The Closing Bell-11/8/08
Steve Cook on Disciplined Investing

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Note: I will be traveling Tuesday and Wednesday next week.  It will still allow me to produce a Morning Call each day; but they will be abbreviated.


  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 Trading Range                                      7853-9707
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 Trading Range                       839-1062
             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                  22%
    High Yield Portfolio                      22%
    Aggressive Growth Portfolio         22%

Economics

    The economy is a neutral for Your Money.  I have been holding out lowering my estimate of the potential length and depth of the current economic downturn and this week’s data doesn’t make it any easier.  The statistics were negative across the board and appear to be pointing to a pretty lousy fourth quarter.

    After being teased with a hint of improvement in the housing, we witnessed a resumption of poor numbers this week with weekly mortgage applications  down 14%.  Although, here is a little good news from another secondary indicator:
http://bigpicture.typepad.com/comments/2008/11/pending-home-sa.html

    Consumer related data was universally bad: both October and weekly  retail sales were sub par.  More important, the employment data--weekly jobless claims, October nonfarm payroll and the unemployment rate--were very discouraging and a clear sign that the recession is upon us.

    Finally, most of the measures of industrial activity were also disappointing.  Both Institute for Supply Management indices were well below estimates, September factory orders were much lower than forecast, and while September construction spending and third quarter productivity were better than expected, they nevertheless pointed at a deteriorating economy.

    It is becoming increasingly clear that the depth of the recession will be worse than I expected.  The fourth quarter gross domestic gross product (GDP) is setting up to be pretty bad.  Even so, it is not likely that it will be so poor as to drive the GDP number for this year outside my current forecast. 

The question is, how crumby will 2009 be?  Almost assuredly, the first quarter will not be good and will put the economy ‘officially’ in recession.  What is left to determine is its length. Given the problems in the financial system, my guess is that this recession will end up being longer than two quarters.  How much longer?  I  would like to have more information before making an educated guess; plus as I suggested in Friday’s Morning Call, Obama’s first moves as president-elect have me at least hoping that He will be more constructive on the economy than I would have thought two weeks ago and I want to give Him a chance to outline His economic agenda.  So I continue to procrastinate on a 2009 forecast.

The bigger question is how much of the economic bad news is in the price of stocks.  Barring a period of economic malaise like we suffered in the mid-1970’s, I think the worst has been discounted. (‘Barring’, of course, is the operative word.)  Nonetheless, assuming that I am correct, the next six to nine months will be a bumpy ride both economically and in the equities market.
 
 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.

The Market-Disciplined Investing
    
    Technical

The indices (DJIA 8943, S&P 930) closed near the mid point of my hypothesized trading range (DJIA 7853--9707; S&P 839--1062).  The rally that ended early this week was a second test of the upper boundary of this trading range and, in my opinion, supports defining it as a resistance level.  At the close of the week, stocks seem to be heading lower; if that continues, we should get a bit clearer delineation of the lower end of the range.  As you know, right now I have two candidates:  (1) the 10/10 intraday low [see above] and (2) the trend line connecting the higher lows off that 10/10 low (DJIA 8322, S&P 848).
 
The volatility index remains very high by historical standards, though it seems to be drifting.  I am going to choose to interpret this as increasing the likelihood that it is working its way lower--which is a positive for equities.  Volume remains low which is not a positive.
 
There was only faint signs that the problem of margin calls/fund redemptions was still around, though some experts say that the current abatement is only temporary.   Finally, as I noted above, there was little to cheer about on the economic front.  While stocks closed down by several percentage points for the week, they nonetheless are well above their 10/10 lows.  That suggests that investors are coming to grips with a recession and believe that the worst case is in the price of stocks.

   Fundamental-A Dividend Growth Investment Strategy

The DJIA (8943) finished this week about 34.3% below Fair Value (13616) while the S&P closed (930) around 40.0% undervalued (1552).

          We received additional information this week on the three big fundamental sources of uncertainty: (1) the credit crisis--where conditions continue to improve, (2) the shape of the recession--where the information flow keeps getting worse; but the big debate among investors right now is not whether things are going to get bad, it is how bad they are going to be--so the deteriorating data is not unexpected. (3) the shape of Obama’s [economic] policies.  I gave you my thoughts in Friday’s Morning Call; bottom line: he gets good marks in his first week.  That doesn’t mean that I will feel this way in a week or month; but right now, credit where credit is due.

Bottom line: unchanged ‘......, the goal of our current investment strategy is to gradually add stability of principal and position our Portfolios for the move up whenever that comes.  On a practical basis, that strategy calls for managing our Portfolios cash position between 15% and 25%, using weakness to buy stocks that have held their 10/10 lows and are making progressively higher lows and strength to sell stocks that either haven’t held their 10/10 lows or can’t make higher lows.’—to which I add, and those stocks that have gotten ahead of themselves on the upside.

As long as stock prices in general hold their October lows that will continue to be our strategy.  

Early this week as stocks rallied, our Portfolios Sold stocks that looked to be ahead of themselves but reinvested the proceeds because they were at our maximum cash position (25%).  Then on Friday, they Bought stocks, taking their cash position from 25% to 22.5%.  Further weakness will prompt additional Buying.

Our investment strategy includes:

(a)    manage our cash assets between 15% and 25%; but remain aware that defense is still critically important and will be become more so if I am wrong about the October 10 lows,

(b)    use price weakness as an opportunity to buy the stocks of attractive companies at attractive prices; use price strength to take profits when a stock’s price moves into its Sell Half Range or to move out of those stocks that traded below October 10 lows and can not recover,

(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                    1555
Fair Value as of 11/30//08                     13616                    1552
Close this week                                        8943                    930

Over Valuation vs. 11/30 Close
      5% overvalued                              14297                    1630
    10% overvalued                              14978                    1707
   
Under Valuation vs. 11/30 Close
    5% undervalued                             12935                    1474   
     10%undervalued                            12254                    1397
    15%undervalued                             11574                    1319    
    20%undervalued                            10893                     1242
    25% undervalued                            10212                    1164
    30% undervalued                            9531                    1086
    35% undervalued                          8850                          1008         

40% undervalued                                    8170                     931   

* Just a reminder that the Year End Fair Value number is based on the long term secular growth of the earning power of productive capacity of the US economy not the near term  the cyclical influences.  The model is now accounting for somewhat below average secular growth for the next 3 to 5 years with somewhat higher inflation. 

The Portfolios and Buy Lists are up to date.
   Company Highlight:

Sanofi-Aventis is the world’s fourth largest pharmaceutical company and the largest in Europe.  Its product line centers on cardiovascular, thrombosis, metabolic disorders, cancer, central nervous system drugs (Allegra, Plavix and Ambien) and vaccines.   In its current corporate form, the company has more than doubled profits in the last five years and almost tripled its dividend earning approximately 10% return on equity.  SNY is faced with a number of drugs coming off patent in the next couple of years as well as increased governmental pressure in Europe for cheaper pricing.  However, the company should still be able to grow profits and dividends 10% annually for the next 3 to 5 years as a result of:

(1)    its pipeline of new drugs,

(2)    acquisitions,

(3)    leading market share in the rapidly growing BRIC countries.

This dividend growth rate combined with its stock 5%+ yield provides an attractive total return for the High Yield Portfolio.  SNY is rated A+ by Value Line and carries a 9% debt to equity ratio.
http://finance.yahoo.com/q?s=SNY
11/08


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 40 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.








Posted 11-08-2008 10:14 AM by Steve Cook

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