The Closing Bell-2/27/10
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:        -1.0 - -2.0%
     Inflation:                                                                      1-2 %
     Growth in Corporate Profits:                                      0- -5%


     Real Growth in Gross Domestic Product:        +1.0- +2.0%
     Inflation:                                                                     1.5-2.5 %
     Growth in Corporate Profits:                                      7-15%

   Current Market Forecast
    Dow Jones Industrial Average

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

        2010    Year End Fair Value                                  9630-9650
    Standard & Poor’s 500

      Current Trend (revised):
          Short Term  Trading Range                                ???-1150
           Long Term Trading Range                                666-1575
      2009    Year End Fair Value                                1165-1185

      2010    Year End Fair Value                                1190-1210   

  Percentage Cash in Our Portfolios

   Dividend Growth Portfolio                  23%
    High Yield Portfolio                            24%
    Aggressive Growth Portfolio             19%

The economy is a neutral for Your Money
though the US economic environment continues to be improve primarily as a result of gridlock in Washington and the Fed’s baby step toward monetary firming.  This week’s lousy housing numbers notwithstanding, the rest of the data was mixed and that continues to support our forecast of an economy that is recovering but struggling to do so.

Longer term, our forecast calls for an economy growing at an historically below average rate.  Those negatives restraining growth include: (1) a financial system in cardiac arrest, unable to provide financing for capital investment or hiring, (2) a political system that hasn’t fully come to grips with the extent of its fiscal profligacy; and even assuming that it does, the demand for funding will usurp capital from the private sector, exacerbating its need for investment capital to finance growth and (3) a Fed walking a fine line between tightening too quickly and staying too loose too long--a line that it has never in history been walked successfully.

Bottom line: these problems notwithstanding, our forecast outlined above likely underestimates growth.  However, I am still struggling with the uncertainty surrounding the political/economic issues (primarily the resolution of healthcare and energy policy) and haven’t yet reached any conviction upon which to base a change in the numbers.

This week’s data:

(1)    housing: weekly mortgage applications fell 8.5%, while both January new  and existing home sales declined much more than expected,

(2)    consumer: weekly retail sales were quite good; weekly jobless claims were terrible; and the two indices of consumer confidence were mixed with the Conference Board’s number being a disappointment and the University of Michigan’s coming in as expected,

(3)    industry: January durable goods orders were double forecasts; the February Chicago purchasing managers index was better than anticipated,

(4)    macro:  revised fourth quarter gross domestic product was reported in line with expectations [+5.9%]; the accompanying chain weighted price index was up 0.4% versus estimates of up 0.6%.
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.)


The domestic environment for Your Money maybe improving although the War on Radical Islam is becoming more negative.

The Market-Disciplined Investing

    The Averages (DJIA 10325, S&P 1104) remain in a trading range defined by 9645-10725, 1009-1150.  As I noted in Friday’s Morning Call, they are currently in an area crisscrossed by multiple resistance/support levels; so there could be some continued churning around the aforementioned resistance/support levels.  In the end, a price break in either direction wouldn’t come as a surprise though our internal indicator currently suggests a bias to a move up.  Nevertheless, given the risk/reward (95 points down, 46 up on the S&P), I am inclined not to try to chase prices here--except where an individual stock’s price action provides an opportunity to Buy at attractive levels, like this week’s purchase of KO. 
Bottom line:

(1) short term, the indices are most likely in a trading range defined by 9645-10725, 1009-1150; at present, they are stuck in an area of congestion; further they are trading in the upper one third of that range, so the risk/reward equation suggests patience,

(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 (10325) finished this week about 8.8% above Fair Value (9482) while the S&P closed (1104) around 6.4% undervalued (1179). 

    Going into next week, the front burner issues are:

(1).  Obama’s life and death struggle to pass a healthcare bill.  While I believe that the political atmosphere in this country currently favors a more responsible budget process and fewer adventures into hope and change, it seems clear that my worst fears about Obama will be realized, to wit, He would rather paralyze economic activity in the process of attempting to impose radical reform over one-sixth of the US economy than listen to the electorate and focus on their more immediate concerns, like improving the economy.  The good news is that we are near the end game; and when it is over, it will most likely truly be over--no matter what the outcome of the vote on healthcare.

(2)  the sovereign debt issue.  Greece is on a short string right now.  It has some major re-financing that has to be done in the next 30 days or so.  Moreover, the passion of masses are starting to get out of hand--protests in Greece, demands for Nazi reparations, name calling.  The Greek pimple could be coming to a head. The problem as I have noted repeatedly, isn’t a Greek pimple, its acute acne of the global financial system.  Credit and liquidity issues exist for a number of countries much larger than Greece, including our own.  It is how the big guys handle their problems [hint: less deficit spending] that will determine whether or not sovereign debt inflicts pain on the global securities markets.  My guess is that like our own financial system problems of the last two years, there will be some casualties but most will survive--though there may be times when investors doubt.

This week, the Dividend Growth and High Yield Portfolios Added to their positions in Coca Cola.
           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*         9640                    1200
Fair Value as of 2/28//10                          9482                    1179
Close this week                                        10325                   1104

Over Valuation vs. 2/28 Close
      5% overvalued                                         9956                    1237
    10% overvalued                                    10430                      1297 
    15% overvalued                                     10904                      1356

Under Valuation vs. 2/28 Close
    5% undervalued                                      9008                    1120
   10%undervalued                                    8534                        1061
    15%undervalued                                      8060                    1002   

* 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 02-27-2010 8:59 AM by Steve Cook