Saturday, September 01, 2012

Fundamental-A Dividend Growth Investment Strategy

The DJIA (13090) finished this week about 17.2% above Fair Value (11165) while the S&P (1405) closed 1.6% overvalued (1382). 

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.

By Steve Cook
All American Investor

The economy continues to limp along; although the overall flow of economic news has improved in the last couple of weeks including more upbeat data in the ‘big four’ economic indicators. If anything that reduces the risk of recession and provides additional support to our ‘sluggish recovery’ forecast.

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Under the category of ‘a change in personnel in Washington’, this week we got the promise of good news (the GOP platform) and some bad news (Bernanke hasn’t given up on the notion of central bank control of the economy). Unfortunately, it is too early to assume the former will take place (plus intrade says it ain’t happening) and the latter is firmly set in our Model. Thus, for the moment, nothing in the economic/political environment warrants altering the assumptions in our Models.

Of course, Europe remains the 800 pound gorilla in our forecast. To be sure, it is still managing to ‘muddle through’ and the investment community continues to maintain its faith in the eurocrats in face of overwhelming evidence to the contrary. However as you know, while ‘muddle through’ is our forecast, I consider it anything but inevitable.

Spain says that it is bailing out a major bank; the question is, with what? (short):

Youth unemployment in the EU (short):

What Credit Suisse expects from Draghi this coming week (medium):

This high level of uncertainty related to whether or not the EU will be successful in solving its sovereign/bank debt problem is disconcerting enough; but my real worry is the magnitude of the downside risk if it fails. To be sure, I buy the notion that a portion of the damage that would take place if the euro broke up is already happening. That diminishes the potential economic risk associated with a break up of the EU. However, it does nothing to lessen the financial (balance sheet) risk our institutions have to the eurobanks. Of course, that risk could be zero; but due to the opacity of bank financial reporting, we simply have no idea regarding its magnitude.

My investment conclusion: ‘stocks (as defined by the S&P) are above Fair Value (as defined by our Model). Under less stressful circumstances, that would dictate a cash position of around 15%. Our Portfolio’s are at double that level primarily because of the large risk of failure in the EU and the even larger downside to our economy and in particular our financial institutions if that occurs. That said, because I can’t quantify either, I believe that the best strategy is to ‘nibble’ through any Market declines which our Portfolios will do but starting at much lower levels.’

Since the last Closing Bell, our Portfolios Added to their GLD 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.


Current 2012 Year End Fair Value* 11300 1400
Fair Value as of 9/30/12 11165 1382
Close this week 13090 1405

Over Valuation vs. 9/30 Close
5% overvalued 11723 1451
10% overvalued 12281 1520
15% overvalued 12839 1589
20%overvalued 13398 1658

Under Valuation vs. 9/30 Close
5% undervalued 10606 1312
10%undervalued 10048 1243 15%undervalued 9490 1174

* 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.

Original content  All American Investor