The Closing Bell-12/20/08
Steve Cook on Disciplined Investing

Syndication

Have You Seen This?

News

  • Make money by accessing all our Portfolios, the supporting research and Price Disciplines using our paid subscription blog, Strategic Stock Invetments. Our work is focused on making money for our Portfolios not as some academic exercise in Internet investing. Check our performance (audited)--our Dividend Growth Portfolio has beaten the S&P by 500 basis points per year for the last seven years but with a beta of only .62. (Mandatory Disclaimer: past performance is not a guarantee of future results.) We give you everything you need to duplicate our results, in particular, a strict price discipline for both Buying and Selling.

Have You Seen This?


  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:        -0.5 - -1.5%
          Inflation:                                                                1-2 %
            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
            Year End Fair Value (revised):                 1533-1577
   
2009    Year End Fair Value                               1595-1635
   
  Percentage Cash in Our Portfolios

    Dividend Growth Portfolio                     17%
    High Yield Portfolio                               18%
    Aggressive Growth Portfolio                  18%

Economics

    The economy is a neutral to negative for Your Money.  The statistical data continue to tell a bleak tale.  However, I am staying with my current theme that the issue is not how bad the economy is, we all know that it is lousy.  The real issues are (1) has the worst been discounted in equity prices? and (2) indeed, is the worst already in the rear view mirror? 

I put the latter question into play two weeks ago because I got all jiggy with a number of reported data points that weren’t nearly as bad as the pundits had forecast.  Last week, there wasn’t a lot of numbers reported; and of those that were, the best that could be said was that they were mixed.  This week was not much different in the sense that there was not a lot of information; but it was different in that there was a more positive tone to the ‘mix’.  While nothing reported was an up tick, some of the data simply wasn’t as bad as had been anticipated. 

So  I leave (2) above on the table for consideration.  I am not yet arguing the case that the worst is over; but I am suggesting that we at least need to ditch our reflective pessimism and ask the question, if much of the poor economic news that we are bombarded with every day is not as bad as the experts thought that it would be, then by definition won’t all the current disheartening forecasts that incorporated those overly pessimistic estimates prove to be wrong?

In other words, is it possible that the recession won’t be as deep as the doomsayers prophesy? and getting back to (1) above since it is the important question relative to Your Money, is all this in the current price of stocks?  While it may be too soon to bet a lot of money on an answer to the affirmative, we are closer to it than we were three weeks ago; and perhaps more important, I am raising a caution flag to an overly pessimistic investment strategy.

Reviewing this week’s data:

In housing, weekly mortgage applications were down (again); and both November housing starts and building permits literally fell off a cliff--the silver lining being that a complete shutdown in home building is the single best means of dealing with a bloated housing inventory.  (I know, I’m just a cockeyed optimist.)

Retail sales were again disappointing although they were up on a week over week basis; and jobless claims not only fell but by more than was anticipated.

    In the industrial sector: (1) both the NY and Philadelphia Fed business surveys [secondary indicators] while down, were better than expected and (2) November industrial production declined but less than estimates.

    The macroeconomic numbers were (1) November leading economic indicators which were down, in line with forecasts but at one half the rate of decline as the October figure and (2) the November consumer price index which fell more than expectations. 

    Of course, there were several significant non-statistical economic developments this week:

(1)    the change in Fed policy announced following the FOMC meeting Tuesday.  I commented on this development in Wednesday’s Morning Call, so I’m not going to be repetitious.  However, I do want to address the criticism aimed at the Fed since.  Several weeks ago I noted regarding the somewhat erratic policy moves by Paulson that the US economy is struggling against a set of problems for which there is no road map.  To assume that every measure taken to correct this situation will work perfectly (a) postulates some sort of a priori knowledge or experience that simply doesn’t exist and, in my opinion, is unfair to those tasked with preventing the worse and (b) neglects to account for the intellectual flexibility of the policy makers to adjust and change as new information about the workability of those measures becomes available.

I repeat that with  respect to this latest move by the Fed.  Yes, it may not work.  Yes, even if it does work, it clearly carries with it the seeds of inflation.  Yes, there may be unintended consequences, perhaps both good and bad.  And yes, the critics provide a useful function in keeping us all aware and sensitive to the risks inherent in this proposed solution.  But my point is that before proclaiming Armageddon, maybe we should take a deep breathe and see if it starts to work.

(2)    W’s temporary bail out of the auto industry.  In these comments, I have       been critical of most efforts that have sought to temper the requisite measures needed to rationalize the operations of the Big Three and quoted experts a lot smarter than myself to bolster that case.  So I probably don’t have to spend a long time repeating all the shortcomings of W’s effort.  In the final analysis, he is simply kicking this can down the road.
 
As a final note, I do want to differentiate the efforts of our elected representatives to solve this problem versus the financial crisis--there is a well developed financial/legal solution (called Chapter 11 bankruptcy) for dealing with inefficiently run corporate enterprises and a rich history of its consequences both intended and unintended, neither of which suggest there is very much to fear except by those conspirators in the failed enterprise. 

This assessment of W’s bail out from my favorite center left analyst:
http://www.slate.com/blogs/blogs/kausfiles/archive/2008/12/19/baby-who-s-your-stakeholder-now.aspx


    In addition, there are a couple of outlier issues: (1) the plunge in the price of oil raising fears of an economic collapse--though traders I talk to tell me that much of the activity is related to year end hedge fund liquidation, (2) the sharp decline in the dollar--which at least some experts say will abate when the rest of the world catches up to the US in easing monetary policy and the (3) the potential negative psychological fall out from the Madoff fraud--which I see as risk only as a potential accelerant should investors faith be undermined by another major crisis within the financial system.

 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

      I opined last week that I was getting less concerned about the economic agenda of  Obama; however, in that brief discussion I linked to an editorial by Charles Krauthammer’s [http://www.washingtonpost.com/wp-dyn/content/article/2008/12/11/AR2008121102951.html?sub=AR ]           who argued that Obama’s conservative appointments in foreign affairs and economic posts were a cover for what will be a more centrally planned industrial policy. 

    I am not sure how one reconciles a conservative financial team and a planned economy; but this is a theme that others are starting to espouse.  So I think it makes sense to be much more cognizant of this as a risk as we digest other appointments and responses to economic developments.  His appointment of Carol Browner as Energy Secretary brings this to mind, given her record, as does his comments to date on the auto bailout.

    Related articles:
 http://article.nationalreview.com/?q=Y2E0YzYzNjIxNWQ0ODkxZjUwMTdlMWNlYzUwOGI0ZTQ=
 http://mjperry.blogspot.com/2008/12/bailout-nation-and-dangers-from.html

    Here is a slightly different take:
    http://online.wsj.com/article/SB122963694275719607.html?mod=article-outset-box

     Other subjects:

    Obama and Iraq:
    http://justoneminute.typepad.com/main/2008/12/the-christmas-g.html

    And Israel:
    http://hughhewitt.townhall.com/blog/g/bf2bd598-527f-456b-9b47-f3c48c949945

    And guess who gets a pay raise?
    http://thehill.com/leading-the-news/with-economy-in-shambles-congress-gets-a-raise-2008-12-17.html

The Market-Disciplined Investing
    
    Technical

This week both indices (DJIA 8579, S&P 887) closed below the November to present up trend which I had been focusing on for short term support.  With W’s announcement of a temporary auto bail out on Friday morning, I thought that it reasonably probable that stocks could recover above the November trend line.  But alas it was not to be.  That puts the DJIA 8133, S&P 839 lows as the short term support level and leaves the last trading high (DJIA 8996, S&P 913) as the short term resistance level.

    Longer term, I am still assuming a trading range defined by a lower boundary of either the 10/10 (DJIA 7853, S&P 839) or 11/19 (DJIA 7424, S&P 740) lows and an upper boundary of DJIA 9707, S&P 1062.

     While it is disappointing that stock prices could not hold that November to present up trend, the volatility index declined all week irrespective of whether stocks traded up or down.  That suggests that even though there may be some short term price follow through to the downside, there is for the moment a decreasing probability that it will accelerate into another major leg down.
 
    Here is a chart of the VIX:
    http://bespokeinvest.typepad.com/bespoke/2008/12/vix-sliding-fast.html

   Fundamental-A Dividend Growth Investment Strategy

The DJIA (8579) finished this week about 37.1% below Fair Value (13650) while the S&P closed (887) around 42.9% undervalued (1555).
         
    Nothing occurred this week to alter my assumptions that (1) stock prices have in general seen their lows but (2) sufficient damage has been done to the capital markets, that it is probably unrealistic to assume the economy’s ability to finance a V shaped recovery, (3) hence, equities will likely be stuck in a trading range for some time.  There may be some mustard seeds out there, as my buddy Larry Kudlow likes to say; but none are powerful enough to dissuade me from caution or to alter our strategy of managing our cash between 15-25%.

 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 appears to have gotten ahead of its underlying company’s fundamentals 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                                           8579                    887

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  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

    Proctor and Gamble is a major household products and cosmetics company with three divisions:

(1) Beauty and Health products: Cover Girl, Max Factor, Olay, Old Spice, Clariol Nice ‘n Easy, Pantene, Head and Shoulders, Wella, Pert, Ivory, Safeguard, Zest, Secret, Right Guard, Always, Whisper, Tampax, Actonel, Prilosec OTC, Vicks, Scope, Pepto-Bismol, Therm-Care, Metamucil, NyQuil and Oral B,

(2) Household Care:  Tide, Gain, Dash, Ariel, Downy, Frebreeze, Dial, Joy, Cascade, Swiffer, Mr. Clean, Crest, Iams, Eukanuba, Papmers, Luvs, Charmin, Bounty, Puffs, Pringles, Folgers, and Sunny Delight,

(3) Gillette: Gillette, Mach 3, Venus, Braun, Duracell.

Management’s objective is to consistently grow its sales and earnings through both the internal development and by acquisition of its portfolio of brand names.  Its strategy to accomplish this is to:

(1) aggressively expand its portfolio of brands through both acquisitions and new product development,

(2) finance a strong marketing effort,

(3) expand rapidly into faster growing developing countries,

(4) emphasize a faster growing, higher margin product mix [eg. health and beauty care products] and divest lower margin/non core operations,

(5) leverage core strengths through acquisitions.

The company should be successful in its objectives because it generates strong cash flow to not only finance the strategy described above but to also conduct a huge stock buy back program as well as raise its dividend every year.  Earnings and dividends have grown 10-11% for the last 10 years on a 15%+ return on equity and a reasonable debt/equity ratio around 26%.  Value Line rates the company A++; and its stock yields 2.8%.
http://finance.yahoo.com/q?s=PG
12/08

************************************************************************


    I leave this for you to contemplate over the Christmas holiday:
    http://article.nationalreview.com/?q=YTMxODc2NzY0OTNhODNhNmUwMjY5MzU2NzliMjA2NDY=

As you know, next week marks Christmas.  My dad and our son and his family were be with us and will be staying though New Year; and I have Christmas cooking duty.  Most importantly the following week means lots of fun times with the grandchildren.  As a result, no Morning Calls or Closing Bells will be produced for the next two weeks.  However, as always, I will stay close to market developments and if any actions are required in our Portfolios, I will  communicate via Subscriber Alert.



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 12-20-2008 11:48 AM by Steve Cook

Comments

TrackBack wrote
on 10-06-2010 9:10 PM

. . . .