Portfolio Review

1/26/2009


List review
Investors hoping for a quick reversal of 2008’s downward trend have been disappointed. 2009 is off to a rough start, with the S&P 500 Index down 10.9% so far — but the Forecasts’ recommended lists are doing better this year after mostly lagging in 2008.

So far this year, the Focus List is down 4.6% on a fully invested basis, while the Buy List is off 5.3% and the Long-Term Buy List down 7.2% — all substantially better than the S&P 500’s return. Including our cash position, the results look even better. For example: The Buy List is 32.5% invested in Vanguard Short-Term Investment-Grade ($9.80; VFSTX), a relatively low-risk bond fund which serves as our substitute for cash and is up 1.3% for the year. Including the fund position, the Focus List is down just 2.7%. The Forecasts continues to believe that the best way to weather a financial storm is to set aside a significant portion of your stock portfolio in cash and keep the rest in a diversified portfolio of quality stocks. Our Focus List, Buy List, and Long-Term Buy List seem capable of outperforming the market during both uptrends and downtrends.

While we are not satisfied with our 2008 performance, the independent Hulbert Financial Digest says Dow Theory Forecasts is one of a select group of newsletters that has outperformed the market — based on both absolute and risk-adjusted returns — for the one, three, five, 10, and 15 years ended Dec. 31. Over the last 25 years, the Forecasts ranks No. 5 among all the newsletters Hulbert monitors.

Financials still in flux
Some kinds of help, the market can do without.

So far, the federal government’s efforts to bail out the financial sector have not provided any lasting lift to stocks. In fact, since the bailout plan was launched last October, the S&P 1500 Banks Group Index has fallen 52%. Financial-services bellwethers — perhaps “former bellwethers” is more accurate — Citigroup ($3; C) and Bank of America ($5; BAC) lost more than 80% of their value during that period. In contrast, the broader S&P 1500 Index is down 19%.

The feds have already infused the financial sector with several hundred billion dollars, and Congress is allowing President Obama to tap the $350 billion remaining from the original $700 billion Troubled Asset Relief Program. The new administration has vowed stricter oversight over new loans and pledged at least $50 billion toward slowing foreclosures.

Banks’ troubles extend far beyond real-estate loans, as consumers nationwide struggle to make payments on such debt as car loans and credit cards. Consensus estimates project $6 billion in losses for the financial sector in the December quarter. Just three months ago, Wall Street expected profits to rise.

The market is skittish about some proposals that would give the federal government unprecedented control over the banking industry. Ideas under consideration include the purchase of huge blocks of securities convertible to common stock and the formation of a government bank that would acquire troubled assets. Both strategies would represent giant steps toward the nationalization of U.S. banks. Concerns that any nationalization would leave shareholders holding an empty bag has hurt financial stocks of all types.

Below, we review top news from the financial stocks we cover.

Bank of America ($5; BAC) lost $2.39 billion, or $0.48 per share, in the December quarter, down from a $0.05 profit in the 2007 period and below Wall Street expectations of an $0.08 gain. The quarterly dividend was slashed to $0.01 per share, down from $0.32 in December and $0.64 in September. Bank of America, already the recipient of $25 billion in federal loans, received another $20 billion, citing trouble at Merrill Lynch. The brokerage, acquired on Jan. 1, posted a quarterly loss of about $15 billion. Bank of America is rated Neutral.


Once considered too big to fail, Citigroup ($3; C) continues to dismantle itself, splitting into two companies in a desperate move to avoid testing that theory. Citicorp will operate the retail and investment banks and transaction-processing units. Citi Holdings will control asset management, consumer finance, a 49% stake in a brokerage joint venture with Morgan Stanley ($13; MS), and $300 billion of troubled assets backstopped by the government. In the December quarter, Citigroup lost $12.14 billion, or $2.44 per share, from continuing operations. Citigroup is rated Neutral.


J.P. Morgan Chase ($18; JPM) lost $0.28 per share in the December quarter excluding an extraordinary gain from its Washington Mutual acquisition, down from a profit of $0.86 per share in the year-earlier period. Including the gain, J.P. Morgan earned $0.07 per share. J.P. Morgan is rated Neutral.

December-quarter earnings
IBM ($82; IBM) earned $3.28 per share, up 17% and $0.25 above the consensus. Revenue fell 6% to $27.0 billion, down 1% at constant currency, but profit margins rose sharply. IBM expects 2009 earnings of at least $9.20 per share, representing 3% growth and well above the $8.75 consensus. IBM is a Focus List Buy and a Long-Term Buy.

Johnson & Johnson ($57; JNJ) earned $0.94 per share excluding special charges, up 7% and $0.02 above Wall Street expectations. Sales declined 5% to $15.18 billion on an 11% decline in pharmaceutical revenue. J&J forecasts a tougher 2009, with earnings flat to slightly lower, versus the consensus estimate of a 3% gain. J&J is a Focus List Buy and a Long-Term Buy.

United Technologies ($49; UTX) earned $1.17 per share excluding special items, up 4% and $0.05 below the consensus. Total revenue slipped 1% to $14.50 billion but rose 3% excluding currency translation. Aerospace segments showed resilience, with their combined sales climbing 8%. United Technologies anticipates a difficult first half in 2009 but believes accelerated costs cuts will allow it to meet a prior per-share-earnings target for the full year — $4.65 to $5.15, representing a range of 5% growth to a 5% decline from 2008 results. United Technologies is a Buy and a Long-Term Buy.

Genentech ($82; DNA) earned $0.95 per share, up 38%. The downturn has yet to hamper profits but remains a concern as patients struggle to pay health-care costs. Genentech forecasts 2009 per-share earnings between $3.55 and $3.90, representing growth of 4% to 14% but below the $3.92 consensus at the time of the announcement. Genentech is a Long-Term Buy.

Intel’s ($13; INTC) profits plunged 89% to $0.04 per share including a $1 billion write-down on an investment in Internet provider Clearwire ($4; CLWR). Revenue fell 23%. Intel is rated Neutral.

News roundup
Microsoft ($18; MSFT) CEO Steve Ballmer reportedly spoke with top Yahoo ($11; YHOO) executives, fueling speculation of renewed merger negotiations between the companies. In other news, the European Union charged Microsoft with breaking antitrust laws by bundling the Internet Explorer browser with its Windows operating system, allegedly stifling competition from other browsers. Internet Explorer controls 68% of the global browser market, down from 85% four years ago. Microsoft is a Buy and a Long-Term Buy. Yahoo is rated Neutral.

Eli Lilly ($37; LLY) agreed to pay $1.42 billion to settle criminal and civil charges regarding the marketing of its top-selling drug for unauthorized uses. Lilly allegedly pushed Zyprexa, approved only to treat schizophrenia and bipolar disorder, as a way to medicate such illnesses as dementia and sleep disorders. Lilly is rated Neutral.

Describing his medical condition as “more complex” than the hormone imbalance announced earlier, Steve Jobs, CEO of Apple ($78; AAPL), took medical leave until the end of June. Apple, which reported solid December-quarter results, is rated Neutral.


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