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A Riddle Wrapped in an Enigma

September 24

This phrase, coined by Vinny Catalano, CFA, in his recent blog really struck me.  He wondered how the US might reach a sustainable recovery without the US consumer.  I’m highly concerned about this myself.  The fact is, there is extraordinary pressure on small businesses, which create the vast majority of jobs and is widely considered the backbone of our economy.

Until this pressure is relieved, there is no way for us to stave off unemployment.  As unemployment increases, consumer sentiment will go down as will consumer spending, which is already at low levels.  Many small businesses are unable to get the capital necessary to stay in business, and those that rely on credit cards are having their limits cut or rates increased.  Banks are putting the squeeze on not just the consumer, but small and medium-sized businesses.  This is in contrast to the President’s desire for reinvigorating the economy.

Yes, there may be good news and the worst of the recession may indeed be over, as Ben Bernanke has publicly announced.  However, we are in the first few miles of a 10k run and there is a long way to go before a full recovery is in order.  We may desire a “V” shaped recovery, but it just may end up being a “W”, meaning another dip is on the way.

The S&P 500 as a whole is clearly overvalued when looking at P/E.  When current price is over 100 times earnings, you have to be concerned.  Take a look at this chart from late August, and tell me that it’s not scary!  Obviously, prices have not dropped as far as earnings, leading to an inflated P/E ratio.  However, since the present value of any investment is typically defined in terms of discounted future cash flows, and these cash flows will be suppressed over the coming years, it is safe to say that today’s market is overly optimistic.

That’s not to say that there are not investment opportunities out there, because there surely are.  But general market indexing will not be able to find these values.  Only careful and detailed fundamental and even technical analysis of individual securities reveals these opportunities.  This is the time for financial advisors to shine, creating value and properly assessing and managing risk.  No one needs an advisor during a bull market.  It is times like these where advisory services can deliver.

Categories: Market Commentary
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