The Closing Bell-11/22/08
Steve Cook on Disciplined Investing

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Next week is a holiday week.  I have to travel 2 days to get my father bring him to our home and take him back.  In addition, more family is coming; and I will be doing most of the cooking.   I will be staying abreast of the Market; if comments are needed the Morning Calls will be abbreviated and there will be no Closing Bell.  As always, if action is required, I will be in touch via a Subscriber Alert.

  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                                   7853-9707
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                      839-1062
            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                  23%
    High Yield Portfolio                      24%
    Aggressive Growth Portfolio           25%

Economics

    The economy keeps drifting further into uncharted waters and will be a drag on Your Money until clarity emerges.  Unfortunately, despite their best efforts Paulson, Bernanke and Company just can’t seem to get the right policy initiatives in place; and our elected representatives continue to prove they all deserve to be summarily dismissed.  That is not to say that we won’t wake up tomorrow and will find some economic equivalent of W’s  ‘surge’ strategy in place; and frankly, that new strategy could be in taking place right now.  Obama is making public His economic team (see below) which surprisingly enough is for the moment improving my outlook for the next four years.  Of course, the first policy move has yet to be intimated much less initiated; so until it happens, the gloom is likely to remain palpable.

    And, of course, the daily flow of data only reminds us that in the absence of a viable strategy, the economy isn’t getting any better.  Reading the housing numbers is like hitting yourself over the head with a hammer: weekly mortgage applications fell 12% despite lower rates, October housing starts were reported down 4.5% while building permits plunged 12%.  The consumer remains in the pits:  retail sales were dismal and jobless claims rose yet again.  The industrial sector showed no improvement: October industrial production rose 1.3% but only because the September figure was revised  down dramatically, October capacity utilization was down and the two regional (secondary indicators) manufacturing surveys fell again.  Finally, the macroeconomic statistics were a mixed blessing: October leading economic indicators fell and more than expected while  both price measures (PPI, CPI) fell more than estimated--which ordinarily is good news but in an environment where deflation is becoming the boogeyman, it becomes bad news.

    The big economic/political news of the week was the Friday afternoon appointment of Tim Geithner, head on the New York Fed, as Treasury Secretary-designate.  His close working relationship with Paulson is viewed by most investors as a positive in that he has a working knowledge of the steps taken to date to address the credit crisis and, therefore, lessens the risk of lack of continuity in the midst of difficult times.  Score another one for Obama.
http://kudlowsmoneypolitics.blogspot.com/2008/11/early-thoughts-on-tim-geithner-at.html

    Bottom line: I still can’t decide if lousy investor sentiment is coloring their view on the economy or the economy is scaring the wits out of investors. 

 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.

    Some thoughts on His presidency:
    http://article.nationalreview.com/?q=ODUxNDY1YTBkNDMxYTdkODAxOTI5ZTg1YzNhN2JhODg=


The Market-Disciplined Investing
    
    Technical

This week both indices (DJIA 8046, S&P 800) busted through the 10/10/08 lows of my hypothesized trading range (DJIA 7853--9707; S&P 839--1062).  Worse, the S&P traded below its 10/2002 low (766). I quote Friday’s Morning Call: ‘The problem is that the S&P (752) which led the DJIA through its 10/10/08 low (839) closed below its 10/2002 low (766) which sets up the same technical dilemma, we were faced with at the Market close on Wednesday, i.e. will the DJIA hold its 10/2002 low and the S&P bounce back or will the DJIA follow the S&P lower?  What makes the resolution of this technical divergence particularly scary is that if the S&P proves to be the leading indicator, then the next visible technical support is at the 1994-1995 double bottom (circa DJIA 3554, S&P 446).’    

I am not trying to lay a doomsday scenario on you; I am simply pointing out that the risk parameter from a technical standpoint has been ratcheted up significantly.

Well, both the DJIA and S&P rallied late Friday and closed above their 10/2002 bottom (DJIA 7146, S&P 766); indeed the DJIA regained its 10/10/08 low (7853).  Volume was pretty good though still not what I would like to see as a confirming sign of a reversal and the volatility index remains at historically high levels.  To be sure, one day’s positive performance doesn’t mean that the decline is over; although a reversal at a key support level gives some added weight to the proposition.  Nevertheless,, given the enormous downside risk mentioned above, caution has to be a primary objective of our investment strategy until we can have some confidence in the viability of the 7146/766 support level.
http://www.ritholtz.com/blog/2008/11/revisiting-the-wyckoff-spring/


What we have to hope happens now from a technical point of view is that stocks (1) successfully test their 10/2002 lows and (2)  re-establish a trend/range.    

   Fundamental-A Dividend Growth Investment Strategy

The DJIA (8046) finished this week about 40.9% below Fair Value (13616) while the S&P closed (800) around 48.4% undervalued (1552).
         
           At this point, our strategy, simple minded as it is, remains as I outlined in Friday’s Morning Call: ‘As I see it, there are two basic scenarios (with variants): (1) a bottom is being made [yes, I know, I have said that before; but I mean it this time, I hope] or (2) it isn’t.

    If stocks are in a bottoming process then either yesterday  [Thursday] was the selling climax or it will likely come today [Friday] or on Monday, depending on how option expiration unwinds. If it does occur today [Friday] or Monday, then stocks could be on another roller coaster ride with gut wrenching implications.  But in the end, by the Market close on Monday at the latest, stock prices will be higher than they are at the open this morning and the big question will be, does the 10/2002 support level mark the low or will stocks rally sufficiently to reset the 10/10/08 low as the bottom end of a trading range.

For the long term investor (if there are any of those left) that means patience through the next two days; and once we know where the bottom is, we can resume the trading strategy which was so rudely interrupted on Wednesday.  For traders, if the sell off continues, you might want to risk putting some cash to work recognizing that scenario (2) above could be the operative model.  Today I will likely follow the long term strategy in the Dividend Growth and High Yield Portfolios and trade the Aggressive Growth Portfolio.

At least for today, it looks (luckily) like Thursday was a test of the 10/2002 support level (scenario 1).  However, as I suggested in the Technical section above, this is no time to be tip toeing through the tulips.  It is probably not a good idea to assume that we have dodged a bullet just yet.  So we remain vigilant, hope that stocks will return to some sort of trading range which will allow us to resume the trading strategy we suspended on Wednesday.

Reviewing the steps taken in our Portfolios this week: when stocks rallied on Tuesday, our Portfolios sold a couple that seemed to be ahead of themselves as well as some of our dogs that had traded below their 10/10 lows and were continuing to act sick.  Unfortunately, we didn’t keep the proceeds in cash but reinvested it in better performing stocks.  Then on Thursday as the DJIA broke below its 10/10 low, we pushed out the remaining shares of the aforementioned dogs.  With that added cash and the decline in equity prices (as stock prices decline, cash as a percentage of the Portfolio goes up) that put our closing cash positions in the 23-25% area. 

For the moment, our investment strategy is caution until stocks prove that the 10//2002 low will hold; or if we were to get really lucky, the S&P just might regain its 10/10 support level but that would have to happen very, very quickly.  Volatility will undoubtedly continue next week.

As I noted above while I have Thanksgiving responsibilities, I will be in close contact with the Market and with subscribers if our Portfolios take any action.

As a final note, in the last half hour yesterday, the Aggressive Growth Portfolio added to several holdings (Blackrock, Balchem) as I indicated it might in yesterday’s Morning Call.

DJIA                    S&P

Current 2008 Year End Fair Value*        13650                    1555
Fair Value as of 11/30//08                       13616                    1552
Close this week                                         8046                    800

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                          1008         

     40% undervalued                           8170                     931   
    45% undervalued                       7489                            853
    50% undervalued                             6808                    776
    55% undervalued                              6127                    698

* 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:

    Genuine Parts distributes automotive replacement parts, industrial replacement parts, business products and electrical and electronic components in North America.  The company has grown profits and dividends at a 5% annual rate over the last 10 years, earning an approximate 18% return on equity.  However, GPC should increase both its dividend and earnings growth rate as a result of:

(1)    product line expansion: in the first half of 2008, GPC acquired four companies,

(2)    penetration of new markets,

(3)    aggressive cost cutting,

(4)    gradual price increases.

Genuine Parts is rated A++ by Value Line, has an 8% debt to equity ratio, has an active ongoing stock buy back program and its stock yields 4.3%.
http://finance.yahoo.com/q?s=GPC

11/08





Posted 11-22-2008 10:30 AM by Steve Cook

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