After evaluating equities under five categories - valuation (both absolute and relative), sentiment & money flow, economic backdrop, political environment and degree of discounting - we conclude that the risk/reward equation has switched firmly to the reward side for equities. However, this is likely the most important week for US economic data for many months. If the market manages to come through Labour Day with the key support of 1040 on the S&P 500 intact, we would view the odds of a Q4 rally as favourable.

Valuation: Last week the S&P 500 touched the lower end of our defined trading range of 1040, which represents 11.5x our 2011 forecast of $90 a share, well below the average price-to-forward earnings multiple of 15x over the past 30 years. On a risk adjusted basis, the relative valuation gap between equities and bonds is on par to that experienced in March 2009. For the first time since 1962, the yield on Dow exceeds that of the US 10 year bond yield. European dividend yields are also back above government bond yields, an extreme valuation event that last occurred back around global market lows in 2003 and 2008.

Economic backdrop: At his eagerly anticipated speech at Jackson Hole last week, Fed Chairman Bernanke said “the Committee is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly”. We therefore believe the Fed will maintain a zero-interest-rate policy for the foreseeable future. For that reason, we would currently side with a moderating expansion rather than a double dip. It also should be noted that new residential investment remains at a record low and any recovery, however modest, could provide weighty support for GDP growth.

Sentiment: A combination of sentiment indicators including put/call ratio, short interest ratio and AAII readings are suggesting a degree of bullish capitulation. According to the American Association of Individual Investors, the number of bullish reading fell to 20%, the lowest since March 2009. Consensus expectations are coming to grips with the structural headwinds of high unemployment, consumer deleveraging and deflation.

Political environment: The recent weak bout of economic data could force politicians into adopting a more lenient tax and regulatory structure. A win for the Republicans in November's mid-term elections could lead to the Bush tax cuts being prolonged. If the Democrats were to lose their congressional majority, the Senate could go into gridlock, thus halting the speed of any changes.

Degree of discounting: Last week saw the first signs that the market may have started discounting bad news again. Firstly, the US homebuilding sector (XHB) rallied over 7% in the two sessions following the release of record low new and existing home sales. Secondly, despite Intel lowering guidance by over 5%, the stock managed to close the session higher suggesting that the stock market may have already discounted a slowing corporate environment.

Ross McEvoy

Tullow has announced this morning that it has agreed to acquire a 50% operated interest in five blocks covering the East African Rift Basins in Kenya and Ethiopia. Tullow highlights the many similar geological features of the East African Rift Basin and the Lake Albert Rift Basin where it is operating in Uganda. A well drilled on one of the blocks in the region in 1992 recovered light waxy crude similar to that Tullow is finding in Uganda. For relatively small entry costs Tullow gains exposure to a significantly larger region (10x the aerial scale of its Ugandan blocks) which should have operating synergies with its Ugandan operations. This is an early stage exploration project but with good medium term potential.

We have a BUY on Tullow Oil.