Weekly Market Commentary 1-18-11

Objects in the Rear View Mirror

Are they closer than they appear?

Retail sales rose 7.9% on a year over year basis for 2010. Retail sales are up 13.5% from the bottom and up 0.2% above the pre-recession peak in November 2007. The consumer is back!

Here is a recent quote from the San Francisco Fed:

"The economic expansion appears to be building steam. After increasing 2.8% in 2010, we expect real GDP to grow nearly 4% this year and for growth to pick up to about 4½% in 2012. Pent-up demand for durable goods and eventually housing, and improving confidence are contributing to a steady improvement in the economy." (http://bit.ly/iekylK)

Job creation is still slow and pent up demand could help drive an inventory driven job growth spurt.

While it's hard to imagine increases in consumption with 14.5 million Americans out of work and another 8.9 million underemployed (http://bit.ly/4zoS3A); it appears that those working are spending and also those not working are still consuming. If many are not paying their mortgages and still receiving unemployment benefits, consumption may increase from the potential of free cash flow.

Whether this consumption leads to employment will be one of the key tests for our economy and equity markets in the months to come. My friends at Bespoke did a terrific job with a 2010 year end summary. Instead of having you read all 128 pages, I want to highlight a few key themes.

1) On average, analyst forecast a modest gain in the S&P 500 from 2010 to 2011 of 9.02%.

2) The trailing P/E on the S&P 500 was 15.92 compared to a historical average of 15.37 marked over an 80 year period. While we are roughly at fair value, we are anticipating significant earnings growth this year and perhaps an expansion in the multiple. Remember, things tend to move above and below the mean, and I expect the same with the 2011 trailing P/E ratio.

3) As seen from the data compiled by Bespoke, historically if the first two years of a president’s term saw strong market performance, the third year also showed higher than average returns. While I don't place a lot of merit on this type of data points, I hope to see this as a repeatable pattern.

While there may not be anything earth shattering in this week's write up, it's precisely the ordinary that most investors overlook and overcomplicate. Sometimes objects in the rear view mirror are exactly as they appear.

I continue to focus on several themes:

• Consumer discretionary, specifically high end retailers
• Gas and Oil
• Business processing technology
• Media (Print that is adapting to on-line)
• Emerging Markets Debt and Equity that is driven by US dollars finding better investment environments
• Segmentation of emerging markets rather than broad based emerging markets exposure, specifically Brazil Energy and Telecom
• Mega Cap US companies that are finding great margins with little top line growth, especially exporters

I am removing Germany from my top of mind theme list as there has been a significant run in its economy and with its neighbors introducing austerity measures it will be tougher for them to export their way to the same growth rates. We all need our neighbors and at this point Germany’s are not strong enough.

Tim Phillips, CEO