Investment Policy Committee Meeting
03/08/10
Discussion
The market gained about 2% last week, basically its entire YTD gain. As we’ve observed for quite a few weeks, the market has been locked in what we call a “trading range” since early January. Basically, that means it bounces up and down repeatedly reversing course when it hits a fairly constant upper or lower price boundary. In our view, this is a market that doesn’t really know whether it should be optimistic or pessimistic.
In our view, many investors continued to be confused by the large number of potentially conflicting news stories or economic data releases. Some have been positive, some negative. Some are positive or negative based solely upon assumptions or biases that differ among investors. It’s in the eye of the beholder in other words. This is the 3-Ring Circus phenomenon we have talked about for several weeks. Ed Yardeni, a well-known economist much sought after these days for help interpreting the economy and the market, recently listed the various “acts” in this multi-ring circus. Some could cause worry. Some optimism. Some both. Here’s the list, without going into an explanation for each point:
“Worry Points” –
Sovereign Debt(e.g. Greece), Political Gridlock, State & Local Budget Deficits, “Subprime” Commercial Real Estate, Federal Reserve Exit Strategy, Inflation, China, Unemployment, Housing, Iran
“Optimism Points” –
Investor Sentiment, Lots of Liquidity, Corporate Cash Flow, Low Fed Funds Rate, Strong Corporate Earnings, Low P/E Valuations, Strengthening Profit Cycle, High Productivity, Global GDP Increasing, Leading Economic Indicators, Sovereign Debt, Political Gridlock.
It’s obvious that you can find arguing points for both a bearish or bullish point of view. And, in the case of sovereign debt and political gridlock, bearish and bullish arguments are made about the exact same phenomenon. The “eye of the beholder” issue mentioned previously.
The Investment Policy Committee continues to hold the view that it’s important to greatly simplify those lists, and to focus on what we believe to be the most important ring of the circus – corporate earnings. Over 75% of companies that have reported
Q4 ’09 earnings exceeded expectations. This is the highest “beat rate” since that particular statistic has been tracked.
Also, industry analysts are currently predicting that the S&P 500 companies will earn almost $100 / share in 2011, up more than 20% than the estimate for this year. Analysts can certainly be wrong. But even if we discount their estimates and use a fairly average Price / Earnings ratio for future earnings – say 15.0 – we get to a December, 2010 S&P 500 Index value of around 1350. that is nearly 20% above today’s closing market price.
We are not forecasting 1350. But our year end expectation of 1200 – 1250 is far less aggressive than the 1350, which itself is derived from a conservative adjustment of current analyst consensus.
So, we’ll continue to watch our ring of the circus – corporate earnings – as well as the other data. But our current asset and sector allocations continue to appear appropriate.
