Weekly Market Commentary 5-23-11
Inflationary head fake?
Tim Phillips, CEO – Phillips and Company
Recently when I’ve been out learning how to see, there has been a lot of discussion on rapid inflation in the near future. Frankly, I agree with their concerns. However, the bond market doesn’t seem to agree. Bond prices continue to rise and continue to push yields lower. The bond market appears to be pricing in the exact opposite: low inflation in the near future.
Instead of arguing in the affirmative for higher and rapid inflation, I want to play devil’s advocate and see if I can build a case for low inflation.
Wage Growth?
Currently, wage growth is around 2% annually. Looking at the wage growth data from the last recession it could still be headed lower before it bottoms out. Unemployment is off the recessionary highs but still has a long way to go to get to pre-recessionary levels.
Housing Market?
The housing market appeared to be stabilizing however, recent data from Case-Shiller and CoreLogic show potentially more downside. If housing is approximately 40% of the CPI then it could prove to be difficult to have runaway inflation with flat or lower housing numbers...
Commodities?
For the year, commodities have done well but recently we have seen a pullback in commodities across the board.
Low Inflation Means What?
If this devil’s advocate scenario of low inflation in the near future is playing out then we should see lower GDP growth. Wait a minute! We have already seen GDP forecasted for the year revised lower. If lower CPI leads to lower GDP growth, does that mean lower stock prices too? At first it makes good logical sense, but the data seems to suggest otherwise.
In 2004, Jay Ritter did an exhausting study entitled, “Economic Growth and Equity Returns” and concluded that there is no stable relationship between growth and equity returns. Goldman Sachs ran their own analysis (“Staying the Course” 01/2011) and found similar results: there is no statistical significance in the relationship between equity returns and pace of economic growth. Lastly, Vanguard also produced similar results when they did their own study (“Investing in Emerging Markets: …”) last year stating that, “Since 1900, the correlation between long-run economic growth and long-run stock returns across 16 major markets has been effectively zero.”
If other people are making the “logical assumption” that cooling GDP numbers means lower stock market returns, we could see some emotional selling and a rocky summer that could prove to be a nice buying opportunity for investors that actually looked at the historical correlation. This could be a good summer to look back and evaluate whether or not your investment managers are actually adding any value and beating benchmarks or if they fall for a potential head fake.
As always, we appreciate all the feedback we get. Please send your thoughts and comments to: tphillips@phillipsandco.com.
You can also find us on twitter: @PHCOAdvisors
Tim Phillips – CEO, Phillips and Company
Learning How to See Part II
Tim Phillips – CEO, Phillips and Company
Weekly Market Commentary 5-16-11
While many professionals in my industry spend hours analyzing data points looking for trends and searching online for industry reports, I prefer an additional tool: hitting the road and meeting with investment decision makers.
I don’t believe you can quite replace a personal relationship and insight with a spreadsheet alone.
Last week I promised to give you a couple of insights into where I am seeing investment dollars flow.
First would be the CIVETS. Not the animal, but a sub segment of the emerging markets. CIVETS is an acronym for: Colombia, Indonesia, Vietnam, Egypt, Turkey, and South Africa. The grouping was introduced by the Economist and the main investment thesis is that while these countries are geographically dispersed, they have important similarities:
- Sizeable, young populations
- Diversified economies not excessively reliant on commodities
- Reasonably sophisticated financial systems
Here’s how they look by the numbers:
While Robert Ward (Global Financing Director for The Economist Intelligence Unit) coined the term in late 2009, Standard and Poor’s just developed an index to track this particular group last month. In my opinion and based on my meetings with investment decision makers, Standard & Poor’s new benchmark is a strong indication that institutions wanted a good benchmark to measure performance against.
The second major area I’m seeing investment dollars flow into is global infrastructure:
Above is a chart from the 2011 Preqin Global Infrastructure Report (ISBN: 978-1-907012-36-5) showing a 225% increase on aggregate capital raised from 2009 to 2010, and just 22% less than what was raised in 2008. Preqin also noted that in January this year, a record 122 unlisted infrastructure funds were on the road targeting $85.5 billion in investor commitments.
In the long run, the Canadian Imperial Bank of Commerce (CIBC) World Market estimates that $35 trillion dollars will be spent on infrastructure in the next 20 years. Below is a table that highlights some of the projected infrastructure spending for 2009 through 2015 broken down by country:
Like everything in my business nothing is certain and much of what we do is based upon a blend of analytics and probabilities. That's why Leonardo Da Vinci was correct when he said "Sapre Vedere” – know how to see.
Please send all comments or questions to tphillips@phillipsandco.com
Tim Phillips – CEO, Phillips and Company
Learning How to See – Part I
Tim Phillips – CEO, Phillips and Company
Last quarter we mentioned that 67.4% of companies beat earnings estimates. We also pointed out that the historical beat rate is 63%. As of this morning, over 80% of the S&P 500 companies have posted earnings for the first quarter and 72.2% of them beat their earnings estimates this quarter.
Alcoa kicked off earnings season after the bell on April 11th. Since then the S&P 500 has returned 1.39%. Now that earnings season is coming to an end, we expect market participants will likely shift their focus towards broader economic trends when making investment decisions.
Looking at the broader economic trends we currently have several cross currents:
On the negative side we have:
- Fiscal concerns with the debt ceiling
- Monetary uncertainty surrounding the end of QE2
- Increased likelihood of default in Greece moving the EU and Euro to a more unstable position
On the positive side we have:
- Strong jobs numbers
- Improving consumer credit markets
- Retail sales are now above the pre-recession peak
We added 244,000 jobs in April, March was revised up from 216,000 to 221,000 and February was revised up from 194,000 jobs to 235,000 jobs. That makes three straight months with 200,000+ new jobs.
This morning the NY Fed released its Quarterly Report on Household Debt and Credit, which continues to show improvements:
- Continued decline of new foreclosures and new bankruptcies, down 17.7% and 13.3% respectively in the last quarter
- 15% decline of total delinquent balances, compared to a year ago
So the question for investors is: which trends win, the trends that suggest a stronger economy or the trends that question the economic recovery?
Either way, most institutional money managers are forced to stay fully invested so it’s unlikely we will see a mass exodus from the market or see it move straight up. There will probably still be large swings in both directions in the near future, but overall it still looks constructive for portfolios that have a heavy allocation to equities.
For our retail investors it's always important to point out this heavy equity bias in institutional portfolios. Pension plans, insurance companies, and college and university endowments, tend to keep portfolios in the 80% plus equity exposure. The math is simple:
Some may need up to 9.5% to 10% in annual returns depending upon their specific payout rate and fees.
The only way institutions get this type of return is with a heavy bias to equity. Be comforted but not too much. I continue to see rotation in and out of asset classes and regular portfolio rebalancing including large allocations of cash (20%+) at times. This type of rotation and rebalancing by large institutions can cause some interim pain for all of us as they adjust their allocations
Next week I will give you some insights into what some of the larger institutions are looking at as sectors and segments; this week I am on the road "learning how to see.”
If you have anything specific you would like some insights on or questions to ask some of these larger institutions please email them to me at: tphillips@phillipsandco.com
Tim Phillips, CEO – Phillips and Company
The Prediction Business
Tim Phillips – CEO, Phillips & Company
Weekly Market Commentary 5-2-11
The week was interesting enough for capital markets. In spite of all the concerning headlines (gas prices, debt ceilings, birth certificates, Fed press conferences) the equity markets trudged higher. I suspect it was mostly driven by higher than expected earnings reports. According to a Reuters news release on Sunday (May 1st, 2011):
“So far, 324 of the S&P 500 companies have reported earnings, of which 73 percent were above analysts' expectations, according to Thomson Reuter’s data. In a typical quarter, 62 percent of companies beat estimates.” - (“Sell in May and go away? Not so fast” by Angela Moon)
Not bad.
Unfortunately, a rear view mirror commentary isn’t worth very much when you’re in the prediction business. Make no mistake about it, when you invest in the stock market you are in the prediction business.
So the forward looking question in my mind continues to be what happens when the Fed stops their purchase of government bonds? Back in November, I discussed the actual Fed mechanism that details the basics about the Fed program. In short, the Fed is pushing the yield curve down forcing banks and others that hold Treasuries to swap short term, low yield, low risk Treasuries for longer term, higher yield, higher risk lending and speculating.
This has appeared to have happened. Since the beginning of October, the S&P 500 is up 17.2% and consumer credit is up $12.1 billion. The Wealth Effect has certainly been given a chance.
The ultimate question is whether the consumer is in better shape now to sustain economic activity than they were when the Fed ended their stimulus programs in April of 2010.
Recall, the Federal Government had many stimulus programs in place which include:
- Term Asset- Backed Securities Loan Facility - TALF
- Troubled Asset Relief Program – TARP
- Public- Private Investment Program – PPIP
- Unemployment Benefit Extension
- American Recovery and Reinvestment Act
- Car Allowance Rebate System – “Cash for Clunkers”
- FHA Housing Rescue – First Time Homebuyers Credit
The list goes on and on. You can go to CNN Money for a full list of bailout programs.
Is the consumer better off? Let's take a look at a few consumer indicators:
- Personal income is up 5.3% YOY
- Consumption is up 4.6% YOY
- Personal Savings rate is 5.5% (which leaves plenty of "dry powder" for consumers to absorb higher gas prices and keep on spending)
- Consumer Credit is up 3.8% YOY
- Revolving Credit is down only 4.0% YOY
- Unemployment is down to 8.8%
- Bank lending on durable or non-revolving assets are up 8.0% YOY
With the cuts made to payroll taxes, accelerated depreciation and other federal tax breaks the consumer might be able to sustain spending at a reasonable pace without another federal stimulus program. The markets will certainly pivot on this issue as more clarity is provided. This is indeed a great time for the prediction business to make intelligent tactical asset allocation bets on whether or not you believe the consumer is juiced up enough to sustain these current trends.
My prediction is they are, but to the tune of 3% GDP, not quite 4 or 4.5% GDP. Just remember, when it comes to the predicting business, the more precise, the more likely it is to be inaccurate.
Thank you for your thoughts and comments, please keep them coming. Send them to: tphillips@phillipsandco.com
Tim Phillips, CEO - Phillips and Company
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