The Closing Bell 9/10/11
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:        +1.5- +2.5%
     Inflation:                                                                     2-3 %
    Growth in Corporate Profits:                                    7-12%


    Real Growth in Gross Domestic Product:        +1.5- +2.5%
    Inflation:                                                                       2-3 %
   Growth in Corporate Profits:                                     0-10%

Current Market Forecast
  Dow Jones Industrial Average

    Current Trend (revised): 
       Intermediate/Short Term Trading Range  10725-12919
       Long Term Trading Range                          7148-14180
       Very LT Up Trend                                          4187-14789   
   2011    Year End Fair Value                             10750-10770
   2012    Year End Fair Value                             11290-11310

Standard & Poor’s 500

   Current Trend (revised):
      Intermediate/Short Term Trading Range    1101-1372   
     Long Term Trading Range                             766-1575
     Very LT Up Trend                                            644-2000

   2011    Year End Fair Value                            1320-1340   

  2012    Year End Fair Value                              1390-1410

Percentage Cash in Our Portfolios

    Dividend Growth Portfolio                  17%
    High Yield Portfolio                             16%
    Aggressive Growth Portfolio              19%

The economy is a modest positive for Your Money. 
There was not a lot of data this week.  What we got was mostly neutral to positive, though the big sore spot was another increase in jobless claims.  The data pattern continues to reflect a sluggish economy struggling for growth. So for another week our forecast remains:

(1) a below average secular rate of recovery resulting from too much government spending, too much government debt to service, too much government regulation, a financial system with an impaired balance sheet and a business community unwilling to hire and invest because the aforementioned,

(2) the likelihood a rising and potentially corrosive rate of inflation due to excessive money creation and the historic inability of the Fed to properly time the reversal of that monetary policy. 

Of course, as I have said many times, this is all reflected in our Economic and Valuation Models.  What is not discounted is (1) a ‘double dip’ which I think more probable today than I did a month ago and (2) the EU sovereign debt crisis spreading beyond Greece and inflicting additional damage to US financial institutions’ balance sheets and to the international earnings of US corporations.

(1)    the Three Stooges: to his credit, this week Bernanke actually did the right thing by signaling he may do nothing.  Investors were not happy with his comments but I think them good news.  The Fed has already done all it can do; it is now up to fiscal policy.  Speaking of which and I wish that I weren’t, Obama’s job speech was so thoroughly leaked, the comments themselves were somewhat anticlimactic.  By and large, His new and improved jobs plan is simply His old failed plan with some lipstick on it.  In other words, it is DOA.  On the other hand as you know, I am, for the moment, giving Him credit for at least mentioning the three free trade agreements, steps to deregulation and an increase in spending cuts.  If this proves to be nothing but election rhetoric, then it only confirms my assumption of a second rate political class in our Models. If there is actually movement on these issues, then I will gladly factor in their impact on our Models and eat some crow.

(2)    the Three Blind Mice. I wrote several weeks ago: ‘As near as I can tell, the euros are simply standing around in a giant circle jerk and praying.  I have no clue how the EU sovereign debt problem resolves itself.  My guess is that neither does anyone else and hence the current Market panic.’ 
The latest examples of the prevailing ineptitude are Angel the refusal of the ECB to ease monetary policy when Europe could either be imploding if the sovereign debt problem extends beyond Greece or at the least, slipping toward recession and Beer the inability to implement the second bailout of Greece. While I have a Greek default in our Model, I don’t have the spread of this contagion throughout Europe and its subsequent impact the political stability of Europe, the damage to the balance sheets of US banks and the revenue and earnings of US companies doing business in Europe.

And the saga continues; for as this is being written Angel a leading member of the ECB is resigning purportedly over disagreement with the bank’s bond buying {Spanish and Italian} program and Beer rumors are rampant that Greece cannot get its bond swap done {it is part of the second bail out package} which in effect means default/restructuring.  This will likely make next week an exciting one and could be presaging the end game of the EU sovereign debt crisis.
    Apparently, the IMF knows something is coming (short):

    Today’s must read (long):

         You may have noticed that I have added our 2012 forecast for the economy and equities to the statistical summary above.  They basically reflect no change in the economic/political climate: an economy continuing to struggle under the burden of too much government regulation, too much government spending, a growing debt burden, an inefficient tax code, a banking system saddled with too much bad debt and little incentive to lend and a corporate and consumer sector frozen by concerns of a government intent on imposing its view of economic and social justice. 

         As uninspiring as this outlook is, there is the risk that corporate America and electorate could lose all hope and in essence ‘go to the mattresses’, pushing the economy back into recession.  On the other hand, if instead of losing all hope, the anger and frustration over the miserable job being done by the current group of morons in Washington bubbles over and it becomes apparent that a wholesale change in the political class will occur in November 2012, then the resulting optimism could spur growth to a higher level than currently forecast.

           The ECRI weekly leading index is one to which I pay close attention and it is moving toward the red zone:
Bottom line hasn’t changed:  ‘the economy continues to muddle through and, if my low expectations for a budget fix from the current crew in power is correct, it should continue to do so through early to mid 2013.  The good news is that both a sluggish economy and a second rate political class are reflected in our Valuation Model.’ 

‘The bad news is that the EU political class seems incapable of properly dealing with the growing likelihood of multiple country bankruptcies.  Until it does, the financial condition of the PIIGS will almost surely continue to deteriorate.  If left unaddressed, that will not good for the euros, it will not good for US companies doing business in Europe, it will not be good for the US financial institutions with exposure to EU sovereign debt and it will likely not be good for stocks.’

This week’s data:

(1)    housing: weekly mortgage applications fell but purchase applications rose,
(2)    consumer: weekly retail sales were [again] mixed; weekly jobless claims increased versus expectations of a decline [again],

(3)    industry: the Institute for Supply Management’s August nonmanufacturing index was much stronger than anticipated; July wholesale inventories rose 0.8% in line with forecasts; however, wholesale sales were unchanged, driving up the inventory to sales ratio,

(4)    macroeconomic: the July trade deficit was considerably less than estimates.

     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 political environment is a neutral but could be improving for Your Money while the international political environment remains a negative.

The Market-Disciplined Investing

The Averages (DJIA 10992, S&P 1154) had a rough week, but closed within their intermediate term trading ranges (10725-12929, 1101-1372).  The S&P violated the 1172 level and has done it so many times that I think we can toss it as potential support.  The DJIA could not hold the lower boundary of its short term up trend (11139), though the S&P did (1145).  With the indices now in conflict (DJIA breaking its short term up trend, the S&P not), we need to hold any action until this divergence in resolved.

As bad as the pin action and as discomforting as the divergence of the Averages were, remember that they are still well above their August lows.  We knew that there was some probability that stocks would re-test those lows and that may be where they are headed.  However, until those lows are broken, our focus, technically speaking, will be on identifying buying opportunities and taking advantage of that on a rebound.

Volume was up on Friday but not dramatically so (that’s good); though breadth was abysmal.  The VIX was up but remains within its current trading range (that is also a positive).  That said, our internal indicator is suggesting that stocks will test the August lows (in a 162 stock Universe, 93 finished Friday below the lower boundary of their short term up trend, 62 did not and seven were too close to call).

GLD had another wild roller coaster ride for the week, though it closed well within its short term up trend.

Bottom line:

(1) the DJIA and S&P are in an intermediate term trading range (10725-12919, 1101-1372), though, as noted, they are out of sync on their short term up trend,

(2)    long term, the Averages are in a very long term [78 years] up trend defined by the 4187-14789, 644-2000 and a shorter but still long term [13 years] trading range defined by 7148-14198, 766-1575. 

   Fundamental-A Dividend Growth Investment Strategy

The DJIA (10992) finished this week about 3.8% above Fair Value (10588) while the S&P closed (1145) 12.5% undervalued (1308). 

Unfortunately, my investment conclusion hasn’t changed in the last month.  Indeed, it seems more relevant this week than it did when I first wrote it.

‘In my opinion, equity prices are now struggling to properly discount (1) the uncertainties related to potential multiple bankruptcies among the EU countries/the dissolution of the EU and the resulting impact on US bank balance sheets and US corporate profits plus (2) the additional pessimism born of a complete lack of faith in the western political class’ ability/will to address and solve these (economic) problems. 

Of course, with the S&P priced 13.7% (12.5%) below Fair Value, at least some of this trauma is being reflected. With respect to Europe, until we know how bad the ultimate outcome is, it is tough to know what the correct stock valuations are.  That said, the worst outcome today is not likely to be nearly as bad as the worst outcome a year from now if the can gets kicked down the road.  The point being that another smoke and mirrors patch is the bad news scenario.  If either Germany or some combination of PIIGS withdrew from the euro Monday morning, there may be an initial negative reaction; but I think stock prices would be higher a week later.  It’s that week that poses the valuation problem.

As far as the lack of confidence in our elected representatives, I haven’t had any confidence in them for at least 12 years.  Yet others seem only now to be waking up to the fact that the electorate has saddled itself with a bunch of self interested, self important parasites.  For better or worse, I have no such delusions and have priced in the continuing reign of this group of morons through 2012.  However, until the rest of the Market gets that done, prices will likely stay under pressure--the operative word being ‘until’ because it could be happening now.
Through this all volatility and emotion, the constant that I hold on to is our Price Disciplines.  Our Model makes plain that stocks, in general, are undervalued and many of our stocks specifically are trading at historically low absolute and relative valuations.  That doesn’t mean that those candidates won’t get cheaper or that there aren’t stocks that remain on the high side of Fair Value that have the potential of getting cracked really hard.  The good news is that our Disciplines provide us with an unemotional gauge with which to make those ‘cheap’ and ‘high side of Fair Value’ judgments.  Staying focused on our Disciplines has always gotten me and our Portfolios through rough times.’ 

Since the last Closing Bell, our Portfolios have (1) bought back the GLD shares Sold earlier and (2) used Market weakness to Buy shares on stocks on our Buy Lists.  These actions took cash from 21-22% to 16-19%.
           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,

(3)    defense is still important.

                                                                             DJIA                    S&P

Current 2011 Year End Fair Value*               10760                 1330
Fair Value as of 9/30/11                                 10588                  1308
Close this week                                               10992                  1145

Over Valuation vs.9/30 Close
      5% overvalued                                             11117                1373
    10% overvalued                                             11646                 1438 
    15% overvalued                                             12176                 1504
Under Valuation vs. 9/30 Close
    5% undervalued                                            10058                   1243
    10%undervalued                                            9529                    1177
    15%undervalued                                            8999                    1112

* 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 09-10-2011 10:56 AM by Steve Cook