Uncle Ben is Not Afraid Why Should We Be?
Tim Phillips, CEO – Phillips & Company
Last week everyone was focused on Ben Bernanke’s speech in Jackson Hole, where last year he outlined QE2. As we expected earlier this summer, he didn’t announce or outline “QE3.” He did however make some very key statements:
Ben confirmed that the Federal Reserve still has options:
“The Federal Reserve has a range of tools that could be used to provide additional monetary stimulus.”
“[The Committee] is prepared to employ its tools as appropriate to promote a stronger economic recovery…”
The economy is not in a deflationary (read recessionary) trap:
“Temporary factors… were part of the reason for the weak performance of the economy in the first half of 2011; accordingly, growth in the second half looks likely to improve as their influence recedes…”
Although we are not out of the woods yet:
“Notwithstanding the severe difficulties we currently face, I do not expect the long-run growth potential of the U.S. economy to be materially affected by the crisis and the recession if--and I stress if--our country takes the necessary steps to secure that outcome.”
A fitting speech given that only 90 minutes before his speech, the Commerce Department lowered its estimate for the second quarter GDP growth down to 1.0 % compared to the initial estimate of 1.3%.
Value Opportunity or Value Trap?
Value Opportunity:
This morning Bloomberg noted that based on Friday’s close the S&P 500 is trading at 10.8x analysts’ forecast for profits in the next 12 months of $109.12 a share and that the five-decade average P/E of the S&P 500 is 16.4x. If companies meet analysts’ expectations ($109.12) and we see a revision back to the mean in the P/E ratio (16.4) then that would mean the S&P 500 would be at 1789.57. That is over 600 points higher on the S&P 500 than the close on Friday!
That may be wildly opportunistic given the current economic environment, but it definitely shows a margin of safety for value investors.
As of this morning the S&P 500 had a slightly higher yield than the 10 year Treasury bond. The last time this happened was in the fall of 2008.
Value Trap:
This potential opportunity could turn into a trap if consumer confidence continues to fade. We have been living in a skittish and frightened state for 3 years now with a “sell first and ask questions later” mentality.
Gallup’s Economic Confidence Index and the University of Michigan Consumer Sentiment Index (released the day of Bernanke’s speech) both fell to levels that were last seen early in 2009. Constantly living in a “sell first and ask questions later” mentality has made equity investing very challenging, but the opportunities tend to lie within the fear. If Ben does not see a deflationary (read recessionary) trap yet, perhaps, and that's a big perhaps, it's just the same fear we've been feeling in our economy for the last 3 years.
If you have questions or comments please let us know, we appreciate all of your responses every week!
Tim Phillips, CEO – Phillips & Company
@PHCOAdvisors
Facebook.com/phillipsandco
Research Provided by:
Adam Gulledge, Associate – Phillips & Company
Cold Hard Facts
Tim Phillips, CEO – Phillips & Company
Last month I mentioned we might “face some pretty gut wrenching days ahead with tremendous market volatility.” That might have been an understatement with everything that has happened.
- Dysfunction in DC
- Weak economic data
- European bank problems
- Downward revision on economic forecasts
The real question is on many investor’s minds is, now what?
If we could all retire comfortably with our cash on hand and live off of near 0% returns, then that would be fantastic. Unfortunately, individual investors, pension plans, endowments, and foundations need better returns in order to meet their future obligations. That necessity for returns is why we invest in riskier assets like stocks and bonds.
Since investing is a necessity and market timing is a parlor trick, let’s look past the Wall of Worry and look at some of the cold hard facts (charts are courtesy of the Bespoke Investment Group)
1) Companies reported better earnings and revenue last quarter. They also raised guidance going forward.
2) Wall Street strategists are still holding onto their return expectations according to Bloomberg. In general, I don’t hold out much faith in this cohort; however they do look at data more analytically and rationally than most.
3) This year is looking a lot like last year. Both peaked at the end of April and saw a very weak summer where the S&P 500 went negative for the year. Last year that weak summer was followed by a monster rally that started just after the Jackson Hole Fed Meeting. That same meeting is set to take place this week.
Last year the Jackson Hole Meeting was on August 27th. Between August 27th and the end of the year the market rallied 18.94%.
Not to sound too wildly optimistic, there is a real chance the consumer loses confidence in this recovery and in the policy makers. Durable goods numbers come out this week which might give us a good indication. While I’m not a pessimist by any measure we could see more downside if consumption data shows significant weakness. Lastly, when markets drop this much they tend to overcorrect to the upside before building a base.
Here are some simple tips to make sure you are prepared for either situation:
- Review statements to make sure you don't have any unknown risks.
- Continue to reflect on your time horizon for the use of your investments. If you have time (3 to 5 years) equity markets can be reasonable places to invest.
- Build in hedges for deflation. If a slowdown in global growth occurs, there will be a mad rush for higher fixed income returns. This is something we focused on with our clients.
- Stop, challenge and choose your path based upon cold hard facts. Emotions are always tempting to follow unfortunately more often than not they lead to poor outcomes.
We appreciate all the feedback we get every week I look forward to your responses throughout the week
Tim Phillips, CEO – Phillips & Company
@PHCOAdvisors
www.facebook.com/phillipsandco
Primary research done by
Adam Gulledge, Associate – Phillips & Company
"After a wild week on Wall Street the world is different"
Tim Phillips, CEO – Phillips & Company
This was the cover of Time Magazine just after the crash of 1987. I remember being very new in the business and thinking, "Had the world fallen apart?" At the time, I also thought a “crash" was a once in a lifetime event. It looks like I was wrong on both accounts.
People think things are different because today we have High Frequency Traders, algorithms and hedge funds, but I would argue similar schemes and large investors existed in 1987 as well. Despite our 2011 “wild week on wall street,” the S&P 500 closed down only 1.64%.
In my opinion this wild week was due to the increased probability of another recession and uncertainty in the European Banking System (note uncertainty not failure). At the same time, retail sales data came out that seems to suggest the consumer is not in too bad of shape (as we suspected). Sales continued to grow for the 4th month in a row including increased sales for electronics and appliances.
We believe if another recession happened it wouldn’t be a repeat of the Great Recession of 2008. Cyclical industries like automotive and homebuilders are not coming off revenue bubbles and are still bouncing along the bottom.
We also know that investor confidence and consumer confidence can be a threat to push the consumer back into a cave. This is one we’ll need to watch closely.
I see two possible scenarios:
- If the consumer does not nose dive then this market reaction is overdone and opportunities lie ahead
- If the consumer does nose dive then the market was right and market prices have already taken that into account.
In other words, possible good upside opportunity with limited downside
The interesting thing about allocating cash into your portfolio at this time is the potential outstanding return opportunities:
The downside to reacting to emotions is the poor returns you can achieve when you try to time the market too much (I am a firm believer in opportunistic cash at the risk of being wrong many times):
Besides the yield on the S&P 500 is currently better than that of treasuries:
After weeks like this it’s a good time to review your investment time horizon relative to your needs. For individuals, this means thinking about your retirement time frame and determining how much time and ability you have to ride out “wild weeks.” For foundations and endowments this means focusing on the big picture; thinking multi-generational and not in terms of “wild weeks.”
Over the last 25+ years I’ve been in the industry, the world has definitely changed. However, over the last 2000 years, our emotions have not. Humans have always been “fight or flight” animals and unfortunately it’s not a good quantitative analysis tool.
If you have questions or comments please let us know, and we always appreciate all your feedback
Tim Phillips, CEO – Phillips & Company
Research Provided:
Scott Edwards, Vice President of Wealth Strategies – Phillips & Company
Adam Gulledge, Associate – Phillips & Company
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More Questions Than Answers
Tim Phillips, CEO – Phillips & Company
As
I discussed in our blog post last week about Deficits, Defaults, and Downgrades, we believed a downgrade was inevitable, but thought it would come to fruition much further down the road. At this point, there are plenty more questions than answers, but here is my insight into this unprecedented downgrade. Please remember there has never been a downgrade in United States History, so much of what I have to say should be taken in that context.
The likely short-run impact on US debt will be limited and muted. I suspect we will see effects to the magnitude of 25bp-50bp. Going from AAA to AA+ doesn’t mean much in terms of the government’s ability to pay. However, the negative outlook, if not removed and if other rating agencies follow suit, we may soon see much higher interest rates.
This situation is really more about prodding the political class to resolve the problems we all know exist in our country: entitlement spending, our debt, the deficit and tax policy.
There could be a significant impact on municipal debt with many downgrades to come. Any debt attached to federal spending or with US agency backing would likely see some deterioration.
Banking Sector
This sector was predominately sparred from the Fed, suggesting holding AA+ debt is the same as holding AAA debt. We shouldn’t see bankers running for the exits. Where would they run to anyway? France? Bermuda? New Zealand?
Corporate Sector
Insurance companies may have a tougher challenge to overcome based upon their charters, prospectuses and covenants. We’ll have to watch this sector closely. Companies in general might need to make some investment policy changes or dump their treasuries if they don’t have rating flexibility. This could pose a problem.
The Fed
As I have been suggesting, the Fed will likely enact some kind of easing policy to push banks into lending and stimulate the economy. This might become more challenging if the Fed attempts to buy the debt from the banks and issues new debt with a lower rating at the same old price. My guess is the banks are going to want better returns at some point in exchange for buying slightly worse debt. That in turn may cause banks to hold the debt with higher yields and not lend. So much for quantitative easing. Let’s see if the Fed can successfully navigate this situation.
Political Class
The real benefit is our politicians just got a cow prod up their you know what’s to resolve systemic problems with government spending habits. As they do this with the Budget Control Act which passed last week, we might actually see much more stability brought back to our markets once the committee makes its big cuts. This is to be done before Thanksgiving.
The Consumer
Assuming rates don’t jump through the roof, which I don’t expect to see in the near future, the consumer is not in too bad of shape.
- RevPar, the average price a consumer pays for a hotel room, is rising. This only occurs when rooms are being rented, suggesting a very good sign for consumer consumption and confidence.
- Furthermore, same store sales growth are rising 3-5%+.
My suggestion is to prepare for volatility and review debt holding in detail with your financial advisor. Also, if you have the time horizon to do so, make strategic investments in the coming months.
If the consumer is in as good of shape as the data suggests and this debt debacle is really about political posturing, then as Washington resolves these issues this could mark a historic buying opportunity.
This is speculation on my part and there are many more questions than answers at this point. Stay tuned to see how this all unfolds and what it might mean for you.
If you have any other questions about the downgrade feel free to contact me.
Tim Phillips, CEO – Phillips & Company
@PHCOAdvisors
http://www.facebook.com/phillipsandco
Primary Research done by:
Adam Gulledge, Associate – Phillips & Company
There is Only One Way
Tim Phillips, CEO – Phillips & Company
As we expected, it looks like the political class will get something done. As anticipated, The Debt Limit Deal also looks like it's heavily back loaded (much ado about nothing). In fact, all the real cuts to spending will likely come under a different congress and perhaps a different President. Now that the "fiscal conservatism" charades are behind us, we can look at the one and only way to really cut deficits and our debt – GDP growth.
In the middle of the debt debate we received a pretty ugly report card on our economic activity. According to the BEA, real GDP in Q2 grew only 1.3% compared to a consensus estimate of 1.9% and Q1 GDP was revised downward to a mere .40%. While the top line number looks weak some of the component parts look pretty good.
- Real nonresidential fixed investment increased by 6.3% in the second quarter, compared with an increase of 2.1% in the first.
- Real residential fixed investment increased 3.8%, in contrast to a decrease of 2.4%.
- Real exports increased by 6%.
- The change in real private inventories added 0.18 percentage points to the second quarter change in real GDP.
The one area of concern, and it's the biggest, is consumption (70+% of GDP). This area had very anemic growth. However, much of the drag came from autos and I attribute much of that to the events in Japan.
It looks like the automotive industry is ramping up for better supply and demand from the consumer, which should bode well for the strong second half of 2011.
As long as we can get our "sausage making" debate about the debt behind us soon and create stability for business, I believe they will begin to hire and continue to spend. This should boost confidence with the consumer and allow them to free up their pocketbooks a bit. With savings rates at 5.0% and corporations sitting on a mountain of cash there is plenty of fuel in the tank.
Once we get some stability from the political class, American businesses and consumers can do what they do best – innovate, create, invent, invest with the outcome being spending.
Remember, investing is anticipatory and requires us to look at past data and make intelligent guesses about the future. I see a pivot, not a growth surge mind you, but a resumption of growth and employment and I'm a buyer (assuming our political class get its act together).
Thank you for your thoughts and comments, please keep them coming.
Tim Phillips, CEO - Phillips and Company
Twitter: @PHCOAdvisors
http://www.facebook.com/phillipsandco
Primary research done by Adam Gulledge, Associate – Phillips and Company
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