will be the time to buy.
Fundamental-A Dividend Growth Investment Strategy
The DJIA (10329) finished this week about 24% below Fair Value (13583) while the S&P closed (1099) around 29% undervalued (1550).
In my mind, what distinguished this week was (1) an unnecessarily messy political process that finally produced a reasonable but somewhat irresponsible solution and (2) the shift in investor focus from the essential need to pass the rescue plan to the fear that it either won’t work and/or if it does, it won’t prevent a serious recession--the center of attention being the functioning of the credit markets and to what extent their problems spill over into the economy.
Let me make two points:
(1) it seems reasonable to assume that credit market participants have been watching our beloved elected representatives to determine if steps legislated to be taken will bolster both the solvency of financial institutions and the liquidity of the distressed assets on their books. The action taken on Friday was a reasonably positive [in my opinion] start towards resolving those two problems. But of course, nothing yet has been implemented and, as the saying goes, the proof of the pudding is in the eating. So it is probably a stretch to expect that the fear level among credit providers [and by extension equity investors] would start to subside [credit markets remained vapor locked at the close of business yesterday] until after the Fed/Treasury begin to actually implement the procedures that will address the solvency/liquidity difficulties; and that is a couple of weeks away.
Furthermore, even after a plan is in place and assuming it is a workable one, it is still not likely to instantly assuage the fear of the participants in the credit markets. Historically, after a problem of the magnitude that we now face gets resolved, it takes a couple of months for emotions and behavior to return to normal.
The point here being that the negative psychology concerning the functioning of the credit markets and any possible fall out for the economy in general may be with us for a while.
(2) That said, I don’t believe the fact pattern necessarily argues that we are faced with some kind of economic calamity. The Fed is pouring money into the system to avert any liquidity problems, rumors abound of an impending Fed Funds rate cut and the FDIC has thus far shown itself reasonably adept at handling any intervening solvency difficulties--all of which should help keep the financial system in tact until the rescue plan is implemented and psychology improves.
Finally from a broader perspective, ask yourself these questions: if the financial system [and with it the economy] is about to implode, why are many bank stocks selling closer to their all time highs than their all time lows [think Wells Fargo {Dividend Growth Portfolio} and US Bancorp {High Yield Portfolio}]? And if all those mortgage related assets are worthless and will ultimately prove the undoing of our financial system [and the economy], why did Wells Fargo just raise the bid for Wachovia [by a lot]?
The point of this is: the fact that we don’t know exactly when or how the credit market ‘fix’ stemming from the rescue plan is going to work doesn’t lead necessarily to the conclusion that there is going to be a serious recession.
All that said, at the moment it matters less whether the Markets’ problem is an impending deep recession or just lousy psychology and more how we adopt investment strategy to deal with the current Market behavior whatever its cause.
I said last week that should the rescue plan pass, our investment strategy would shift from defense (preserve profits, avoid large losses) to a less defensive posture in which we would manage our cash position in what I thought would be a trading (non trending) Market.
However, as the week unfolded and the shift in investor focus became more apparent, the deterioration in the stock prices of companies in the material/industrial/transportation sectors kept our Portfolios firmly centered on our Sell Discipline and playing defense. As you know, I almost never argue with our Price Disciplines; so I am going to dismiss as premature the thought that our strategy would become less defensive following enactment of the rescue plan.
The bottom line: whether the economy deteriorates more than prior consensus or the current negative psychology is simply the ‘group think’ that occurs at emotional extremes, our Sell Discipline at the moment is paramount; and hence, our strategy remains defense, defense, defense, accepting that (and not to be repetitious), our risk is that we Sell and have to Buy stocks back at a higher price versus the alternative of Holding and risk prices being down considerably more.
My final thought (opinion) before sending this out: the economy is not as bad as the media is telling us or stocks are suggesting. Equity prices are going down because hedge funds run by a generation of kids who don’t understand risk have performed terribly and are being forced to liquidate stock because their investors are demanding their money back, not because the world is coming to an end. One day , we will get a panic sell off, the sellers will be gone and within days if not hours, the world view will change. We may have some gut wrenching days in between; but our Portfolios own the stocks of great companies, they have lots of cash, so they are going to be able to buy more stocks of great companies at cheap prices and if the worse case happens, our Sell Discipline will insure our principal remains in tact. Now enjoy the rest of your weekend; smok’em if you got’em.
Our investment strategy includes:
(a) defense--protect profits and avoid losses,
(b) use price weakness as an opportunity to buy the stocks of attractive companies at attractive prices; use price strength to take profits when a stock’s price moves into its Sell Half Range or to move out of those stocks that traded below their Buy Value Range in the recent decline but can not recover to within that Range,
(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 1555
Fair Value as of 10/31//08 13583 1550
Close this week 10329 1099
Over Valuation vs. 10/31 Close
5% overvalued 14262 1628
10% overvalued 14941 1705
Under Valuation vs. 10/31 Close
5% undervalued 12903 1473
10%undervalued 12224 1395
15%undervalued 11545 1318
20%undervalued 10866 1240
25% undervalued 10187 1162
30% undervalued 9508 1085
The Portfolios and Buy Lists are up to date.
Company Highlight:
Wells Fargo and Co is the fifth largest bank holding companies in the
(1) the bank has a strong capital and liquidity position which will be invaluable in generating strong growth in loans, deposits and fee income,
(2) it has a diverse geographic and business mix as well as a strong consumer franchise,
(3) its strong capital position puts it in a position to acquire assets at distressed prices then offer a wider range of products than the acquired company increasing the number of products purchased per household,
(4) WFC has an aggressive expense reduction program.
Wells Fargo is rated A+ by Value Line and its stock yields 4.5%.
http://finance.yahoo.com/q?s=WFC
10/08
Make money by accessing all our Portfolios, the supporting research and Price Disciplines at www.strategic-stock-investments.com. Our work is focused on making money for our Portfolios not as some academic exercise in Internet investing. Check our performance (audited)--our Dividend Growth Portfolio has beaten the S&P by 500 basis points per year for the last seven years but with a beta of only .62. (Mandatory Disclaimer: past performance is not a guarantee of future results.) We give you everything you need to duplicate our results, in particular, a strict price discipline for both Buying and Selling.
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.
