Weekly Market Commentary 6-6-2011

Weekly Market Commentary 6-6-11

Tim Phillips, CEO – Phillips and Co.

The Probability of Being

pair of dice

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.

inflation expectation survey

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.

graph of consumer confidenceBloomberg – 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