Ben Bernanke's “Investor Insurance for Investors”

Weekly Market Commentary 6-27-11

Tim Phillips, CEO – Phillips & Company 

This week Ben Bernanke, Chairman of the Federal Reserve, gave a press conference following the release of the FOMC statement.

While the market reacted poorly to the Fed's downward revisions to GDP it might have missed a critical point.

¹ Projections of change in real GDP and in inflation are from the fourth quarter of the previous year to the fourth quarter of the year indicated. 

After Bernanke read his prepared remarks, he opened the floor up for questions. During that Q&A session he made an interesting statement when asked why the Fed wouldn’t consider taking more actions to stimulate growth if the Fed believes the recent uptick in inflation is transitory:

“We'll continue to look at the outlook and act, you know, as appropriately as the news comes in and the projections change. We do have a number of ways of acting… We could, for example, do more securities purchases and structure them in different ways.  We could cut the interest on excess reserves that we pay to banks…. But we'd be prepared to take additional action, obviously, if conditions warranted.”

I interpreted this statement as a possible blanket “insurance policy for investors” issued by Bernanke and the Fed. The question is no longer if the Fed will step in if needed, but instead what would need to happen for the Fed to step in. There are two games of brinksmanship going on and consequently, it could cause the Fed to take additional action.

At home the Democrats and Republicans are playing brinksmanship with the US Debt Ceiling while internationally, Greece and the ECB are doing the same thing with the European Union’s next round of funding for Greece.

I believe the most probable outcome concerning the US Debt Ceiling is it gets lifted at the 11^th hour. Everyone agrees on spending cuts, the fundamental public disagreement is on tax increases. In the end, the democrats won’t need to fight too hard because the current tax cuts expire at the end of 2012. Republicans would perhaps like to have tax policy as a major issue in the next presidential campaign. Much of this is all public posturing in my opinion.  This political theater should provide improved ratings for the 24/7 news channels and provide investors with good buying opportunities leading up to August 2nd.

Looking across the Atlantic at the Greece situation, I agree with Bernanke. A disorderly default would no doubt roil financial markets globally; I don’t believe that is the most probable outcome. The European Central Bank (ECB) and the International Monetary Fund (IMF) have too much at stake to let Greece simply default. I think the more probable outcome will be continued talks among the ECB, the IMF, the Greek Parliament, and other countries to enable members of the European Union (EU) to save face and gracefully exit the EU before an actual default. I also believe this will provide investors with a good buying opportunity at some point.

In the long run, I don’t think the Fed will have to pay out on its “insurance policy for investors,” but because it’s there I’m using these brinkmanship events at home and abroad as buying opportunities.

Thank you for your thoughts and comments, please keep them coming. Send them to: tphillips@phillipsandco.com

Tim Phillips, CEO - Phillips and Company

Twitter: @PHCOAdvisors

Primary research done by Adam Gulledge, Associate – Phillips and Company

Nothing is Exactly as it Appears

Weekly Market Commentary 6-20-11

Tim Phillips, CEO – Phillips and Company

According to the advance monthly sales for retail and food services released last week by the US Census Bureau, retail sales declined 0.2% in May (seasonal adjusted). While the headline suggests slowing sales, some things may not be exactly as they appear.

First, looking passed the headline number and on to a breakdown of the number calculation, it’s clear 16.83% of the adjusted total is derived from motor vehicle & parts dealers. This represents the biggest component of the monthly sales number.

Secondly, on the third page of the press release the percentage change is broken down for each section of the total retail sales headline number. The section with the highest percentage drop from April to May was motor vehicle & parts dealers at -2.9%, followed by electronics & appliances stores at -1.3%.

This means May’s biggest drop in month over month sales came in the biggest section of the headline number. When excluding motor vehicle & parts dealers sales numbers, the headline retail number goes from -0.24% to 0.32%, a difference of 56 bps. Is this divergence between “motor vehicle & parts dealers” and “total retail sales excluding motor vehicle & parts dealers” an early indicator of a decline in consumption?

One way to measure demand for big ticket items (like automobiles) is to look at the change in non-revolving credit, also known as installment credit. According to the Federal Reserve’s most recent consumer credit report released June 7, 2011, non-revolving credit increased at an annual rate of 5.25% in April and 6.0% in the first quarter of 2011. Based on this data, consumers are buying and banks are lending and it doesn’t appear to be an issue with demand.

What about the other side of the economic coin? Supply

Since the March 11 earthquake and tsunami hit Japan, Japanese auto makers have taken a big hit and investors are just now beginning to see the effect. For the month of April: Nissan, Honda, and Toyota sales fell by 9.1%, 22.5% and 33.4%, respectively. While the earthquake and tsunami happened in mid-March, it seems apparent that the supply chain for automobile manufacturing and exporting in Japan will take a few months to fully recover.

Nothing is exactly as it appears. A headline number first appearing to indicate a potential slowdown in consumption and demand, turns out could actually be a result from a temporary supply chain disruption. This also supports the potential future outcome #2 discussed at the beginning of the month.

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

Tim Phillips, CEO – Phillips and Company

Primary research done by Adam Gulledge, Associate – Phillips and Company

Twitter: @PHCOAdvisors

Weekly Market Commentary 6-13-11

Our Emotions or Their Stupidity

Tim Phillips, CEO – Phillips and Company 

The S&P 500 is down 6.8% since the end of April and is currently on a six-week losing streak. According to Bespoke Investment Group:

Going back to 1928, this is only the 17th time the S&P 500 has had a six-week losing streak. The last time this occurred was back in July of 2008 during the midst of the Financial Crisis… there have only been three weekly losing streaks of seven or more for the index.

Despite this six week losing streak, earnings forecasts are still fairly loft:

• We’re almost half way through the year and the mean 2011 EPS forecast for the S&P 500 is $95.61. That represents an increase of 8.88% between now and the end of 2011.
• The mean forecast for the 2011 close of the S&P 500 is 1400. That represents an increase of 10.15% between the close on June 10^th and the end of the year.
• This weekend JP Morgan came out and said it expected earnings to climb an average of 10% a year through 2013.

Something has to give. Either the analysts’ forecasts are wrong and we will see a lot of downward revisions in the coming weeks, or pessimism is the emotion of the day and the market is exacerbating any negative information.

Personally I think the latter and here’s why. Below is a chart of the S&P 500 (the white line) overlaid on top of the American Associate of Individual Investors (AAII) Bullish Sentiment Survey (the orange line). As you can see from recent data, very low bullish sentiment has historically been a good time to buy.

That said, I'm not saying the analysts’ forecasts are 100% right either. They may be precise but that doesn’t mean they are always accurate. In fact, a friend of mine who is a highly respected fund manager told me he believes sell side analysts (brokerage firm analysts) tend to miss earnings by +/- 22% due to forecasting errors in their models.

Just keep in mind that since this six-week losing streak began in May the S&P 500 is down 6.8% and that big of a move over a short time frame might be enough of a discount to compensate for analysts errors.

Going Forward

With the end of the quarter a few weeks away, we are coming into “window dressing” season where managers sell their biggest losers and buy more of their high performers. With this recent dip it might provide a good opportunity for these managers to accumulate more of their favorite high-flying stocks.

Secondly, earning season is around the corner with Alcoa set to kick things off on July 11^th after the close of the market. Looking at EPS forecasts for this quarter and next we are currently discounting some pretty tough comparative earnings for the S&P 500. Below is a chart showing Q2 and Q3 estimates and the forecasted YOY change.

I'm going to continue to seek good entry points that represent value over the long term regardless of the analysts’ forecasts for the next few quarters or our emotions today.

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

Tim Phillips, CEO – Phillips & Company

Primary research done by Adam Gulledge

 Weekly Market Commentary 6-6-11

Tim Phillips, CEO – Phillips and Co.

The Probability of Being 

When it comes to investing it’s about trying to predict future outcomes. These predictions about future outcomes have a range of probabilities and likelihoods of happening. Last week’s avalanche of gloomy economic data, believe it or not, helped me clarify the probabilities of what might lie ahead of us.

Potential Future Outcome #1: QE3

Based on the poor economic data below coming in the last few weeks, the Fed orchestrates another round of quantitative easing.

• Falling house prices
• Weak auto sales
• Lower manufacturing numbers
• Weak labor report

At first, this once again seems intuitive because this is what the Fed has done in the past, however, I don’t see a high probability of this outcome in the near term. I believe the main purpose of past rounds of quantitative easing have been to primarily fight deflationary pressures and not to stimulate the economy.

Bloomberg - The University of Michigan’s Inflation Expectation Survey of Consumers historical 12 month expectations

The University of Michigan’s Inflation Expectation Survey of Consumers shows that the median expected price change for the next 12 months is 4.1%. Therefore, I don’t see a high probability of deflation in the near term, so at this point I rank the probability of this outcome as low. Now if we do see signs of continued slow growth in the economy and an increase in the probability of deflation then I believe the likelihood of QE3 goes up very quickly.

Potential Future Outcome #2: Resumption of Consumption

The economic data we have seen for the past two months could be in part due to a series of major natural disasters (tsunamis, floods, and tornados) across the world and their effect on consumer psychology and the global supply chain. Once consumer confidence returns and the breaks in the supply chain are fixed we should see a resumption of consumption.

 Bloomberg – Graph of graph of consumer confidence

Looking at the consumer confidence numbers, these tragic events appear to me to be a contributor to malaise. We may not see the consumption resume as fast as it fell, but I would rank the probability of this outcome higher than the first one.

Potential Future Outcome #3: Political Normalcy

The political silly season is now upon us and we have already seen politicians point out economic problems that, “they and only they can fix as President,” such as:

• Our national debt
• Tax policies
• Entitlement spending

And anything else that shows America is on an “unsustainable path.” Since we are currently in between earnings seasons the market has nothing else to focus on except this daily attack on our economic foundation by politicians who make a living by pointing out these problems.

In the end, the political process works its magic: compromises are made on our national debt, tax and spending policies are reformed, and then we return to normalcy. We talked about this effect of political uncertainty on consumption earlier this year. Based on my insights from when I ran for US Congress, these are textbook politics at work.

There are, of course, an infinite number of possible outcomes, but out of the three broad outcomes discussed, I rank this one with the highest probability. Based on that, I’m using market pull backs as buying opportunities. While we aren’t believers in being able to time the market, we do like to layer in cash at times like these that appear to be opportunistic.

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

Tim Phillips, CEO – Phillips & Company

Primary research done by Adam Gulledge

Sector Rotation

Tim Phillips, CEO – Phillips and Company

“An elegant solution for keeping track of reality” – Inception

Right now, there seems to be a healthy debate over GDP growth for the US. Q1 real GDP growth remained unrevised at 1.8% compared to a forecasted upward revision to 2.1%.  Other economic data was soft as well:

• Manufacturing numbers were light for the week in Chicago, Kansas City, and Richmond
• Initial unemployment claims still are over 400K
• Consumer data was mixed at best.

This has people asking: Is this the beginning of a soft patch for the US economy or is this data just “statistical noise” in an economy that is still trending up?

The good news is that we might not have to answer that question because as we pointed out last week, investor returns do not correlate very well to GDP growth. Along with softer economic data last week we also saw some of the defensive sectors (consumer staples and utilities) underperform the broader index and cyclical sectors (basic materials and energy) outperform the broader index. Now, this seems counterintuitive so we decided to dig a little deeper.

Let’s take a step back. According to Bloomberg, there are only 612 large cap (market cap > $5 billion) US based companies and over 6000 mutual funds focused on US large cap. Couple this data point with advances in technology and continual regulatory reform efforts to make the US markets more efficient and you get a lot of fishermen in a very small, crystal clear pond that continues to get clearer. This makes for a pretty fair and level playing field; however, it also makes it incredibly difficult for those 6000 managers to consistently outperform their benchmark.

One way we can attempt to gain a slight advantage (legally) over all these money managers (chasing so few companies) is through sector rotation.  Broadly speaking, sector rotation is when money managers shift investments from one sector (or asset class) to another.  If we can identify sectors that might be coming into favor early on we can take advantage of this information and rotate in before all 6000 mutual fund managers do.

Moving forward, perhaps this helps explain what at first seemed counterintuitive when we focused on just the broad economic data. Looking back at the last three months, utilities and consumer staples outperformed the S&P 500 compared to materials which were about even, and energy which had underperformed.

This raises the question: Could last week be the beginning of a sector rotation from defensive sectors to cyclical sectors?

Thoughts and comments are always welcome. Please Email me directly at tphillips@phillipsandco.com

You can also find me on twitter: @PHCOAdvisors

Tim Phillips – CEO, Phillips and Company

Primary research done by Adam Gulledge