The Closing Bell

The Closing Bell

Note: CJS wife and I will be leaving for the coast today (kids, grandkids, brother and sister) and will not return till New Year’s Eve Day. There will be no Morning Call until Wednesday January 2 and no Closing Bell next week. As always I will have my computer, will be monitoring prices and will notify you if any action is needed. My very best wishes for a Happy Holiday season.

12/22/07

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): 2.0-2.5%

Inflation: 1.75-2%

Growth in Corporate Profits: 3-5%

Current Market Forecast

Dow Jones Industrial Average

2007

Current Trend:

Medium Term Trading Range 12523-14203

Long Term Uptrend 11757-23751

Year End Fair Value: 13250

2008 Year End Fair Value: 14050

Standard & Poor’s 500

2007

Current Trend:

Long Term Trading Range 750-1527

Long Term Uptrend 1225-2400

Year End Fair Value (revised): 1525

2008 Year End Fair Value (revised): 1615

Percentage Cash in Our Portfolios

Dividend Growth Portfolio 12%

High Yield Portfolio 26%

Aggressive Growth Portfolio 16%

Economics

The economy is a positive for Your Money. Most of the economic data reported this week reflected trends already in place: housing terrible, the consumer and industry erratically stabilizing at a slower rate of growth. Two points: (1) we are nearing the point where the imploding housing market if not soon reversed will force another downward revision to my 2008 forecast for economic growth and (2) while progress is being made in defining the magnitude of the sub prime problem and clarifying its resolution, the recent steps taken by the Fed to address that resolution have been to date insufficient to relieve the lack of liquidity in the short term credit market and if not done could act as an accelerant pushing the US economy into recession.

(1) housing statistics continue to plummet as [a] weekly mortgage applications reversed their recent sharp rise, plunging 20%, [b] November housing starts fell 3.7%, though this was slightly less than expectations of down 3.9% and [c] November building permits dropped 1.5% versus estimates of a rise of .7%,

(2) the consumer numbers were generally positive: [a] November personal income rose .4% versus expectations of up .5% but up from +.2% in October, [b] November personal spending jumped 1.1% versus estimates of a .9% increase and a +.2% reading in October, [c] the International Council of Shopping Centers reported weekly sales of major retailers up 1.4% and up 2.1% on a year over year basis, while Redbook Research reported month to date retail chain store sales fell .6% versus the same period in November but were up 1.4% versus the comparable timeframe in 2006, [d] weekly jobless claims were up 12,000 versus expectations of a rise of 2,000, and [e] the University of Michigan’s revised December index of consumer sentiment came in at 75.5 versus expectations of 74.5 and November’s final reading of 76.1,

(3) there were only a couple of data points measuring industrial activity released this week and two of them were secondary indicators: [a] the NY Fed reported its December manufacturing index at 10.31 versus expectations of 20.0 and 27.37 recorded in November; while the Philadelphia Fed reported its December manufacturing index at -5.7 versus estimates of +7.5 and November’s +6.2 reading. Neither are good; but remember at least with respect to the NY Fed report, anything over 0 signifies growth and [b] third quarter corporate profits were reported flat with the second quarter number {which was up 5.2% versus the first quarter} and up 2% on a year over year basis,

(4) most of the data on the macro economic picture were slightly worse than expected though none were particularly worrisome: [a] final third quarter gross domestic product was reported at +4.9% versus estimates that it would be up 5%; the chain weighted price index was up 1.0% versus estimates of +.9% and second quarter’s rise of 2.6%, [b] another inflation index, the personal consumption expenditure index {PCE} increased in the third quarter at an annualized rate of 1.8% versus the originally reported 1.7% while the core PCE was up 2.0% versus the originally reported 1.8% and [c] November leading economic indicators were down {-.5%} more than expected {-.3%}.

The Fed

In my opinion, the Fed continues to be ‘the story’ in the economy; specifically, the longer the yield curve remains inverted and money supply tightly constrained (Fed policy (reading the data correctly)), the higher the probability of recession (the economy is weaker than expected). Indeed, I think the worse case is no longer just recession but a major recession accompanied by deflation. This is not a forecast; but it has become part of the spectrum of reasonable alternatives.

Bottom line: for the moment, I am leaving the ‘soft’ landing scenario (the economy’s rate of growth slows but does not stop) in place; in addition, inflation will continue to moderate. But another month or so of a collapsing housing industry and/or Fed ineptitude and, in my opinion, recession will become all but inevitable.

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 a negative for Your Money. By the time the next Closing Bell is written the 2008 political season will have begun. Forget what leading contenders of the Democratic party (Clinton/Obama/ Edwards) and Huckabee in the Republican camp are saying; look at their records on economic issues. (disclaimer) You may agree with the social implications of those records, but their impact when (if) carried out was (would have been) a negative for Your Money.

As we get into 2008, we will hopefully see more specifics on economic policy from all the candidates. As we get those policy statements, particularly on taxes, government spending, federal regulation and trade, I will include links to them.

http://www.clubforgrowth.org/2007/12/new_democratic_white_paper.php

The Market

Technical

The DJIA (13451) is in a trading range defined by 12523 (the August intra day low) and 14203; the S&P (1484) similarly is in a long term trading range of 750-1527 and a shorter term trading range (roughly comparable to the current DJIA trading range) of 1370-1573.

I noted in Thursday’s Morning Call that a price rise above 13314 (DJIA) would suggest a further move up--which we got Friday in spades. For this move to develop into anything significant to the upside, stock prices have to firmly break through 13696 (DJIA) in order to render meaningless what I interpret to be a head and shoulders formation that goes back to June.

Fundamental

The DJIA (13451) finished this week about than 1.5% over Fair Value (13250) while the S&P closed (1484) almost 2.5% undervalued (1525).

Again a couple of short notes:

(1) After a rough two weeks, then the arrival [at last] of the Santa Claus rally on Friday, I think it makes sense to once again point out that [a] the difference between the performance of the two major indices continues to be directly attributable to their respective relative weighting of the financial stocks; this is because there are a large number of [nonfinancial] stocks in our Universes that are at or near the high end of their Valuation Ranges and [b] despite Friday’s rally, the financial stocks still look terrible technically speaking; so until we get some sort of major reversal in sentiment among investors, I don’t see them ‘catching up’ anytime soon.

(2) between the option expiration and shorts running to cover, on Friday volatility picked up once again. Looking out into January, investors/speculators are pricing even more volatility into the options and futures than we saw in November/December. So it appears that we need to be ready for more 3 digit up and down days.

The point here is to not get too giddy about what looks to me like the typical (though late arriving) Santa Claus rally and to focus on individual stocks and our Price Disciplines. While I clearly didn’t adjust the Valuation Model fast enough to catch the rapid deterioration of the financials, our Price Disciplines have thus far served us well (with the sole exception of VF Corp--maybe) in a very volatile market. Discipline and caution remain the keys to managing our way through this Market.

Our investment strategy remains:

(a) continue to use our Sell Price Discipline to take profits in those stocks moving into their Sell Half Range and our Buy Price Discipline to average into stocks of great companies when they trade into their Buy Value Range,

(b) 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,

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

DJIA S&P

Current 2007 Year End Fair Value 13250 1525

Fair Value as of 12/31/07 13250 1525

Close this week 13451 1484

Over Valuation vs. 12/31 Close

5% overvalued 13912 1601

10% overvalued 14575 1678

Under Valuation vs. 12/31 Close

5% undervaluation 12588 1449

10%undervaluation 11925 1372

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 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: a $1.9 billion expansion in its Detroit refinery, a $3.2 billion refurbishing of its Louisiana refinery, the acquisition of Western Oil Sands ( a development in the Canadian oil sands), production projects in Norway, Equatorial Guinea and the Gulf of Mexico. MRO is rated A+ by Value Line and its stock yields 1.7%.

EPS: 2006 $6.42, 2007 $6.10, 2008 $6.25; DVD: $.92 YLD 1.7%

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

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.