9/19/08

Economics

Recent Data

August leading economic indicators fell .5% versus expectations of a .2% decline and -.7% reported in July.

The September Philadelphia Fed manufacturing index came in at 3.8 versus estimates of -10.7 and the August report of -12.7. Even though this is a secondary indicator, it is first good news out of the industrial sector in a couple of weeks.

Other

AIG and ‘mark to market’ accounting:

http://online.wsj.com/article/SB122169320421449849.html

Politics

Domestic

More on the mischief currently going on in the Senate:

http://www.cato.org/people/jeff-patch

International War Against Radical Islam

The Market

Technical

Chart porn on yesterday’s turnaround:

http://traderfeed.blogspot.com/2008/09/anatomy-of-market-turnaround-tracking.html

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Well, it looks like yesterday was the day for me to be wrong for being too defensive. Both the DJIA and S&P bounced hard yesterday afternoon following the news that the Treasury was presenting a plan to Congress (last night) for the creation of a Resolution Trust type entity. Both indices closed above their July 2008 lows. As you know I am not a strict technician and I believe that trading one day below a support level no matter dramatic (Wednesday) followed by a bounce back above it (Thursday) doesn’t count as a break below it. This kind of pin action looks an awful lot like a selling climax. In addition, both volume and the volatility index spiked, providing additional evidence that Wednesday and Thursday marked a selling climax.

I hasten to add that doesn’t mean that we are in bull market, Indeed both indices are still well within the two downtrends about which I constantly talk. At the moment, I am assuming the stocks have made the technical bottom but will still struggle to establish a simple trading range. As I note below, maintaining a healthy cash position (15-20%) still seems reasonable; but our Portfolios posture are less defensive.

Fundamental

I begin with a quote from yesterday’s Morning Call: ‘But necessity is the mother of invention; and just like we saw no way out of an AIG bankruptcy on Tuesday, it took a day for a solution to arrive--the point being that there are a lot of very smart people working on solving the problems we are facing.’

It looks like there are several plans in the works involving a comprehensive solution to the credit crisis, the most talked about being a Treasury plan to revive a Resolution Trust type entity. While it is not clear how depressed assets on financial firms balances sheets will be transferred to the proposed government entity or how they will be valued, the objective here is to have the government implement a sweeping plan to re-instill confidence and liquidity in the financial system. Clearly, at this point, without knowing details of the plan, it is impossible to know whether or not it will work. But, not to be repetitious, there are a lot of smart people working to try and make it work.

Two other steps were taken: (1) the Treasury will provide FDIC type protection to money market funds If they meet certain conditions and (2) the SEC is suspending short sales of financial companies temporarily [I know that I have railed against the naked short sale {selling stock that you can’t deliver}; but short selling provide a useful function to the Market. So I think that this step is one too far.]

Are happy days here again? No. But as the outline of the Treasury’s RTC-redux plan becomes clear, it will at the least allow equities to find a valuation level absent the fear of financial collapse but commensurate with an economy with a crippled but in tact financial system that is likely to grow at a below average pace for some time. Hence, it doesn’t solve all our economic problems nor does it bring any clarity to the long term issue of the impact of a potential shift in the political landscape and what that shift might mean economically. But based on our Valuation Model, those problems were in the price of stocks at higher levels.

Bottom line: I am going to move back toward the strategy of managing our Portfolios’ cash position between 15--20%. Going into the game changing development, our Portfolios were approximately 34% in cash. In the Subscriber Alert yesterday, I noted that our Portfolios, as a first step, were moving toward a 17% cash position. The purchases yesterday took cash from about 34% to about 20%. It is clear that the Market is going to open up big. Before moving further towards a 17% cash position, I am going to wait for stocks to take a breathe and settle a bit.

News on Stocks in Our Portfolios

More Cash in Investors’ Hands

9/18/08

Economics

Recent Data

Weekly jobless claims rose 10,000 versus expectations of a 5,000 decline. Another disappointing number.

Other

More fiscal mischief from our elected representatives (this time it’s the Senate):

http://www.pajamasmedia.com/instapundit/archives2/024400.php

The receding risk of inflation:

http://mjperry.blogspot.com/2008/09/dont-worry-about-inflation.html

The SEC’s role in the collapse of the major investment banking houses (must read):

http://bigpicture.typepad.com/comments/2008/09/regulatory-exem.html

Comparing today’s crisis with those of the past:

http://mjperry.blogspot.com/2008/09/crisis-as-bad-as-great-depression-or.html

Speculators and the price of oil:

http://mjperry.blogspot.com/2008/09/study-shows-speculators-helped-lower.html

Politics

Domestic

McCain on Fannie/Freddie:

http://corner.nationalreview.com/post/?q=YTBiMjNlZjQzNTM4OGIwMTE3YTU5MjM2ZGVhYzY4NWU=

International War Against Radical Islam

The Market

Technical/ Fundamental

So much for the July 2008 lows and the hope of a rolling bottom. Both indices busted through their July intraday lows and remain firmly within the October 2007 to present downtrend (DJIA 10659-12579; S&P 1154-1375) and the shorter term May to August down trend (DJIA 9985-11296; S&P 1112-1263). Barring a big rally tomorrow, we need to be focused on lower support levels: the DJIA 2006 double bottom (10663--note its proximity to the lower boundary of the October 2007 to present down trend) and the S&P 2004 bottom (1062).

Two other factors to note: (1) the volume yesterday was lower than the prior two days, suggesting that the panicky puking out of stocks may have more to go, (2) the volatility index spiked to near 35, suggesting the opposite of (1) (see below).

I said in yesterday’s Morning Call that I thought that (1) given the Market’s performance on Tuesday, the likelihood that the worst of this Market cycle was behind us and (2) the reason being that the Fed’s action in the AIG crisis cleared the decks of the last of the major problems in the financial system. Wrong and wrong. If there is anything redeemable from that Morning Call is that (1) I felt uneasy enough with Market’s pin action that our Portfolios held off committing any cash and (2) the sales that we made last week which I thought were going to look really stupid now look like sheer genius [our Portfolios cash positions are now: Dividend Growth Portfolio 27%, High Yield Portfolio 29%, Aggressive Growth Portfolio 26%].

Yesterday’s Market really began to have the feel of the panics of 1970, 1974, 1987 and 2002. CNBC aired one depressing analysis after another. Worries about the collapse of the financial system are pervasive. Bad news is bad news and good news is bad news. The price of gold is spiking; Treasury bills are spiking--the 30 day cash management bills sold at a yield of .1%; the volatility index is spiking--now over 30; but be aware that it hit 55+ in the 2002 plunge.

A chart of volatility index:

http://bespokeinvest.typepad.com/bespoke/2008/09/vix-spikes-to-3.html

To be fair and balanced there are some positive things happening: (1) Morgan Stanley is reviewing merger alternative with several partners. (2) Washington Mutual has hired Goldman Sachs to find a buyer. (3) yesterday the SEC changed the naked short sale rule, which as you know from past comments, I think was a necessity. Here’s the new rule: [ http://www.sec.gov/news/press/2008/2008-204.htm]. (4) The Fed is making another massive injection of liquidity into financial system. [http://www.breitbart.com/article.php?id=080918083207.wh5hl7iv&show_article=1], (5) Voices are growing louder for the suspension or reform of the ‘mark to market’ rule. More : [http://www.thestreet.com/p/_htmlrmm/rmoney/investing/10437857.html]. (6) In addition, talks are gathering steam for the revival of the Resolution Trust.

Cramer on what can go right:

http://www.thestreet.com/p/_htmlrmd/rmoney/jimcramerblog/10437993.html

Traderfeed sees some technical positives:

http://traderfeed.blogspot.com/2008/09/quick-note-on-weak-market.html

Granted, I have no idea if any or all these will take place. But necessity is the mother of invention; and just like we saw no way out of an AIG bankruptcy on Tuesday, it took a day for a solution to arrive--the point being that there are a lot of very smart people working on solving the problems we are facing.

To be sure, I am not saying everything is fine. Indeed, our Sell Discipline is telling us to Sell stocks at the open this morning. Given what looks to be a positive opening, I am going to use it to lighten up on a few holdings.

Remember a couple of things: (1) many of these sales are to preserve profits, (2) sooner or later, the philosophy of that ‘I’d rather sell and buy back 5% higher than not sell and lose another 10-20%’ is by definition going to be the wrong move; I know that I have been saying that for the last 1500 DJIA points, but one day unless I get blind lucky, it will happen. If that is unacceptable to you, don’t sell. (3) our Price Disciplines will continue to protect us on the downside, (4) we have 25%+ in cash and the stocks we own raise their dividends [the cash return to you] on a consistent basis [meaning your cash flow is going up every year no matter what the Market does]; and even more important, the companies that they represent have the financial wherewithal to continue to pay those dividends, barring the end of the world, (5) the world is not coming to an end; but if it is, you have bigger concerns than what stock prices do today.

Subscriber Alert

Each of these sales will reduce the indicated holding to stipulated size:

Dividend Growth Portfolio: (1) to one half of normal: Manulife Financial (MFC-$32), Ingersoll Rand (IR-$32), Automatic Data Processing (ADP-$42); (2) to a three quarter of normal: Emerson Electric (EMR-$41), T Rowe Price (TROW-$53), VF Corp (VFC-$53). In addition, Northern Trust (NTRS-$70) is being Added to the Dividend Growth Buy List but no shares will be purchased at this time.

High Yield Portfolio: (1) to one half of normal: Bank of Nova Scotia (BNS-$40), (2) to a one quarter position: Plains All American Pipeline (PPA-$36) and Penn Virginia Resource Ptrs (PVR-$18). In addition, WP Carey & Co (WPC-$26) and Reynolds American (RAI-$47) are being Added to the High Yield Buy List but no shares will be purchased at this time.

Aggressive Growth Portfolio: (1) to a one half of normal position: SEI Investments (SEIC-$21); (2) to a three quarter of normal: Franklin Resources (BEN-$89), Avon Products (AVP-$40), Stryker (SYK-$62), Sun Hydraulics (SNHY-$29) and Accenture (ACN-$36). In addition, CME Group (CME-$321) is being Added to the Aggressive Growth Buy List but no shares will be purchased at this time.

Company Highlight

Philip Morris International is a recent spin off from Altria. It manufacturers, sells and distributes a wide range of tobacco products in markets outside the US. Operating profits from this segment of the old Altria business grew at an 11% annual rate. PM expects earnings to grow at a 10-11% rate in the future; given its commitment to payout 65% of profits, the dividend growth should match growth of earnings. The company is expected to earn a return on equity in the 50-60% range. Management believes earnings will advance based on:

(1) strengthening its brand through product innovations such as smoother taste, new tobacco blends and innovative packaging which provides pricing power,

(2) acquisitions [8 in the last three years] in particular into Asian markets [China, India, Bangladesh and Vietnam] where it had little exposure,

PM is rated B++ by Value Line, has a debt to equity ratio of about 30%, is in the midst of a $13 billion stock buy back program and its stock yields 3.5%.

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

9/08

News on Stocks in Our Portfolios

Positive comments on Peabody Energy (Aggressive Growth Portfolio):

http://www.zacks.com/rank/zcommentary/?id=8611

More Cash in Investors’ Hands

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