The Closing
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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 - +1.0%
Inflation: 2-3%
Growth in Corporate Profits: 0-5%
Current Market Forecast
Dow Jones Industrial Average
2008
Current Trend:
Short Term Up trend 11609-12373 (?)
Medium Term Downtrend 10781-12690
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 Uptrend 1293-1375 (?)
Medium Term Downtrend 1173-1395
Long Term Trading Range 750-1527
Long term Up Trend 1317-1797
Year End Fair Value (revised): 1533-1577
2009 Year End Fair Value 1595-1635
Percentage Cash in Our Portfolios
Dividend Growth Portfolio 17.1%
High Yield Portfolio 17.3%
Aggressive Growth Portfolio 16.9%
Economics
The economy is a neutral for Your Money though we were up to our snoot in poor economic data this week. The only positive news was from the consumer and that a result of these statistics being neutral in the midst of otherwise generally negative reports from the other sectors. What really dominated the headlines this week was (1) the increasing speculation over the collapse of Fannie Mae and Freddie Mac and how this latest chapter in the financial market crisis will be resolved and (2) the volatility in oil prices. We covered both of these issues in several Morning Calls and will opine a bit more below.
Finally, while we didn’t get much coverage of Bernanke’s speech on Friday, it should be a topic next week specifically because (1) he proposed a vast reformation of the banking system involving increased scrutiny by regulators and more accountability for management, and (2) as part of that, should a financial institution get in trouble, any resolution would wipe out the principal of equity holders AND much of the debt holders. Hooray for Ben if he can get this done.
Bottom line: (1) the economy is in a mild recession, (2) inflation is a problem but perhaps not as large a one as I originally thought, (3) the government has shown time and time again that it will not allow a major player in the financial markets to fail; there is no reason to assume that anything has changed. Nevertheless, I am a little surprised by the positive market performance as the anticipation mounts for a cathartic event and a subsequent government bailout of Fannie Mae and Freddie Mac, i.e. instead of stocks getting whacked because of fear of another major financial institution collapsing, they are rallying because investors are confident that the government will take whatever steps are necessary to insure the financial systems remain viable. [Granted, the rumors of an acquisition or capital infusion in Lehman Bros helped investor buoyancy.] Isn’t that a pretty good indicator that investors believe that the worst is over? (4) Friday’s price action notwithstanding, ‘demand destruction’ may not be quite the force some had hoped.
(1) housing remains a disaster: [a] July building permits declined 14.1% {-11% for home building permits} versus expectations of being down 13.8%, [b] July housing starts fell 9.5% versus forecasts of a decrease of 10.8%--I have said this before: poor housing starts are good news in that the only way to work down the current bloated inventory of homes is to NOT build new ones, [c] finally, weekly mortgage applications {secondary indicator} fell 1.5%,
(2) consumer related data were thin but at least neutral after a couple of poor weekly performances: [a] the International Council of Shopping Centers reported weekly sales of major retailers up .1% over the prior week and up 2.4% over the comparable period in 2007; Redbook Research reported month to date retail chain store sales rose 1.3% versus the similar timetable in 2007, [b] weekly jobless claims fell 18,000 versus expectations of a 5,000 decline,
(3) the only measure of industrial activity was the Philadelphia Fed’s August business activity survey {secondary indicator} which was reported at -12.7 versus estimates of -13.5 and -16.3 recorded in July--while the reported number may have been better than anticipated, it was still not encouraging,
(4) the macroeconomic statistics portrayed perfectly the current economy-- inflationary pressures and faltering growth: [a] July producer price index {PPI} came in at +1.2% versus estimates of +.4% and +1.8% recorded in June; while core PPI was reported at +.7% versus expectations of +.2% and June’s +.2% reading, [b] July leading economic indicators dropped .7% versus forecasts of a decline of .2% .
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.
Some thoughts on the longer term implications of the Russia/Georgia conflict (this is kinda long, but worth the read):
The Market
Technical
On Tuesday the DJIA and the S&P closed below the lower boundary of their July 2008 to present up trends (DJIA circa 11609--12373; S&P circa 1293--1375), remained there thru the close Thursday, then managed to close right on that lower boundary on Friday--the DJIA (11628) slightly above the support line, the S&P (1292) fractionally below. Whether the Tuesday to Thursday decline was an aberrant fall below a trend line or a legitimate breakdown is unclear to me because it is right on the cusp of the outer limits of the time/distance parameters I use to make that determination. In other words, I am very unsure about the short term trend and will wait for the Market to give me a better read.
However, there is no question that both indices remain firmly within a longer term downtrend off their October 2007 highs defined by DJIA circa 10781-12680 and S&P circa 1164-1389.
While my gut tells me that the July lows will be marked as the bottom, the current technical evidence is way too inconclusive to persuade me to spend anymore of our cash reserves until we get better clarity.
Fundamental-A Dividend Growth Investment Strategy
The DJIA (11628) finished this week about 14% below Fair Value (13516) while the S&P closed (1292) around 16.9% undervalued (1555).
This week we took our cash position from circa 18% to circa 17%, Most of that cash went into the energy sector of our Portfolios which on Monday was approximately one half of a Market weighting. Given Friday’s big decline in oil prices, that doesn’t look so smart at the moment, though (1) our purchases were confined to Wednesday and the Market open Thursday morning and (2) our Portfolios closing positions on Friday still equal only about 60% of a Market weighting. Nevertheless, the issue is, has oil bottomed? I think that it has, but the violence of oil’s price decline on Friday gives me pause.
So given that (1) we had suspended stock purchases in general on Tuesday when the Averages broke below the July to present upward trending support line, but (2) did nibble on energy stocks Wednesday and early Thursday because we thought that the energy sector had gotten too undervalued, (3) Friday’s pin action provided sufficient cognitive dissonance regarding both stocks in general and energy stocks in particular that I don’t want to do anything until I re-gain some confidence in what is happening both fundamentally and technically.
On a slightly longer term basis, our investment strategy remains:
(a) defense is still important--protect profits and avoid losses,
(b) watch Market technicals for confirmation that a bottom has been made; and in the mean time on a short term basis, resume buying positions in great quality companies whose stocks are trading within their
(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 1570
Fair Value as of 8/31//08 13516 1555
Close this week 11628 1292
Over Valuation vs.8/31 Close
5% overvalued 14192 1632
10% overvalued 14868 1710
Under Valuation vs. 8/31 Close
5% undervalued 12840 1477
10%undervalued 12164 1400
15%undervalued 11488 1322
20%undervalued 10813 1244
The Portfolios and Buy Lists are up to date.
Company Highlight:
Frontier Oil Corp is an independent energy engaged in crude oil refining and wholesale marketing of refined petroleum products. The company has grown profits and dividends in excess of 30% annually over the past five years earning a 25%+ return on equity. While profits in 2008 will decline, that appears well reflected in the price of FTO’s stock. Nevertheless, earnings should recover over the coming years as a result of:
(1) the company’s disproportionate exposure to diesel fuel which has sustained much higher margins than gasoline,
(2) its ability to process heavier, less expensive types of crude oil while still producing higher value added refined products,
(3) an aggressive capital expenditure program.
FTO is rated A by Value Line, has a modest 13% debt to equity ratio and its stock yields .8%
http://finance.yahoo.com/q?s=FTO
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.
