Updating Dr. and Mrs. Millhalf's (Ret.) Portfolio

In October 2005, Market Watch published the first article pertaining to Dr. and Mrs. Millhalf. They had just moved here full-time with $500,000 to invest. Their goal is to leave a million dollars to their grandchildren. Initial investments were made on October 28, 2005. Pfizer was added in early July.

DR. & MRS. MILLHALF'S (Ret.) PORTFOLIO (July 26, 2006)
Security	Amount	Current Price	Value
BAC	1,160 shares	51.00	$59,160
GLD	1,050 shares	62.00	$65,100
UST	1,300 shares	49.53	$64,389
PFE	2,150 shares	25.11	$53,987
Short Term Tax Free Bonds			$306,335
Total Portfolio Value			$549,971*

DOW JONES INDUSTRIAL AVERAGE
10/28/05	At Initial Purchase	10,400
7/25/06	Most Current	11,104*

(*)DJIA increase = 6.8% & Millhalf Portfolio Increase = 10% ($549,951 ÷500,000 = a 10% increase in value). The 10% increase in value is 8-1/2 months from the initial investment. Annualized, the return would be 14%.

It is our habit every few months to sit down with Dr. and Mrs. Millhalf to try to answer their questions.

Dr. Millhalf: Not to be picky, but this 14% annualized return appears to be behind the 15% we are looking for. Is 15% maybe too much of a stretch?
Market Watch: 15% remains obtainable. Our goal remains to buy “A” rated, well managed, undervalued stocks that pay a dividend exceeding 4%, and that sell at a price earnings ratio of less than the Dow Jones historical average of 14.4 times earnings. This portfolio is building nicely. We just added a $50,000 investment in Pfizer, the largest producer and distributor of drugs in the world.

Mrs. Millhalf: I see Pfizer is valued at $53,987, not $50,000. Didn’t we just add this a few weeks ago?
Market Watch: Yes, we did. Pfizer has gotten so cheap, and is such a well managed company, that it met your criteria for purchasing additional stocks to add to your portfolio.

Mrs. Millhalf: The gain of $3900 in only a few weeks must mean this stock is going to the moon.
Market Watch: Not really, Mrs. Millhalf. Pfizer may yet get to a price below what you purchased it for; however, Pfizer, like other stocks in your portfolio, was purchased at the right price. Over the long run, Pfizer should do well.

Dr. Millhalf: This portfolio however is still lagging our market return goal of 15%, isn’t it?
Market Watch: If you look at the short term tax free bonds, and the yield thereon, you are saving income taxes in your tax bracket of 30%. Because of the tax free status of part of this portfolio, you and Mrs. Millhalf are enjoying an annualized return in excess of 15%.

Mrs. Millhalf: This is a much greater return than we are getting on our other investments. Should we liquefy our other investments and do this?
Market Watch: It is important to become comfortable with the system first. This system is very simple: we buy only A-rated, well managed, dominant companies in their industries. They must have high cash dividend yields, and they must be selling at historically low price earnings ratios. This system is not for everybody because it is extremely conservative. Investors want their portfolios to fly to the moon. But the dirty little secret that Wall Street doesn’t want you to know is that most people don’t make money in the stock market

Dr. Millhalf: Don’t these large brokerage houses have a lock on research and knowing which stocks are going to move?
Market Watch: Not at all. Wall Street firms are marketing companies. They have sold the public on the concept that they are the true market experts, and that their judgment is better than yours. With the internet, all sorts of information is available on every company. Investors who do the best in the market tell their stock brokers to buy stocks like you and Mrs. Millhalf are picking to build your portfolio. Most stock brokers are pushing stocks their research departments suggest they sell. There are huge conflicts of interest in these recommendations because most of the recommendations are commission driven.

Mrs. Millhalf: Shouldn’t this be illegal? We don’t know anybody that has done really well in the stock market.
Market Watch: It never works very well to try to regulate financial markets. It’s better to educate yourself, and make your own decisions based upon a common sense conservative system. For every investor that takes a flier and makes a million dollars, there are thousands who lose money. It is of note, however, that Wall Street’s record bonus’ last year of $21.5 billion roughly equaled the total increase in the value of the stock market in 2005. The profits went to Wall Street. If you check around with your friends, you’ll find that most people either lost a little bit of money last year, or made nothing. A lot of trading occurred, and a lot of commissions were earned in a record Wall Street year.

Dr. Millhalf: If all that activity was illegal, wouldn’t the public at large enjoy the gains instead of Wall Street?
Market Watch: Theoretically, yes. But it is not going to happen. Just try to remember that for investors as a whole, their returns decrease as activity in their accounts increase. Buying and selling your securities benefits Wall Street for the average investor. It does not serve the best interests of the investor.

Mrs. Millhalf: With all the uncertainties and economic dislocations pointed out by Market Watch, might we be better off to be completely in cash and bonds?
Market Watch: That would be the most conservative place to be, without a doubt. But this is a good time to start building a portfolio. As the well managed, dominant companies become priced more reasonably by the market, it pays to purchase them and add them to your portfolio.

While the market is still overpriced, it is much cheaper than it was 6 years ago when there were no attractively priced stocks available. As previously pointed out, groups like banks, drug stocks, and tobacco stocks are currently depressed to the point where they are selling at their all time relative lows. There is little risk in the best managed companies purchased at the right price. If we stick by our goal of purchasing stocks that pay at least a 4% dividend or better, the growth, for your grandchildren, could be excellent.

Conclusion

Buyers in this market should remain cautious. Big money makes the major trends. Big money is still primarily in cash and short term debt securities. And big money is accumulating stocks like the Millhalf’s own. Accumulation (demand) is why these stocks are going up in price.

There continue to be difficult economic factors influencing the market. Retail sales are down. The housing market has slowed down significantly. Consumer discretionary spending, which represents 70% of our GDP, is decreasing, and the $750 billion borrowed against their homes in 2005 by consumers is not being borrowed at the same pace in 2006 as it was last year. The price of oil and gas remains high. Inflation continues its uptrend. (Since the Federal Reserve System was founded in 1913, our money has lost 98% of its value.) We have $50 trillion of debt in this country and only a $13 trillion GDP. The Dow is still selling at 19.8 times earnings, 38% above the Dow’s historical average price earnings ratio. The Dow cash dividend yield is 2.4%, about half of its historical cash yield of 4.3%. Our trade deficit continues to set records. The U. S. government budget deficits remain at high levels adding to our future interest payment obligations. Foreigners continue to increase their ownership of U. S. assets while we Americans continue to reduce our percentage of the World’s assets. This means that we will pay out more of our income to foreigners in the future than will be received in income from them.

The key to Dow Theory is understanding values. There is tremendous wealth in the United States, and much more wealth will be created over the next 50 to 100 years. In spite of our economic dislocations, it’s important to look favorably upon the fact that we are the tail that wags the economic dog of the world. In one year, we still produce 30% of the world’s goods and services, an astounding figure for only 4-1/2% of the world’s population. Selective purchases of stocks, purchased when each stock is a value, is most likely to produce nice capital gains with a minimum of risk.

Caveat Emptor.
George Rauch
July 26, 2006

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