Download the full pdf at: Thoughts Mkt Performance & Midterm Elec 9-2-10

 Facts to Consider:

 Polls and prediction markets point to a significant Republican victory in the November midterm elections that will likely change the control in the House of Representatives to the Republicans and may do the same in the Senate.

• Gridlock in Washington is good for the stock market. When different parties control the White House and the Congress, there has been dramatically improved stock market performance.
• The Q2 earnings season exhibited continuing above average earnings growth that significantly beat expectations.
• Corporate profits, including public and private companies, continue to exhibit the strongest recovery in modern history.  Corporate profits are set to mark a new all time high in Q3 this year resulting in a full recovery in only 7 quarters.
• Corporate cash flows and after tax margins have already set a new record high in Q2.
• Investment in technology remains the best in 10 years.
• Market valuation is compelling . . . The S&P 500 P/E ratio is the lowest in 20 years.
• Investor sentiment measures are at levels consistent with market lows.
• Companies have cash and are starting to spend it on acquisitions and stock buybacks
• Q4 is a predominantly up quarter.  Q4 has shown a gain for the S&P 500 in 80% of the cases since 1980 and risen sequentially over Q3 by an average of 7.4%.
• The stock market is predominantly up in mid-term election years.  Q4 has seen an increase in the S&P 500 87.5% of the time in midterm election years in the post WWII modern political era. 

 Conclusion:    Conditions for stocks are improving.  The flight from equities has been excessive.  The “surprise” potential is for upside events.  Earnings growth is likely to continue to be stronger than macro economic concerns would suggest.

 BUY MORE GROWTH STOCKS – SELL BONDS

One would be led to think that the uptick in unemployment claims was a signal that earnings growth will dramatically slow.  That conclusion seems a bit hasty particularly in light of the fact that earnings in Q2 came in at 49% above Q2 2009 and were 15 percentage points above the consensus estimates for growth going into the earnings season.  Keep in mind that the median year over year change in the S&P 500 earnings since 1928 is only 8.6%.

The above chart comes courtesy of the Bespoke Investment Group on their blog at www.bespokeinvst.com.

I have updated the work on the “p/e ratio” of 10 year Treasury bonds (i.e. divide 100 by the yield) that I presented in July in contrast to the p/e ratio of the S&P 500.  Since that time the 10 year rate has gone down and the earnings for the S&P 500 have gone up.  The 10 year Treasury is yielding 2.6%.  The earnings yield on the S&P 500 is 7.3% (using LTM operating earnings adjusted for Q3 estimates).  The spread between the 10 year rate and the earnings yield has expanded to the widest since December 1974.  The S&P 500 rose 21.6% in Q1 1975 following the sharp widening of the spread in the fall of 1974.  The S&P 500 was up 31.5% in the 12 months following the wide spread of Dec. 1974.  The spread today is even wider than in 1974 when one considers that the spread today is equal to182% of the 10 year Treasury rate vs. 74.5% of the 10 year rate in Dec. 1974.  The historical implication is the odds favor stocks rising in the near future.

Treasuries are trading at an implied p/e ratio of 38.4X.  As I said in July, with stocks, earnings can improve and drive up the value of the shares.  With bonds – the amount of income is “fixed” – So if the “p/e ratio” of bonds is at an extreme high and income is fixed the only thing that can adjust if the “p/e ratio” should decline is price . . . and the “adjustment” would be down.

 It was noted by Bloomberg that bond funds attracted $559 billion of net inflows in the 30 months ended June.  Bloomberg went on to note that investors withdrew $209.4 billion from domestic equity funds in the same time frame.  This is as strong a contrary signal to sell bonds and buy stocks as you may see in a lifetime of investing. 

 In closing, I have chosen to present an update of my over/under valuation chart that plots the S&P 500 relative to implied value of the S&P 500 if it was capitalized by the 10 year treasury rate.  The S&P 500 has never been so undervalued as it is today.  The model implies that the S&P 500 is trading 64.5% below where it should be trading given today’s level of interest rates and operating earnings.

Bottom Line:       

1) The recent economic data headlined by the unemployment claims data does not signal a reversal in the economic recovery that is evidenced by the surge in earnings. 

2) Bonds are selling at historical high prices and low yields and should be sold or hedged.

3) The S&P 500 has never been as undervalued in modern market history.

Aberdeen sent out a one question survey to over 250 friends and clients on July 30, 2010.  The recipients are sophisticated investors from all over the U.S.

 The survey asked the recipients to provide an indication where they stand in terms of U.S. market prospects.  38% of the recipients opened the survey and 17% of the recipients responded.

 The responses were as follows. 

 Our crowd is clearly “cautiously optimistic”.  It’s an open question if this means “ready to re-enter the market” or “sit tight – hold cash”.

 There were quite a few comments.  49% of the respondents provided more color to their views.  The comments were most consistent in concerns about the size of government and prospect for rising taxes.

 The ratio of the bulls to the bears was 0.70.  The following chart from Yardeni Research provides some historical context to the low bull/bear ratio.  As you can see, “low” = “good time to be a buyer” and is consistent with recent low points in the market in 2002-2003 and 2008-2009.

(The following market commentary can also be viewed at the following linked pdf file: General Market Comment July 19, 2010)

We have had quite a roller coaster in the equity market.  No one would have guessed the market volatility or the extremity of sentiment we have seen if the only information they had to go by was that 1) S&P 500 earnings grew 92% in Q1 over 2009, 2) earnings look to grow 43% in Q2, 3) inflation is trending down, 4) interest rates are down and 5) employment and personal consumption are up.  These facts are all true.  

I have written in recent weeks that market conditions were remarkably oversold and that stocks are testing historic low valuations.  I was discussing all this with another money manager friend – Shad Rowe of Greenbriar Partners – who made a very interesting point.  He noticed that if one looked at the “p/e ratio” of 10 year Treasury bonds (i.e. divide 100 by the yield) no one would believe that bonds were anything but grossly overvalued.  I decided to have a look at this and generated the following chart contrasting the p/e ratio of the S&P 500 compared to the implied “p/e ratio” of the 10 year Treasury.   The 10 year Treasury is yielding 2.9%.  The earnings yield on the S&P 500 is 6.7%.  Have a look.Treasuries are trading at an implied p/e ratio of 34X.  This is extreme to say the least.  With stocks, earnings can improve and drive up the value of the shares.  With bonds – well the amount of income is “fixed” – that’s why they call it “fixed income” – eh?  So if the “p/e ratio” of bonds is at an extreme high and income is fixed the only thing that can adjust if the “p/e ratio” should decline is price . . . and the “adjustment” would be down. 

The markets don’t like bubbles and that’s what we have in Treasury bonds.  They don’t like high p/e ratios.  The reason bond prices are so high and rates are so low is there is broad consensus that the economy and more specifically, corporate America, is at the precipice of a material slow down – mind you most don’t say “decline” – just “slow down”.  Given that the broad consensus is usually wrong, the easy contrarian bet is that the “slow down” won’t be so bad. 

So, Snap Out It! . . . Go Buy some stocks! 

I have stated all year I would not be too concerned if we had some pullback in prices.  I doubted we would see appreciable downside “failing some exogenous shock to our collective psyche”.  Well – we had the “exogenous shock” – the European debt crisis and the Gulf of Mexico oil spill – and we had a correction in stock prices.  Now we have entered what should be a very respectable Q2 earnings season with prices lower and interest rates also lower.  The combination of the those factors – rising earnings, low interest rates and lower prices should result in a resumption in rising equity prices. 

Please do not hesitate to call if there are any questions. 

Regards: 

Jeb Terry

Wk:   214-347-9114

Cel:   214-552-6708 

Caution: It’s a risky world we live in. My opinions are based on information believed to be reliable but hey, I could be wrong.  When investing, try to use good judgment and don’t hesitate to seek professional assistance. Remember to set limits and have a plan. . . Good Luck!

“Most people get interested in stocks when everyone else is.  The time to get interested is when no one else is . . .” – Warren Buffett

I have never seen as strong a confluence of indicators in support of a market bottom and prospects for a rally.  

• A record number of consecutive down days in the QQQQ  
• Extreme oversold market conditions  
• There has not been a sustained decline in the market when there is strong earnings growth such as seen in the market up to now and expected for Q2.  
• The earnings yield has not been as strong as now since September 1990 – a bear market bottom. The spread between the earnings yield and the 10 year Treasury rate is the widest since 1979 when the S&P 500 gained 12.3% for the year.  Spikes in the spread such as now have been coincident with market bottoms.  
• The combination of low Treasury rates and a high earnings yield results in a near record low undervaluation.  We have haven’t seen this low a valuation since December 2008 and March 2009 – the panic lows of the last bear market.  
• We have not had a recession or a bear market when the yield curve is as steep as now.  

The recent sell off seems to be an extreme reaction.  The next news wave will be earnings related.  There is over $800 billion of cash at S&P 500 companies available for M&A and stock buybacks which increased 80% in Q1 from 2009.  It is normal to expect buybacks to pick up following earnings reports – like those coming up this month.

March 2009, with similar conditions as now, marked the start of a greater than 90% move from the NASDAQ low to the April 2010 high close.  July 2010 could mark the start of a similar move.

Please following link for the complete note and attendent charts.

The Wildebeests are Running Again 7-2-10

The NASDAQ peaked on April 23 after 8 weeks of consecutive gains.  It has apparently bottomed on June 9.  I made note in April that extended strings of up weeks were generally precursors to even more movement to the upside punctuated occasionally by modest pullbacks.  Of course a 15% correction qualifies as more than a “modest pullback”.  Nevertheless, I submit that the combination of economic data, earnings outlooks, interest rates and liquidity still favor a rising instead of a falling equity market.

There continues to be a great deal of fear about sovereign debt risks in Europe.  People are forgetting to consider how European corporations are doing.  The following table from Thomson Reuters as of June 18 displays the estimated annual earnings growth, P/E ratios and ratio of negative to positive earnings revisions by country – you will be surprised – I was. (FY1 is 2010 and FY2 is 2011).

Only Spain appears to be a laggard in Europe.  While there are certainly going to be fiscal consequences of the sovereign debt crisis it is not a given that profits will be similarly impaired for the very globalized European corporate community.

So, what’s the bottom line? . . . 

I stated in April and in May I would not be too concerned if we had some pullback in prices.  I doubted we would see appreciable downside “failing some exogenous shock to our collective psyche”.  Well – we had the “exogenous shock” – the European debt crisis and the Gulf of Mexico oil spill – and we had a correction in stock prices.  Now we approach what should be a strong Q2 earnings season with prices lower and interest rates also lower.  The combination of the those factors – rising earnings, low interest rates and lower prices should result in a resumption in rising equity prices.

Aberdeen Investment Management, Inc. Collaborates With Research 2.0

Aberdeen Investment Management, Inc. (AIM), is pleased to announce that it has entered into a collaboration with Research 2.0, a next generation technology research firm based in Boston, to provide research services to AIM on publicly-traded, emerging technology companies.  AIM has been providing advice to high net worth clients on micro cap, emerging technology companies since 2003.

Research 2.0 brings decades of experience in evaluating both public and private technology enterprises.  Their founder and Director of Research, Kris Tuttle, formerly ran a 70 person research organization for Soundview Technology Group, which has been described as the leading technology research boutique on Wall Street during the late 1990’s.  Kris also previously served as Director of Research for Adams Harkness & Hill, a well regarded Boston-based regional broker dealer, prior to its acquisition by Canaccord Capital.  He brings particular expertise and knowledge in software businesses.

Steve Waite, head of Strategy for Research 2.0, was a co-founder of a multi-billion dollar investment management firm, Trilogy Advisers.  Steve has managed a number of long-only technology and global equity portfolios.  He is a noted author of two books on investing, and has extensive experience on both the buy and sell side of Wall Street, having worked with several firms including Morgan Stanley, The Capital Group, Merrill Lynch, and Credit Suisse Asset Management/BEA Associates.

AIM’s President, Jeb Terry, stated “the collaboration with Research 2.0 will allow AIM to expand the depth and reach of its technology research that will incorporate the best ideas generated by Research 2.0.”  Research 2.0’s research approach and coverage compliments AIM’s core micro cap, emerging technology focus, and will expose AIM to larger market cap opportunities.

AIM and Research 2.0 each believe the correct strategy to capture optimal upside is one of long term investment predicated on a thorough investigation of the target investment’s business model, addressable market, competitive strengths and weaknesses and intellectual property.  AIM’s present strategy and micro cap focus recommends relatively concentrated investments to maximize returns with minimal turnover and without the use of leverage. In addition, Research 2.0’s resources will bring further diversification of AIM’s investment process with a focus on larger cap technology companies who are strategically well-positioned with global operations benefiting from many of the same waves of technology innovation that are central to the AIM portfolio.

Interested parties can learn more about AIM’s emerging technology practice at their web site at www.aberdeeninvestment.com .  They can contact Jeb Terry, President, via email at jbtsr@aberdeeninvestment.com  or by phone at (214) 347-9114. 

More information on Research 2.0 can be found at their web site: www.research2zero.com . Their principals can be reached by e-mail and telephone as follows:

Kris Tuttle        kris@research2zero.com          617-828-6462

Steve Waite      steve@research2zero.com        203-537-0263

For example . . .  The retail money has yanked money from equity mutual funds.  The following chart from BofA Merrill Lynch shows they fled equities at a rate never seen before except at the panic points of Oct/Nov 2008 and March 2009 – the Great Recession market low.

Bespoke Investment Group (www.bespokeinvest.com) has pointed out that spikes in bearish investor sentiment coincide with market bottoms.

Of course the S&P 500 remains near an all time degree of undervaluation in relation with earnings growth and the 10 year Treasury rate.

Bottom Line:             The data rarely presents a more obvious case for a rising stock market.  The prospect for a very strong employment report tomorrow could be the icing on the cake.

 Jeb B. Terry, Sr.

President

Aberdeen Investment Management, Inc.

jbtsr@aberdeeninvestment.com

Tel: 214-347-9114

Cell: 214-552-6708

Caution: It’s a risky world we live in. My opinions are based on information believed to be reliable but hey, I could be wrong.  When investing, try to use good judgment and don’t hesitate to seek professional assistance. Remember to set limits and have a plan. . . Good Luck!

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• S&P 500 is down 10.9% from April high, down 2.8% year to date – so far it’s a correction that falls within the bands of “normal”.
• The S&P 500 has been this or more undervalued only twice since 1970 – it was 59% undervalued in December 2008 and 50.1% undervalued at March 31, 2009.
• The S&P 500 was up 23% 12 months after Dec. 2008 and up 47% 12 months after March 2009. 

 The market is cheap and oversold.  Today may be the point of the “THUD”

(The following market commentary can also be viewed at the following linked pdf file: General Market Comment May 17 2010)

 The market, as I define as the NASDAQ here, is down 7% over that last 21 days.  Are market lore, cycle theories, some market internal measures, fear of a spreading Eurozone crisis and general pessimism sufficient reasons to continue to “sell in May and go away” as the saying goes? 

My read of the data says you may want to think twice before you dash for the exits.

My indicators continue to be consistent with early stages of a bull market that will increasingly be led by technology, i.e. our kinds of companies.  This view is not inconsistent with a notion that the economy – while exhibiting robust year over year gains in all manner of macro economic measures – is still far from performing at its full potential.  This fact bolsters the case for subdued inflation and interest rates – which are conditions that are supportive of rising earnings and stock prices.  

The following chart from Thomson Reuters displays the earnings for the S&P 500 since 2005.

There are legitimate concerns about the Eurozone debt crisis.  It is not clear to me that the restructuring of the PIIGS debts will either stop European economic growth or drag the rest of the world into a financial crisis.  As the analysts at the Bank Credit Analyst noted – the crisis had reached the “riot point” and hence commanded forceful and coordinated policy responses such as we saw last week and are likely to see more of going forward.  There is much about the crisis that I characterize as being resolvable “with a stroke of a pen”.  Don’t get me wrong – there are fiscal consequences, but central bankers and governments have demonstrated a willingness to act decisively to stop financial panics as has been unfolding in Europe. 

So, what’s the bottom line? . . . There are many brick masons ready and willing to add to the proverbial “wall of worry” that the stock market has to climb.  There is undeniable historical evidence that the period from May through October is a weak period for stocks but that does not mean that they won’t rise this year.  Stocks rise when earnings outlooks are rising and interest rates are stable . . . kinda like now . . . The recent market correction is not alarming given the youth of the economic recovery, the persistence of easy of monetary conditions and the strength in earnings.

 I stated in April I would not be too concerned if we had some pullback in prices.  I remain of that conviction.  I doubt we will see appreciable downside from current levels failing some exogenous shock to our collective psyche. 

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Please refer to the latest Market Analysis report dated March 9, 2010 entitled “Spring Returns to the Serengeti” on our web site www.aberdeeninvestment.com for more data supporting our opinions on the economy and the market.

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