Saturday, March 24, 2012

The Closing Bell -- Fundamental -- A Dividend Growth Investment Strategy 324


Fundamental-A Dividend Growth Investment Strategy

The DJIA (13080) finished this week about 20.0% above Fair Value (10895) while the S&P closed (1397) 3.8% over valued (1346).

Incorporated in that ‘Fair Value’ judgment is a ‘muddle through’ scenario in Europe and a sluggish recovery at home that isn’t likely to improve until we change the personnel in Washington.

The economic data continues to support both our Economic and Valuation Models. After a couple of weeks of mostly positive headlines, the news flow turned a bit more mixed this week. The US housing numbers were not very good and industrial production in Europe and China was disappointing. Try as I might when I analyze the numbers at hand combined with higher interest rates, higher oil prices and slippage in the global economic growth rate, I can’t get to a forecast sufficiently higher than our current one. Hence no reason to alter the assumptions in our Valuation Model.

Our political class continues to disappoint. This week: Obama’s almost delusional narrative on His own energy policy and the GOP’s (Paul Ryan) new budget plan which, while better than a sharp stick in the eye, schedules most spending cuts in the out years--a typical ploy by our political class to tout cuts today and leave itself the option to renege later.

Europe remains a conundrum to me.

I look at the math in terms of debt and income (i.e. the ability to service and pay it back) and I can’t figure out what the optimists are thinking about. It is like they are stepping off a cliff and assuming the laws of physics are going to change. I say that knowing that our forecast is the good news scenario, i.e. the Europeans through public and private austerity hold off bankruptcy long enough to bring their fiscal situation back in balance. But implicit in that forecast is a no growth economy (Japan 2.0); and if oil prices continue to rise--a development with far worse consequences for the EU than the US--our outlook will almost assuredly be too optimistic. The whole point here being that Europe may be out of the headlines but it is not out of the woods.

Of course, I may be way underestimating the near term growth potential for the US and all those negatives about which I worry could already be discounted at current prices. As I said last week, price is truth and right now truth is saying that I have miscalculated some where.

That is the reason that our Portfolios (1) Added 2.5% to stocks this week via the Vanguard Dividend Appreciation ETF (VIG) which provides a good hedge in that it is liquid and easily tradable thereby allowing a hasty retreat when, as and if necessary and (2) will continue to inch their way toward a 20-25% cash position.

Bottom line:

(1) our Portfolios will carry a high cash balance,

(2) we continue to include gold and foreign ETF’s in our asset mix because we continue to believe that inflation is a major long term risk. An investment in gold is an inflation hedge and holdings in other countries provide exposure to better growth opportunities. However, the likelihood of a continued strengthening in the dollar argues for less emphasis on these investment alternatives over the intermediate term.

(3) defense is still important.

DJIA S&P

Current 2012 Year End Fair Value* 11300 1400
Fair Value as of 3/31/12 10895 1346
Close this week 13080 1397

Over Valuation vs. 3/31 Close
5% overvalued 11439 1413
10% overvalued 11984 1480
15% overvalued 12529 1547
20% overvalued 13074 1615

Under Valuation vs. 3/31 Close
5% undervalued 10350 1278
10%undervalued 9805 1211 15%undervalued 9260 1144

* 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.