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


Have You Seen This?


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Have You Seen This?

    Let’s begin with some administrative items:

           First of all, you will recall that as the Market plunge steepened last fall, I suspended our Buy ratings because (1) stock prices were reaching the point that virtually all the stocks in our Universe were Buys and (2) my main focus was not on what to Buy but on preserving capital and I thought that having a huge Buy List would just confuse the issue.  Then earlier this year even though we went from over 40% in cash to just under 25% in the rally off the March lows, I refrained from resuming the updating of the Buy List because given my lack of conviction that THE market bottom had been reached, those stock purchases were as much a trade as they were an investment. 

    I think it time to re-instate issuing Buy ratings, reflecting my belief that it is becoming increasingly likely that the March lows marked the bottom.  I have already begun the process of altering the Valuation Ranges of the stocks in our Portfolio listings.  That project will hopefully be completed by the end of next week.

          As an aside during this Buy List hiatus, I tweaked the Valuation Model several times reflecting the slower secular economic growth rate and the higher inflation rate that is now part of our forecast--the net affect of which has been to lower the Valuation Ranges of most of the stocks we follow. 

    Second, over time I have been adding alternative investments to our Portfolios without having listed them in our website as such.  First it was the 10 Baggers in the Aggressive Growth Portfolio, then gold in all of our Portfolios, then the high yield corporate bond ETF’s.  I am correcting that, adding a section to each Portfolio Listing titled ‘Alternative Investments’.  Along those lines, as a result of my growing concern about inflation, the dollar and the relative competitiveness of the US economy versus the rest of the world, I am working on a number of foreign stock ETF’s that I will soon add to the list of Alternative Investments.

Finally, our credit card processor is going out of business and, therefore, a change is necessary.  A new processor has been selected.  At the moment I am not sure exactly what is entailed from an administrative point of view.  As soon as I know, I will let you know.

  Statistical Summary

   Current Economic Forecast
        Real Growth in Gross Domestic Product (GDP):   -1.0 - +1.0%
        Inflation:                                                                             2-3%   
        Growth in Corporate Profits:                                          0-5%
        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

            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

            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                  28%
    High Yield Portfolio                            28%
    Aggressive Growth Portfolio             28%

The economy is a neutral for Your Money.  Data this week reinforce the notion that the economy is in a bottoming process; indeed, it appears to me that the real issue investors face now is not how bad the economy will be but rather how good can it get.  And as you know, my response to the latter is ‘not very’.  Restraining the magnitude and strength of a recovery are, in my opinion:

(1)    the extended period of time that will be needed to repair the US financial system.  True, steps taken by the government, capital raises by the banks plus their improving profitability have all contributed to restoring the financial viability of the banking system.  But these positive developments simply prevented  the financial system from falling off a cliff.  Going forward (a) recent comments by the Treasury suggest that more work still needs to be done by way of healing bank balance sheets, (b) banks are still facing mounting loses in the commercial real estate and consumer finance sectors and (c) psychologically, the lending standards pendulum has probably swung from  overly accommodative  to too restrictive.  These factors are likely to impact the availability of expansion capital as it only slowly increases from a diminished base.

(2)    the usurpation of productive resources by the federal government.  If the Obama fiscal policy is enacted, federal spending as a percent of GDP will grow dramatically--and the more government demands from the production resources of this country, the less is left to private enterprise.  This does not necessarily mean a slow down in economic growth; however, historically government spending has proven less efficient than private spending.  I am hard pressed to assume that this time things will be different.

(3)    the crowding out of private capital requirements by the federal deficit.  Once again if the Obama fiscal plan is enacted, the federal deficit will skyrocket.  That deficit has to be financed; and that increased demand for funds by the  federal government will prevent an equal amount of capital from being invested in entrepreneurial pursuits by the private sector.  Does anyone doubt that a dollar invested (in equipment, R&D, etc) by corporations will produce more goods and services than a dollar invested in a Treasury note?

Of course, our’s isn’t the only economic forecast out there.  There are two other  scenarios being bandied about which bear a brief comment:

(1)    the ‘V’ shaped recovery.  This seems to be becoming from (a) those that are simply relieved that the economy isn’t still in a waterfall formation, and (b) those that aren’t old enough to remember the Nixon/Carter era when increased regulation, misguided energy policy, deficit spending and an expansive monetary policy served to constrain economic growth and fuel inflation.   In my opinion, the only way this forecast proves correct is if  Obama’s vision of bigger more intrusive government gets soundly defeated. While that may be the hope for optimists like me, it is not something that I am going to bet any money on.

(2)    a ‘W’ shaped nonrecovery.  This is the permabear’s case and one that I can’t dismiss quite so lightly as (1).  Its central thesis is that the current improvement in the economic statistics is a head fake and that there is still considerably more pain for the economy to endure before any growth can resume.  What makes it tough to refute is that it simply takes the above three arguments I made on why the recovery will be anemic and doubles down on them--making the debate a matter of degree.  My bottom line is that (a)  this forecast is where the risk exists in our own outlook (b) but I believe that the inherent stabilizing forces in a free market economy have begun to work their magic on the upside and, barring an exogenous negative event, will lead to gradual economic improvement.

    But back to focusing on the more positive notion that the worst is over, here is the summary of this week’s economic data.

(1)    housing: weekly mortgage applications rose 4.3%--a welcome improvement,

(2)    consumer: April personal income rose versus estimates of a decline, while April personal spending came in as expected; both weekly and May retail sales were disappointing, while car and truck sales were slightly better than forecast;  offsetting the retail stats were better than expected weekly jobless claims and the May nonfarm payroll numbers,

(3)    industry: both of the May ISM manufacturing and nonmanufacturing indices showed improvement from April; April construction spending was up versus estimates of a decline; first quarter productivity improved markedly; however, April factory orders while up, rose less than anticipated.

 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.)


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

The Market-Disciplined Investing


The indices (DJIA 8763, S&P 940) closed above the lower boundary (8466, 919) of the re-set uptrend off the March lows but still below their January resistance level (9078, 947).  Until stock prices push either through 947 on the upside or the lower boundary of the current short term up trend on the down side, it is tough to define a technical trend irrespective of a time frame. 

That said I went looking for some evidence of the Market internals and once again surveyed the stocks in our Universes.  Of the 156 stocks, 107 are in an uptrend off their March lows, 44 are in a trading range comparable to S&P 876-947 and 5 are in a downtrend.  Of the 107 stocks that are in an uptrend, 68 (44% of all stocks) are trading above the January 2009 high resistance level (comparable S&P 947).  Of the 44 stocks in a trading range, 22 are priced right on their January 2009 high (resistance) level.  That leaves 66 out of 156 stocks (42%) that are either not already above or challenging the comparable S&P 947 level.  I don’t think that this information gives us much insight into whether stock prices will ultimately sustain an uptrend or a trading range; but it does suggest a reasonable likelihood that the S&P 876 support level will hold if tested.

   Fundamental-A Dividend Growth Investment Strategy

The DJIA (8763) finished this week about 26.7% below Fair Value (11959) while the S&P closed (940) around 31.8% undervalued (1380).
          My bottom line:
(1)    the difficult economic environment made worse by a 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 lower boundary will remain at 666 and the upper boundary will remain at 947. 

(4)    at the moment, patience is a virtue,

As to our Portfolios’ actions this week: none
 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                                          8763                    940

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 06-06-2009 4:26 PM by Steve Cook