The Closing Bell--3/28/09
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 Trading Range                         6432-?
              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 Trading Range                        666-?
            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                  27%
    High Yield Portfolio                             27%
    Aggressive Growth Portfolio                27%

Economics

    The economy is a neutral for Your Money.  We may look back on this week and identify it as a cognitive turning point.  By that I mean that (1) the economic data has been mixed for weeks suggesting, though certainly not conclusively so, that the economy was struggling for a bottom, (2) while investors have, by and large, been skeptical.  However, this week the numbers turned had a more positive tone.  That and a little help from the Fed seems to have investors reconsidering. 
http://bespokeinvest.typepad.com/bespoke/2009/03/a-week-of-stronger-than-expected-economic-reports.html

Of course, one week of generally positive economic news does not a trend make.  So this week’s statistics may be nothing more than a head fake; and even if the economy has seen the bottom, it doesn’t mean that we are not going to get more bad news.    Nonetheless, I am very hopeful that this week’s datapoints (summarized below) along with the Fed’s announcement of an even more aggressive policy in dealing with illiquid assets on the books of financial institutions are a sign that the nadir in the current economic downturn is upon us.

(You may note that I did not include Geithner’s new bank bail out plan as another reason that the worst could be over.  As I stated earlier this week in a Morning Call that while it had its merits, I had doubts that it would work because [1] hesitation to participate in any meaningful way for fear of congressional claw backs if the plan did prove successful in the first instance and [2] the questionable likelihood of any agreement on price for the toxic assets.  Furthermore, if all the chatter from the banks is to be believed, the longer we go without a bail out, the less we need it--the amazing recuperative powers of a capitalist economy.)  

My more upbeat tone notwithstanding, I re-emphasize that the end of the economic malaise does not mean the beginning of a normal recovery.  If the economic/social/political agenda being concocted by Obama and his congressional cohorts is enacted, any recovery will be hampered by increased taxes, increased regulation and increased protectionism.  Furthermore, it will take a miracle for the Fed to successfully reverse the enormous infusion of money that it has made into the financial system and avoid the inflationary consequences. 

But back to the good news.

In housing, weekly mortgage applications rose 4.2%; February existing home sales jumped 5.1% and February new home sales were up 4.6% versus expectations of a 1.9% increase.

Consumer data was mixed:    February personal income fell .2%, in line with expectations, while February personal spending rose .2% versus estimates of a .3% increase; weekly retail sales remained soft though they were heavily (negatively) influenced by seasonal factors (Easter); weekly jobless claims rose more than expected; and the final March University of Michigan index of consumer sentiment came in at 57.3 versus forecasts of 57.2 and February’s final reading of 56.3.
       
    The only industrial stat was February durable goods orders but it was a standout, recording a rebound of 3.4% versus estimates of a 1.6% decline--the first increase in six months.

    Lastly, final fourth quarter gross domestic product was reported down 6.3% versus forecasts of down 6.7% and the preliminary reading of down 6.2%; and the personal consumption expenditure index rose .5% in line with expectations and versus the preliminary reading of up .1%.

 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.

As a reminder of why I am not optimistic:
    http://www.free-eco.org/articleDisplay.php?id=659
    http://article.nationalreview.com/?q=Njk5NTRjOTRhN2I1MjVhMDM3ZjU5YmUzMmRiNDc2NGM=
    http://article.nationalreview.com/?q=YjBlNjQyNzYzNzk2YjBhNjg4NDM2Y2I5MjJkMDYzNjQ=

The Market-Disciplined Investing
 
  Technical

The indices (DJIA 7776, S&P 815) closed this week having taken out resistance from the October 2008 to present downtrend.  As I noted in Friday’s Morning Call, I believe that stocks are now in a trading range: 

‘In my simplistic application of technical analysis, stocks are now in a trading range with a lower boundary defined by the March 2009 lows (DJIA 6432, S&P 666).

The unknown is the upper boundary.  I see three easily identifiable candidate levels: DJIA 8294, S&P 874; DJIA 9036, S&P 940, DJIA 9628, and S&P 1004.  I haven’t a clue which one might end up defining the upper boundary of the trading range or if some other level ultimately proves to be that boundary.’

  Fundamental-A Dividend Growth Investment Strategy

The DJIA (7776) finished this week about 34.7% below Fair Value (11914) while the S&P closed (815) around 40.9% undervalued (1374).
 
           Clearly, the most significant development this week was the change in investment strategy to a less defensive posture.  Our Portfolios’ managed cash position went from 30-50% to 20-30%; and we are no longer considering hedging with the S&P short ETF although a position in gold remains important (currently between 3.5% and 5%).  Further, our Portfolio weightings are shifting towards those sectors that are beneficiaries of inflation.         

     None of this is to suggest a wildly bullish attitude.  The Market has probably, but by no means certainly, seen its lows.  The first big test of that proposition will come with the first quarter earnings season which clearly will soon be upon us.  And if my thesis that of a trading range survives, equities will likely remain stuck  there for sometime to come.  Our task is to focus on those stocks that demonstrate relative strength and to remain mindful that the worst may not be over. 

As to our Portfolios’ actions this week, on three separate occasions, they bought stock drawing down cash to approximately 27%.
 
 Our investment strategy includes:

(a)    manage our cash assets between 20% and 30%; and remain aware that defense remains 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                                        7776                    815

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:

Medtronic Inc. (MDT) is the world’s largest manufacturer of implantable biomedical devices in the cardiac, neurological and vascular markets. The stock of MDT has experienced some weakness recently based on a shortfall in revenues in implantable cardioverter defibrillators. That appears to be temporary phenomena. The company seems poised to return to its historic growth rate in earnings and dividends (14-15% annually) and return on equity (20-22%).   Facilitating this is:

(1) the company’s strong R&D program and the resulting product pipeline:

(a) MDT expects to launch 25 new products in the next 12 months in its largest division--the cardiac rhythm disease management division,

(b) the company is expanding its offerings in the growing heart valve tissue  market,

(c) Medtronics recently received regulatory approval for a new line of neurostimulation systems to treat chronic pain,

(d) MDT recently launched its FDA approved time continuous glucose monitoring systems.

(e)  the company expanded its portfolio of spinal products with the 2007 acquisition of Kyphon Inc. (vertebral compression fractures and spinal stenosis) and introduced the first commercially available artificial disc in 2008,

(f) MDT recently introduced its next generation cobalt alloy, drug eluting stent.

(2) an aggressive acquisition program: so far in 2009, MDT has acquired Ablation Frontiers, a medical device company whose products serve individuals suffering from atrial fibrillation and other cardiac arrhythmias.

 (3) expansion into international markets.

MDT is rated A++ by Value Line, carries a 30% debt to equity ratio and its stock yields 2.3%.  Management recently stated the goal of returning 40-50% of free cash flow to shareholders annually.
http://finance.yahoo.com/q?s=MDT
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 03-29-2009 9:58 AM by Steve Cook