Weekly Market Commentary 8-29-2011

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