The Closing Bell

The Closing Bell

6/7/08

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 Up Trend 12710-13538

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 Uptrend 1386-1482

Medium Term Trading Range 1306-1841

Long Term Trading Range 750-1527

Year End Fair Value (revised): 1570-1615

2009 Year End Fair Value (revised): 1615-1711

Percentage Cash in Our Portfolios

Dividend Growth Portfolio 11%

High Yield Portfolio 14%

Aggressive Growth Portfolio 12%

Economics

The economy is a neutral for Your Money. On balance this week’s economic data was positive and supports the notion that while the economy may have slowed considerably, it has not slipped into recession. However, on Friday we got two disappointing pieces of news: (1) the May unemployment rate rose to a much higher level than anticipated and (2) saber rattling by the Israelis raised the prospects of a conflict with Iran with it all the attendant risks of a sharp drop in Middle East oil supplies (See #3 under Economic Risks).

Frankly, based on (1) the improving economic statistics over the last couple of weeks, (2) the fact that employment is a lagging indicator and (3) the non farm payroll numbers coming in better than expected, I am prepared to rationalize away the larger than anticipated rise in the unemployment rate on the seasonal increase in high school and college students looking for summer employment--at least until we get additional negative data. So absent a Middle East conflict (more on that later), I am not particularly discouraged and not altering the economic forecast.

(1) once again weekly mortgage applications {secondary indicator} were the only housing data; and unfortunately, they weren’t all that promising, falling 15.3%,

(2) consumer related numbers were largely negative with the real blow coming in the May unemployment rate: [a] May vehicle sales declined 10.7% versus expectations of 8.5% rise--the result of a plunge in truck sales, [b] the International Council of Shopping Centers reported weekly sales of major retailers down .8% but up 1.2% on a year over year basis; Redbook Research reported month to date retail chain store sales jumped 1.9% versus the comparable period in April and 1.8% versus the similar time frame in 2007, [c] weekly jobless claims fell 18,000 versus expectations of a rise of 1,000, [d] May non farm payrolls fell 49,000 versus forecasts of a decrease of 70,000, [e] the end of May unemployment rate came in at 5.5% versus estimates of 5.2% and 5.0% at the end of April,

(3) signs of industrial activity continue to improve: [a] April construction spending dropped .4% versus expectations of a decline of .6% and a .6% decrease in March; ex residential construction, activity was up 1.6%, [b] the Institute for Supply Management {ISM} reported its May manufacturing index at 49.6 versus estimates of 48.5 and 48.6 recorded in April, [c] the ISM’s May nonmanufacturing index {measures 60-70% of the economy} came in at 51.7 versus estimates of 51.1 and 52.0 recorded in April, [d] April factory orders rose 1.1% versus forecasts of an increase of .1%, [e] April wholesale inventories increased 1.2% versus expectations of +.5%; importantly, wholesale sales rose 1.4%, once again pushing the wholesale inventory to sales ratio down,

(4) the macro economic numbers were positive: [a] first quarter productivity was reported at up 2.6% on an annualized basis versus expectations of +2.4% and the +2.2% preliminary report, [b] first quarter unit labor costs rose 2.2% on an annualized basis versus forecasts of +2.1% and +2.8% reported in the fourth quarter of 2007.

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.

Surprisingly enough, on Thursday I wrote a comment for the Closing Bell on the decreasing risk in the international political environment which I have included unedited primarily because I think that Friday’s Middle East scare notwithstanding, it is correct. Indeed, I am not sure what to make of the Israeli cabinet member’s statement. There appears to be internal Israeli political reasons for it that are only tangentially related to content of the statement. Even assuming that internal politics weren’t the motivating factor, who in his right mind is going to announce to the world (and the prospective bombee) that the planes are on the way. To me that simply raises the risk of failure.

That said, I am not a military strategist. Nevertheless, while clearly a disruption in global oil supplies (It is not the price of oil but its availability that will cause severe economic dislocation.) remains a risk to our economy, it doesn’t mitigate my comments below whose most prescient point appears to be ‘and certainly there is an independent risk of some sort of confrontation with Iran or one of its proxies’.

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I haven’t said much on either the domestic or international landscape for sometime--preferring to simply let the headlines speak for themselves. However, I do think it time to shade the international environment less negative as a result of the progress in the war against radical Islam, in particular as it relates to the fight with al Qaeda.

Setting aside the issue of whether or not the US should have invaded Iraq in the first place, if captured documents as well as public statements by al Qaeda are to be believed, al Qaeda made the decision to focus its war against the US in Iraq. And if recent progress reports from Iraq including those from the main stream media are to be believed, US has gained the upper hand in this struggle. The investment point here being that to the extent that the US has destroyed/disrupted/defeated al Qaeda, the danger that existed of another attack from this source either in the US or against US economic interests elsewhere in the world has diminished. I am not smart enough to quantify that but it seems to me that should progress continue to be made, investors will intuitively factor that into stock valuations.

This isn’t to say that there is no probability of an al Qaeda sponsored attack; and certainly there is an independent risk of some sort of confrontation with Iran or one of its proxies. But it is to say that on balance, in my opinion, the international political environment is fraught with less risk than existed a year ago.

http://www.washingtonpost.com/wp-dyn/content/article/2008/05/31/AR2008053101927.html

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On the other hand, my concern about the course of the domestic political environment has not lessened. This being a perfect example of why:

http://www.townhall.com/Columnists/DonaldLambro/2008/06/05/nations_spending_totally_out_of_whack

But to be fair and balanced, on Friday the biggest news of the day was largely ignored; and it was the ignominious demise of the ‘cap and trade’ bill. To date, I have not voiced my own thoughts on this piece of legislation; but rather offered what I considered to be the best professional opinions on the subject (recognizing that editorial license exists). With its defeat (at least temporarily), I will, at the risk of sounding too strident, opine that were it to pass, this would have been one of the most economically egregious regulatory nightmares that ever to be foisted on the American electorate. The floor of the NYSE should have been jubilant. Clearly, I am somehow out of touch; but to me in terms of the impact on Your Money, this was by far the most important story of the day.

The Market-Disciplined Investing

Technical

Since the Averages broke their March to May up trend, I have been assuming that stocks were going into a trading range; the big question was at what level they would establish a lower boundary to that range. Initially, it appeared that the DJIA found support at its April 2008 level (12263) and the S&P at its August 2007 level (1370), although I speculated in Friday’s Morning Call that those levels could give way to lower boundaries. Little did I know.

Yesterday, the DJIA (12209) took out its April low (12263); the next visible support level is the January 2008 low (11634). The S&P (1360) took out its August 2007 low (1370) but it has several support levels to watch: [1] its April 2008 low (1325), [2] its 1982 to present up trend line (circa 1317) and [3] its January 2008 low (1269).

The immediate issue (hopefully to be answered clearly on Monday) is, will stocks snap back from Friday’s highly emotional sell off, re-establishing the DJIA April 2008 low (12263) and the S&P August 2007 low (1370) as the discernable low boundary of a trading range or will they continue to decline, setting up a new lower boundary? We’ll know soon enough. In the meantime, the one positive technical factor is that the S&P remains well within the bounds of its 1982 to present up trend.

The statistics on stock price performance following a -3% day:

http://bespokeinvest.typepad.com/bespoke/2008/06/dow--3-days.html

And:

http://bespokeinvest.typepad.com/bespoke/2008/06/looking-forward.html

Fundamental-A Dividend Growth Investment Strategy

The DJIA (12209) finished this week about 9.9% below Fair Value (13550) while the S&P closed (1360) around 12.4% undervalued (1553).

I gotta tell you, even though I thought stocks could have more downside technically, I am mystified by the stock price action on Friday. Yeah, the payroll numbers were a bit disappointing; but that was largely because the jobless claim data on Thursday was so unexpectedly positive. In reality, the payroll numbers were better than had been forecast earlier in the week.

http://bespokeinvest.typepad.com/bespoke/2008/06/unemplyment-rat.html

And yeah the statement by the Israeli politician was concerning; but no more so than the constant stream of vitriol spewing out Ahmadinejad and when is the last time one of his incendiary remarks touched off a 400 point decline? Besides as I suggested above, who in his right mind is going to go global with sneak attack?

In my opinion what happened was that the Middle East saber rattling caught oil traders with huge short positions by surprise, they panicked to cover because they didn’t want to go into a weekend where Middle East tensions could escalate and that stampeded the stock jockeys. Of course, that is only an opinion.

Re-inforcing my perhaps too Pollyannaish attitude is that, save a couple of stocks, virtually all of our positions remain both technically sound and within their Buy Value Ranges or higher. That may not last, but for the moment, it allows us the flexibility to do what I think is the most sensible thing: nothing and wait to see if there is a bounce back or follow through to downside on Monday.

The question may occur to you that if our Portfolios were Buying stocks on Thursday and Friday, why wouldn’t they be Buying stocks Monday. The answer is that if yesterday’s carnage had taken place within the confines of an established trend or trading range (i.e. if the decline had stopped at the DJIA April 2008 low and the S&P at its August 2007 low), our Portfolio would be Buying stocks on the Market open Monday. However, since we now have some uncertainty as to this trading range’s support level, it seems reasonable to hold off spending more cash till we have some clarity.

Our investment strategy is to:

(a) use any price declines to buy positions in great quality companies whose stocks are trading within their Buy Value Range,

(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 Buy Value Range and the Stop Loss Price but have been unable to recover into their Buy Value Range,

(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 6/30/08 13550 1558

Close this week 12209 1360

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

The Portfolios and Buy Lists are up to date.

Company Highlight:

Avery Dennison is a global manufacturer of self adhesive base materials, tapes, office products and specialty chemical adhesives. The company has grown dividends and profits at a 10 annual rate over the past 10 years, earning a 18%+ return on equity. AVY should continue this performance thanks to the recent acquisition of Paxar, expansion into overseas markets and improving profit margins. Avery has too high a debt to equity ratio (49%) as a result of the Paxar acquisition; but management expects to use free cash flow to rapidly pay down this debt. AVY is rated A by Value Line and its stock yields 3.3%.

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

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.