Fear or Rationality

Fear or Rationality
Weekly CEO Commentary 11-19-12
Tim Phillips, CEO – Phillips & Company

With the markets down 3.7% in the last three weeks, it's easy to think investors are fearful. Or, they could also be rationally pricing in some legitimate issues.

Let's take the fear side first. It's easy to be fearful of the fiscal cliff, as it has significant economic importance to future growth. According to Credit Suisse, the most likely case after negotiations are finished is a -1.5% drag on GDP growth.

It's also important to consider these cuts not as a cliff, but perhaps something much more gradual. As you can see from the graph from Goldman Sachs below, the economic impact is expected to come over the course of the year. As for reasons to sell assets immediately, that would fall on the massive increase in capital gains taxes as well as increased tax on dividend and interest.

same basic goldman piece

However, both parties agree that one critical component of any deal cannot be policies that hurt growth in our economy. According to MarketWatch, President Obama has been in conversations with business leaders to try to mitigate the impact of the fiscal cliff, including names such as Jamie Dimon (JP Morgan), Tim Cook (Apple), and Jim McNerney (Boeing).

Representative Tom Price, the chairman of the Republican Policy Committee, also spoke on CNN’s State of the Union on November 18, saying “We want a real solution, which means increasing tax revenue through pro-growth policies.”

Certainly it is plausible that investors are selling from fear of the unknown. But, for investors that are collecting some very large yields from investments bought cheaply, selling is much harder to do. For example, if you bought GE at its price of $7.60 on March 2, 2009 you would be receiving an annual dividend yield of 8.9% with today’s quarterly dividend of 17 cents per share. To put that 8.9% in perspective, buying GE today has a current dividend yield of only 3.3%. It’s hard to sell something that gets you generous cash flows, when you would have to re-invest in much lower yields today.

Rationally, there could be more to this pullback than fear of the unknown. As we mentioned in a past blog, earnings matter most when it comes to driving stock performance.

With earnings season wrapping up soon, we now have a clear picture of what's going on.

s&p 1500 net earnings revisions

sperad between percent of companies raising and lowering guidance

According to Bespoke, more analysts are now revising earnings expectations downward and more companies are lowering guidance than this time last year. More troubling, however, is that 58% of S&P 500 companies missed expectations on sales last quarter.

q3 revenue surprises

You can see from this data that overall, earnings and revenue growth are showing some deterioration. But, there is a bright spot in retail. As we wrote about in a previous blog, the American consumer has been surprisingly resilient. According to FactSet, estimated Q4 earnings growth is expected to be high in apparel retail, stemming from “Black Friday” and holiday shopping.

retail sub industries earnings growth

I believe this might be a small earnings recession that you would see in any business cycle.

It might just be magnified as we are in a slow growing economy—but one that could erupt with growth if we could eliminate the fear that is plaguing investors and consumers.

If you have questions or comments please let us know as we always appreciate your feedback. You can get in touch with us via Twitter, Facebook, or you can email me directly. For additional information on this, please visit our website.

Tim Phillips, CEO – Phillips & Company

Research supported by:
Alex Cook, Associate – Phillips & Company