The Closing Bell-4/24/10
Steve Cook on Disciplined Investing

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Statistical Summary

   Current Economic Forecast
   
2009
    Real Growth in Gross Domestic Product:        -1.0 - -2.0%
    Inflation:                                                                     1-2 %
    Growth in Corporate Profits:                                      0- -5%

2010 (revised)

   Real Growth in Gross Domestic Product:        +3.0- +4.0%
    Inflation:                                                                  1.5-2.5 %
   Growth in Corporate Profits:                                     10-20%

Current Market Forecast
   
    Dow Jones Industrial Average

     Current Trend (revised):
       Short Term Up Trend                              10850-13290
       Long Term Trading Range                      6432-14180
                    
    2009    Year End Fair Value                        9440-9460

    2010    Year End Fair Value (revised)       10120-10140
 
    Standard & Poor’s 500

            Current Trend (revised):
            Short Term Up Trend                             1155-1471
             Long Term Trading Range                     666-1575
               
     2009    Year End Fair Value                          1165-1185

     2010    Year End Fair Value                          1250-1270   

  Percentage Cash in Our Portfolios

    Dividend Growth Portfolio                  22%
    High Yield Portfolio                             23%
    Aggressive Growth Portfolio              20%

Economics
   
The economy is a short term positive for Your Money and may be even better than our revised forecast.  This was a slow week for data. 
What there was, was pretty positive, in particular the housing numbers.  This all fits well with our revised economic forecast.  In fact, as I have suggested in our Morning Calls, the relentlessness of current Market momentum may be pointing to a recovery that is more robust than my revised outlook.  I think it too soon to make any changes to our numbers; but the point is that the pin action is telling me that the risk to our forecast is on the up side.

All that said, barring a voting revolution in November, nothing alters my longer term view that the US economy will grow at a below average historical rate as a result of the numerous factors I harp on repeatedly: a wounded banking system incapable of financing historically ‘normal’ growth (which may become in more so with the pending financial regulatory reform and the SEC probe of malfeasance among the larger investment banks), a federal (along with many state and local) government devoid of fiscal responsibility and a Fed faced with the very difficult task of pulling the enormous excess liquidity out of the system and simultaneously avoiding inflation or a double dip.

Bottom line: economic growth will likely increase at a faster rate than anticipated for the next 9-12 months.  Longer term, we are still faced with an economy stifled by the aforementioned factors resulting in a historically below average rate of long term secular growth.
 
This week’s data:

(1)    housing: weekly mortgage applications rose 10.1%; both existing and new home sales came in much better than expected,
 
(2)    consumer: weekly retail sales were again mixed while weekly jobless claims fell, in line with forecasts,

(3)    industry: March durable goods orders were off;  though the primary reason was a drop in aircraft orders; ex transportation, the index was up much more than anticipated,

(4)    macro:  the March leading economic indicators rose more than estimates; the March producer price index jumped considerably more than expected though the core number remained tame.
       
The Economic Risks:

(1)    the economy is stronger 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 negative for Your Money.
     
    Is the US a banana republic?  This article is not tongue in cheek, though it may be a bit over the top.  Nonetheless, it shouldn’t be lightly dismissed.  Read it and decide (long):
    http://www.nakedcapitalism.com/2010/04/guest-post-a-banana-republic-with-no-bananas.html

The Market-Disciplined Investing
    
  Technical

The Averages (DJIA 11204, S&P 1217) are in an up trend off their March 2009 lows.  Boundaries of their up trends are defined by 10850-13290, 1155-1471,              with additional resistance at 11811, 1311 and support at 10725, 1150.

I feel no different that I did last Saturday: ‘I would characterize the Market as similar to the guy watching another person smoking a cigarette who hasn’t flicked the ash and the ash keeps getting longer and longer, and the longer it gets, the more focused the guy becomes in anticipating when the ash is going to fall to the exclusion of everything else around him.  Everyone has been increasingly watching all the technical indicators that are measures of how extended current prices are (the level of sentiment, insider trading, stocks above their 50 day moving average, etc)--with little concern about Greek insolvency, China slamming on the monetary/fiscal brakes, the mounting tensions in the Middle East.’ 

That said, we have to live with the Market we have, not the one we think we ought to have,   The underlying strength continues with only a few indications that investors may be getting cautious; and the most important one--failure to challenge the recent highs (11154, 1214)--was surpassed Friday. 

Of course, our time and distance discipline requires patience to assure this break is valid,  However, assuming that it is, technically speaking, the Market has re-gained its momentum and there remains considerable upside as a result of virtually no resistance between current levels and 11811, 1311.
    http://www.investmentpostcards.com/2010/04/24/technical-talk-respect-the-sp%E2%80%99s-uptrend/?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+wordpress%2FVYxj+%28Investment+Postcards+from+Cape+Town%29&utm_content=Yahoo!+Mail

Bottom line:

(1) short term, the indices are in an up trend defined by 10850-13290, 1155-1471; while a consolidation by definition has to occur at some point, nothing in the underlying technicals provides even a hint as to when that is going to happen,

(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 (11204) finished this week about 15.7% above Fair Value (9676) while the S&P closed (1217) around 1.0% overvalued (1203).
 
Economically speaking, the data flow is on a hot streak. As you know, last week I revised not only my economic forecast but also our Valuation Model and hence, 2010 Year End Fair Values to reflect these signs of a stronger rebound.  However, having done that the differential between the new stock valuations and current prices weren’t sufficient to warrant any dramatic strategy moves.  Indeed, I thought that the most significant impact of the revisions was to lower the downside risk to stocks.

This week investors shrugged off several pieces of bad news (Greek financial dilemma, Goldman Sachs problems, signs of creeping inflation) that given the proximity of Fair Value to current prices, I thought should have pushed the Market into some sort of consolidation.  But what do I know?  The stubbornness with which investors continue to buy stocks in the face of concerning developments raises the question in my mind as to whether my recent revisions still understate the rate of economic improvement and the resulting increase in equity valuations. 

In my opinion, there isn’t enough additional data to support another upward revision in our economic forecast and Valuation Model.  So I find myself in a situation were the technicals and fundamentals disagree.  While I usually err on the side of the fundamentals, our internal technical indicator, which historically is almost perfect in predicting Market direction (though sometimes with a lag), is telling me that the direction is up.

So my solution is another of those hedged ones.  In this case, assuming stocks continue to move up, a slow move to an increased stock position, Buying stocks that have lagged, i.e. those few remaining on our Buy Lists.  In addition, our Portfolios will be Adding to their gold (if the economy is stronger than our forecast indicates, then so too will be inflation) and foreign ETF’s (I feel more comfortable invested in areas that don’t have to overcome the political problems that the US does).  I will include a Subscriber Alert in Monday’s Morning Call.

I recognize that altering an investment strategy, particularly when the technicals and fundamentals conflict, carries a lot of risk.  The worst being that of getting whipsawed and looking like a complete idiot.  My reasoning for doing so is: (1) I could also look like a fool if prices advance another 10-15% and our Portfolios are sitting around with 20-25% in cash, (2) our Stop Loss Discipline will keep me from looking too stupid, (3) the stocks on our Buy List have seriously underperformed the Market, so we are not chasing momentum; as always we are Buying only stocks that are in their Buy Value Range.

This week, our Portfolios took no action.

           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 2010 Year End Fair Value*        10130                    1260
Fair Value as of 4/30/10                            9676                    1203
Close this week                                         11204                   1217

Over Valuation vs. 4/30 Close
      5% overvalued                                       10158                    1263
    10% overvalued                                       10643                    1323 
    15% overvalued                                       11127                    1383

Under Valuation vs. 4/30 Close
    5% undervalued                                         9192                  1142
   10%undervalued                                         8707                  1082
    15%undervalued                                       8224                    1022   

* 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 04-24-2010 10:51 AM by Steve Cook