The Closing Bell-3/7/09
Steve Cook on Disciplined Investing

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  Statistical Summary

   Current Economic Forecast
   
2008
        Real Growth in Gross Domestic Product (GDP):   -1.0 - +1.0%
        Inflation:                                                                    2-3%   
        Growth in Corporate Profits:                                      0-5%
         
2009
         Real Growth in Gross Domestic Product:           -1.0 - -2.0%
         Inflation:                                                                   1-2 %
        Growth in Corporate Profits:                                      0- -5%

   Current Market Forecast
   
    Dow Jones Industrial Average

        2008
            Current Trend:
                Short Term Down Trend                         5461-7627
                 Long Term Up Trend                             3874-13539
                 Year End Fair Value (revised):                13450-13850
        
        2009    Year End Fair Value (revised):                12030-12070
 
    Standard & Poor’s 500

2008
            Current Trend:
            Short Term Down Trend                           346-772
             Long Term Up Trend                              592-1733
            Year End Fair Value (revised):                 1533-1577
   
2009    Year End Fair Value                                1370-1410

  Percentage Cash in Our Portfolios

    Dividend Growth Portfolio                  40%
    High Yield Portfolio                            43%
    Aggressive Growth Portfolio              35%

Economics

    The economy is a neutral of Your Money and is giving signs that it is struggling to find a bottom. However, if our political class doesn’t get its act together (i.e. address once and for all the solution to the toxic asset problem on the bank balance sheets), it could very well turn negative again.  Furthermore, barring some unforeseen turnaround in the policies already set forth (increased regulation, higher taxes, social versus infrastructure spending), even if the economy does find its footing soon, the recovery is apt to be sub par but with an uncharacteristically high probability of accelerating inflation. 
http://www.ritholtz.com/blog/2009/03/backdoor-bailouts-for-goldman-sachs/
http://www.ritholtz.com/blog/2009/03/ibanks-grabbed-50-billion-in-aig-bailout-cash/

    On that happy note, here’s the summary of this week’s economic stats which contained both good and bad news.

    The sole housing related number was weekly mortgage applications (secondary indicator) which dropped 5.6%.

    The consumer data was mixed with both January personal income and spending coming in above expectations, weekly retail sales soft but chain store sales in February better than forecast, February auto sales absolutely terrible and weekly jobless claims falling more than estimated while February nonfarm payrolls were down significantly though not unexpectedly.

    Measures of industrial activity were universally dismal though in several cases they weren’t bad as had been anticipated.  January construction spending was down more than estimates, both the Institute for Supply Management indices were negative albeit not as much as forecast and January factory orders were off but less than expected.

    The macroeconomic data included the January personal consumption expenditure (PCE) index which was up .2% with the core PCE up .1% and fourth quarter productivity which fell versus estimates of an increase while unit labor costs spiked more than anticipated.       

 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.

    Do I need to comment here?

The Market-Disciplined Investing
 
  Technical
   
    The indices (DJIA 6626, S&P 683) closed in a down trend whose boundaries are defined by approximately DJIA 5657-7793, S&P 556-799.  The nearest support level is the long term up trend line of both Averages which now sit a roughly the DJIA 3852, S&P 594 levels.  On a very short term basis, I am watching the S&P 741 as a resistance level when, as and if we get a rally.  

   
  Fundamental-A Dividend Growth Investment Strategy

The DJIA (6626) finished this week about 44.4% below Fair Value (11914) while the S&P closed (683) around 50.2% undervalued (1374).
 
          Clearly barring my total misreading of the economic environment (which I put at 30% in Friday’s Morning Call), stocks are significantly undervalued; and there is a growing chorus of pundits trumpeting that notion and suggesting that it is time to buy stocks.  And well it might be.

         However, as I have also noted, our task in this emotion charged Market is to be sure that we survive and have the chips to be at the table when conditions improve.  Hence, till there is some indication (a big flush or prolonged trading at these or lower levels), our strategy focuses on liquidity (cash 30-50%) and a hedged position (gold 0-10% and the S&P short ETF 0-10%).  Within our equity holdings, the focus is on those stocks that at a minimum hold their October/November 2008 lows.            

         As to our actions this week, once that it was clear that the S&P 741 support level had given way, our Portfolios reduced the size of most of their holdings and eliminated all bank, most insurance and most REIT positions.  In addition, they Added to their gold position and traded the S&P short ETF ending the week with no exposure.  As I noted in Friday’s Subscriber Alert, that is not a sign of bullishness but rather one of caution--I simply didn’t want to be short over a weekend.
 
        For the moment, our investment strategy includes:

(a)    manage our cash assets between 30% and 50%; and remain aware that defense is critically important,

(b)    insulate our Portfolios from the impact of future inflation by increasing the position in gold and adjusting the weightings of various industry sectors to favor inflation beneficiaries [see the 2/14/09 Closing Bell],

(c)    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 appears to have gotten ahead of its underlying company’s fundamentals or to move out of those stocks with weak relative price performance,

(d)    on a longer term basis, recognize that there are a growing number of fundamental factors that argue for increased caution and therefore to proceed carefully in anticipation of valuation and strategy changes that could result from the current extraordinary domestic economic agenda.

                                                                DJIA                    S&P

Current 2009 Year End Fair Value*        12050                    1390
Fair Value as of 3/31//09                        11914                    1374
Close this week                                        7062                    735

Over Valuation vs. 3/31 Close
      5% overvalued                                  12510                    1443
    10% overvalued                                  13105                    1511
   
Under Valuation vs. 3/31 Close
    5% undervalued                                  11318                    1305   
     10%undervalued                               10722                    1237
    15%undervalued                                 10127                    1168   
    20%undervalued                                 9531                     1099
    25% undervalued                                 8935                    1031
    30% undervalued                                 8340                     962
    35%undervalued                                  7744                     893
    40%undervalued                                  7148                     824
    45%undervalued                                 6553                     756
    50%undervalued                                 5957                     687
    55%undervalued                                 5361                     618

* 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:

     The CME Group is the largest futures exchange in the US and the largest clearinghouse in the world for trading futures and options on futures.  Annualized contract volume as of the end of the third quarter was 338 million.  The company earns a 10%+ return on equity which is expected to trend back toward its historical 20%+ rate as it reduces the debt it incurred as a result of recent acquisitions; it has grown its earnings and dividends in excess of 30% over the last five years.  That record should continue because:

(1)    CME has the most diverse product line of any exchange in the world and is experiencing strong growth across that range of products except for those that are interest rate related.  That growth has been achieved from:

(a)    acquisitions [Chicago Board of Trade, BM&F Bovespa exchange in Brazil, Credit Market Analysis and the New York Mercantile Exchange],
(b)    technological and new product innovation [e.g. E-mini S&P 500 futures]
(c)    the secular demand for derivative products for risk management,
(d)    clearing and transaction fees

(2)    operating leverage resulting from the increased revenue capture and scalability gained from electronic trading,

(3)    geographic expansion particularly in emerging markets.

      CME is rated A by Value Line, carries about an 11% debt to equity ratio and its stock yields approximately 2.5%.
       http://finance.yahoo.com/q?s=CME
       3/09


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 03-07-2009 10:20 AM by Steve Cook