The Closing Bell-12/6/2008
Steve Cook on Disciplined Investing


Have You Seen This?


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Have You Seen This?

  Statistical Summary

   Current Economic Forecast
        Real Growth in Gross Domestic Product (GDP):   -1.0 - +1.0%
        Inflation:                                                                    2-3%   
        Growth in Corporate Profits:                                 0-5%

Real Growth in Gross Domestic Product:                    -0.5 - -1.5%
                 Inflation:                                                       1-2 %
Growth in Corporate Profits:                                           0-5%

   Current Market Forecast
Dow Jones Industrial Average

            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

            Current Trend:
            Short Term Trading Range                      839(?)-1062
             Long Term Trading Range                      750-1527
            Year End Fair Value (revised):                 1533-1577
2009    Year End Fair Value                               1595-1635
  Percentage Cash in Our Portfolios

Dividend Growth Portfolio                  19%
    High Yield Portfolio                      18%
    Aggressive Growth Portfolio         19%


    The economic statistics remain dismal but may be having a diminishing impact on investor psychology.  One of the potentially positive takeaways this week was that a surprising number of the reported data points, while clearly registering a slowdown, were nonetheless better than expected.  In other words, estimates were for conditions to be worse than actually occurred; which in turn raises the question, are investor expectations now worse than what reality will prove to be?  To be sure, this is only one week of statistics; so I am not attributing any predictive value to what happened.  However should it continue, the economy could, at the least, cease to be a drag on Your Money.

    The only housing number this week was that of mortgage applications which soared 38.1% on lower mortgage rates and the seasonal impact of Thanksgiving week.  In addition, housing affordability was reported as its best in six years.

    In the consumer area, weekly retail sales were off but less than expected, November retail sales were also poor, weekly jobless claims were much better than estimated though November nonfarm payrolls were considerably more negative than most analysts had predicted; and finally, November auto sales were abysmal.

    Some perspective on the jobs report:

    Data on business activity were more disappointing: both Institute for Supply Management’s November indices showed contraction and at a more negative rate than forecast; October construction spending fell more than anticipated; however, factory orders while down were less than expected.

    Finally, third quarter productivity improved 1.3% which was more than estimated; but the result was a function of hours worked declining faster than the fall in output.
    In the arena of nonstatistical economic news, the Fed’s Beige Book reported weakness throughout all sectors and geographic segments of the country (that’s not news) although it did have its bright spots (lower prices); the Treasury is working on a plan to lower mortgage rates (that’s a wet dream which I hope stays under the covers) and the auto executives were once again in Washington, hats in hand (and proving once again that they still don’t get it).  Some kind of bail out will almost assuredly occur; we just have to hope that congress exercises its fiduciary responsibility and extracts the proper concessions.

    Please note that I have finally set a 2009 economic forecast.  It incorporates: (1) a very poor first quarter, a less poor second quarter and then a mild recovery in the third and fourth quarters. (2) a low rate of projected inflation; even though I am concerned long term about the ability of the Fed to sop up all the funds it is currently pumping into the system, that issue will not likely come into play until late 2009, (3) corporate profits which will be nothing to write home about, but should matter little since historically in the early stages of an economic recovery, investors are looking forward.  So 2010’s earnings outlook will become the relevant number as we move through 2009.

    Bottom line: it is not pretty out there.  When the stats are in, this quarter and next are going to make for depressing reading.  However, ever the optimist, I am taking heart from some of the less-worse-than-expected data released this week--if the economy is not deteriorating as rapidly as analysts think, then the next step is for it to start improving before they anticipate it. 
 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.)


Both the domestic and international political environments are a negative for Your Money.

The Market-Disciplined Investing

This week both indices (DJIA 8635, S&P 876)  traded within what will hopefully prove to be a trading range defined by a lower boundary of either their 10/10 (DJIA 7853, S&P 839) or 11/19 (DJIA 7424, S&P 740) lows and an upper boundary that is the last easily identified high (DJIA 9707, S&P 1062).  Friday’s action seemed to lend support to the notion that this trading range will prove to be the dominant trend and as a bonus both indices closed above their September to present downtrend (resistance) lines.

To briefly recap, at the Market close Thursday the S&P was only slightly above its 10/10 low (839); Friday, it opened below 839, traded there for a couple of hours and then moved up and closed above the aforementioned September to present downtrend line. The DJIA which closed Thursday a more comfortable distance from its 10/10 low followed a similar pattern as the S&P and like the S&P closed slightly over its September to present downtrend line. 

As you know, I like to see an index or stock trade above (below) a resistance (support) level for more than a single trading session before declaring it no longer of value.  However, if they do hold above those resistance lines in the early part of next week that sets up the potential for a test of DJIA 9707, S&P 1062.   For now, we simply  watch for follow through next week.

   Fundamental-A Dividend Growth Investment Strategy

The DJIA (8635) finished this week about 36.7% below Fair Value (13650) while the S&P closed (876) around 43.6% undervalued (1555).
    The two big questions on my mind going into next week: (1) does the slightly better than expected performance of some of the reported economic data released this week mean that the economy is starting to stop declining? and (2) does investors seeming new found willingness to buy stocks in spite of a couple of absolutely horrendous economic numbers and the ongoing clown show (the ‘auto bailout’) in Washington suggest that the worst of the economic decline is presently in the price of equities?   

Despite the fact that we won’t have the answers to those questions for a while, I think that the Market has stabilized sufficiently to resume our trading strategy (managing our cash position between 15-25% within the ‘hopeful’ DJIA 7853-9707) trading range)--our Portfolios’ purchases of stocks Tuesday morning and in the last hour of trading on Friday reflecting just that.  However, I re-emphasize that even if we gain visibility on the economy, what we will see is probably not a robust recovery; hence, I expect stocks to remain in the indicated trading range as investors come to grips with a slow and stumbling upturn. 

Of course, that optimistic (?) point of view could be all wrong.  There is still a lot about which to worry: the economy could collapse, the political class could make matters worse (think Hoover and FDR), the stories that I repeated in Friday’s Morning Call regarding coming massive hedge fund redemptions may be true and so on.  So defense and strict adherence to our Price Discipline are still critical to our strategy.

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 10/10--11/19 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 12/31//08                       13650                    1555
Close this week                                      8635                    876

Over Valuation vs. 12/31 Close
      5% overvalued                                14332                    1632
    10% overvalued                                  15015                    1710
Under Valuation vs. 12/31 Close
    5% undervalued                             12967                    1477   
          10%undervalued                        12285                    1399
    15%undervalued                             11602                    1321    
    20%undervalued                            10920                     1244
    25% undervalued                           10237                    1166
    30% undervalued                                9555                    1088
35% undervalued                                 8872                    1010
40% undervalued                                 8190                     933
45% undervalued                                   7507                     855

* 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   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:

Leggett & Platt is a manufacturer of bedding components, residential and office furniture, store fixtures, displays, die castings, specialty wire products, auto seating control cable systems.   LEG’s profits have shown little growth over the past 10 years though dividends have increased at an 11%+ rate.  Return on equity has been a modest 10-11%.  Nevertheless, the growth rate of profits and dividends are expected to pick up in the next couple of years because:

(1)    a shift in consumer preferences from foam and other alternative mattresses to innerspring mattresses,

(2)    LEG owns its own steel mill giving it a competitive price advantage in numerous products,

(3)    management efforts to streamline the company, shedding underperforming businesses [it expects to sell 6 in 2009]

(4)    the proceeds for the above sales will be largely used to buy back stock.

Leggett & Platt is rated A by Value Line, has a 37% debt to equity ratio and its stock yields over 7%.


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 12-06-2008 9:32 AM by Steve Cook


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