Higher Gas Prices-Who's the loser?

Tim Phillips – CEO, Phillips & Company

A few weeks ago we mentioned how we had already seen some GDP forecasts revised down to 2.97% from highs in February of 3.20%

Either all of these guys aren’t very good at accurately forecasting the size of the world’s largest economy 12 months in advance or there’s a fly in the 2011 economic ointment they were depending on.  My guess is that we are all lousy at forecasting the outcomes of a $14.7 trillion economy 12 months in advance. However, to humor these professionals I wanted to see if one of the flies in the ointment is higher gas prices.

According the Energy Information Administration (EIA), US Regular Conventional Retail Gasoline Prices have risen by 33.90% in the last 12 months.

As seen with current data, politicians generally take a hit in their approval rating for rising gas prices.  Even when the economy has been improving Obama’s approval ratings have dropped lately with the spike in gas prices.

Recent research has shown that marginally higher gas prices don't have a large impact on gas consumption, so the real questions are:

• Do rising gas prices have an impact on consumer spending?
• If so, how big is that impact?

To put it another way, how much does a rise in gas prices take from discretionary income? Experts have called this the “Discretionary Income Effect”.

Opinions vary, but according to the US Department of Energy, in 2007 the average percentage of household income spent on gasoline was 4.80%.

If the average income per household is $49,777 (as recorded in 2009) and gas prices are up 33.90% then the lost dollars to other consumables is $810 per year or $67.50 per month.  That’s a fairly insignificant amount to those that drive most of the consumption (which are earners above the median income).

While there are other casual implications like:

• Does the uncertainty of rising gas prices drive consumers to save more vs. spend on other items?
• What’s the impact of consumption of durables and specifically items that consume energy? 

The bottom line is fairly straightforward, the politicians have much more to lose than our consumption driven economy. 

Please send me your thoughts, comments and feedback to tphillips@phillipsandco.com

Tim Phillips, CEO – Phillips & Company

Painful Start or Painful Taxes

Tim Phillips, CEO – Phillips and Company

Last quarter, when we were in the thick of earnings season we noted how well the numbers were looking at the top line and bottom line. When all was said and done, Bloomberg’s numbers showed that 72% of the S&P 500 beat earnings estimates. Unfortunately, this quarter’s earnings season isn’t looking so optimistic.

Bespoke Investment Group noted that a number of analysts have come in and revised their earnings estimates downwards over the last few weeks.

Although we are just at the start of earnings season, so far in general, it hasn’t mattered if you beat or missed the numbers you traded lower.

Not listing as a recommendation, but for an example last week Alcoa officially kicked off the earnings season after the close on Monday (4/11); they beat their earnings per share number but missed their sales number. Tuesday the stock opened down 4.84% and closed down 6.02%.

Tax Day Vs. Good Friday

We have two interesting things going on this week: Tax Day (pushed back from Friday due to Emancipation Day) and Good Friday.

Last week’s rough start to earnings season might have been exaggerated due to the Federal Tax Deadline. According to Bespoke, historically over the last 30 years the average performance of the week before the tax deadline has been muted. Last week was no exception, the S&P closed down 0.70%.

Looking ahead though, historically the week after tax day has been much stronger. Over the same time period the S&P 500 has risen on average by 1.10%. We also have Good Friday at the end of the week. Going all the way back to 1928 the S&P 500 has averaged a gain of 0.53% during the 4 day work week leading up to Good Friday. It will be important to focus on companies that report earnings this week to see how they do with these historical tail winds.

A few major earnings reports this week:

• Citigroup (4/18)
• Intel (4/19)
• EMC (4/20)
• Apple (4/20)
• McDonalds (4/21)
• Honeywell (4/21)

This should help determine if this painful start is a sign of what to expect throughout earnings season or if was just the painful effects of taxes.

As always, we appreciate all the feedback we get. Please send your thoughts and comments to: tphillips@phillipsandco.com

Political Drama – Enter Stage Left & Right

Tim Phillips, CEO – Phillips and Company

In, The General Theory of Employment, Interest and Money, John Maynard Keynes laid out six objective factors that influence the propensity to consume. I would like to take a moment to focus on two of them that are pretty straight forward:

 1.  A change in the difference between income and net income: The amount of consumption depends on net income rather than on income, since it is, by definition, his net income that a man has primarily in mind when he is deciding his scale of consumption. (emphasis added)

 2.  Changes in fiscal policy:  In so far as the inducement to the individual to save depends on the future return which he expects, it clearly depends not only on the rate of interest but on the fiscal policy of the Government. Income taxes, especially when they discriminate against “unearned” income, taxes on capital-profits, death-duties and the like are as relevant as the rate of interest (emphasis added). 

People consume net income and not their gross since their net income is dependent on expectations for interest rates and fiscal policy.

Since fiscal policy directly impacts our consumption (which is approximately 70% of our GDP), it’s rather interesting that despite the fact we went into the weekend with no clear agreement on the government budget and a real possibility of a government shutdown, the S&P 500 was only down about 4 points (-.32%).

Since that debate has been decided, I suspect that the markets will turn their attention back to fundamentals with earnings season set to kick off today after the close. However, the fiscal drama is far from over for the year as the political theater turns their eyes to the debt ceiling and the 2012 Budget for their next act.

If we learned anything from last week’s political theater, it’s that both sides benefitted from brinksmanship (the practice of pushing dangerous events to the verge of disaster in order to achieve the most advantageous outcome) and it will most likely be utilized by both sides again in the next act with the debt limit debate and 2012 budget set to debut over the next several months.

While this may be beneficial to the two political parties, it unfortunately could be detrimental as increased uncertainty in fiscal policy (i.e. Medicare and social security) and our net income (i.e. personal and corporate tax rates, and personal deductions) could cause a decrease in our propensity to consume and significantly threaten corporate earnings and our GDP.

In fact we have already seen some GDP forecasts revised lower over the last month. The mean GDP forecast for the US is now 2.97%, which is down from the highs in February of 3.20% (per Bloomberg).

My most likely scenarios (based upon a healthy dose of skepticism and lack of trust for the political class) are:

• If the 2012 budget is to truly address entitlement spending then it could rage on throughout fall and could in fact continue on through the 2012 political season.
• The 2012 budget will likely drop any entitlement spending reform and that debate will be delayed for the following act, The 2012 Elections.
• The debt limit will be raised and those practicing brinksmanship (playing chicken) will find some way to save face.

Overall, market reaction will probably be muted (similar to last week) as most of the investor class has grown weary of the political drama. However, we could see increased volatility as the two political parties play chicken. This volatility could provide additional dips and buying opportunities for the investors who prefer to take a dynamic approach to investing as we go through economic cycles.

Below is a chart of the S&P 500 with the dates of the last three times we raised the debt limit circled in green:

Thoughts and comments are always welcome and I look forward to them throughout the week. Please send them to:

tphillips@phillipsandco.com

Tim Phillips, CEO – Phillips and Company

Jobs – Now What?

According to the BLS data for March employment increased by 216,000 and the unemployment rate dropped to a 2 year low of 8.8%. They also revised up the January and February employment numbers. So for the first three months of the year the economy has added 188,000 private payroll jobs per month. Based on this trailing indicator the economy is clearly improving.

Now What?

With the US economy now improving, the next questions to ask are:

• How good will it get?
• How soon will it take to get there?

When the recession began we used this simple graph below to illustrate the question at that time. It seems to me we can dust off the graph and use it again.

We now know how far the economy fell and we are coming close to knowing how long it will take to recover.

It's my guess (emphasize on guess) that if we continue to get 3.3%+ GDP growth then we could see continued job growth around 225k/month and possibly 300k/month by the end of the year.

As discussed last week, we still have a “Wall of Worry” at center stage that we have to work through, and that’s going to generate some bumps and bruises for those that lose perspective.

To keep the right perspective, remember that the markets are forward looking. So at the same time, we have to start thinking about how good can the future get because our markets are fairly efficient at discounting news and can do so far into the future

Because asset allocation matters most, per the illustration below, it is critical to contemplate the next adjustments to our portfolios. Much more on this in future comments.

Determinants of Portfolio Performance:

Source: Financial Analysts Journal, May-June, 1991, “Determinants of Portfolio Performance II: an Update” by B.G.P. Brinson, B.D. Singer and G.L. Beebower. Results are based on the 10-year performance record of 91 pension funds.

As for now, it's on to earnings season to see if the lagging jobs numbers match the earnings capabilities of companies.

The “Now What?” always comes quicker than we realize.

Please send me your thoughts, comments and feedback to tphillips@phillipsandco.com

Tim Phillips, CEO – Phillips and Company