The Closing Bell-2/20/2010
Steve Cook on Disciplined Investing


Have You Seen This?


  • Make money by accessing all our Portfolios, the supporting research and Price Disciplines using our paid subscription blog, Strategic Stock Invetments. Our work is focused on making money for our Portfolios not as some academic exercise in Internet investing. Check our performance (audited)--our Dividend Growth Portfolio has beaten the S&P by 500 basis points per year for the last seven years but with a beta of only .62. (Mandatory Disclaimer: past performance is not a guarantee of future results.) We give you everything you need to duplicate our results, in particular, a strict price discipline for both Buying and Selling.

Have You Seen This?

Statistical Summary

   Current Economic Forecast
     Real Growth in Gross Domestic Product:        -1.0 - -2.0%
     Inflation:                                                                     1-2 %
Normal 0 MicrosoftInternetExplorer4
     Growth in Corporate Profits:                                   0- -5%


      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

      Current Trend (revised):
        Short Term Trading Range                                ???-10725
         Long Term Trading Range                                6432-14180
    2009    Year End Fair Value (revised):                 9440-9460

    2010    Year End Fair Value                                  9630-9650
 Standard & Poor’s 500

     Current Trend (revised):
         Short Term  Trading Range                            ???-1150
         Long Term Trading Range                              666-1575
    2009    Year End Fair Value                                1165-1185

    2010    Year End Fair Value                     1190-1210   

  Percentage Cash in Our Portfolios

     Dividend Growth Portfolio                  23%
    High Yield Portfolio                              24%
    Aggressive Growth Portfolio              19%

The economy is a neutral for Your Money 
though the environment continues to be improve.  This week’s economic comments are really no different from last week:  ‘........the economic data was again mixed--which sounds like a broken record.  However, the good news is that it signals that the economy remains on track for a slow struggling recovery.  Longer term, our forecast calls an economy growing at an historically below average rate, though as I have noted previously, I think that prospects for a slightly better long term secular growth rate have improved as the probability of gridlock in Washington increased.’

However, another stab at a healthcare bill is apparently coming next week:

To the above positive observation on Washington gridlock, I would add that the Thursday night move by the Fed to raise the discount rate is another plus to the longer term secular outlook.  I outlined my rationale in Friday’s Morning Call, so I won’t be repetitious though I will restate my conclusion: Angel I for one am pleased that the Fed has formally began the ‘exit’ process, Beer I think that in doing so it at least gives itself a chance to avoid the mistake that every other Fed has made following a recession--which is staying too easy for too long and that Coffee doing nothing would be far more negative for stocks long term than doing something.’

This week’s data:

(1)    housing: weekly mortgage applications fell 2.1%, while January housing starts rose more than expected,

(2)    consumer: weekly retail sales were lousy  as were weekly jobless claims,

(3)    industry: both the New York and Philadelphia Fed February indices of general business conditions came in much better than anticipated; January industrial production was up, in line with expectations,

(4)    macro:  the January producer price index was up more than estimates while the January consumer price index was lower than forecasts; January leading economic indicators rose less than expected.
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.)


The domestic environment for Your Money maybe improving although the War on Radical Islam is becoming more negative.

    Since Indiana Senator Evan Bayh announced that he would not run for re-election, the political class has been crying and moaning about how the ‘system is broken’.  Rich Lowery at the National Review addresses the reasons (must read):

The Market-Disciplined Investing

    The Averages (DJIA 10402, S&P 1109) remain in a trading range with the upper boundary defined as 10725, 1150 and the lower boundary tentatively set at 9645, 1009. 

I would characterize this week’s pin action as strong.  Prices began trading above the down trend line off the January high, then drove through the 10238, 1084 support turned resistance level and the 10320, 1104 prior trading high (resistance level).  The S&P even traded back above the down trend off the October 2007 high (intersect 1108) although the DJIA remains slightly below its comparable line (10404). 

In trading this week, a number of our stocks that had broken their March 2009 to present up trend moved up sufficiently to re-set that up trend.  In our 162 stock Universe, 40 stocks are now in firm up trends off their March lows and another 9 are less than a point from re-setting their own up trend.  That is a very strong base in a trading market where the indices are still 5% from challenging the upper boundaries of their own trading ranges.

Finally, if the parameters of the trading range are as I have defined them, then are current price levels the S&P has 41 points upside and 100 points downside.  So despite some good fundamental news, it is too late to be getting frisky on the buy side.  There will be other opportunities down the road to buy great companies at great prices.

Bottom line:

(1) short term, the indices are most likely in a trading range defined by 9645-10725, 1009-1150; this week’s performance in which stocks traded through multiple resistance points strengthens that notion,

(2)    long term, stocks are in a trading range defined by the 2002/2009 lows [S&P 666-766] and the 2000/2007 highs [1545-1575].  Importantly, I think that equity prices will continue to recover within that range but it will be a slow and volatile process.

   Fundamental-A Dividend Growth Investment Strategy

    The DJIA (10402) finished this week about 9.7% above Fair Value (9482) while the S&P closed (1109) around 5.9% undervalued (1179). 

    As I noted above, the Fed’s increase in the discount rates was the noteworthy event of the week.  Its importance is that it starts the clock on monetary tightening.  To be clear, I don’t believe that means that they will slam on the brakes.  Indeed, I suspect that before the whole tightening process is over, there will be times that serious misgivings will be resurrected about the Fed’s will to continue the process; and I will undoubtedly be at the forefront of the pack.  So while I am very upbeat about the Fed’s move, Nirvana is not here; and I suspect that the rise and fall of clarity as to future Fed action plus the still high probability that it will fail anyway despite this recent move will keep stocks volatile and without a lot of directionality.   

We must also not forget that sovereign debt problems that roiled the markets the previous week have not gone away.  Greece has a big financing that may come as early as next week; so this issue will be back in the headlines.  In addition, as I have noted repeatedly, this is not a problem particular to Greece.  Other pot holes exist out there, not the least of which is our own soaring deficit/national debt.

The other issue that has been capturing investor attention of late is the monetary tightening by China.  I am sure that nothing has occurred to defer the Chinese from their appointed task.  However, my guess is that the Fed’s move this week will lower the heat generated by this issue at least as long as investors believe that our Fed is now acting just as responsibly as the Chinese central bank.

Finally, there is the impact the change in Fed policy will have on the dollar and, in turn, stocks.  I think that there is general agreement that a firmer Fed means higher US interest rates and that means a stronger dollar.  The question is, will the inverse dollar/stock relationship continue or disconnect?  As you know, I am a big proponent of a strong dollar; and long term, I think a strong dollar is good for stock prices.  However, for the past year that has not been the case; and I have been wrong.   I remain unconvinced. Further, I note that in two days trading last week the dollar and stocks moved in unison.  That clearly is no trend and not enough upon which to base a forecast.  However, it is a hopeful sign.  We just need some time and distance to see how well the relationship holds together (or not).

This week, our Portfolios Added to several positions (see Percentage Cash in Our Portfolios above).
           Bottom line:

(1)      our Portfolios will carry a higher cash balance than pre-financial crisis but it will be more a function of individual stock valuations and less on macro Market technical trends,
(2)    we continue to include gold and foreign ETF’s in our asset mix because we continue to believe that inflation is the major long term risk.  An investment in gold is an inflation hedge and holdings in other countries provide Angel a hedge against a weak dollar and Beer exposure to better growth opportunities [now under review]

(3)    defense is still important.
                                                                     DJIA                    S&P

Current 2010 Year End Fair Value*         9640                    1200
Fair Value as of 2/28//10                          9482                    1179
Close this week                                        10402                   1109

Over Valuation vs. 2/28 Close
      5% overvalued                                     9956                    1237
    10% overvalued                                    10430                   1297 
    15% overvalued                                    10904                   1356

Under Valuation vs. 2/28 Close
    5% undervalued                                    9008                   1120
   10%undervalued                                    8534                   1061
    15%undervalued                                  8060                    1002   

* 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 02-20-2010 8:59 AM by Steve Cook