The Closing Bell-6/27/09
Steve Cook on Disciplined Investing

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The Fourth of July is upon us and that’s another signal for beach time.  I am departing this weekend and will return the weekend of 7/12.  Hence, there will be no Morning Calls or Closing Bells for two weeks.  There will be a 7/13 Morning Call.  We are staying with friends who are in the business; so I will be in close touch with the Markets.  If any action is called for, I will be in touch via Subscriber Alert.

 
  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                  26%
    High Yield Portfolio                             26%
    Aggressive Growth Portfolio              26%

Economics

    The economy is a neutral for Your Money. 
This week’s data was mixed, much as one would expect in an environment where the economy is struggling to bottom; so there was nothing convincing to suggest that the economy is either headed lower or is bouncing.  As you know, I believe that the worst is over, that the economy is either in or through a bottoming process but that any recovery will be anemic as a result of an impaired financial [lending] system and a growth stifling fiscal policy which could be further exacerbated by an administration eager for more government regulation and more protectionist measures,  That remains my forecast and appears to be gaining consensus status on the Street.

    The other portion of our forecast--that the major risk to the economy is inflation brought on by (1) the massive explosion of liquidity injected into the financial system by the Fed, made worse by (2) the likely intense pressures on the Fed from the president and congress to finance [monetize] the enormous budget deficits which are already baked into the cake and which will only increase further if the current legislative agenda is enacted. 

    The inflationary outlook is where a good deal of disagreement exists on the Street.  Many believe that deflation remains the major risk; while others believe that the Fed will be able to both (1) absorb the excess liquidity in the system in a timely way, avoiding the usual price pressures associated with a vastly expansive money supply and (2) resist the political pressure to monetize the growing federal debt.  Barring enormous luck, major legislative reversals of the current political agenda and a tungsten steel backbone of Bernanke, I don’t.  The issue is not if but when inflation starts to manifest itself.
 
    On that happy note, here is the summary of this week’s economic statistics:

(1)    housing: weekly mortgage applications [secondary indicator] jumped 7%; May existing home sales were up though somewhat less than anticipated and still down big on a year over year basis, while May new home sales fell versus an expected increase,

(2)    consumer: weekly retail sales remain soft; May personal income jumped much more than estimated [helped by government transfer payments] while May personal spending rose less than expected; weekly jobless claims increased again and by more than anticipated; finally the final June University of Michigan consumer sentiment index came in at 70.8 better than expected,

(3)    industry:  only one number--May durable goods orders came in surprisingly strong,

(4)    macroeconomic data:  the final first quarter gross domestic product was slightly better than the preliminary report; the quarterly personal consumption expenditure  index (inflation) rose 2.8%, in line with forecasts while the monthly [May] number increased 0.1%.

    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.)

    Speaking of which, the House passed a 1200 page ‘cap and trade’ bill last night that no one had read and with apparently little thought to the impact it will have on your and my lives (like doubling our electricity bill).  The good news, of course, is that the pundits say that it has little chance of passage in the Senate.  The bad news is that the ranks of the morons of the world has grown to the point that a bill like this has any chance any time. 

    Here’s the Heritage Foundation’s estimate of what it will cost:
    http://www.heritage.org/Research/EnergyandEnvironment/wm2504.cfm
   
    Here’s more excellent follow up coverage by Michelle Malkin on the obfuscation going on in the EPA which makes it easier for these clowns in the House to justify last night’s action:
http://michellemalkin.com/2009/06/26/epa-plays-hide-and-seek-suppressed-report-revealed/

Politics

Both the domestic and international political environments are a negative for Your Money.

The Market-Disciplined Investing

  Technical

    A good analysis of the ‘golden cross’ (when the S&P 50 day moving average rises above the 200 day moving average):
    http://pensionpulse.blogspot.com/2009/06/from-golden-cross-to-golden-goose.html

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

The Averages (DJIA 8438, S&P 9181) closed in a trading range.  For the time being, the upper boundary of that range is circa 9078, 947; but it is unclear to me that stocks have established a lower boundary beyond the obvious March low (666).  As I noted in Friday’s Morning Call, Wednesday’s close may have been the test of the 8220, 876 for which I have been looking (and would set 876 as a support level).  Thursday’s pop seemed to confirm that but as I also noted, it just wasn’t convincing enough for me.  Regrettably, Friday’s pin action even though it was accompanied by expanded volume was impacted by the re-balancing of the Russell Averages; so it provided little information value. 

Notably, the VIX closed Friday below the support level which I suggested  yesterday would be  a good sign that Wednesday’s close did indeed mark the end of a successful test of the 8220, 876 support level.  However, I am a little uneasy being too assertive about calling Wednesday as the low.  First, I must confess that I am not clear on whether or not the Russell re-balancing influenced trading in the VIX--though one options expert I talked to insists that it did.  I am also mindful that the end of quarter window dressing by mutual funds is occurring and will continue to do so Monday and Tuesday--and that too could have an aberrant impact on the VIX.  Finally, as is my habit, I am reluctant to accept a one day break in trend (support/resistance) as a fait accompli.  So I am holding off re-setting the boundaries of the trading range and altering our strategy (see below) until I get a time (a day or two) or distance (a meaningful move)  confirmation that volatility is headed lower.

          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 until we are clear as to whether this last Wednesday marked the end of a solid test,

(3)    I am waiting for either a more aggressive challenge of the 8220, 876  level or a firm follow through to Thursday’s strong move up to confirm [at least in my mind] 876 as the lower boundary of a trading range.  If the S&P doesn’t fall below the 876 level on any sell off or we get that follow through, then I am going to shift the lower boundary of our trading range to from 666 to 876 and the upper boundary from 947 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 stocks were to reverse Thursday and Friday’s action and the S&P can’t hold the 876 level, then the candidates for the  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 (8438) finished this week about 29.4% below Fair Value (11959) while the S&P closed (918) around 33.4% undervalued (1380). 

My bottom line remains: ‘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 [remains some]........short term investor uncertainty over whether or not the economy is....in recovery [.....‘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.......seem to be exerting a very substantial influence on investors’ minds and actions.’ 
 
As to our Portfolios’ actions this week: we lowered our cash position from 29% to 26%, using the funds to Buy stocks; and Friday, the High Yield Portfolio lightened up on its Sanofi Aventis position investing the proceeds in additional shares of Kimberly Clark. 
 
 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                                           8438                    918

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 06-27-2009 11:08 AM by Steve Cook