The Closing Bell

11/1/08

  Statistical Summary

   Current Economic Forecast

    2007
        Real Growth in Gross Domestic Product:        2.0- 2.5%
                 Inflation:                               2 - 2.5 %
Growth in Corporate Profits:                                      6-8%

2008 (revised-again)
        Real Growth in Gross Domestic Product (GDP):   -1.0 - +1.0%
        Inflation:                                2-3%   
        Growth in Corporate Profits:                         0-5%

   Current Market Forecast
   
Dow Jones Industrial Average

        2008
            Current Trend:
Short Term Trading Range                      7853--?
Long Term Trading Range                      7100-14203
            Year End Fair Value (revised):                13450-13850
        
        2009    Year End Fair Value (revised):                13850-14250
 
    Standard & Poor’s 500

2008
            Current Trend:
            Short Term Trading Range                         839--?
                                    Long Term Trading Range                      750-1527
            Long term Up Trend                    1317-1797   
            Year End Fair Value (revised):                 1533-1577
   
2009    Year End Fair Value                               1595-1635
   
  Percentage Cash in Our Portfolios

Dividend Growth Portfolio                  25%
    High Yield Portfolio                      23%
    Aggressive Growth Portfolio                  26%

Economics

    The economy is a neutral for Your Money.  This week’s economic data was basically mixed though the third quarter gross domestic product number (-.3%) appears to be pointing at the much anticipated recession.  Appears is the operative word here because some of the economists I talk to suggest that both the inventory and trade numbers are likely to be revised up (more positive) and that could very well bring final GDP to a plus figure, though (1) there is much disagreement on this point and (2) any revision will be only modest. 

    Housing statistics gave us the second positive week in a row--weekly mortgage applications up 8.5% and September new home sales up 2.7% versus expectations of a decline--raising the hope ever so slightly that the worst could be over for this sector.

    There were lots of data on the consumer, some good, some bad.  The good news: retail sales were up though only slightly, September consumer income was up and jobless claims were flat (i.e. they didn’t decline); the bad news was that September consumer spending fell (but that has to happen as consumers retrench) and the two sentiment indicators fell off a cliff--the Conference Board’s October index down from 52.0 to 38.0 and the University of Michigan’s preliminary October index fell to 57.0 from 70.3 (while this sounds terrible, there is actually little correlation between sentiment and future behavior).

    Measures of industrial activity were also mixed:  September durable goods orders unexpectedly increased, while the Chicago purchasing managers’ index (secondary indicator) nosedived from 56.7 to 37.8.

    Finally, the macroeconomic statistics were generally positive: as noted above, third quarter GDP was not down as much as anticipated and could be revised up even more; the accompanying personal consumption expenditure index (PCE) was in line with estimates though the core PCE was higher than expectations; and the Fed did what most investors assumed it would do, which was to lower the Fed Funds rate by 50 basis points.  More important it took another step toward easing the credit crisis by extending a lending facility to the central banks of several emerging market countries.

    Bottom line: the economy has clearly weakened though its extent remains a matter of debate.  I am sticking with my forecast for a -1%--+1% 2008 gross domestic product number.  As for 2009, not to state the obvious, but its estimate is dependent on the depth and length of the slow down and right now I simply don’t have a very good feel for that.  One thing that there seems to be a growing consensus on is the threat of inflation once the economy bottoms.
http://paul.kedrosky.com/archives/2008/10/30/the_looming_def.html
http://www.ft.com/cms/s/0/94bc1a0e-a67e-11dd-95be-000077b07658.html?nclick_check=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.

The Market-Disciplined Investing
    
    Technical

This was the first good week that we have had in I don’t know how long (DJIA 9325, S&P 968).  While stocks were up circa 11%, I am sticking with my hypothesis that they will trade in a range (DJIA 7853--9707; S&P 839--1062) until there is clarity on the depth and length of the economic slowdown. I pointed out earlier this week that there was another easily identifiable resistance level for both indices (DJIA 9264, S&P 985) which the DJIA but not the S&P  managed to close above on Friday.  Further, not that it matters now, but both indices have a series of higher lows off their 10/10 low which could serve as support. 

The volatility index, though still very high by historical standards, closed below the lower boundary of an up trend off an early September low.  That bodes well for higher equity prices.  Volume just keeps getting worse; that’s a negative. 

Finally, once again it seems that the ferocity of late day selling brought on by margin calls/fund redemptions might be dissipating.  While Tuesday the selling took the DJIA from triple digit gain to a double digit loss, there was little evidence of it Wednesday or Thursday; and on Friday in the last 30 minutes, the DJIA went from a triple digit gain to almost flat and then back to triple digits.  I still hear stories of disasters waiting to happen; and, of course, I have been wrong already calling the end to this kind of liquidation.  So for the moment, I am simply pointing evidence that it could be happening.

   Fundamental-A Dividend Growth Investment Strategy

The DJIA (9325) finished this week about 31.5% below Fair Value (13616) while the S&P closed (968) around 37.6% undervalued (1552).

Progress continued to be made this week in the unfreezing of the credit markets; and my guess is that the performance of stocks signified a kind of collective sigh of relief that the global financial system was not going to implode.  To be sure, that is a positive.

The question now is how rough the current economic slowdown is going to get; and I don’t think any of us have a clue.  Furthermore, I don’t think that there is going to be any sudden epiphany as to the answer.  More important, even when we do start getting clarity, crucial to Your Money is how much of the damage is in the price of stocks.  Truth be told, I think that if the recession is modest (which is my forecast), then current equity prices adequately reflect the worst.  The problem is my lack of confidence in that forecast.
   
           The point here is that while it is unquestionably a positive to have increased visibility of the difficulties in the credit markets, there remains a lack of clarity on the economy; and until we have at least a sense of it, stocks will likely trade in a range.  At the moment, I am hypothesizing that this range is defined by DJIA 7853--9707; S&P 839--1062; however, I could be wrong on those parameters.

In this environment, the goal of our current investment strategy is to gradually add stability of principal and position our Portfolios for the move up whenever that comes.  On a practical basis, that strategy calls for managing our Portfolios cash position between 15% and 25%, using weakness to buy stocks that have held their 10/10 lows and are making progressively higher lows and strength to sell stocks that either haven’t held their 10/10 lows or can’t make higher lows.

As long as stock prices in general hold their October lows that will continue to be our strategy.  

Our investment strategy includes:

(a)    manage our cash assets between 15% and 25%; but remain aware that defense is still critically important and will be become more so if I am wrong about the October 10 lows,

(b)    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 moves into its Sell Half Range or to move out of those stocks that traded below October 10 lows and can not recover,

(c)    on a longer term basis, recognize that there remain fundamental factors that argue for caution and therefore to proceed carefully with our Buying, keeping a larger than normal cash position in anticipation of valuation and strategy changes that could result from a potentially new domestic economic agenda.

                                                                DJIA                    S&P

Current 2008 Year End Fair Value*        13650                    1555
Fair Value as of 11/30//08            13616                    1552
Close this week                10329                   1099

Over Valuation vs. 11/30 Close
      5% overvalued            14297                    1630
    10% overvalued            14978                    1707
   
Under Valuation vs. 11/30 Close
    5% undervalued                             12935                    1474   
          10%undervalued            12254                    1397
    15%undervalued                             11574                    1319    
    20%undervalued            10893                                            1242
    25% undervalued            10212                    1164
    30% undervalued             9531                    1086
    35% undervalued                   8850                                             1009
    40% undervalued                            8170                                               931

* 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  the 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:

    McCormick & Co is a leading manufacturer, marketer and distributor of spices, seasonings, flavorings and other specialty food products.  The company has grown profits and dividends at a 9-10% annual pace over the past 10 years earning a 20%+ return on equity.  MKC should be able to sustain this record because:

(1)    pricing flexibility in a tough economic environment,

(2)    a major cost reduction program,

(3)    introduction of new products especially in its industrial division,

(4)    international expansion,

(5)    acquisitions that support its brands.

McCormick is rated B++ by Value Line, has a 34% debt to equity ratio and its stock yields 2.8%.
http://finance.yahoo.com/q?s=MKC
11/08
 

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 38 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.