The Closing Bell-12/13/08
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:        -0.5 - -1.5%
  Inflation:                                                               1-2 %
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
            Year End Fair Value (revised):                 1533-1577
   
2009    Year End Fair Value                               1595-1635
   
  Percentage Cash in Our Portfolios

Dividend Growth Portfolio                  17%
    High Yield Portfolio                      17%
    Aggressive Growth Portfolio          17%

Economics

    The economy continues to be neutral to negative for Your Money.  There was little follow through to the hopeful signs in last week’s statistics that the decline in economic activity could be coming to an end.  To be sure, this week witnessed a paucity of  data and even amongst what was released, there were a couple of minor bright spots.  Nevertheless, without additional signs from the upcoming economic releases that last week wasn’t an aberration, we can only conclude that it in fact was.  In summary:

    Housing’s only data point this week was mortgage application which were down big time--17.4%.

    Measures of consumer health were somewhat mixed.   November retail sales both including and excluding autos were off but still came in better than analysts were forecasting; while both weekly (ICSC and Redbook Research) retail sales figures were anemic.  The really bad news came in weekly jobless claims which rose 58,000 versus expectations of an 11,000 increase; and the good news was the University of Michigan’s preliminary December index of consumer sentiment which was reported at 59.1 versus expectations of 54.5 and November’s final reading of 55.3.

    Both October wholesale and business inventory reports were dismal--falling more than expected but not nearly as fast as their corresponding sales, resulting in accumulating inventories in each sector.

    Finally, on the macroeconomic front, producer prices in November fell more than anticipated (good news) while the budget deficit is in a Titan III formation.   

    Bottom line: the economy is undoubtedly declining.  The issues are: (1) by how much, (2) do the few recent signs that it could be struggling to flatten hold any promise and (3) most important for our purposes, how much of the answers to both are in the current price of stocks?  I have noted over the last two weeks how well equities have absorbed bad news; and I was particularly impressed with their performance yesterday which could have been a horror show. I am not saying that we haven’t seen the worse numbers on the economy in this cycle, I am suggesting the hypothesis that they could already be discounted--‘suggesting’ being the operative word.
   
 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--although based on the significant but under reported success in Iraq and Obama’s seeming drift to the center, I am contemplating whether or not this factor should be a neutral for Your Money.  We will know within the first six months of the New Administration.

    However, Charles Krauthammer is not optimistic:
    http://www.washingtonpost.com/wp-dyn/content/article/2008/12/11/AR2008121102951.html?sub=AR

The Market-Disciplined Investing
    
    Technical

This week both indices (DJIA 8629, S&P 879)  traded within what will hopefully prove to be a trading range defined by a lower boundary of either their 10/10 (DJIA 7853, S&P 839) or 11/19 (DJIA 7424, S&P 740) lows and an upper boundary that is the last easily identified high (DJIA 9707, S&P 1062).  In addition, following Thursday’s decline, both Averages closed Friday right on the uptrend line off their November lows--which given the potential for yesterday to have been a terrible day,  is, in my opinion, a big positive. 

Going into next week, I will be watching the November to present uptrend line (circa DJIA 8542, S&P 863) for very short term support and first the last high in the November to present move up (circa DJIA 8996, S&P 913) then the highs since November 19 (DJIA 9707, S&P 1062) as resistance. 

   Fundamental-A Dividend Growth Investment Strategy

The DJIA (8629) finished this week about 36.7% below Fair Value (13650) while the S&P closed (863) around 44.5% undervalued (1555).
         
    Last week, I asked: ‘....(1) does the slightly better than expected performance of some of the reported economic data released this week mean that the economy is starting to stop declining? and (2) does investors seeming new found willingness to buy stocks in spite of a couple of absolutely horrendous economic numbers and the ongoing clown show (the ‘auto bailout’) in Washington suggest that the worst of the economic decline is presently in the price of equities?’   

We received some clarity on questions # 2 above this week--lots of bad news in the form of some disappointing economic stats (see above), the Laurel and Hardy show in Washington and the collapse via fraud of the Bernard Madoff hedge fund.  Yet the pin action was positive and was accompanied by a declining risk premium as defined by the volatility index.  I don’t think it a stretch to think that this adds weight to the proposition that the October/November lows marked the bottom to this Market cycle.  That said and at the risk of being repetitious, (1) I was wrong when I thought the July lows would be the bottom and I can be wrong this time as well and (2) even assuming that stocks have seen their lows, this doesn’t mean that equity prices are off to the races; it simply reinforces my courage to buy stocks when they are sold off to the lows of the hopeful trading range.

 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 10/10--11/19 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 appears to have gotten ahead of its underlying company’s fundamentals 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 12/31//08                       13650                    1555
Close this week                                        8629                    863

Over Valuation vs. 12/31 Close
      5% overvalued                                      14332                    1632
    10% overvalued                                       15015                    1710
   
Under Valuation vs. 12/31 Close
    5% undervalued                             12967                    1477   
          10%undervalued                          12285                    1399
    15%undervalued                             11602                    1321    
    20%undervalued                            10920                       1244
    25% undervalued                              10237                    1166
    30% undervalued                               9555                    1088
35% undervalued                                 8872                    1010
40% undervalued                                 8190                     933
45% undervalued                                    7507                     855



* 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:

Ross Stores operates a chain of off price retail stores offering high quality, in season apparel, shoes, cosmetics, accessories, fragrances, linens and home merchandise.  The company has grown profits and dividends at a 15-20% annual rate over the past 10 years, earning a 25%+ return on equity.  While current retail environment is anything but robust, ROST’s off price business model should produce above average results because:

(1)    with full price retailers struggling, it benefits from an increased supply of name brands,

(2)    it is focused on strict inventory management giving it flexibility to take advantage of close outs, raises its merchandise turn and reduces markdowns,

(3)    it has begun implementing a program of increased local control over merchandise allowing each store to carry goods most sought after by local customers

Ross Stores is rated A by Value Line, carries a 13% debt to equity ratio and its stock yields 1.4%.
http://finance.yahoo.com/q?s=ROST

    12/08
 

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 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 12-13-2008 9:16 AM by Steve Cook

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