Macro Economic Outlook:

• No double-dip, but no “W”, or “V-shape” recovery either. “It won’t look like any letter in the alphabet, it will look more like punctuation marks (e.g. ! ? - : )”
• There are still more opportunities in the distressed debt market.
• The American consumer (70% of GDP) lost 11 trillion in net worth due to the collapse in the real estate market
• While headline unemployment is 9.7%, realistic unemployment (under employed, no longer looking) is probably double that. Unemployment is no longer cyclical and is becoming structural.
• Large corporations are in great shape from a balance sheet perspective which is why we are seeing small increases at the top line leading to big bottom line increases. Corporations are doing more with less and creating bigger profits with fewer workers.

The following is Mr. Ross’s current investment themes for distressed investments:

Banks

• Buying small local and community banks to create larger regional banks then selling off the large regional bank as a whole.
• Outside of the US, Ireland and German banks look favorable too

Healthcare

• Healthcare represents 16% of the US economy
• The recent healthcare reform has created the biggest opportunity since the Clinton Administration passed the Medicare reform

Shale Gas and Natural Gas

• Specifically looking in the Exploration and Production area.
• The increase in natural gas due to shale gas production in TX, WY, and PA has caused a glut in natural gas cause the price of natural gas to fall substantially.
• Natural Gas is much cheaper and much clearer than other fossil fuels
• At $4mcf natural gas companies are just breaking even, but going forward he sees prices increase to $7-$8mcf which will make the industry much more profitable

Real Estate Services

• Specifically in RE brokerage, property management, CRE special services
• The firm (Invesco Inc. which is the parent company for WL Ross & Co) is also one of eight Public-Private Investment Program (PPIP) members.

India & China

• The Firm has recently opened up offices in Mumbai, India and Beijing, China.  They are specifically looking at the housing market in India as well.
• Continued flow of opportunities in India and Beijing

Bonus: Long Term outlook for America:

America is producing 1/7 the engineers as China and India combined. This will lead to a lack of talent and innovation in America. One of the reasons this is happening is due to the complexities and problems with getting visas.

All written content on this site is for informational purposes only. Nothing in this blog should be construed as investment advice in any way, shape or form. Comments, as well as, content on other sites linked to or from this one do not necessarily represent the opinion of the owner of this site. Material presented is believed to be from reliable sources and we make no representations as to its accuracy or completeness. All information and ideas should be discussed in detail with your individual advisor prior to implementation.

 Investment advisory services are offered by Phillips and Company, a registered Investment Advisor/Broker Dealer. The presence of this blog on the internet shall in no direct or indirect way be construed or interpreted as a solicitation to sell or offer to sell investment advisory services to any residents of any state other than states we are licensed in or where otherwise legally permitted. We are legally empowered to provide investment advisory services to residents of states we are licensed in and certain other states.

Consistent downgrades from Wall Street analysts have set us up for a very smooth start to the earnings season.

"Of the 132 companies in the S&P 500 that reported results since Oct. 7, more than 85 percent have topped analysts’ per- share earnings estimates, according to data compiled by Bloomberg. Analysts surveyed by Bloomberg predict 26 percent growth in third-quarter profit from a year earlier for S&P 500 companies, the fourth straight quarterly increase." (Bloomberg)

The chart I have displayed below from the Bespoke Investment Group, LLC. (B.I.G) shows earnings per share beat rate (the % of companies that beat estimates) has crushed the long-term historical average of 63%.  

A bit more concerning is the top line growth of companies.  After all, it's one thing to make a profit from cutting expenses (jobs, technology, health care etc.) and an entirely different picture to have revenue growth due to increased demand by the consumer.

 If you look again at the B.I.G. data, revenues have gotten off to a relatively weak start. Only 58% of companies that have reported beat top line estimates so far. 

An obvious absence of top line growth from the broad based market does not mean we can't get a lift in GDP growth.  After all, it's hard to fall off the floor.  Analysts are anticipating Q3 GDP growth to come in around 2% vs. the 1.7% for Q2.  Much of this marginal increase will be driven by an increase in consumer spending.  It looks like consumer spending was up 2% for the 3rd quarter.

If you scroll back through some of my earlier posts you'll see a common formula:

Jobs, Wages, Profits = Consumption and Investments = Jobs, Wages, Profits 

Here's the good news, companies are making profits albeit at the expense of jobs, but profits none the less.  These profits should be circulated back into our economy through planned investments, dividends and perhaps a few jobs here and there. 

The story goes that if enough profits are created, enough jobs might follow and then reckless consumption can start all over again (Happy days will be here again).  This is what I believe is being discounted in our current equities markets.  Of course, I did leave a few key factors out of the equation:  Savings and Consumer Credit.  While savings is on the rise, consumer revolving credit is still being shrunk.  Both of these have a draw down impact on consumption.  Let's see how these play out in the coming months reports.  I'll keep you posted.

For now, it's an investing environment with lowered expectations, muted consumption and better profits.

My themes continue to be:

• Weak dollar opportunities-exporters
• Select technology-specifically in business processing
• Media (Print that is adapting to online) see some tweets on this @PHCOadvisors.
• Rare Earths (again see our Tweets on this)

I'm also anticipating some kind of equipment tax credits that could be passed during a lame duck session.  There seems to be some common ground on this element of tax cuts so equipment manufacturers could benefit.  More on this in coming tweets and postings.

This weekend in the Northeast corner of the United States a very interesting conference took place. It was titled ‘Revisiting Monetary Policy in a Low Inflation Environment: Remarks at the Federal Reserve Bank of Boston’s 55th Economic Conference,’ and the speaker was Eric S. Rosengren, President & Chief Executive Officer of the Boston Federal Reserve Bank (http://bit.ly/biJDTo)

If you’re too busy to read the entire speech, the bottom line is this: even with tax, fiscal and social policies, once you enter a true deflationary period you will run the risk of deflation persisting.  The data he draws upon is from the last 20 years in Japan and it's clear that a deflationary spiral is nothing to fool with.

Coincidentally, the NY Times ran a very interesting article this Sunday showcasing some snippets of life in Japan.  It was troubling to see this article show the human sides of deflation on the spirit and drive of the Japanese people and its impact on the culture.  Low interest rates and government stimulus can't begin to solve the motivational and incentive problems in Japan. You can access the article from my Twitter (@PHCOAdvisors) or directly from here: http://nyti.ms/cHXolC

The Kitchen Sink

Before I get to the kitchen sink, I probably should back up and give a quick primer on GDP in the simplest terms.  In fact, I think this will explain what's going on with our politicians right now once we agree on some basics.

Is there really a new roadmap to GDP growth?

First, GDP is a simple formula that is quite easy to explain.  There are only a few ways to move the needle on GDP growth.  We can consume a whole lot more, have our government spend more, we can invest more in plant, equipment and technology as businesses, or we can export more of what we make and import less of what "they” make. Everything else you read about, listen to and watch, when it comes to economic policy feeds into those basic facts.

Dr. Mohamed Abdulla El-Erian a wise man from PIMCO coined the term "New Normal" when it comes to this investing environment.  What he doesn’t go onto suggest is a ‘new normal’ for the one component of GDP that matters most… (drum roll please) CONSUMPTION.

As you can see by the slide it's over 70% of our GDP formula.

I asked my team to run some "What If's" if the "New Normal" meant less consumption by all of us.   What would have to go up if we dropped consumption by 10% in the GDP formula?  By the way, during the Great Depression consumption dropped by 41% so a 10% drop is not unimaginable.

You can see that all things being equal:

Investment would have to go up by:

Government Spending would have to go up by:

 
Imports vs. Exports would have to balance out by:

Or you can run a combination of all four to make it less severe on each component:

Let's connect the dots, formula to reality:

• Investments by private business are strained by not having a clear picture of demand from the end consumer.  However, we hear about accelerated depreciation ideas and R&D tax credits. These are all incentives to move the needle on planned investments by the private sector.

• Government Spending is something that we’ve all heard a lot about in the last 18 months. We all know the spending spree the government is on and now we know why.  It's controllable by them, it can have a major impact on the GDP formula and the government can almost manufacture any amount of GDP growth for a period of time (for as long as they are willing to borrow or until it all breaks down). Ideas like stimulus and road projects are a few examples of this component.

• Imports vs. Exports, or in other words, our Trade Balance. We know the current administration has said several times that we need to import less and export more.  It’s not rocket science as to why.  Ideas like bailing out poorly operated auto manufacturers, support for unions, trade wars, and our weak dollar all support this policy.  One of the problems in playing with this part of the equation is that this is how real wars start. This is a topic that deserves its own article at a later date.

The bottom line, as the slides suggest, is that without Consumption restored the entire formula has limited chances of functioning well over the long term. There is no “New Road Map.”

Now here's the kitchen sink part. It’s clear that:

• Any opinion leader, politician or policy maker is coming to grips with the reality that there are only temporary and likely unsustainable solutions without the consumer.

• Without demand from the consumer, prices of everything will drop until they find a new equilibrium level (deflation).

• If deflation is persistent, and we have probably been in a deflationary environment for 10 years (as evident by housing prices, stock market values, real wages and income, higher rates of poverty, unemployment, under employment, low overall demand), then we are not far from falling into the “Japanification” of our people.

 Remember, this is also a behavioral phenomena and not just an economic one.

 No one, and I mean no one, wants to see the lost decades of Japan come to our shores.  So you can expect the Fed to react in the extreme with more quantitative easing, all while the government tries every policy trick in the book. Even the educational academy will get involved by encouraging all kinds of ideas to fix the formula or change the mix of the formula.  They will throw everything at this problem, including your kids and grandkids futures, as well as the kitchen sink.

Conclusion:

• The real economy will likely limp along until "they", and I'm not exactly sure who "they" is, find the right combination.
• The stock market and financial economy will likely benefit from all the attempts to re-inflate the economy in the short run.
• The human spirit of investment, speculation and desire for more will be muted until "they" realize we need stability in all areas before we can consume massively again.

There is no “New Road Map”, just attempts at fixing the road we have always traveled on.

My investment themes continue to be:

• Yield, Yield, Yield - deflationary hedge
• Media (Both print and on-line)
• Germany for a weak euro as the 2nd largest exporter in the world
• Technology-especially business processing
• US Mega Capitalized Companies with large cash balances paying dividends

On Institutional Allocations:

Hold steady, but be prepared to have discussions about a very choppy sea ahead and gain alignment with your board on multiyear return expectations. Alignment is more important right now than investment policy tweaks.  Rough seas can mean bad decisions especially when it comes to liquidity constraints.

I was having a recent conversation with a well respected lawyer and very intelligent investor in my community (his specialty is timber- which is in a bit of a recession itself). After some pretty good discussion on a range of topics he asked me the obvious question- why is the stock market up?

I gave him the obligatory answers someone in my position is expected to give and off we went onto the next topic.  However, this time that question stuck with me.  Why was the stock market rallying?

Was it all the jobs being created in the economy…. nope.

Was it the slew of clearly positive data during this week’s economic reporting calendar let’s see:

• Factory Orders shrank by -.5%
• Chain Store Sales shrank by -.8%
• The ISM Non-Manufacturing showed some strength.
• Revolving Credit balances shrank which is good for balance sheets but not good for consumption, while Non-Revolving credit balances grew demonstrating that lower interest rates are having a positive impact of larger purchases like vehicles.
• The work force shrank again losing another 95,000 jobs but the private sector added 65,000 yet the Unemployment rate held steady at 9.6%.
• Bookings for non-military capital goods excluding planes increased 5.1 percent, the biggest gain since March.
• The number of contracts to buy previously owned houses rose 4.3 percent, topping the median forecast of economists surveyed by Bloomberg News, data from the National Association of Realtors showed.

Well it looks like a mixed bag of data so that can't be driving the markets

Was it Warren Buffett's comments this week?  He announced this week that his Berkshire companies are "coming back" and when asked about his outlook on equity markets he said investors buying bonds after yields fell this year "are making a mistake."  He went on to say, “It’s quite clear that stocks are cheaper than bonds, I can’t imagine anyone having bonds in their portfolio when they can own equities.”….Perhaps?

How about Goldman Sachs, the pillar of social justice and their outlook for our economy?

They lowered their outlook for next year's GDP growth to 1.5% to 2% saying the economy could be "fairly bad to very bad" for the next six to nine months… That can't be why the markets are rallying.

Could it be investors looking at the third year effect that I posted on twitter that moved the markets?  Since I only have 43 followers I don't think so but the data is outstanding and you can find it on Twitter @PHCOAdvisors (Article: http://yhoo.it/cSwojJ). The article simply suggests that markets rally a lot when there is gridlock in the 3rd year of a Presidential Cycle, something to the tune of 16% to 21%.

So what is it?  My conclusion is twofold:

Major market participants have already discounted a pretty tough start to next year.  They have also discounted a pretty difficult earnings season we are entering into.  My belief is that the season will have more surprises to the upside due to the fact so many analysts guiding down over the last few weeks.

Second is all this talk of QE2.  QE2 is not a ship.  What all the noise this last week was about is Quantitative Easing being considered by the fed.  Simply put the Fed will resume buying treasuries and other interest rate instruments.  The thinking goes something like this:  when the Fed buys these financial vehicles it will put liquidity into debt markets and support business and consumer credit.

The hope is consumption and investment = Jobs, wages and profits which equals more consumption and more investment

Here's a slight wrinkle in the Fed's thinking.  They might be assuming it's the supply of money (lending) that's the problem.  What if it's the demand for money?  My thinking suggests it might be that most business (small and mid size) are not saying their business is bigger than the debt they can take on or at least the debt service they would take on.

So the capital markets are rallying and that's a good thing.  Anything can happen in the equity markets and it usually does.

The labor markets are still shrinking and that's bad.

Someone or some company will need to breach the supply for money and demand for money void and make a move to grow.  Animal Spirits (Keynes) will need to kick in and the profit motive will move some smart CEO or Company to make a move to grow.

While all of this goes on I continue to find relevant themes to invest.

• I'm still focused on yield, yield, yield. Select corporate bonds that can provide the appropriate yield with the right controlled risks.
• I especially like the Mega Cap US based export driven companies with a continuing weak dollar theme.
• Of course the iPad that I'm writing this post on right now, and other tablet PCs, promise to provide a nice segment of companies to invest in.  This is also another theme I would consider.
• Don't forget Media (both print and on-line)
• With all the trade war talk between China and Japan the Rare Earth space also seems to be heating up.

In the mean time, the capital market can continue to rally and labor market can continue to suffer but at some point one has to support the other. 

Tim Phillips, CEO

References:

http://www.goldmansucs.com/2010/09/28/goldman-releases-most-bearish-2011-outlook-presentation-yet-sees-sp-in-725-800-range-in-qe2-case/

Some people say the craziest things to grab headlines. Jeff Hirsch the Editor of the Stock Almanac made such a prediction calling for Dow 38,000 by 2025.

What's interesting about the prediction isn't the prediction itself.

It's the reaction it received. It was met worldwide with skepticism, disbelief and contempt. This is the mental state of affairs investors have about investing.

As unbelievable as the number seems on face value it's really quite possible.  To have a Dow at 38,000 by 2025 we would need an 8.8% annual return. It wasn't that long ago when we all talked about the equity markets generating 10% per year as a rule of thumb.  By the way, that would put the Dow at 45,000 in 2025.

In another intriguing analysis by Bespoke, they spotted a very interesting trend with yield curves.  I'll paraphrase some of their analysis.

Since April 2010, the slope of the yield curve on Treasuries has gone from more than a 1.5 standard deviation above its long-term average to less than one standard deviation above its long-term average. Since 1962, there have only been ten other periods where the yield curve has seen this swift a decline from such high levels.

"In those ten periods, the S&P 500 has averaged a gain of 3.99% during the initial six-month decline in the yield curve.  Over the following three months, the S&P 500 has averaged a gain of 5.21% with no occurrences of negative returns. Six months later, the S&P 500 averages a gain of 8.65% with positive returns in eight out of ten periods. Finally, over the next year the S&P 500 has seen an average gain of 17.97% with gains 80% of the time."

With bond yields so low it's not hard to believe investors choose stocks over bonds in hopes of higher returns.

On to Don Robinson's comments on Friday which were not all that uplifting and positive for the next few years.  You can find my summary on Twitter under PHCOAdvisors.  His forecast calls for very muted returns in stocks with sub-par growth in GDP over the next few years.  While I agree with many of his thoughts, particularly around the absence of inflation, a slight bias toward deflation and persistent unemployment, I do think we will find positive growth periods in equities driven by a few trends.

            Technology will drive innovation and in this environment drive efficiencies and productivity.  Technology will fill the gap that the consumer can’t.  If the consumer can't drive profits for companies, innovation, efficiency and optimization will.

            Health Care and Longer Living- with a global baby boomer generation entering retirement there should be plenty of opportunities to profit from the most highly educated, wealthiest and largest population cluster in the history of the world.

            Higher Standards of Living- regardless of what may be said to the media; the world wants our living standards, from quality of food to construction, media and entertainment.  We will continue to set the benchmark and those in emerging markets will aspire to attain our level of abundance.

My point is human instinct and animal spirits (Keynes) will drive the profit motive and help fuel equities forward.  As I have suggested several times in the past equity returns will be very uneven across sectors and segments.  Rising tides will not lift all boats and selection matters most in this type of market.

In the very near term my themes continue to be:

German Exporters-with a weak Euro they will benefit Technology especially export driven Media (both print and television.) Emerging Markets Yield, Yield, Yield (preferred's, very selective bonds.)

I also like the directional approach Lockwood suggested - long/short and market neutral.

The new generation of Phillips Advisors has convinced me to take this step and it proves to be a fascinating and great way to share relevant information. You can see some of my favorite articles and current ideas on Twitter by following us at PHCOAdvisors.