The Closing Bell: 6/20/09
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%

    2010
   
        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

        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

        2010    Year End Fair Value                              12400-12600
 
    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

        2010    Year End Fair Value                                  1430-1450   


  Percentage Cash in Our Portfolios

    Dividend Growth Portfolio                  29%
    High Yield Portfolio                             29%
    Aggressive Growth Portfolio             29%

Economics

    The economy is a neutral for Your Money. 
This week’s statistics while somewhat mixed still clearly confirmed our ‘the worst is over, the economy is in the process of bottoming’ forecast.  Particularly encouraging were better housing starts, the jobless claims (which have steadily become ‘less bad’), the Philadelphia PMI and May leading economic indicators. 

Unfortunately, the second part of our forecast (inflation is the biggest risk) also got support.  To be sure the PPI and CPI were reported lower than expected; but our outlook stresses the institutional problems (massive federal deficit spending, explosive monetary growth) that the economy faces which I believe will lead inevitably to higher inflation.  This week we learned (1) that the Treasury would auction another record volume of bills, notes and bonds next week [a signal of an out of control budget process] and (2) that under the new proposals for regulation of the financial system, a provision would increase the likelihood of a more politicized Fed [more power, more political oversight; see Friday’s Morning Call] which is not good news for those wanting the Fed to exercise strict control over the growth in the money supply.
http://www.capitalspectator.com/archives/2009/06/a_bull_market_i_3.html#more

Bottom line: the worst is likely over, but the upside is limited by a shrunken and more regulated financial system, a federal budget deficit that drains resources from the private sector and an explosion in the money supply which will result in spiking inflationary fears barring a miracle from the Fed.

This week’s data:

(1)    housing: weekly mortgage applications fell 3.5%, while May housing starts and building permits rebounded sharply,

(2)    consumer: weekly retail sales continue to be very disappointing, although the employment numbers are improving [in the sense that they are increasingly less bad],

(3)    industrial:  May industrial production and capacity utilization were down modestly but in line with expectations; the two most watched purchasing managers’ indices [secondary indicators] provided a mixed picture: the NY index was down more than forecast, while the Philadelphia index came in much stronger than anticipated,

(4)    macro economic: both price [inflation] measures [PPI, CPI] for May were reported much lower than estimates and the May leading economic indicators rose more than expected--April and May’s reports represent the first two back to back increases in many months.

The latest from John Mauldin--this is a bit long but an excellent read:
http://www.ritholtz.com/blog/2009/06/this-time-its-different/

 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.

The Market-Disciplined Investing

  Technical

The Averages (DJIA 8539, S&P 921) closed in a trading range.  We have a handle on the upper boundary of that range (9078, 947); but stock prices are still in search of a lower boundary.  As I see it, there are three identifiable possibilities: (1) the February [resistance-turned-support] high [8220, 876], (2) the November 2008 low (7432, 740), (3) the March lows [6432, 666].  Of course, there are a multitude of other possibilities which I will call alternative (4) where the Market finds support at any level of its choosing. If I were a betting man, I would put the odds of stocks finding  support at or above 876 at 35-40% and at or above 740 at 75-80%. 

    Friday morning I noted that I was really impressed with the technical strength being demonstrated by the stocks in our Universes and was seriously considering nibbling at stocks.  However, after I spent more time looking at the charts, I have changed my mind.  I’m going to hold off.  The reason actually has a positive to it; that is, most stocks have plenty of room to decline and still not challenge either their March to present up trend or their February high support level.

          My bottom line remains:
   
(1)    the difficult economic environment made worse by an anti-capitalist social/political agenda and a Fed facing an almost impossible task will serve to limit the upside in stock prices,

(2)    uncertainty still exists on the downside and will continue to do so until we get some kind of meaningful test,

(3)    if the S&P doesn’t fall below the 876 level on any sell off, then I am going to shift the lower boundary of our trading range to 876 and the upper boundary to the November 2008 high (1004); that will also entail an adjustment to our cash levels from 20-30% to 15-25%.   On the other hand if the S&P can’t hold the 876 level in the next decline, then the candidates for  lower boundary are 740 [November 2008 low] and 666 [March 2009 low] and the upper boundary will remain at 947. 

   Fundamental-A Dividend Growth Investment Strategy

The DJIA (8539) finished this week about 28.5% below Fair Value (11959) while the S&P closed (921) around 33.3% undervalued (1380). 

My bottom line from last week: ‘Stocks clearly remain substantially undervalued at least as determined by our Valuation Model.  However, short term I think this circumstance unlikely to change because (1) our Model places the most weight on longer term secular economic trends while currently there is simply too much short term investor uncertainty over whether or not the economy is even in recovery [I would add ‘and if recovery does occur whether or not it will be accompanied by a psychologically debilitating rebirth of inflation] and (2) at the moment technical factors [see above] seem to be exerting a very substantial influence on investors’ minds and actions.’ 
 
As to our Portfolios’ actions this week: the High Yield Portfolio Sold Worthington Industries because the company cut its dividend.  That meant automatic expulsion from the High Yield Universe and forced Sale of the stock.  Proceeds were reinvested in ConocoPhillips.
 
 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 6/30//09                         11959                    1380
Close this week                                            8539                    912

Over Valuation vs. 6/30 Close
      5% overvalued                                     12556                    1449
    10% overvalued                                     13155                    1518
   
Under Valuation vs.6/30 Close
    5% undervalued                                    11361                      1311
   10%undervalued                                     10763                    1242
    15%undervalued                                    10165                    1173   
    20%undervalued                                     9567                     1104
    25% undervalued                                     8969                    1035
    30% undervalued                                     8371                      966
    35%undervalued                                     7773                       897
    40%undervalued                                      7175                       828

* 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 06-20-2009 9:41 AM by Steve Cook