The Closing Bell

The Closing Bell

10/27/07

Statistical Summary

Current Economic Forecast

2007

Real Growth in Gross Domestic Product (revised): 2.0- 2.5%

Inflation: 2 - 2.5 %

Growth in Corporate Profits (revised): 6-8%

2008

Real Growth in Gross Domestic Product (GDP): 3-3.25%

Inflation: 1.75-2%

Growth in Corporate Profits: 7-9%

Current Market Forecast

Dow Jones Industrial Average

2007

Current Trend:

Medium Term Uptrend 13224-14815

Long Term Uptrend 11757-23751

Year End Fair Value: 13250

2008 Year End Fair Value: 14250

Standard & Poor’s 500

2007

Current Trend:

Medium Term Uptrend (?) 1462-1592

Long Term Uptrend 1225-2400

Former Long Term Trading Range (?) 750-1527

Year End Fair Value: 1525

2008 Year End Fair Value: 1640

Percentage Cash in Our Portfolios

Dividend Growth Portfolio 15%

High Yield Portfolio 30%

Aggressive Growth Portfolio 17%

Economics

The economy is a positive for Your Money though I am admittedly hanging on to the ‘soft’ landing scenario by my fingernails--this discouraging tone at least partially a result of this week’s economic data which witnessed disappointing statistics in every sector. However, my stubbornness in sticking with the ‘soft’ landing forecast is anchored in the thought that the credit freeze up back in August was responsible for the economy’s poor August/September performance and with the return of liquidity to the (none sub prime) credit markets, economic activity should rebound. Bottom line: I will have to monitor this rationale closely and objectively over the next 3-4 weeks--and if it proves to be wishful thinking, adjust the SSI forecast accordingly.

(1) the stats on housing continue to be mostly lousy: while weekly mortgage applications rose .03% [the third week in a row; but remember this is a secondary indicator], existing home sales in September dropped 8% versus expectations of a decline of 3.6%. September new home sales appeared more promising [+4.8% versus expectations of -2.5%]; however, [a] new home sales are a small percentage of total home sales and [b] new home sales for the prior three months were revised down dramatically, lessening the positive appearance of the headline number.

http://bigpicture.typepad.com/comments/2007/10/no-new-homes-sa.html

(2) there was little positive news on the consumer:

(a) the International Council of Shopping Centers reported weekly sales of major retailers fell a whopping 1.5% [more than offsetting last week’s rise of 1%]; year over year sales were up 2.2%. Redbook Research reported month to date retail chain store sales declined .2% versus the comparable period in September but up 2.1% versus the similar 2006 period,

(b) weekly jobless claims fell 8,000 versus expectations of a decline of 15,000--the second week in a row that this report was weaker than anticipated,

(c) the University of Michigan’s final October index of consumer sentiment came in at 80.9 versus expectations of 82.0, the preliminary October reading of 82.0 and the final September index of 83.4 [a declining sentiment index tends to portend poor consumer spending].

(3) the only industry related data point was September’s durable goods orders which while confusing were still nonetheless a mild negative: orders dropped 1.7% versus expectations of a 1.5% increase. The chief culprit was a 39% fall in defense orders which are historically quite volatile; however, ex defense orders, the number was up only .7%--still a shortfall from the +1.5% expectation.

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 US economic growth.).

(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 negative for Your Money.

Domestic: Charlie Rangel’s ‘mother of all tax reforms’:

http://www.opinionjournal.com/editorial/feature.html?id=110010781

http://article.nationalreview.com/?q=NmUxNjM4YjM0MWMwNGFiNGFiYjlkZDk5ZDYzZmMyYjA=

International: Turkey attacking Kurds in Iraq; US imposes sanctions on Iran (these guys aren’t apt to take this laying down).

The Market

Technical

The DJIA is in an up trend defined by the approximate boundaries of 13220 and 14815. The S&P is in an up trend defined by the boundaries of 1462 and 1592; and I should note that it traded back above the 1527 level. As you know, I have been hesitant to buy into an S&P uptrend because heretofore while it has traded above 1527 on several occasions, it just couldn’t stay above it. However, in the recent sell off, it traded below 1527 and then rebounded quickly. All other things being equal that supports the view that the dominant trend is now up (1462-1592) versus the old trading range (750-1527).

Fundamental

The DJIA (13806) finished this week about 5% over valued (13125), the S&P (1535) slightly overvalued (1513). Under normal circumstances that would suggest that we might either be close to taking some money off the table or already doing so as some of our stocks hit their Sell Half prices--and we have taken some profits in the oil stocks. But in the last 2-3 weeks both the Dividend Growth Portfolio and the Aggressive Growth Portfolio have gone from a cash position of 2-3% to one of 15-18%; not because stocks are hitting their Sell Half Price but because financial and retail stocks are hitting their Stop Loss Prices. This is a great indication of how bifurcated and schizophrenic this current Market is.

It makes me once again realize the worth (unashamed plug) of a bottom up Valuation Model with strict Price Disciplines--because I can stop worrying about being torn between (1) an ‘iffy’ economy and a deteriorating political environment on the one hand and (2) the major indices appearing both technically and fundamentally sound on the other; I can stop agonizing over whether (1) this Market is climbing a wall of worry as some say or (2) there is a violent ‘mean reversion’ [either the housing, financial, retail and other consumer discretionary stocks rally hard or the industrial, material and technology stocks get whacked] in our future as others suggest.

It is great fun speculating about what is happening and will happen; but in the end, it is our Price Disciplines that determine the actions our Portfolios take. They tell us when stocks are cheap (sometimes a bit too early--think Citigroup and Merrill Lynch), they limit our losses when we are wrong and they force us to not be too greedy when we do well. That is what will get us through this very difficult and confusing Market phase whatever its outcome.

http://bigpicture.typepad.com/comments/2007/10/ursine.html

Our investment strategy is:

(1) use our Price Disciplines to take advantage of the ongoing heightened volatility to upgrade the quality of our Portfolios by Selling our weakest holdings and to take profits in those stocks rising into their Sell Half Range when prices spike to the upside and buying the stocks of great companies when opportunities present themselves [and the Markets dip],

(2) pay very close attention to the Stop Loss Discipline, occasionally moving the Stop Loss price above its historic level,

(3) insure that our Portfolios can ride out any further turmoil brought on by trouble in the credit markets

DJIA S&P

Current 2007 Year End Fair Value 13250 1525

Fair Value as of 10/31/07 13125 1513

Close this week 13806 1535

Over Valuation vs. 10/31 Close

5% overvalued 13781 1589

10% overvalued 14438 1664

Under Valuation vs. 10/31 Close

5% undervaluation 12469 1437

10%undervaluation 11812 1361

The Portfolios and Buy Lists are up to date.

Company Highlight:

Reynolds American is the second largest producer of cigarettes in the US; its brands including Winston, Camel, Salem, Pall Mall, Kool, Vantage and Doral. The company has earned a 16-18% return on equity over the last five years on a capital structure with 38% debt. It has also grown profits and dividends in the 8-10% range which when coupled with a 5%+ yield on its stock provides an attractive total return. RAI should be able to continue to grow its earnings and dividends as a result of the strong worldwide demand for premium cigarettes and smokeless tobacco and management’s continuing focus on expense control.

EPS: 2006 $4.10, 2007 $4.50, 2008 $4.75; DVD: $3.20 YLD 5.3%

http://finance.yahoo.com/q?s=RAI

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.