CI Outlook - Archives

January 2011

January 4, 2011

When writing our last letter there were many issues that still needed clarification.  The biggest was the tax bill before Congress.  That was resolved and many business friendly provisions were incorporated into it.  As a result two important considerations for stock market investors have been clarified.  First, with the extension of tax rates, the need for tax related selling has been postponed.  This kept the rally alive into year end.  More importantly, the inclusion of favorable corporate tax provisions, such as liberalized deprecation rules, will keep the rally going this year.  These provisions will result in higher than expected corporate earnings and therefore higher stock prices. 

Before the tax bill passed estimated earnings for the S&P 500 were in the range of $88 to $95 per share.  With the tax changes, estimates have been raised to a range of $93 to $100.  Using a price earnings ratio of 15 the S&P range for 2011 should be 1400 to 1500.  That is a gain of 10 to 20 percent from last year’s close.  We think this is possible for two reasons.  The first is the institutional reallocation trade we have written about in the past.  The second reason is public involvement in stocks.  The small investor is beginning to return after two years of absence.  In November stock mutual fund flows turned positive for the first time since 2008.  This is important.  It represents expanding investment confidence which usually results in expanding P/E ratios.  This will serve as a great counterbalance to the very real possibility of higher interest rates later this year or next. 

In summary we think the reallocation trade and return of retail investors will be the driving forces behind this year’s market.  These are two very powerful trends and they are long term trends which take years to play out.  While the current longer term outlook is positive, short term the markets are extended, and may soon suffer a price correction.  However the potential money flows are so strong that any correction should be short lived.  With that in mind we will continue to stay relatively fully invested.  We will however be selling under-performing holdings hoping to reinvest the proceeds in more promising securities as the opportunities arise.

We hope this explains our present investment stance.  As always we would be pleased to answer your questions or discuss our thinking with you in more detail.  Please call anytime we enjoy hearing from you.  Thank you for your patronage.

 


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