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Investment Outlook

 The desire for constant action irrespective of underlying conditions is responsible for many losses on Wall Street, even among the professionals, who feel that they must take home some money every day, as though they were working for regular wages. 
- Jesse Livermore

If you follow sports for any length of time I would suggest that at some point you will hear/read/view this phrase from a commentator, “the aura of invincibility.” This phrase is typically attributed to a team or an individual who compiles a track record for dominating their competition so thoroughly that it becomes conventional wisdom that this dominance will perpetuate indefinitely.

Of course athletes age, get injured or as often is the case, buy into the myth that they are the greatest of all time and don’t know when to gracefully exit stage left. Adoration by the masses is a highly-addictive drug and it is difficult for any human being that having experienced the heights of celebrity has the gravitas and wisdom to accept that their skills have deteriorated and they can no longer perform at the super-human level. And, once the aura of invincibility has been cracked, it is the rare team or individual that can reclaim their previous level of dominance (see Mike Tyson, Tiger Woods, et al).

The aura of invincibility for the Dow Industrials and the NYA was cracked last week when both of those averages broke significantly below the trend lines of support that have been in place since the bottom of the financial crisis in 2009. The S&P 500 and the Nasdaq Composite fared better in that they didn’t crack their 2009 trend lines, but they did break the ones in place since the 2011 lows.

The vaunted Chinese economy and stock market has also fallen from the ranks of the invincible and now sits alongside those of Japan and Europe as examples of hubris run amuck. I would further suggest that the aura of invincibility for the Federal Reserve, the European Central Bank, the Bank of Japan, the Bank of England and the Peoples Bank of China have taken a hit as well.

Some of you may remember the Chiffon Margarine commercials from the 1970’s where the company claimed their margarine looked and tasted so much like butter that it even fooled Mother Nature. At the end of the commercial a rather indignant Mother Nature admonished the company that, “It’s not nice to fool Mother Nature,” before raising her arms and bringing thunder and lightning crashing down.

Just as there are laws of nature there are laws of economics. Both can be manipulated for a time and to an extent but neither can be repealed forever. Gravity, someone once said, is a stubborn thing; you just can’t get away from it.

A major characteristic of capitalism is the force known as creative destruction. Goods and services are created and deployed only to be supplanted by something else that is better, cheaper, etc. Some call this progress, others the natural order. Behind all goods and services are human beings with nervous systems and emotions who sometimes adapt to progress and stay in business and others that fail. That my friend is how the business cycle works: it is what it is.

Markets follow a cycle of creative destruction as well. They expand, often to excess, and then must contract, again often to excess, where the floor is swept clean so the cycle can start over again. It is when that process is subverted that things can get ugly. You see in the end gravity matters, which is why trees don’t grow to the sky.

The good news from my perspective is that we can now get a sense of how the remainder of this half-cycle will play out.

Without getting into the tall weeds of technical analysis, the high in the broad market in May was the end of the uptrend that began at the lows in 2011. Since the high in May the market has been undergoing a corrective sequence that typically plays out in a three-part series of down-up-down moves. In my opinion the low on August 24 represented the initial down move and since then has been in the intermediate up move. If this scenario plays out in text-book fashion we will see one more move down before the market begins the final uptrend of this half-cycle.

Some additional good news is that this corrective sequence in the broad market has, as a result of some particularly indiscriminate selling, given the quality/value investor an opportunity to acquire shares of some outstanding companies at historically repetitive areas of good value.

If you recall in earlier missives from this spring and summer, I suggested that readers research the S&P 500 sectors to find the heaviest weighted Select Blue Chips in each sector. Once these stocks are identified you then look in the data tables of the newsletter to find where each offers good value, which is within 10% of their respective lowprice / high-yield area.

By example, Procter & Gamble (PG) is the heaviest weighted stock in the Consumer Staples sector and now offers excellent good value. In the Consumer Discretionary sector the highest weighted Select Blue Chip is Walt Disney (DIS), which briefly dipped into Undervalue and may do so again. What you are looking for is a price of $91.30 or lower.

In the Energy sector the world is your oyster. In the Healthcare sector the number one stock is Johnson & Johnson (JNJ), which is right at the top of its Undervalued area and the number two stock, Pfizer Inc (PFE) is not too far off as well.

In the Industrial sector 3M Company (MMM), Boeing Company (BA) and Union Pacific (UNP) offer good value, as does United Technologies (UTX). Who knows, you might even get a shot at the highest weighted company in the sector, General Electric (GE), if it drops to the $20 area as it did for about 30 seconds on the 24th. Hey, anything is possible.

In closing declines may be unpleasant emotionally, but they are healthy and necessary and provide opportunity to the enlightened investor that has been disciplined. Your reward is you get to acquire great companies that not only offer good value but also have the most upside potential with the least downside risk. Carpe Diem!