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Sterling Weekly for the Week of February 1st, 2010
A Few Thoughts on the Economy, Valuations, and Inflation

Since the previous edition of the Sterling Weekly, the Dow Jones Industrial Average rose 12.55 points or approximately 0.1%, to finish at 10,185.53 The lack of volatility in those numbers actually masks the deterioration in the overall market that occurred between the 22nd of January and the 1st of February. During this period of time the vast majority of the sector indices I track developed bearish chart patterns, and the stocks with the highest trading volume all saw increased volume as they moved lower. Combined these are typically very bearish trading signals.

While I really wanted to write up a sector index I hadn't talked about in quite a while, when looked at the charts of the various sector indices I track I couldn't find one that looked positive. Normally there would be some sector indices that are moving lower, there would be some tracking sideways, and some that are doing well. However, since the financial crisis of 2008 all the various sector indices have been moving together in the same direction, whether that is up or down. The lack of divergence can make life tougher than it normally would be, not to mention finding a topic to write about every week tougher on some weeks than others. So I find myself looking at a chart of the Dow Jones Industrial Average and asking myself where does the market go from here?

Unfortunately I do not see the overall market making any significant gains from these levels. For more information as to why please see the November 23rd, 2008, December 7th, 2008, and the January 25th, 2009 editions of the Sterling Weekly for my thoughts on this. What I see is a combination of macro economic factors including increasing federal deficits, rising taxes, higher inflation, and higher interest rates slowing the economic growth. Lower growth rates will result in a lower Price to Earnings (P:E) multiples for the overall market and individual stocks. Rising interest rates and inflation will do the same. While I won't tire everyone with the math behind the formula; it all has to do with the time value of money and the fact that higher interest rates reduce the current value of future money, additionally higher inflation has the same effect, what it is worth today will be worth less today due the cancerous effects of inflation.

A lower Price to Earnings multiple for the overall market will ultimately increase the cost of capital for companies, or in layman's terms make it more expensive for them to finance future projects. This will in turn further slow the growth of the economy. Once economic growth drops below the population growth people will begin to feel real economic pain.

Since we can short stocks forever, the next question become what do I think will ultimately perform well under these conditions? If I am correct in my assessment of the the factors that will be weighing in on the economy, then all those factors with the exception of inflation will be a depressant on the economy. Historically commodities perform the best in periods of rising inflation. However, in reviewing the various commodities I don't yet see any of the major commodities setting new highs. Which leads us to the question of when does inflation start to kick in? And how high will it get? If you believe inflation is a function of increasing the money supply, and that it typically takes 12-24 months for the effects of monetary expansion to be reflected in the economy, which last week's GDP report reflected, then we expect to see rising inflation in the second half of this year. If that is the case, then the market should start to anticipate the rising inflation sometime in the second quarter of the year, and move lower as a result of the anticipated rising inflation. Or so I think.

I am going to do some research this week and see if I can find an estimate of future economic growth that I feel comfortable with and I'll run the calculations to see what the P/E ratio will be under the conditions I foresee.

Please note that this is heavy week for corporate earnings announcements, and that an earnings surprise always has the possibility of reversing an existing trend.


Sterling Calendars for the Week of February 1st, 2010.
Economic Calendar

Date

Est. Time Release

For

Consensus Prior
02/01 8:30am Personal Income Dec. 0.3% 0.4%
02/01 8:30am Personal Spending Dec. 0.3% 0.5%
02/01 10:00am Construction Spending Dec. (0.5%) (0.6%)
02/01 10:00am ISM Index Jan. 55.2 55.9
02/02 10:00am Pending Home Sales Dec. 1.1% (16.0%)
02/02 2:00pm Auto Sales Jan. N/A 4.14M
02/02 2:00pm Truck Sales Jan. N/A. 4.49M
02/03 7:30am Challenger Job Cuts Jan. N/A (72.9%)
02/03 8:15am ADP Employment Change Jan (40K) (84K)
02/03 10:00am ISM Services Jan. 50.9 50.1
02/03 10:30am Crude Inventories 01/29 N/A (3.89M)
02/04 8:30am Initial Claims 01/30 454K

470K

02/04 8:30am Continuing Claims 01/30 4,600K 4,602K
02/04 8:30am Productivity-Preliminary Q4 6.0% 8.1%
02/04 8:30am Unit Labor Costs - Prelim Q4 (2.5%) (2.5%)
02/04 10:00am Factory Orders Dec. 0.6% 1.1%
02/05 8:30am Nonfarm Payrolls Jan. 13K (85K)
02/05 8:30am Unemployment Rate Jan 10.0% 10.0%
02/05 8:30am Average Workweek Jan. 33.2 33.2
02/05 8:30am Hourly Earnings Jan 0.2% 0.2%
02/05 3:00pm Consumer Credit Dec. ($9.5B) ($17.5B)
  Misc. Calendar
Date: Comments:
02/01 Humana, Inc. 'HUM' announces earnings at 6:00am. Est. $1.48
02/01 Rent-A-Center 'RCII' announces earnings after the close. Est. $0.56
02/01 Sysco Corp. 'SYY' announces earnings. Time N/A. Est. $0.42
02/02 Aflac, Inc. 'AFL' announces earnings after the close. Est. $1.15
02/02 Archer Daniels Midland 'ADM' announces earnings before the open. Est. $0.72
02/02 Automatic Data Processing 'ADP' announces earnings before the open. Est. $0.58
02/02 BP, Plc. 'BP' announces earnings at 2:00am Est. $1.49
02/02 D.R. Horton 'DHI' announces earnings before the open. Est. ($0.14)
02/02 Marathon Oil 'MRO' announces earnings. Time N/A. Est. $0.51
02/02 Patriot Coal 'PCX' announces earnings before the open. Est. $0.40
02/02 Pioneer Natural Resources 'PXD' announces earnings after the close. Est. $0.05
02/03 Black & Decker 'BDK' announces earnings. Time N/A. Est. $0.77
02/03 Cisco Systems 'CSCO' announces earnings after the close. Est. $0.35
02/03 International Paper 'IP' announces earnings before the open. Est $0.23
02/03 Pfizer 'PFE' announces earnings. Time N/A. Est. $0.50
02/03 Western Union 'WU' announces earnings before the open. Est. $0.32
02/04 Clorox 'CLX' announces earnings. Time N/A. Est. $0.76
02/04 HH Gregg 'HGG' announces earnings. Time N/A. Est. $0.44
02/04 Microchip Tech. 'MCHP' announces earnings after the close. Est. $0.29
02/05 Aetna, Inc. 'AET' announces earnings before the open. Est. $0.42
02/05 Spectra Energy Partners 'SEP' announces earnings before the open. Est. $0.45
02/05 Weyrhaeuser 'WY' announces earnings before the open.. Est. ($0.38)
  The full earnings calendar for this week can be found (here)

Prime Update:

The Prime Stock Newsletter is our daily newsletter that contains commentary on the overall market, and our single best trading idea for the day! (Both Long & Short Sale Recommendations) We select this stock through a combination of technical (charting) and fundamental (financial) analysis. The Prime Stock Newsletter provides select expanded quotation information, corporate description, select recent company news, our technical analysis of the shares and our expectations, and our options recommendation for the company.

Our most recent Performance Report is now available available (here). We are proud to report 16 of our last 20 recommendation resulted in profitable trades for an average profit of $0.35/share. This is an 80% success rate.

Archived copies of our Performance Reports can be found (here).

Highlights from Recent (20) Editions of the Prime Stock Newsletter
Recommendation Date Entry Point Recent Close or Exit Price Profit* Note
Travelers Co. 'TRV' short Dec 17 $49.50 $47.89 $1.61 Covered on the 18th
Patriot Coal 'PCX' Dec. 23 $14.90 $17.24 $2.34 Sold on the 28th
Fibria Celulose 'FBR' short Jan 14 $22.63 $20.02 $1.19 Covered on the 15th

* Our January 19th short sale recommendation of Western Digital 'WDC' @ $43.98/share, closed at $40.74/share Friday January 22nd for a gain of $3.24/share.

* Our January 13th short sale recommendation of Texas Inst. 'TXN' @ $24.91/share, closed at $23.11/share Friday January 22nd for a gain of $1.80/share.

* Our January 12th short sale recommendation of Best Buy, Inc. 'BBY' @ $39.23/share, closed at $37.15/share Friday January 22nd, 2010 for a gain of $2.08/share.

* Our December 23rd recommendation of Patriot Coal 'PCX' @ $14.90/share, reached an intra-day high of $22.37/share on January 11th for a gain of $7.47/share.

* The per share PROFIT is a theoretical calculation based upon the opening price the day the recommendation is published and the intra day high (or low for short sales) on the exit day. The exit day is determined based upon the application of our "Rules for Trading", the implementation of "stops" within our stated policy, and may not reflect the complete or full movement of the underlying recommendation.

 

Disclaimer: The Sterling Investments series of newsletters is produced by Sterling Investment Services, Inc. All information used in the production has been obtained from sources believed to be reliable and accurate. Sterling Investment Services does not warrant or assume any liability for inaccuracy of the information used to produce our publications. To receive further information on these services please visit our web page at: www.sterlinginvestments.com If you would like to contact us our fax # is (404)-816-8830 Email address is: enelson@sterlinginvestments.com Sterling Investment Services may hold positions in the securities recommended or may be providing consulting services to the companies mentioned within this report.
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