The Closing
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 11600-14203
Medium Term Up Trend (?) 12516-16584
Long Term Trading Range 7100-14203
Year End Fair Value: 13250
2008 Year End Fair Value: 14050
Standard & Poor’s 500
2007
Current Trend:
Medium Term Uptrend 1269-1722
Medium Term Trading Range 1062-1527
Long Term Trading Range 750-1527
Year End Fair Value (revised): 1525
2008 Year End Fair Value (revised): 1615
Percentage Cash in Our Portfolios
Dividend Growth Portfolio 20%
High Yield Portfolio 25%
Aggressive Growth Portfolio 28%
Economics
The economy may be a positive for Your Money. This week’s data remained mixed which, in my opinion, indicates an economy bumping its way to a slower rate of growth. The one disconcerting bit of news was a second disappointing monthly jobs report--although the monthly figures seem out of whack with the weekly numbers and the decline in nonfarm payrolls appear in conflict with a lower unemployment rate. I am sure these inconsistencies will resolve themselves soon; and until they do, I am not going to get overly pessimistic about the employment picture (this also lessens my concern http://mjperry.blogspot.com/2008/02/recession-probability-66-only-1-out-of.html). Even if we assume the worst case, one of the results of the Fed’s actions in the last two weeks will be to moderate any economic weakness.
Speaking of the Fed, it remains, in my opinion, the key to the economy navigating its way through the cyclical slowdown and the sub prime financial problems. I have already commented on Fed related events in multiple Morning Calls, so I will only repeat my conclusions: (1) lowering the Fed Funds rate was a positive, (2) barring some terribly negative event, it needs to stop worrying about rates and (3) start focusing on growing the monetary base [which turned negative again this week for the 3, 6, and 12 month periods].
Bottom line: my forecast remains unchanged: slowing economic growth, moderating inflation.
(1) the housing numbers continue abysmal: [a] December new home sales fell 4.7% versus expectations of +0.4% result--no sign here of a housing turnaround and [b] weekly mortgage applications were up 7.5%--the fourth weekly increase in a row; applications for new homes declined while re-financings continued to rise dramatically.
(2) the data on the consumer were mixed with the employment figures especially disappointing: [a] December consumer income rose .5% versus expectations of an increase of .4%, [b] December consumer spending was up .2% versus estimates of up .1%, [c] the International Council of Shopping Centers reported that weekly sales of major retailers declined 1.2% though they remain up (1.3%) on a year over year basis; Redbook Research reported month to date retail chain store sales which fell .3% versus the similar period in December and rose a paltry .7% versus the comparable time frame in 2007, [d] on the employment front, {i} weekly jobless claims jumped 69,000 versus expectations of a 14,000 rise--the larger than expected increase was due, at least in part, to the impact of the Martin Luther King holiday, {ii} while January nonfarm payrolls fell 17,000 versus expectations of a rise of 75,000, {iii} although the unemployment rate came in at 4.9% versus estimates of 5%, [e] finally, {i} the Conference Board’s January index of consumer confidence fell to 87.9 versus December’s reading of 88.6 but better than analysts’ estimate of 87.0, {ii} while the University of Michigan’s January consumer sentiment index rose to 78.4 versus forecasts of a 78.0 reading and 75.5 recorded in December,
(3) industry statistics remain largely upbeat: [a] December durable goods orders jumped 5.2% versus expectations of an increase of 2.0%, [b] December construction spending was down 1.1% versus expectations of a .5% decline, [c] the Institute for Supply Management’s January manufacturing index increased to 50.7 versus forecasts of 47.0 and 47.7 reported in December, and [d] a secondary indicator, the January Chicago purchasing manager’s index fell to 51.5 versus 56.4 recorded in December and estimates of 52.5--a bit disappointing but 51.5 still designates growth,
(4) on the macro economic front, the news wasn’t so good: [a] the initial estimate of fourth quarter real gross domestic product {GDP} came in up .6% versus expectations of an increase of 1.2%; for all of 2007, real GDP grew 2.2% and [b] the fourth quarter personal consumption expenditure index {PCE} was reported up 3.9% {at an annualized rate} while core PCE rose 2.7%. {also annualized}; in another measure of inflation, the fourth quarter employment-cost index rose .8%, in line with expectations.
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. For me it was another depressing week on the domestic front which witnessed the Dem’s Presidential candidates arguing over who could give away the most money, raise taxes the fastest and impose the most regulations, the Senate arguing over how much money could (uselessly) be thrown at the electorate and W presenting his FY 2009 budget which projected a $400 billion deficit (see The Economic Risks #5 above).
The Market
Technical
The DJIA (12743) is either in a short term trading range defined by 11622 /11900 and 14203 or in a longer term uptrend defined by the boundaries of the 1982-present trend (circa 12500-16500). At the moment, the big technical question in my mind is whether or not the DJIA has regained the necessary momentum to keep in the 1982-present up trend. Given the distance and length of time the DJIA traded below the lower boundary of this trend, I want to allow it sufficient time to trade above it before assuming it to be the operative trend. With the S&P (1325) I am watching the boundaries of up trend off the 1982 low (circa 1269-1722) and the 750-1527 2002-present trading range. The number to be watching next week is the lower boundary of the DJIA 1982-present up trend (12559 at the close Friday).
Fundamental
The DJIA (12743) finished this week about 4.7% below Fair Value (13383) while the S&P closed (1395) around 9.4% undervalued (1540).
Once again, there is not much to add to the blow by blow narrative of this week’s Morning Calls. My bottom line: I believe that the Market has likely bottomed, though the volatility will probably continue. Our investment strategy is to:
(a) use any price declines to buy positions in great quality companies whose stocks have either remained within their Valuation Range or have briefly traded below it but quickly rebounded,
(b) insure that my research on the Valuation Model especially for those stocks that have broken below or are near their Stop Loss Price is up to date and the Values generated by the Model reflects the current economic reality,
(c) build our Buy Lists, drawing largely from stocks on our Watch Lists as we review their financials and gain confidence in their Value Range [see (a) and (b) above],
(d) use positive days in the Market to Sell stocks that have traded into that ‘no man’s land’ between the lower boundary of their
(e) be mindful that the Market may very well not have bottomed; so our Stop Loss Discipline and a large cash position [see Percentage Cash in Our Portfolios above] remain critical,
(e) on a longer term basis, 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.
DJIA S&P
Current 2008 Year End Fair Value 14050 1615
Fair Value as of
Close this week 12743 1395
Over Valuation vs. 2/29 Close
5% overvalued 13981 1608
10% overvalued 14647 1685
Under Valuation vs. 2/29 Close
5% undervaluation 12650 1455
10%undervaluation 11984 1378
The Portfolios and Buy Lists are up to date.
Company Highlight:
Johnson Controls is an industrial conglomerate supplying seating, interior and door systems to the automotive industry and providing advanced battery technology and systems engineering and installed building control systems. The company has earned a 15-18% return on equity and has grown profits and dividends at a 12-15% pace over the last 10 years. This record should be extended as a result of strong global demand in the commercial building markets, growing sales as well as improving pricing power in batteries and solid revenue gains in its North American and European automotive markets. JCI has a debt/equity ratio of approximately 27% and is rated A by Value Line. Its stock yields 1.5%.
http://finance.yahoo.com/q?s=JCI
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.
