The Closing Bell-7/24/10
Steve Cook on Disciplined Investing

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Next week I leave again.  Since I don’t depart till Tuesday morning, I will do a Monday Morning Call.  I don’t return till the following Tuesday.  So that week, I will do a Morning Call for the balance of the week plus a Closing Bell.
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Statistical Summary

   Current Economic Forecast
   
2009
   Real Growth in Gross Domestic Product:        -1.0 - -2.0%
   Inflation:                                                                    1-2 %
   Growth in Corporate Profits:                                  0- -5%

2010 (revised)

   Real Growth in Gross Domestic Product:        +3.0- +4.0%
   Inflation:                                                                    1.5-2.5 %
  Growth in Corporate Profits:                                       10-20%

Current Market Forecast
   
    Dow Jones Industrial Average

        Current Trend (revised):
          Short Term Trading Range                     9645-10725
          Long Term Trading Range                      6432-14180
                    
        2009    Year End Fair Value                                9440-9460

        2010    Year End Fair Value (revised)                 10095-10115
 
  Standard & Poor’s 500

     Current Trend (revised):
          Short Term Down Trend                           1009-1147
          Long Term Trading Range                        666-1575
               
         2009    Year End Fair Value                      1165-1185

        2010    Year End Fair Value                     1240-1260   

  Percentage Cash in Our Portfolios

    Dividend Growth Portfolio                  21%
    High Yield Portfolio                             20%
    Aggressive Growth Portfolio              22%

Economics
   
The condition of the recovery remains  uncertain, though the economic environment has improved recently.  However, for the moment, I continue to rate the economy, a neutral  for Your Money.
  There was a dearth of data this week and what there was did not paint a particularly pretty picture.  So you might ask, what’s with the above statement about a better ‘economic environment’?

(1)    yes, the economic stats haven’t been great but they have been less bad than many expected. As I noted in Friday’s Morning Call, that is not a clarion call to get positive; but if the numbers aren’t deteriorating at the rate of consensus expectation, then either the ‘double dip’ will be of a lesser magnitude than estimates or may not occur at all,

On the other hand, the ECRI leading indicators just gave a ‘recession’ reading:
http://www.zerohedge.com/article/ecri-leading-indicator-breaches-critical-10-threshold-hits-105

(2)    this earnings season is coming in quite well and more importantly, revenues are beating estimates and managements are providing optimistic guidance,

(3)    oil is no longer spilling out of the leaking BP well.  While there are still hurdles ahead, it appears that the worst of this situation is behind us,

(4)    the macroeconomic data out of Europe is better than forecasts.  In addition, results from the banking ‘stress test’ were released Friday afternoon: most banks passed. To be sure, the skeptics on this test may be proven right; and as you know, I have my own doubts.  So there remains the potential for bad news out of Europe; however, at the moment, it is not obvious,
http://www.businessinsider.com/chart-of-the-day-heres-the-adverse-economic-scenario-european-banks-were-tested-on-2010-7?utm_source=Triggermail&utm_medium=email&utm_campaign=CS_COTD_072310


And this assessment (short):
http://blogs.reuters.com/felix-salmon/2010/07/23/the-silver-lining-to-the-lenient-stress-test/

(5)    Chinese economic data as well as actions by its fiscal/monetary authorities suggest that the country is heading for a ‘soft landing’,
          
(6)    there are growing signs that the Obama economic/social/political agenda has reached its limits.  I am hesitant to get too jiggy this far ahead of the elections; but that is the way the cards are playing out at the moment.

And here’s the reason why there is no room for celebration (short):
http://gregmankiw.blogspot.com/2010/07/midsession-review.html

Bottom line: not that different from our last Closing Bell:  ‘each of the above...l holds the potential to be a major economic positive.  Of course, ....there is enough ‘hair’ on each to make it is unlikely that they will all prove to be pluses.  On the other hand, it would probably be equally unrealistic to assume that none of these factors will ultimately lead to an improved outlook for the US economy.  So as skeptical as I may be on any one of them, I believe that in total the prospects for a double dip have lessened and the odds of our short term forecast (an economy struggling but nonetheless growing) playing out have gotten better.  Indeed, there is even some chance that the longer term outlook (an economy growing but at an historically below average pace) could be somewhat improved if Obama is not faking His recent Clintonesque moves to the center--but I am not making any bets on that one.’

This week’s data:

(1)    housing: weekly mortgage applications rose 7.5%; June housing starts were very disappointing [which is OK because we already have too many houses] though existing home sales were not as bad as expected,
 
(2)    consumer: weekly retail sales were on the positive side of mixed; weekly jobless claims rose more than anticipated,

(3)    industry: no data this week,

(4)    macro:  June leading economic indicators came in better than estimates.
   
    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 negative for Your Money.
       
The Market-Disciplined Investing
    
  Technical

The indices (DJIA 10424, S&P 1102) successfully challenged the upper boundary of the down trend off the April high and then the last high of the down trend--in effect  insuring that the Averages have followed a higher low with a higher high (than 10413, 1099).  This re-sets the trend to a trading range which I speculate will be defined by 9645-10725, 1009-1147.  Increasing my comfort level is (1) higher volume on big up days, (2) better breadth and (3) the gradual improvement in our internal indicator.  The VIX remains the negative hold out; while trading down, it still closed above major support. 

Bearish sentiment near highs (short):
http://www.bespokeinvest.com/thinkbig/2010/7/23/sentiment-checkup.html

Bottom line:

(1) short term, the indices are likely re-setting to a trading range probably defined by 9645-10725, 1009-1147,

(2)    long term, stocks are in a trading range defined by the 2002/2009 lows [S&P 666-766] and the 2000/2007 highs [1545-1575].  Importantly, I think that equity prices will continue to recover within that range but it will be a slow and volatile process.

   Fundamental-A Dividend Growth Investment Strategy

    The DJIA (10424) finished this week about 6.0% above Fair Value (9833) while the S&P closed (1102) around 9.9% undervalued (1224).
 
This week’s news flow provided additional clarity to many of the headwinds that have overhung the Market of late (see the Economics section above).  Even better, stocks, at least as defined by the S&P, remain undervalued; and that notion is bolstered by the increased level of M&A activity which suggests that corporate management agree.  And the even better news is that those corporations have gobs of cash on their balance sheet to facilitate this activity; and if that isn’t enough, they can borrow all they want at the lowest interest rate in decades.

Certainly, all is not coming up roses.  There remain questions on the EU sovereign debt problem, the ultimate capping of the BP oil spill and just how Obama will react to His and dems poll numbers that are in a waterfall formation.  Really bad news from any of these could turn prices on a dime.  So I have no intention of driving to the hoop to get fully invested.  However, barring some devastating piece of news, our Portfolios will be working their way toward a 15% cash position; though as I noted Friday, prices are at the high end of (what I think will be ) the trading range.  So most of our Portfolios’ activity will be at lower levels of the trading range.
 
This chart indicates that stocks are still over valued:
http://www.ritholtz.com/blog/2010/07/total-market-capitalization-as-of-gdp/

17 reasons to be bullish, from David Rosenberg no less (short):
http://pragcap.com/17-reasons-to-be-bullish

This week, our Portfolios Bought a small amount of stock when equities broke out of their down trend.

           Bottom line:

(1)      our Portfolios will carry a higher cash balance than pre-financial crisis but it will be more a function of individual stock valuations and less on macro Market technical trends,
 
(2)    we continue to include gold and foreign ETF’s in our asset mix because we continue to believe that inflation is the major long term risk.  An investment in gold is an inflation hedge and holdings in other countries provide Angel a hedge against a weak dollar and Beer exposure to better growth opportunities,

(3)    defense is still important.

                                                                                          DJIA                    S&P

Current 2010 Year End Fair Value*               10105 (revised)                        1250 (revised)
Fair Value as of 7/31/10                                                9833                    1224
Close this week                                                             10343                   1104

Over Valuation vs. 7/31 Close
      5% overvalued                                                        10324                    1285
    10% overvalued                                                        10816                    1346 
    15% overvalued                                                        11307                    1407

Under Valuation vs. 7/31 Close
    5% undervalued                                                        9341                     1162
   10%undervalued                                                        8849                      1101
    15%undervalued                                                        8358                    1040   

* 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.


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 07-24-2010 11:00 AM by Steve Cook