9/17/08

Economics

Recent Data

The International Council of Shopping Centers reported weekly sales of major retailers fell 1.6% but rose 1.3% on a year over year basis; Redbook Research reported month to date retail chain store sales increase 1.4% versus the comparable period in 2007. These numbers are portraying a weak consumer.

The Federal Open Market Committee met yesterday and left the Fed Funds rate unchanged. In the accompanying statement, it nodded toward economic weakness but left inflation as its primary risk. As you know, I have been concerned about inflation but have also acknowledged that this risk is subsiding rapidly. So I am not sure this emphasis on inflation is the right move. On the other hand, the Fed has pumped about $130 billion of liquidity into the financial system in the last two day and that doesn’t count reserves being injected by foreign central banks--and that is a positive.

Here’s the statement:

http://online.wsj.com/mdcapp/public/page/2_3024-info_fedparse_shell.html

This morning: (1) weekly mortgage applications rose 2.4% largely on the back of lower interest rates, (2) August housing starts fell 6.2% versus expectations of a drop of 1.6%, and (3) August building permits declined 8.9%. Bottom line: no improvement.

Other

Ten little known facts about US trade:

http://www.chamberpost.com/2008/09/top-ten-overloo.html

More optimistic words in a negative environment:

http://www.clubforgrowth.org/2008/09/wise_words_from_brian_wesbury_1.php

Politics

Domestic

Some levity in current situation might help. This is hilarious:

http://www.clubforgrowth.org/2008/09/saturday_night_live.php

Immigration in an Obama versus McCain presidency--from the best Democratic blogger I know:

http://www.slate.com/id/2200209/#ilwmccain

Here is what our elected representatives (the House) have given us as an energy policy:

http://www.cqpolitics.com/wmspage.cfm?docID=news-000002952290

And here is the roll call vote:

http://clerk.house.gov/evs/2008/roll599.xml

International War Against Radical Islam

The Market

Technical/ Fundamental

Not very positive:

http://www.marketwatch.com/news/story/did-mondays-stock-plunge-constitute/story.aspx?guid=%7B61C4BD70%2D7D76%2D420D%2D84F2%2D66951B8D9697%7D

The latest chart on credit spreads:

http://bespokeinvest.typepad.com/bespoke/2008/09/high-yield-spre.html

A rally off a Fibonacci support level?

http://bespokeinvest.typepad.com/bespoke/2008/09/big-picture-poi.html

Update on the percentage of stocks above their 50 day moving average:

http://bespokeinvest.typepad.com/bespoke/2008/09/percentage-of-1.html

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On Tuesday the DJIA assaulted its July 2008 low (11809) and bounced, closing above that level. The S&P which had closed Monday below its July 2008 low (1198) also declined further in yesterday’s trading but like the DJIA finished the day above the July low. The good news is that the July lows have held and they did it on decent volume; but yesterday’s stock price advance just wasn’t characteristic of the bounce following an emotional sell off.

The likely reason is that American International Group dominated the headlines all day and its financial future remained unresolved as of the close. I don’t think it a stretch to rationalize that stocks really couldn’t move strongly to the upside in the absence of a solution to this dilemma.

Of course, after the close the Fed announced that it is going to make bridge loan to American International Group ala Fannie/Freddie; that is, it will put up $85 billion to provide capital (and secure the bond ratings) of AIG in exchange for 80% of the company. This, I think, ought to help lift the weight that prevented a stout bounce back in the Averages yesterday.

So now that we have it, what does it mean?

(1) It appears to be a culmination of a major re-ordering of our financial system; and I am not sure there are that many problems left with which to deal. After all, three of the top five investment banks are no longer. It doesn’t seem likely that Goldman and Morgan Stanley are in danger. Plus Fannie/Freddie which were disasters waiting to happen are gone. What’s left? Washington Mutual, Wachovia, maybe Citigroup. They might fail, but their problems are well known and they are much less leveraged than the investment banks. I don’t see their demise, were they to happen, as earthshaking as anything that we have been through this week.

(2) It raises the probability that the July 2008 lows marked the bottom of this cycle.

(3) I would have thought that it also increases the likelihood that our sale of shares at the open yesterday will turn out to have been wrong. However, as this is being written, stock futures are down. Frankly, I am more than a little surprised by this for the reasons outlined above. Indeed last night I would have bet anything that today we would see the spike in stock prices that would mark the bounce off the bottom. So what do I know? That said, I am making a list of the positions that our Portfolios will start re-building plus Adding some new stocks to our Buy Lists should stocks turnaround.

One final note: there are a lot of positive aspects to this Fed bridge loan to AIG. For one, it quite likely prevented a freeze up in the global financial system. Secondly, it keeps moral hazard (risk takers suffer the consequences for accepting an inappropriate level of risk) in the equation by wiping out most of the shareholder equity. However, as I said yesterday, I am bothered by the lethal combination of mark to market accounting coupled with the naked short sale rule. In AIG’s case, it had plenty of assets to support its liabilities; however, its liquidity was negatively impacted persistently by (1) the necessity of putting up extra capital because of the daily mark down of asset values and (2) the inability to raise that capital because the short sellers were destroying its credibility. I don’t have an answer to this problem; but our financial system is not going to regain long term stability till we solve it.

Subscriber Alert

Here is the list of potential Buy candidates (note that most are add-on shares to replace those that were sold generally at much higher prices to protect profits):

The Dividend Growth Portfolio: Home Depot (HD-$28), MDU Resources (MDU-$29), UGI (UGI-$27), Praxair (PX-$86), Emerson Electric (EMR-$43), General Dynamics (GD-$85), Linear Technologies (LLTC-$30), Automatic Data Processing (ADP-$44), T Rowe Price (TROW-$58), ConocoPhillips (COP-$72), ExxonMobil (XOM-$76), Chevron (CVX-$82) and Marathon Oil (MRO-$42). These will be 100-200 share additions taking these holdings to 2/3 to ¾ of normal size. Wells Fargo (WFC-$35) and Nucor (NUE-$47) are being Added to the Dividend Growth Buy List.

The High Yield Portfolio: Kimco Realty Trust (KIM-$38), Rayonier (RYN-$47), Realty Income Trust (O-$26), BP (BP-$52), Dow Chemical (DOW-$35), Gannett (GCI-$17), Universal Corp (UVV-$51). As with Dividend Growth Portfolio these are all 100-200 share additions. Worthington Industries (WOR-$17) is being Added to the High Yield Buy List.

The Aggressive Growth Portfolio: Franklin Resources (BEN-$95), XTO Energy (XTO-$50), Lowe’s (LOW-$24), Peabody Energy (BTU-$50), Accenture (ACN-$37), Donaldson (DCI-$42), Sun Hydraulics (SNHY-$30),l, Amphenol (APH-$45), Staples (SPLS-$25). Harley Davidson (HOG-$40) is being Added to the Aggressive Growth Buy List.

The Dividend Growth Buy List

Company Close 9/16 Buy Value Range

Aflac $58.44 $55-63

Automatic Data Processing 44.43 41-47

Colgate Palmolive 78.50 64-74

Federated Investors 33.06 30-35

Home Depot 27.58 27-31

Hormel Foods Corp 36.60 31-36

Johnson & Johnson 69.80 63-71

Manulife Financial 33.50 31-36

McDonald’s 64.69 59-68

Paychex 32.58 31-36

T Rowe Price 58.29 55-63

UGI Corp 27.12 24-28

News on Stocks in Our Portfolios

Positive comments on Abbott Labs (Dividend Growth Portfolio):

http://www.zacks.com/newsroom/commentary/index_pdf.php?id=8606

Positive comments on 3M (Dividend Growth Portfolio):

http://seekingalpha.com/article/95884-3m-is-just-the-right-stock-for-today-s-market?source=front_page_long_ideas

More Cash in Investors’ Hands

9/16/08

Economics

Recent Data

August industrial production fell 1.1% versus expectations of a .3% decline and a .1% increase in July; capacity utilization for the same period came in at 78.7 versus estimates of 79.5 and 79.9 recorded in July.

The September Empire State Manufacturing survey index reading was -7.4 versus forecasts of +.5%; looking at the internals of this index, there was a bright spot in new orders which were 4.5 versus expectations of -2.2.

Clearly, these are disappointing data from what has been the strongest sector of the economy.

The August consumer price index was reported down .1% (yeah, it was oil); core CPI was up .2%. Both were in line with estimates.

Other

Some positive notes on what looks like a negative day:

http://mjperry.blogspot.com/2008/09/resilience-of-american-finance.html

http://mjperry.blogspot.com/2008/09/factual-evidence-shows-significant.html

http://mjperry.blogspot.com/2008/09/when-it-comes-to-economy-we-have-become.html

Politics

Domestic

International War Against Radical Islam

The problem with Pakistan:

http://www.slate.com/id/2200134/#

The Market

Technical/ Fundamental

Technical thoughts on the market:

http://traderfeed.blogspot.com/2008/09/few-thoughts-about-current-stock-market.html

Charts on the S&P and the financial sector:

http://bespokeinvest.typepad.com/bespoke/2008/09/sp-500-and-the.html

***************************************

Yesterday the DJIA (10917) closed above its July 2008 intraday low (10809) while the S&P (1192) finished below its similar level (1198). The next support level for the S&P lies in the lower boundaries of the October 2007 to present downtrend (1152) and the May to August downtrend (1115).

In yesterday’s Morning Call, I held out the hope that by the close we would have a clearer technical picture than we had at the start of the day. I don’t feel like we do. On the positive side, (1) the DJIA held above its July 2008 low, (2) the volatility index spiked to above 30 [which is usually a sign of a bottom], (3) volume was typical of a bottom, (4) historically [4 out of 5 times] when stocks experience a day like yesterday, it marked a bottom and (5) despite the problems of Lehman Bros, Merrill Lynch and AIG and a big drop in oil prices, only a couple of our financial and oil stocks performed poorly. The bad news is that (1) the S&P didn’t hold its July 2008 low, (2) there was no price reversal and (3) most disconcerting, the stock price of a number of our Portfolios’ holdings pushed through their pre-set Stop Loss Prices.

What to do? If it was clear that a bottom had been made, our Portfolios would be buying today. If was clear that the July lows had been broken and further downside appeared ahead, our Portfolios would be Selling all or a portion of those holdings mentioned above whose stock prices fell below their Stop Loss. Unfortunately (at least for me) it is not enough of either. Plus today we get (1) Goldman Sachs earnings report and of more interest the narrative about its financial condition that will accompany, (2) the Fed meeting and (3) hopefully additional clarity in AIG’s crisis.

My dilemma is that if yesterday was the ‘flush’ and today is the ‘bounce’, any sale would be stupid. Of course, if yesterday was just the beginning of the ‘flush’ any sale will look like genius. As always, I am erring on the side of preserving principal. So this morning at the Market open:

Subscriber Alert

The Dividend Growth Portfolio will Sell (1) sufficient shares in T Rowe Price (TROW-$54) to reduce this position to a three quarter size holding (2) sufficient shares of Chevron (CVX-$80) to reduce this position to a one half size holding (3) it entire position in McGraw Hill. On MHP, it seems to me that ultimately S&P (which McGraw Hill owns) and Moody’s are going to be held responsible for their role in this financial crisis. They will almost surely survive; but I have no idea how much pain the shareholders will have to endure. This is a potential problem we don’t need at this time.

The High Yield Portfolio will Sell sufficient shares in Realty Income Trust (O-$24) and Universal Corp (UVV-$50) to reduce these positions to one half size positions.

The Aggressive Growth Portfolio will Sell sufficient shares in Charles Schwab (SCHW-$23) and Staples (SPLS-$24) to reduce these positions to one half size holdings. It will sell sufficient shares of Medtronic (MDT-$53) to reduce this position to a three quarter position.

I made the statement last week and 600 points ago that I would rather sell today with the objective to preserve capital and look stupid if the Market rallies afterward than not sell and lose money. Ditto today.

************************************

As a final comment with much longer term implications than anything said above, to ultimately correct the problems that led to this mess that we are in, something needs to be done about (1) the rules on short selling, particularly the naked short sell [selling a stock that can’t be delivered to the buyer], (2) the unbelievably, irresponsible high leverage ratios investment banks were/are able to assume and (3) the current application of the ‘mark to market’ accounting treatment of highly illiquid securities.

A look at the mark to market problem:

http://www.thestreet.com/p/_htmlrmd/rmoney/marketcommentary/10437271.html

A look at the risk management (high leverage) problem:

http://www.capitalspectator.com/archives/2008/09/nirvana_for_nib.html

Company Highlight

McDonald’s operates or licenses more than 31,000 fast food restaurants world wise. Over the past ten years, the company has grown profits at a 9% pace but dividends at 20% annualized while earning a 25%+ return on equity. Looking forward, the pace of advance of dividends should slow somewhat although earnings growth is expected to rise as a result of:

(1) despite the recent rise in commodity prices, the company’s purchasing power and menu diversity should fuel margin expansion,

(2) global growth not only in the number of restaurants but also in same store sales,

(3) introduction of new higher margin products [coffee, chicken],

(4) shorter term, the trade down from casual dining to less expensive fast food.

MCD is rated A++ by Value Line, carries a 42% debt to equity ratio, has an ongoing stock repurchase program and its stock yields 2.4%.

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

9/08

News on Stocks in Our Portfolios

A positive write up on McDonald’s (Dividend Growth Portfolio):

http://www.zacks.com/rank/zcommentary/?id=8586

More Cash in Investors’ Hands

9/15/08

Economics

Recent Data

A graphic look at the rebound in consumer confidence:

http://mjperry.blogspot.com/2008/09/consumer-confidence-rebounds.html

Other

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.). New estimates of the federal budget deficit are not positive:

http://www.heritage.org/Research/Economy/wm2057.cfm

This is a great analysis of how economic and stock market performance varies under Democrats versus Republicans:

http://www.poorandstupid.com/2008_09_07_chronArchive.asp#5994601770590690716

The Commodity Futures Trading Commission’s report to Congress on speculation in oil:

http://www.ibdeditorials.com/IBDArticles.aspx?id=306024468188608

A look inside the home foreclosure statistics:

http://mjperry.blogspot.com/2008/09/excluding-az-ca-fl-mi-and-nv.html

Some historical perspective on bank failures:

http://mjperry.blogspot.com/2008/09/were-still-long-way-from-real-banking.html

Are our Markets too de-regulated?

http://www.forbes.com/opinions/2008/09/12/lehman-greenspan-regulation-opinions-cx_br_0912ritholtz.html

Politics

Domestic

Palin and the Bush Doctrine, courtesy of ABC:

http://hughhewitt.townhall.com/blog/g/7656b78a-a090-4a56-9bf5-0e37bdaff80a

Palin and the bridge to nowhere:

http://article.nationalreview.com/?q=Y2FiMjBlNWE0ZTJhNDBjZWExYzA2M2M5MWZkYmFlN2I=

International War Against Radical Islam

The Market

Technical

Technical update from Traderfeed:

http://traderfeed.blogspot.com/2008/09/indicator-update-for-september-15th.html

Fundamental

As I am sure you know, today is going to be a wild ride. Lehman Bros is declaring bankruptcy, Bank of America is buying Merrill Lynch, American International Group is begging the Fed for a $40 billion bridge loan and oil prices are off $5 a barrel suggesting that the forced liquidation we witnessed last week is not over. Markets around the world are off 4-5% . Clearly my assertion in last week’s Closing Bell that the financial stocks in general appeared to have bottomed will get a stiff challenge. At the moment about the only good news is that our Portfolios have a 20-22% cash position.

The big question on my mind today will be, assuming the Market sells off big initially, will there be a rebound and if so, will that constitute the emotional sell off/test of the July lows that we have been looking for? I hope that we have an answer to that by tomorrow morning. In the meantime, remember our Portfolios own good quality, financially sound (even our holdings of financial stocks) companies that raise their dividends consistently, we have a cash position that provides stability of capital and a reserve to allow us to buy stocks of good companies inexpensively and a Sell Discipline that will help us continue to preserve capital.

News on Stocks in Our Portfolios

Walgreen (Aggressive Growth Portfolio) has made an offer to acquire Long’s Drug Stores for $3 billion in cash.

http://www.thestreet.com/story/10437222/1/walgreens-offers-to-buy-longs-drug-stores.html?puc=_htmlbtb

More Cash in Investors’ Hands