Money Matters with Rose Greene

LPL Financial Weekly Market Commentary for May 15, 2012

Rose Greene, CFP — Tue, 15 May 2012 20:07:09 +0000

Look Who’s Buying and Selling

Jeffrey Kleintop, CFA
Chief Market Strategist
LPL Financial

Highlights

At the heart of it, all markets come down to buyers and sellers.

U.S. stocks are being purchased by foreigners and corporations while notable selling is coming from individuals and insiders, or top executives, of companies.

We believe the forces of selling will win out over the buying power in the coming months.

We devote this commentary each week to assessing the many reasons markets may rise or fall. But at the heart of it, all markets come down to just one thing: buyers and sellers. Taking a look at who is buying and who is selling can tell us something about the durability of the market’s performance and what may lie ahead.

Presently, there are four notable trends in buying and selling in the stock market. U.S. stocks are being purchased by foreigners and corporations while selling is coming from individuals and insiders, or top executives, of companies.

Foreigners are Buying

Purchases of U.S. stocks by foreigners in the first quarter of 2012 shows that demand by foreigners has rebounded from the uncharacteristic selling that took place in the second half of last year. Net purchases of U.S. stocks by foreigners in the first quarter totaled about $10 billion, according to the U.S. Treasury.

Companies Are Buying Back Shares

After taking advantage of the market rebound in 2009, corporations issued shares in 2010. However, since then they have returned to near record levels of net share repurchases.

Corporations have become net buyers of shares as rising cash flow and wide profit margins compel them to shrink their share count to boost earnings-per-share as revenue growth slows.

Individual Investors are Selling

Individual investors have been net sellers, measured by the flows of mutual funds that invest in U.S. stocks. They have been selling for 12 straight months. During the past 12 months, investors in these funds have sold more than they did during 2008. Individual investors as a group wield far more buying power and influence over the marketplace. When individual investors make up their minds, they can be a powerful and durable force in the markets.

Insiders are Selling

Selling by insiders, or top executives, of companies has been well above average. As of the latest week, according to data tracked by Argus Research of the number of shares insiders have sold and those that they have bought on the NYSE, the sell-to-buy ratio was 7.1-to-1.0 This is a historically high level of insider selling.

Should this data be seen as an important signal by those “in the know” of impending doom for corporate America? History offers a very different interpretation. Corporate insiders were buying in 2007 at the peak, and they were selling in 2009 as stocks were bottoming. Back in August of 2007, around the peak of the stock market, insiders at Financial companies were doing the most buying in 12 years. At the time, this trend was interpreted by some as a buy signal for Financials just before the companies in this sector fell more than 80%. Given this track record, we do not interpret the insider selling as a signal of impending losses. This fact does not suggest that they are acting on any inside information that would benefit an individual investor and instead may be selling in response to a three year bull market that doubled the value of the overall stock market.

Projecting the Trends

We expect foreigners and companies to continue to be net buyers while insiders remain sellers in the coming quarters. Fuel for a new bull market would most likely have to come from individual investors. One of the trends powering bond prices higher, and yields lower, is the strong demand from individuals as they continue to shift their investments from stocks to bonds.

The potential for money to flow into the stock market and lift stocks is significant. However, individual investors must first become disillusioned with bonds. Since bonds have offered returns over the past thirty years that are competitive with stocks and provided much lower volatility, many are reallocating their portfolios toward bonds as they seek to provide for a comfortable retirement. It may take a period of rising interest rates from near historic lows to demonstrate the potential for losses and volatility that bond investors in the late 1960s and throughout the 1970s experienced to reverse the individual investor money flows back to stocks.

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IMPORTANT DISCLOSURES

LPL Financial Weekly Market Commentary for May 8, 2012

Rose Greene, CFP — Thu, 10 May 2012 18:54:56 +0000

The “Wall Street” Election Poll

Jeffrey Kleintop, CFA
Chief Market Strategist
LPL Financial

Highlights

The biggest event for investors over the next six months is likely to be the November elections in the United States. The outcome of the elections will define the political context and leadership for the policies that address the looming fiscal imbalances coming to a head in early 2013.

Based on the relative performance of legislation-sensitive industries that may react more favorably to one party, we have created two indexes to help us track the markets’ implied forecast of the election outcome reflected in the performance of these industries.

While there are other factors that may influence the relative performance of these indexes, as time goes on the election consequences may become paramount as investors increasingly vote with their money.

The biggest event for investors over the next six months is likely to be the November elections in the United States. The outcome of the elections will define the political context and leadership for policies that address the looming fiscal imbalances coming to a head in early 2013. We have explored this budget bombshell in prior commentaries and what it could mean for the markets and economy. This week we will take a look at what the market is pricing in regarding the election outcome.

As we explore the issue of what the market is pricing in when it comes to the outcomes of the November elections, it is important to be aware of the shortcomings of overly simplistic election analysis. An illustration of this can be seen in Figure 1, where we plot the odds of President Obama’s re-election (measured by contracts traded on Intrade.com) and the movements in the stock market, measured by the S&P 500 Index. Is the stock market going up because of the rise in Obama’s re-election odds, or are Obama’s re-election odds going up because the stock market is rising — or, more likely, are both tied to something else?

Attempting to draw simple conclusions about what the market is saying about the election is fraught with the potential for misinterpretation. Instead, there is a better, more analytical way for investors to attempt this kind of potentially rewarding analysis. Analyzing the market by the industries most impacted one way or another by the election outcome can provide more precise insight into what the market is pricing in regarding the election.

For example, the components of the 10 stock market sectors are impacted in different ways by election outcomes:

Health Care is the biggest driver of the long-term budget problems at the Federal level. States are already cutting Medicaid to balance their budgets. A sweeping win for the GOP holds the most promise for Managed Care providers as risks decline and investors increase the odds for a repeal of all or part of the Affordable Care Act. Diagnostic labs, generic drug makers, hospitals, and nursing homes may benefit if the Act is upheld and from Democrats’ leadership, given expanded health care coverage and an emphasis on preventative care and legislation to speed up the introduction of generic drugs to market.
We may see a relief rally among the banks in the legislation-sensitive Financial sector. If the GOP takes the Senate it will result in the change of chairmanships of key committees. While major changes to the financial reform law, Dodd-Frank, are unlikely, an all GOP Congress might influence regulations implementing the law. On the other hand, Republicans would likely look to address Fannie Mae and Freddie Mac conspicuously left out of the Democrat-led financial reform law, which could have negative ramifications on home loan originators. Democrats may also provide more housing support programs benefitting home builders and construction materials providers.
As previously mentioned, the potential extension of Bush tax cuts would mean the dividend tax rate may remain closer to 15% instead of going to 43.4%, a plus for companies with lots of cash to distribute. High dividend-paying sectors such as Telecommunications Services, Consumer Staples, and Utilities may benefit. Cash-rich companies in other sectors may also benefit as they introduce or substantially increase their dividend payout as they look to attract a new class of investor seeking yield. Alternatively, some food and staples retailers may benefit from potential for a further extension of unemployment benefits.
Companies in the Energy sector may be impacted by a strong election for the GOP in a number of ways. Regulations on drilling would be more favorable as would EPA regulations. We could see lower regulatory costs for producers in the Materials sector and users of coal such as Utilities. Gas may benefit from stricter coal regulations under the Democrats. On the other hand, alternative energy companies would face a less supportive outlook for subsidies under a GOP outcome.
Sectors highly sensitive to trade, including Technology, may benefit from a strong showing by the GOP. The Consumer Discretionary sector could also benefit from the diminished risk of China trade protectionism — a plus for retailers dependent on low-cost imports and U.S. exporters of capital equipment fearing Chinese retaliation.
The election could hold positives and negatives for companies in the Industrial sector. At 20% of the budget, defense spending will likely see cuts next year, but would likely see a more shallow trimming under the GOP than Democrats. On the other hand, transportation funding will likely be smaller under GOP leadership, resulting in fewer government dollars for engineering and construction companies.

While there are many “man on the street” polls, what matters most to investors is what is priced in on Wall Street rather than what people are saying on Main Street. A stock market based “election poll” is useful in that it highlights what the market is pricing in about the outcome of the election that is more refined than merely looking at the overall market.

Based upon these legislation-sensitive industries, we have created two indexes to help us track the markets’ implied forecast of the election outcome reflected in the performance of these industries. Each index is composed of an equal weighting among seven industries that combined total about 100 S&P 500 stocks.

To track what the market has priced in for the Democrats’ odds of retaining the White House and Senate we have taken the Democrats index and divided it by the Republicans index. An upward sloping line suggests the market may be pricing in a rising likelihood of the Democrats retaining the White House and their majority in the Senate, while a downward sloping line suggests improving prospects for the Republicans. While other factors may influence the relative performance of these indexes, as time goes on the election consequences may become paramount as investors increasingly vote with their money. As you can see in Figure 3, already this year Obama’s re-election odds on Intrade.com are generally tracking the relative strength of our Democrat vs. Republican indexes.

If you elect to follow our “Wall Street” election poll index, we pledge to continue to keep you informed as to how these issues are likely to affect the markets. We will update this index frequently as the election becomes an increasingly important driver of the markets over the coming six months.

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IMPORTANT DISCLOSURES

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
Stock investing may involve risk including loss of principal.
The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
Consumer Discretionary Sector: Companies that tend to be the most sensitive to economic cycles. Its manufacturing segment includes automotive, household durable goods, textiles and apparel, and leisure equipment. The service segment includes hotels, restaurants and other leisure facilities, media production and services, consumer retailing and services and education services.
Consumer Staples Sector: Companies whose businesses are less sensitive to economic cycles. It includes manufacturers and distributors of food, beverages and tobacco, and producers of non-durable household goods and personal products. It also includes food and drug retailing companies.
Energy Sector: Companies whose businesses are dominated by either of the following activities: The construction or provision of oil rigs, drilling equipment and other energy-related service and equipment, including seismic data collection. The exploration, production, marketing, refining and/or transportation of oil and gas products, coal and consumable fuels.
Financials Sector: Companies involved in activities such as banking, consumer finance, investment banking and brokerage, asset management, insurance and investment, and real estate, including REITs.
Health Care Sector: Companies are in two main industry groups — Health Care equipment and supplies or companies that provide health care-related services, including distributors of health care products, providers of basic health care services, and owners and operators of health care facilities and organizations. Companies primarily involved in the research, development, production, and marketing of pharmaceuticals and biotechnology products.
Industrials Sector: Companies whose businesses manufacture and distribute capital goods, including aerospace and defense, construction, engineering and building products, electrical equipment and industrial machinery. Provide commercial services and supplies, including printing, employment, environmental and office services. Provide transportation services, including airlines, couriers, marine, road and rail, and transportation infrastructure.
Manufacturing Sector: Companies engaged in chemical, mechanical, or physical transformation of materials, substances, or components into consumer or industrial goods.
Materials Sector: Companies that are engaged in a wide range of commodity-related manufacturing. Included in this sector are companies that manufacture chemicals, construction materials, glass, paper, forest products and related packaging products, metals, minerals and mining companies, including producers of steel.
Information Technology: Companies include those that primarily develop software in various fields such as the Internet, applications, systems and/or database management and companies that provide information technology consulting and services; technology hardware & Equipment, including manufacturers and distributors of communications equipment, computers and peripherals, electronic equipment and related instruments, and semiconductor equipment and products.
Telecommunications Services Sector: Companies that provide communications services primarily through a fixed line, cellular, wireless, high bandwidth and/or fiber-optic cable network.
Utilities Sector: Companies considered electric, gas or water utilities, or companies that operate as independent producers and/or distributors of power.
Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.

LPL Financial Weekly Market Commentary for May 1, 2012

Rose Greene, CFP — Tue, 01 May 2012 21:53:01 +0000

Spring Slide Indicators Update

Jeffrey Kleintop, CFA
Chief Market Strategist
LPL Financial

Highlights

In each of the past two years the stock market began a slide in the spring that lasted well into the summer months.

This week we update the status of the 10 indicators we identified that foreshadowed the declines in 2010 and 2011.

So far, about half of the 10 indicators are waving a red flag, while four are yellow for caution, and only one is green. On balance the indicators point to a significant risk of a repeat of the spring slide this year.

One month ago we provided our list of the 10 indicators to watch that seemed to precede the stock market declines in 2010 and 2011 and may warn of another spring slide. In both 2010 and 2011 an early run-up in the stock market, similar to this year, pushed stocks up about 10% for the year by mid-April. On April 23, 2010 and April 29, 2011, the S&P 500 made peaks that were followed by 16 – 19% losses that were not recouped for more than five months, a phenomenon often referred to by the old adage “sell in May and go away.” Now that the time the prior slides have begun has arrived it is time to revisit the status of the indicators.

So far, about half of the 10 indicators are waving a red flag, while four are yellow for caution, and only one is green. On balance the indicators point to a significant risk of a repeat of the spring slide this year. We will continue to monitor these closely in the coming weeks.

1. Fed stimulus – In each of the past two years, Federal Reserve (Fed) stimulus programs known as QE1 & QE2 came to an end in the spring or summer, and stocks began to slide until the next program was announced. The current program known as Operation Twist was announced on September 12, 2011 and is coming to an end. It is scheduled to conclude at the end of June 2012. The Fed’s communications in April appeared no closer to announcing QE3, raising the risk of a repeat of the spring slide.

2. Economic surprises – The Citigroup Economic Surprise index [Figure 1] measures how economic data fares compared with economists’ expectations. The currently falling line suggests expectations have become too high; this typically coincides with a falling stock market relative to the safe haven of 10-year Treasuries.

3. Consumer confidence – In 2010 and 2011, early in the year the daily tracking of consumer confidence measured by Rasmussen [Figure 2] rose to highs just before the stock market collapse as the financial crisis erupted. The peak in optimism gave way to a sell-off as buying faded. Investor net purchases of domestic equity mutual funds began to plunge and turned sharply negative in the following months. This measure of confidence is once again beginning to fall from the highs.

4. Earnings revisions – Last week was about earnings and the news was good. S&P 500 profits were up 7% (4.7% ex-Apple) from a year ago with 72% of companies beating expectations, relative to 68% in the past four quarters. However, strong first quarter earnings reported in April of 2010 and 2011 were not enough to avoid the spring slide. The first couple of weeks of the first quarter earnings season in April 2010 and April 2011 drove earnings estimates for the next 12 months higher, but as the second half of the earnings season got underway in May 2010 and May 2011, guidance disappointed analysts and investors as the pace of upward revisions began to decline. This year the earning revisions have followed a similar pattern, so far. It is too early to say whether this indicator is flashing a warning sign. We will be watching to see if estimates begin to taper off now that earnings expectations have risen on the initial reports.

5. Yield curve – In general, the greater the difference between the yield on the 2-year and the 10-year U.S. Treasury notes, the more growth the market is pricing into the economy. This yield spread, sometimes called the yield curve because of how steep or flat it looks when the yield for each maturity is plotted on a chart, peaked in February of 2010 and 2011 at 2.9%. Then the curve started to flatten, suggesting a gradually increasing concern about the economy, as the yield on the 10-year moved down to around 2%. This year the market is pricing a more modest outlook for growth, but we will be watching to see if the recent flattening in the yield curve continues with the yield on the 10-year having moved back to 2% during April 2012.

6. Oil prices – In 2010 and 2011, oil prices rose about $15 – 20 from around the start of February, two months before the stock market began to decline. This year oil prices have climbed back to the levels around $105 that they reached in April of last year. However, they have risen only about $10 since around the start of February 2012 and seem to have stabilized. A further surge in oil prices would make this indicator more worrisome.

7. The LPL Financial Current Conditions Index (CCI) – In 2010 and 2011, our index of 10 real-time economic and market conditions peaked around the 240-250 level in April and began to fall by over 50 points. This year, the CCI recently reached 249 and has started to weaken and currently stands at 224.

8. The VIX – In each of the past two years the VIX, an options-based measure of the forecast for volatility in the stock market, fell to a low around 15 in April before ultimately spiking up over 40 over the summer. Last week, the VIX declined once again to 16. This suggests investors have again become complacent and risk being surprised by a negative event or data.

9. Initial jobless claims – It was evident that initial filings for unemployment benefits had halted their improvement by early April 2010, and beginning in early April 2011, they deteriorated sharply. In 2012, April has again led to deterioration in initial jobless claims as they have jumped by about 30,000 to nearly 390,000 [Figure 4]. A continued climb this week would echo last year’s spike.

10. Inflation expectations – The University of Michigan consumer survey reflected a rise in inflation expectations in March and April of the past two years. In fact, in 2011, the one-year inflation outlook rose to 4.6% in both March and April. This year, inflation expectations also jumped higher in March, but receded a bit from the March jump that echoed what we saw in 2010 and 2011.

Finally, one issue not addressed specifically in the indicators, but important in the markets, is the rising European stresses — evident in the spring of 2010 and 2011. European policymakers including those at the European Central Bank, who meet later this week (May 3, 2012), have been facing a lot of pressure to act and do something about the renewed fears evident in the yields on Spanish and Italian debt and European stocks. European leaders have once again refocused away from unpopular austerity to talk of stimulating growth, at the expense of rising bond yields. If leaders continue to do little to address the market’s concerns it could again accelerate the bond market sell-off and begin to affect stocks here in the U.S. similar to the spring slides in 2010 and 2011.

This week most of the attention will be directed towards the Institute for Supply Management (ISM) and employment reports for April 2012. But as we pointed out a month ago, these measures did not deteriorate ahead of the market decline, but along with it. It is not that they are not important; it is just that they did not serve as useful warnings of the slide to come, while the above 10 indicators did.

The return of daily volatility in April 2012 and the fact that April 2012 ended up as a flat month for stocks after six months of strong gains may suggest we are near a turning point. Given this year’s double-digit gains and the possibility of another spring slide for the stock market, investors may want to watch these indicators closely for signs of a pullback.

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IMPORTANT DISCLOSURES

LPL Financial Weekly Market Commentary for April 24, 2012

Rose Greene, CFP — Tue, 24 Apr 2012 21:17:48 +0000

Spring Allergies or Something Worse?

Jeffrey Kleintop, CFA
Chief Market Strategist
LPL Financial

Highlights

In April, the markets seem to be suffering from a case of spring allergies. Like pollen-induced sneezes, the spasms at each of the data points have resulted in a noticeable uptick in volatility after a very quiet first quarter.

The symptoms are not likely to clear up this week with many allergens floating around: the Fed meeting, first quarter earnings reports, key economic data, the French elections, the worsening recession in Europe, and earnings reports from Spanish banks.

Investors’ immune systems may be hypersensitive after the past five years. But the market’s symptoms may also be signs of an oncoming illness potentially leading to a sustained pullback.

In April, the markets seem to be suffering from a case of spring allergies. One day they are feeling better and climbing higher, the next they weaken and drop. Like pollen-induced sneezes, the almost involuntary market spasms at each of the data points have resulted in a noticeable uptick in volatility after a very quiet first quarter. In fact, so far during April nearly half of the trading days, six out of 14, have seen more than a 1% swing in the S&P 500. This is just one day less than the seven 1% swing days in the stock market during the entire first quarter.

The symptoms are not likely to clear up this week. The allergens floating around the U.S. this week that markets may react to include: the Fed meeting, first quarter earnings reports, and key economic data.

The Fed may not offer enough insight on a potential QE3 — a third round of quantitative easing — that investors seem to be looking for after recent economic data.
First quarter earnings reports thus far generally exceeded analyst estimates by a wide margin without material downward revisions to upcoming quarters’ estimates. Yet the stock market, as measured by the S&P 500, was up only about 0.6% last week and investors’ bar of expectations may now be even higher as the earnings reporting season nears the halfway point later this week.
Among the economic data released this week, initial jobless claims will be closely watched to see if they make a third consecutive week of deterioration and qualify as red flag number five out of our 10 leading indicators of another spring slide in the stock market and other “risk assets.” (See the Weekly Market Commentary “10 Indicators to Watch for Another Spring Slide” from March 26, 2012 for more details).

The real test for the markets this week may come from overseas as markets react to: the French elections and accompanying policy uncertainty, the recession worsening in Europe, and finally Spanish banks will report their earnings.

We will have to see what Socialist Party candidate Francois Hollande’s victory in the first round French presidential election on Sunday, April 22 means to European politics and the French-German relationship in leading the unified anti-crisis programs. Hollande’s socialist political ideology may make for a difficult relationship with Germany’s right-leaning Chancellor Angela Merkel. In addition, French domestic politics could change with
higher spending proposals likely under Hollande — he has stated an intention to renegotiate European treaties on deficit limits — and could push French bond yields higher.
As the European recession deepens — evidenced this week by a disappointing European manufacturing report for April — for the first time since before Japan entered its multi-decade slump, German 2-year bond yields have dipped lower than those of Japan, at around 0.1%. This decline in 2-year yields to near zero reflects both a flight to quality within Europe, as money leaves Spanish and Italian bonds, and a deteriorating outlook for growth. The specter of a lost decade is overhanging Europe as it echoes the post-bubble Japanese economy in the 1990s defined by troubled banks, a deepening recession, a volatile stock market, and very low yields.
Many Spanish banks will report first quarter earnings this week, including heavyweights Banco Popular, Santander, and BBVA. Spain’s problems lie largely with its banks. Markets have been pricing in an increasing probability of a bank default in recent weeks, suggesting injections of capital may be necessary. Investors will be looking for the scope of the damage to balance sheets resulting from the ongoing real estate declines and recession along with the accompanying need for government capital. The scrutiny will be intense, with Spanish 10-year bond yields back up to around 6% from as low at 4.8% in February, despite the International Monetary Fund (IMF) getting pledges for an even bigger financial crisis backstop.

Investors’ immune systems may be hypersensitive after the past five years. But the market’s symptoms may also be signs of an oncoming illness. Despite worries, stocks climbed 30% during the past two quarters. With volatility now returning and the market advance becoming led by fewer stocks (the average S&P 500 stock is stuck at the level reached in early February), further signs are emerging in market behavior that it may be vulnerable to a pullback.

To download a copy of the commentary click here

IMPORTANT DISCLOSURES

Institute of Business & Finance Announces a New CIS Desginee

Rose Greene, CFP — Mon, 23 Apr 2012 19:29:41 +0000

San Diego, CA, April 23, 2012 – The Institute of Business & Finance (IBF) recently awarded Rose Greene with the only nationally recognized retirement designation, CIS™ (Certified Income Specialist™). This graduate-level designation is conferred upon candidates who complete a one-year educational program focusing on fixed-income instruments, retirement and financial planning, taxes, Social Security, withdrawal plans, stretch IRAs, and reverse mortgages.

CIS™ certification requires mastery of Medicare, income taxes, fixing any income shortfall, home health care, reverse mortgages, surviving a bear market, plus accumulation and distribution concerns. According to IBF, “Members of the financial services community are taught how to help their clients accumulate assets. What has always been missing is comprehensive and unbiased information as to how to turn assets into reliable income. The CIS™ program addresses these issues and provides the answers.”

The student must pass three comprehensive exams, complete a written case study as well as adhere to the IBF Code of Ethics and IBF Standards of Practice as well as fulfill annual continuing education requirements. The CIS™ designation is designed for brokers and advisors who have clients that are seeking current income.

ABOUT THE INSTITUTE OF BUSINESS & FINANCE – Founded in 1988, IBF is a non-profit provider of financial education and designations to members of the financial services industry. IBF is the fourth oldest provider of financial certification marks in the United States. In 1988, IBF launched its first certification program, CFS® (Certified Fund Specialist®). Today IBF offers four additional financial designation programs: CAS® (Certified Annuity Specialist®), CES™ (Certified Estate and Trust Specialist™), CIS™ (Certified Income Specialist™) and CTS™ (Certified Tax Specialist™).

LPL Financial Weekly Market Commentary for April 17, 2012

Rose Greene, CFP — Tue, 17 Apr 2012 20:32:21 +0000

A Taxing Issue for Investors

Jeffrey Kleintop, CFA
Chief Market Strategist
LPL Financial

Highlights

Perhaps surprisingly, it appears that the tax rate changes have played little or no direct role in stock or bond market performance.

The most likely reason is that the effects on after-tax returns were deemed negligible relative to the macroeconomic and geopolitical drivers.

The far bigger impact is an indirect one determined by the magnitude and direction of overall fiscal policy taken (or not taken) in 2013 to put the United States back on a path to financial stability.

This Tuesday, April 17, is tax day — and it may never be the same. The 2012 elections hold major consequences; one of them is tax policy. While there is much that we could present regarding the potential changes, we will constrain our comments to how tax changes may directly affect investors in the stock and bond markets.

Already written into law for 2013 are big changes including the expiration of the Bush tax cuts and the payroll tax cut and the new Medicare tax on investment income, not to mention the impact of the increasingly costly annual fix to the alternative minimum tax. However, this default option may instead be replaced by something else.

President Obama has devoted a lot of his recent campaigning to highlighting his preference for the so-called “Buffet rule,” which places a top minimum tax rate on capital gains of 30% and, combined with other changes, produces a top rate of 43.4% on dividends and interest income.
Alternatively, included in the Mitt Romney supported House Republicans’ proposal is a cut to the top income tax rate that would apply to interest income to 25% and maintain the 15% rate on dividends and capital gains.

The outcome is likely to be somewhere in the middle of the wide range between these two proposals. Given the scale of the changes, it may be surprising to note that we do not expect major direct impacts of tax changes on the stock or bond market. The far bigger impact is an indirect one determined by the magnitude and direction of overall fiscal policy taken (or not taken) in 2013 to put the United States back on a path to financial stability.

Bond Market Tax Rate Impacts

Historically, changes in income tax rates that apply to interest income appear to have had little, if any, direct impact on government bond yields. Yields rose with inflation in the 1970s and fell as inflation fears receded over the vast majority of the last 30 years regardless of tax code changes or their impact on the deficit.

Over the past 30 years, municipal bond yields traditionally traded at a discount to taxable bond yields. However, in recent years credit fears driven by macroeconomic events have resulted in a breakdown of the historic spread between taxable and non-taxable municipal bonds. Municipal bonds now trade at yields in line or above those of their taxable Treasury counterparts. The potential for higher income tax rates applied to interest income is likely to make municipal bonds even more attractive to investors as credit fears fade.

Stock Market Tax Rate Impacts

Tax changes have also had minimal effects on stock market performance. To illustrate, we can look at the two most important drivers of stock market return: earnings growth and valuations.

Generally, higher taxes mean less of an incentive for individuals to work, invest, take risks to create value and become entrepreneurs. It can also mean less disposable income to spend on goods and services. However, income tax changes have not had much measurable effect on earnings growth.

Earnings growth is very cyclical — it falls sharply during recessions and rebounds early in expansions to average about a 7% growth rate over the full cycle. This has been consistent regardless of the prevailing tax rates. In fact, the growth rate of earnings from the peak of one business cycle to the next has consistently been about 7% over the six major earnings cycles spanning the past 50 years, despite average top marginal income tax rates that ranged from 91% at the beginning of the period to the current 35% and corporate tax rates that ranged from 52.8% to 34%.

With no discernible effect on earnings growth, what about the impact of tax rates on valuations? Certainly, tax rates have the ability to directly impact the value investors place on the stock market. In theory, stocks are valued by investors based on expected total return, net of applicable taxes. For example, if dividend and capital gains taxes were each set at 100%, stocks would have little value to a taxable investor. It is reasonable to believe that the lower the tax rate, the more a taxable investor would value stocks up to that of a non-taxable investor.

However, over the past 30 years, higher effective federal income tax rates for the top 20% of earners (who tend to make up the majority of individual investors) have not resulted in lower stock market valuations, measured by the price-to-earnings ratio for the S&P 500 index. Counter-intuitively, periods of higher valuations occurred during periods of higher effective tax rates and lower valuations occurred when tax rates were lower. Much of this can be explained by cyclical factors. For example, in the late 1990s, stock market valuations rose to record highs despite relatively high marginal and effective tax rates.

Based on our analysis of the tax debate in Washington, we place the highest probability on the dividend and capital gains tax rates both rising to 20 – 30%. However, a reversion to the much higher rates that preceded the Bush tax cuts or a one-year extension of all current tax rates of 15% are also possible outcomes.

One reason the direct impact of tax rate changes may be muted is that it appears that stocks may already reflect the return of higher tax rates. One way we can see this is to look back at prior periods with similar tax rates and what it may imply for 2013. If we average the historical top dividend and capital gains tax rates together, we find that during the post-WWII period a 25 – 30% combined investor tax rate was in effect only during 1991 – 92 and 1997 – 2002. During the later period, stock market valuation was at record highs well above current levels and do not serve as a good comparison due to the impact of the internet bubble distorting the overall market value. However, 1991 – 92 may offer a comparable period for analysis. During this period, the macroeconomic and geopolitical backdrop included the aftermath of the S&L crisis, sluggish U.S. economic growth, a European recession, the geopolitical risks surrounding the first Gulf War, and pessimistic consumers.

During this 1991 – 92 period, the average top dividend and capital gains tax rate was between 25% and 30%, and stock market valuation, measured by the price-to-earnings ratio on the next twelve months expected earnings for the S&P 500 companies, was about 15. This figure is above the current forward price-to-earnings ratio of about 13. What this suggests is that while there are many factors that affect stock market valuation, the direct impact of the potential for higher tax rates on dividends and capital gains may already be discounted by the market.

Investor Tax Rate Changes

It seems that the bond and stock markets have adjusted to different tax rates without any apparent long-term direct effects on performance. But what about during short-term periods when those rates were changed, did markets have abrupt adjustments to the changes in rates? The answer is no; history shows that the markets took the changes in stride.

For example, the capital gains tax rate went from 20% to 28% for 1987 when the 1986 tax reform act was passed, and that did not stop a rally in stocks beginning as the act was passed that lasted for most of 1987 (until the unrelated October 1987 crash).

In addition, the market impact of the investor tax cuts in 2003 that lowered dividend and capital gains tax rates to 15% was difficult to discern, given the geopolitical and economic environment at the time, and the impact of the reversal of these provisions may be equally difficult to discern separately from their macro context. We can see this difficulty by looking back at the stock market’s reactions to the news of the proposed investor tax cut and then the passage of those cuts:

Initial details of the 2003 investor tax cuts began to appear in early December of 2002 with a statement from President Bush providing further insight into the package of tax cuts on January 7, 2003. Stocks slumped in December and January — even around the days details came to light — as investors were focused on the impending invasion of Iraq. The performance of both non-dividend paying and dividend-paying stocks was very similar, despite the prospects for a cut in the dividend tax rate.
Attention returned to the tax cuts in April 2003, as competing bills with various provisions moved through both houses of Congress. There was much uncertainty as to what the final tax cut elements were to be and whether any investor tax cuts were going to be passed. The tax bill narrowly passed in mid-May with Vice President Cheney breaking the tie in the Senate. The package including the investor tax cuts was signed by the President on May 28, 2003. As you can see in Chart 2, in April and May (and over the rest of the year), the stocks of low or no dividend-paying companies outperformed high dividend payers as stocks rallied powerfully and the invasion of Iraq got underway.

During both of the above-referenced periods, U.S. and non-U.S. stocks also performed very similarly, with the world focused on Iraq. The impact of the investor tax cuts in the U.S. did not result in U.S. stock market outperformance. Also, low and non-dividend paying stocks outperformed the high-dividend payers that would benefit most from the lower dividend tax rate.

It appears that the tax rate changes have played little or no direct role in stock or bond market performance. Possible reasons may be that investors discounted the effect since changes were not made permanent or, more likely, that the effects on after-tax returns were deemed negligible relative to the macroeconomic and geopolitical drivers.

We believe the heightened attention on taxes and the deficit is more of a concern than in prior episodes of tax rate change. The direction of the markets is dependent upon substantive action taken to address the debt ceiling, potential debt downgrades, and fiscal stability with any change in tax rates likely to be secondary to how successfully the challenges are addressed.

Year-End Effects

While history suggests otherwise, given that a lame duck session after the election is unlikely to result in enough time or cohesion to adjust tax rates before they change, investors might take action around year-end to take advantage of expiring low tax rates. As the year-end expiration of the 15% capital gains tax rate looms, investors might be prompted to sell to lock in the 15% rate. Also, a potential outcome of the year-end dividend rate tax hike could be a large number of public companies with a high concentration of family and closely held shares declaring and making a one-time, special dividend payment in the fourth quarter to be sure to take advantage of the 15% tax rate before it goes away.

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LPL Financial Weekly Market Commentary for April 10, 2012

Rose Greene, CFP — Tue, 10 Apr 2012 22:02:20 +0000

What Investors Should Watch This Earnings Season

Jeffrey Kleintop, CFA
Chief Market Strategist
LPL Financial

Highlights

While macroeconomic data and events are likely to remain key drivers of the market this week, microeconomics will also garner investors’ attention as companies begin to release first quarter earnings reports.

In each of the past two years, as the last week of April unfolded, the S&P 500 Index peaked and began to decline 16 – 19% as the back half of the earnings season got underway. We will be watching developments closely to determine if a repeat of that pattern will emerge again this year.

During this earnings season, we are paying special attention to the breadth of earnings growth, earnings guidance on upcoming quarters, and profit margins.

After a strong first quarter, the stock market, measured by the S&P 500 Index, got off to a weak start in the second quarter with a decline of -0.7% last week. Investors focused on the Federal Reserve’s (Fed) lack of support for round three of quantitative easing (QE3) in the minutes that were released from the March Fed meeting. As we noted a few weeks ago in our commentary, this is one of the 10 indicators we are watching that might foreshadow another spring slide in the stock market.

While macroeconomic data and events are likely to remain key drivers of the market this week, microeconomics will also garner investors’ attention as companies begin to release their first quarter earnings reports. While only a handful of S&P 500 companies report results this week, it is widely considered to be the start of earnings season with big, well-known companies like Alcoa and JPMorgan Chase due to report first quarter results.

Four times a year investors focus on the most fundamental driver of investment performance: earnings. The close connection between earnings and stock market performance can be seen in the fact that the S&P 500 Index and earnings per share have both risen about 80% over the past three years. A slowdown in earnings growth may indicate the same for the stock market.

Stock market momentum has stalled over the past few weeks during the period known as the pre-announcement, or confession, season — so called because business leaders often use this period to offer investors guidance on how the quarter’s results are shaping up relative to expectations. This season, of the companies that pre-announced first quarter earnings guidance in recent weeks, the ratio of negative-to-positive news was 3.0, worse than the average ratio of 2.3 since 1995.

The first quarter earnings season runs about four to six weeks, starting around two weeks after the close of the quarter. During this earnings season, we are paying special attention to the breadth of earnings growth, earnings guidance on upcoming quarters, and profit margins.

Breadth of Earnings Growth

We believe first quarter earnings are likely to post a mid-single-digit percentage gain from a year ago as earnings growth continues to decelerate.* The fourth quarter of 2011 marked the first time earnings growth fell into the single digits since the recovery began in 2009. The slowing growth rate for S&P 500 company earnings reflects not only slower growth among individual companies, but also reflects the shrinking number of companies expected to post growth in earnings for the quarter with about 20% of companies expected to reveal declines.

Just like the recent performance of the stock market, earnings growth is being driven by fewer companies. In fact, just one company, Apple Inc., is expected to account for 1.4 percentage points — or about a third of the growth in earnings for the entire S&P 500. The same single company, Apple Inc., accounted for 15% of the performance of the S&P 500 in the first quarter.

The fewer the number of companies that drive earnings growth (and stock market performance), the more vulnerable the overall market is to disappointments and declines.

Earnings Guidance and Revisions

The first couple of weeks of the first quarter earnings seasons in April 2010 and April 2011 largely contained good news and drove earnings estimates higher. Earnings estimates for S&P 500 companies for the next year rose a greater-than-average 3 –25% during the first couple of weeks of reports. But as the second half of the earnings season got underway in early May 2010 and May 2011, forward earnings guidance disappointed analysts and investors, and the pace of upward revisions declined sharply. This year, we will be watching to see how much earnings expectations rise as the initial reports come in and if they begin to taper off sharply.

The consensus of analysts tracked by Thomson Financial expects earnings growth of 3% in the first quarter of 2012 (compared to the first quarter of 2011). While the bar of expectations may be low for the first quarter of 2012, looking further out on the calendar to the fourth quarter of 2012, year-over-year earnings growth estimates for S&P 500 companies remain high at 16.3%, according to data from Thomson Financial. Earnings guidance may result in substantial downward revisions to earnings growth for coming quarters, undermining support for the stock market.

Profit Margins

The analyst consensus forecast of 3% earnings growth in the first quarter is the slowest growth rate since the recovery in earnings began in 2009. The weakness stems from the end of profit margin expansion. Analysts expect earnings to track revenue growth of about 4%.

Over much of the past few years, companies were able to post earnings growth rates that were several times the pace of revenue growth as profit margins expanded, granting more profit per dollar of sales. However, the ability to post faster earnings growth than revenue growth has faded; rising costs have contributed to slower earnings gains relative to revenue. In fact, nearly a quarter of S&P 500 companies are expected to report a year-over-year drop in earnings per share despite year-over-year revenue gains in the first quarter. Three sectors are expected to post earnings declines despite revenue growth. The most dramatic of these is the Materials sector, where 5% revenue growth is expected to accompany a -15% decline in earnings.

In this environment, those areas of the market able to sustain their profit margins are likely to be rewarded by investors. These sectors may include the Information Technology and Industrials sectors. Companies in these sectors are those that appear likely to generate higher-than-average earnings growth rates in the first quarter.

Importantly, the companies that report early in the season are most often not the bellwethers they are commonly thought to be. We may not really know how overall corporate results for the first quarter are shaping up until early May, when about half of the S&P 500 companies will have reported. In each of the past two years, as the last week of April unfolded, the stock market peaked and began to decline 16 – 19% as the back half of the earnings season got underway. We will be watching developments closely to determine if a repeat of that pattern will emerge again this year.

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IMPORTANT DISCLOSURES

LPL Financial Weekly Market Commentary for April 3, 2012

Rose Greene, CFP — Tue, 03 Apr 2012 19:28:36 +0000

The Election Impact: The Presidency

Jeffrey Kleintop, CFA
Chief Market Strategist
LPL Financial

Highlights

During the next six months, the elections will likely become an increasingly potent driver of financial markets.

There has been no significant performance difference in the year after the presidential election based purely on which political party won the White House.

Instead, the stock market has been more likely to respond to whether the incumbent political party won or lost. The stock market may be returning to favoring challengers.

This week marks six months until Election Day. During the next six months, the elections will likely become an increasingly potent driver of the markets. While we believe the impact for changes to the makeup of Congress may be more meaningful than the presidential election, we will tackle that in a later commentary. In this week’s commentary, we focus on the presidential election’s relationship to the performance of the markets and economy. Specifically, we address:

The market’s impact on the election,
The election’s impact on the markets,
The economy’s impact on the election, and
The election’s impact on the economy.

Market Impact on Election

Perhaps surprisingly, the stock market does not predict the outcome of the election. A strong stock market does not appear to favor an incumbent nor has a weak stock market acted as material negative. For example:

Franklin D. Roosevelt was re-elected in a landslide victory in 1940, despite losses in the S&P 500 in the third and fourth years of his term.
Harry Truman (1948) and Richard Nixon (1972) also were re-elected in the face of lackluster stock market results.
Adlai Stevenson lost in 1952, even though the stock market rose over 50% in the two years before the election under his party’s leadership.
Incumbent George H. W. Bush lost in 1992, even with a 57% gain in the stock market during his tenure.
Al Gore was unable to secure the presidency in 2000, despite the powerful eight-year stock market gain while under his party’s tenure in the White House.

History shows that voters are unwilling to attribute moves in the market directly to presidents, either positive or negative.

Election Impact on Market

Historically, the election does appear to have a significant impact on the stock market. This is explained, in part, by the material impact on corporate profits of regulatory policy guided by the White House and legislation passed by Congress. Industries that are heavily regulated are the most affected; these include: Health Care, Utilities, Telecommunications, Media, Energy, Materials, and Financials.

Usually the market performs well in an election year. In fact, there have been only three election years that suffered losses since WWII. The market usually posts better-than-average gains (2008’s plunge brought down the average, but the median return is above average).

The four-year presidential cycle of stock market performance evident in Chart 1 has been remarkably consistent over the years, with strong performances in years three and four of a presidential term, with weaker results in years one and two. Interestingly, 16 of the 20 down years since 1940 came in the first or second year of a presidential term. A key reason for this historical pattern of stock market performance during a presidential term is the greater amount of economic stimulus, in the form of both monetary and fiscal policy, applied during year two and three, which then begins to fade in year four. Since this stimulus affects the economy with a lag of around a year, stock market performance tends to follow this pattern of stimulus, leaving years one and two paying the price for the better years three and four leading up to the election.

A relatively volatile and range-bound stock market leading up to a fourth quarter breakout — one direction or another — has been a common occurrence in election years, taking place in 1992, 1996, 2000, 2004, and 2008.

Looking out to 2013, there has been no significant performance difference in the year after the presidential election based purely on which political party won the White House. Instead, the stock market has been more likely to respond to whether the incumbent political party won or lost. This is intuitive, since another term for the same party will likely result in a more consistent political, legislative, and regulatory environment than if the balance of power shifts to that of a new administration, raising the level of uncertainty.

The uncertainty can be seen, when incumbents lose, in the greater risk aversion for both corporate leaders in pursuit of earnings growth and investors in the form of valuations. S&P 500 earnings-per-share growth has been positive on average during the first year of an incumbent’s term, but negative when an incumbent loses. Likewise, price-to-earnings multiples have expanded during the first year of an incumbent’s term and contracted when the incumbent loses.

Reflecting back on the year after an election over the past 85 years, the stock market’s reaction has had three distinct periods, as seen in Table 1.

During the turbulent period of the 1920s, 30s, and early 40s that included the stock market crash of 1929, the Great Depression, and World War II, the stock market favored challengers over incumbents.
From the mid-1940s until the early 1970s, the stock market reaction to the election outcome was mixed — neither favoring nor fretting over incumbents.
Over the three decades from the mid-1970s to the mid-2000s, noted for above-average stock market returns and lengthy economic expansions, investors appear to have displayed a strong preference for incumbents.
It may be that the cycle is repeating and the current turbulent period is prompting voters to once again favor challengers over incumbents.

Of course, the election affects the bond market, as well. A president sets the tone on trade and fiscal policy, which, among other factors, can influence the bond market. The political party of the winner of the election, rather than whether the incumbent or challenger was elected, has historically affected performance in the bond market. Since the late 1920s, during the year after a presidential election the bond market has fared better under a Republican president, with government bond returns of 6.8%, than a Democrat, with returns of 4.3% (according to the Ibbotson Intermediate Term Government Bond Index).

It is notable that the best years for bonds have been during the first two years of a presidential term. This is no doubt related to the more stimulative (and potentially inflationary) fiscal and monetary policy that takes effect in years three and four.

The election impact on taxes plays a role for municipal bonds. As a key part of their agenda, Republican candidates for president in 2012 have indicated they would seek to make permanent the tax cuts on income, capital gains, and dividends that are due to expire in 2012, while President Obama has indicated a desire to let them expire. The potential for higher taxes on capital gains and dividends could be a positive for the municipal bond market, which may see a demand response to higher marginal tax rates.

Economic Impact on Election

The impact of the economy on the election can most clearly be seen through the relationship between income growth in the year leading up to the election and election results. As you can see in Chart 3, inflation-adjusted, after-tax income growth of about 3 – 4% appears to be the threshold for incumbents to get 50% of the popular vote. This measure of per capita income, contained in last week’s Personal Income and Spending report, is only growing at 0.3%.

Clearly, factors other than taxes, inflation, and income have a bearing on the election. However, income growth and related job creation may be the key measures by which the presidency will be judged. While job growth has improved in recent months to over 200,000 new jobs per month, helping to boost incomes, inflation has also risen.

Election Impact on Economy

The economy is impacted by fiscal, monetary and regulatory policy. The outcome of this year’s election may be more consequential, given that it will help to determine the path taken in 2013 to address the U.S.’s fiscal challenges including the debt ceiling and potential debt downgrades. In addition, the tax increases and spending cuts in 2013 already written into existing legislation amount to 3.5% of GDP (Gross Domestic Product), the largest percentage since 1947. The U.S. has never experienced a fiscal drag of 2% or more of GDP without an economic recession. As much as ever, the election is likely to have a major impact on the economy.

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IMPORTANT DISCLOSURES

LPL Financial Weekly Market Commentary for March 27, 2012

Rose Greene, CFP — Tue, 27 Mar 2012 20:58:36 +0000

10 Indicators to Watch for Another Spring Slide

Jeffrey Kleintop, CFA
Chief Market Strategist
LPL Financial

Highlights

In each of the past two years the stock market began a slide in the spring that lasted well into the summer months.

We have identified 10 indicators to watch closely in the coming weeks that may warn of an impending slide.

So far, about half of the 10 indicators point to a repeat of the spring slide this year, while the other half do not.

In each of the past two years the stock market began a slide in the spring, a phenomenon often referred to by the old adage “sell in May and go away,” which lasted well into the summer months. Are stocks poised to repeat the pattern this year? We have identified 10 indicators to watch closely in the coming weeks that may warn of an impending slide.

What to Watch

In both 2010 and 2011 an early run-up in the stock market, similar to this year, pushed stocks up about 10% for the year by mid-April. On April 23, 2010 and April 29, 2011, the S&P 500 made peaks that were followed by 16 – 19% losses that were not recouped for more than five months. While late April is still four weeks away, judging by what indicators seemed to precede the declines in 2010 and 2011, we have identified 10 indicators to watch over the next four weeks.

The 10 indicators include:

1. Fed stimulus – In each of the past two years, Federal Reserve (Fed) stimulus programs known as QE1 and QE2 came to an end in the spring or summer and stocks began to slide until the next program was announced. The current program known as Operation Twist was announced on September 12, 2011 and is scheduled to conclude at the end of June. The stock market may again begin to slide until another program such as QE3, the scope of which was recently hinted at by the Fed, is announced.

2. Economic surprises – The Citigroup Economic Surprise index [Chart 2] measures how economic data in the United States fared compared to economists’ expectations. A rising line indicates that the data is consistently exceeding expectations. A falling line suggests expectations have become too high. The index moved to what has historically marked the peaks in optimism about a month or two before the peaks in the stock market in 2010 and 2011. This year, it appears the index may have already started to retreat from a peak since early February; if this index again leads by two months the slide may soon begin.

3. Consumer confidence – In 2010 and 2011, early in the year the daily tracking of consumer confidence measured by Rasmussen [Chart 2] rose to highs last seen on September 5, 2008, just before the stock market collapse as the financial crisis erupted. The peak in optimism gave way to a sell-off as buying faded. Investor net purchases of domestic equity mutual funds began to plunge and turned sharply negative in the following months. This measure of confidence is once again close to the highs seen in early 2010 and 2011; we will be watching for a turn lower in the index that would indicate the start of an erosion of confidence.

4. Earnings revisions – The first couple of weeks of the first quarter earnings season (April 2010 and April 2011) drove earnings estimates higher in both 2010 and 2011. Earnings estimates for S&P 500 companies over the next year rose a greater-than-average 3 – 5% over the first couple of weeks of reports. But as the second half of the earnings season got underway in May 2010 and May 2011, guidance disappointed analysts and investors as the pace of upward revisions declined sharply. This year, we will be watching to see how much earnings expectations rise as the initial reports come in and if they begin to taper off sharply.

5. Yield curve – In general, the greater the difference, or spread, between the yield on the 2-year and the 10-year U.S. Treasury notes, the more growth the market is pricing into the economy [Chart 2]. This yield spread, sometimes called the yield curve because of how steep or flat it looks when the yield for each maturity is plotted on a chart, peaked in February of both years at 2.9%. Then the curve started to flatten, suggesting a gradually increasing concern about the economy. This year the market is pricing a more modest outlook for growth, but we will be watching to see if the recent slight decline in the spread (currently about 190 basis points) begins to decline.

6. Oil prices – In 2010 and 2011, oil prices rose about $15 – 20 from around the start of February, two months before the stock market began to decline. This year oil prices have climbed back to the levels around $105 – 110 that they reached in April of last year. However, they have risen only about $10 since around the start of February 2012. A further surge in oil prices would make this indicator more worrisome.

7. The LPL Financial Current Conditions Index (CCI) – In 2010 and 2011, our index of 10 real-time economic and market conditions peaked around the 240 – 250 level in April and began to fall by over 50 points. This year, the CCI recently reached 249 and has started to weaken and currently stands at 232.

8. The VIX – In each of the past two years the VIX, an options-based measure of the forecast for volatility in the stock market, fell to a relatively low 15 in April. This suggested investors may have become complacent and risked being surprised by a negative event or data. This year, the VIX has recently declined once again to 15 in the past two weeks.

9. Initial jobless claims – It was evident that initial filings for unemployment benefits had halted their improvement by early April 2010, and beginning in early April 2011, they deteriorated sharply. So far, in 2012 initial jobless claims continue to improve at a solid pace, but it may yet be too early, and so we will be watching for any weakening as April gets underway.

10. Inflation expectations – The University of Michigan consumer survey reflected a rise in inflation expectations in March and April of the past two years. In fact, in 2011, the one-year inflation outlook rose to 4.6% in both March and April. This year, inflation expectations have also jumped higher so far in March, reaching 4%.

While this list may seem incomplete, it is notable that many of the most widely watched indicators of economic activity such as manufacturing (the Institute for Supply Management Purchasing Managers Index known as the PMI or the ISM), job growth, and retail sales, among others, did not deteriorate ahead of the market decline, but along with it. It is not that they are not important; it is just that they did not serve as useful warnings of the slide to come, while the above indicators did.

So far, about half of the 10 indicators point to a repeat of the spring slide this year, while the other half do not. We will continue to monitor these closely in the coming weeks.

Shorter Slide?

While it is possible we will experience another spring slide this year, there are factors that may mitigate the decline short of the 16 – 19% seen in the past two years.

Looking back, in 2010 the negative environment that helped fuel the decline included the end of the Fed’s QE1 stimulus program, the uncertainty around the impact of the Dodd-Frank legislation, the eurozone debt problems and bailouts, central bank rate hikes, and the end of the homebuyer tax credit. In 2011, the negatives included the end of the Fed’s QE2 stimulus program, the Japan earthquake and nuclear disaster that disrupted global supply chains and pulled Japan into a recession, the Arab Spring erupted pushing up oil prices, the budget debacle and related downgrade of U.S. Treasuries, rising inflation, central bank rate hikes, and the eurozone debt problems coming to a head.

Looking ahead, the negatives we face in 2012 already include the end of the Fed’s Operation Twist stimulus program, rising oil prices, China’s slowdown, the European recession, the election uncertainty, and anticipation of the 2013 budget bombshell of tax hikes and spending cuts. However, there are some positives this year that may help offset some of the negatives making for a potential decline that may be less steep than those of the past two years. First, central banks are now cutting rather than hiking rates, which should help to temper global recession fears evident during the past two years’ spring slides. Second, housing is showing signs of improvement as both new and existing home sales are rising at about a 10% pace. Third, while energy prices are up this year (same as last year) food prices are decelerating, which helps to explain why consumer sentiment is going up in the face of higher gasoline prices. Finally, auto production schedules are robust for the next quarter and likely to support
manufacuring activity, which had fallen in May through July of the past two years and contributed to the market decline.

Given this year’s double-digit gains and the possibility of another spring slide for the stock market, investors may want to watch these indicators closely for signs of a pullback despite the current upward momentum in the stock market and solid economic growth.

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IMPORTANT DISCLOSURES

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
The economic forecasts set forth in the presentation may not develop as predicted and there can be no guaran¬tee that strategies promoted will be successful.
International and emerging markets investing involves special risks, such as currency fluctuation and political instability, and may not be suitable for all investors.
The fast price swings in commodities and currencies will result in significant volatility in an investor’s holdings.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values and yields will decline as interest rates rise and bonds are subject to availability and change in price.
Government bonds and Treasury Bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate.
The fast price swings in commodities and currencies will result in significant volatility in an investor’s holdings.
The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The Standard & Poor’s 500 Index is an unmanaged index, which cannot be invested into directly. Past perfor¬mance is no guarantee of future results.
Citigroup Economic Surprise Index (CESI) measures the variation in the gap between the expectations and the real economic data.
The Federal Open Market Committee action known as Operation Twist began in 1961. The intent was to flatten the yield curve in order to promote capital inflows and strengthen the dollar. The Fed utilized open market operations to shorten the maturity of public debt in the open market. The action has subsequently been reexam¬ined in isolation and found to have been more effective than originally thought. As a result of this reappraisal, similar action has been suggested as an alternative to quantitative easing by central banks.
Gross Domestic Product (GDP) is the monetary value of all the finished goods and services produced within a country’s borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory.
Quantitative Easing is a government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity.
Yield Curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity dates. The most frequently reported yield curve compares the three-month, two-year, five-year and 30-year U.S. Treasury debt. This yield curve is used as a benchmark for other debt in the market, such as mortgage rates or bank lending rates. The curve is also used to predict changes in economic output and growth.
The VIX is a measure of the volatility implied in the prices of options contracts for the S&P 500. It is a market-based estimate of future volatility. When sentiment reaches one extreme or the other, the market typically reverses course. While this is not necessarily predictive it does measure the current degree of fear present in the stock market.
Purchasing Managers Index (PMI) is an indicator of the economic health of the manufacturing sector. The PMI index is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment.

LPL Financial Weekly Market Commentary for March 20, 2012

Rose Greene, CFP — Tue, 20 Mar 2012 19:23:20 +0000

Stocks’ Sweet Sixteen

Jeffrey Kleintop, CFA
Chief Market Strategist
LPL Financial

Highlights

It has been a sweet sixteen weeks for the S&P 500. The broad stock market index has had only three down weeks out of the past sixteen, tying a record unbroken for over 20 years.

As the NCAA basketball tournament gets down to its own sweet sixteen this week, it is a good time to reflect on the sixteen competing drivers of the markets that may make for an exciting showdown in the weeks and months to come.

There will likely be some upsets that result in volatility as these factors face off against each other. In the end, we expect the positive factors are likely to win and help to support the strong gains we have already seen this year.

It has been a sweet sixteen weeks for the S&P 500. The broad stock market index has had only three down weeks out of the past sixteen. There has not been a sixteen-week period with fewer weeks of losses in over 20 years — since the period ending September 1, 1989!

As the NCAA tournament gets down to its own sweet sixteen this week, it is a good time to reflect on the competing drivers of the markets that may make for an exciting showdown in the weeks and months to come.

The four “regions” of market moving factors vying for investor attention are: economy, geopolitics, fundamentals, and market dynamics.

Economy

Employment – Job growth has been picking up with more than 200,000 jobs created in each of the past three months.*
Housing – The soft housing market could grab attention, given the coming wave of foreclosures.
Confidence – Consumer confidence has been improving, but it remains well below average.**
Federal Reserve – As the latest stimulus program, Operation Twist, winds down will the stock market suffer the same sell-off that surrounded the ending of the prior two programs QE1 and QE2?

Geopolitics

Elections – Upcoming elections in France and the United States potentially could have a material impact on the regulatory and legislative environment affecting the markets.
Iran Conflict – A military conflict with Iran is a low probability “dark horse” factor that could have a major impact on the markets if it were to develop.
China’s Growth – A hard or soft landing in China’s economy makes a big difference to global growth and the prospects for stocks.
European Debt – Further progress on sovereign debt problems and budget challenges must take place in Europe, with Portugal as the next country eyeing a debt restructuring.

Fundamentals

Earnings – The most consistent factor in recent years, earnings for S&P 500 companies, have grown about 55% since the end of 2008, in line with the gain of about 55% in the S&P 500 over the same time period, but growth has slowed sharply as we look toward the first quarter’s results.
Oil Prices – Oil prices have been over $100 per barrel for the past four weeks and may begin to negatively impact the markets the longer they linger here.
Credit – Demand for credit has improved and credit spreads have narrowed; both trends are critical supports to growth.
Fiscal Policy – A budget bombshell hits the economy in 2013, with tax hikes and spending cuts totaling 3.5% of GDP.

Market Dynamics

Momentum – Stocks have been on a strong winning streak that could continue.
Volume – Trading volume in the markets has been light, traditionally seen as a sign that a trend has become vulnerable.
Volatility – Investors have been net sellers of U.S. stock mutual funds for much of the past month despite strong and steady gains (according to ICI data) – a return to more volatile markets may further undermine individual investor support.
Interest Rates – Interest rates are on the rise, potentially acting as a drag on everything from housing to the U.S. budget, but from very low levels.

There are quite a few listed here, but these certainly are not all the factors that are influencing the markets.

The key message for investors in considering these factors is: don’t be too confident in any particular outcome. Respect the complexity of the situation. This is a time for caution and taking some profits, not for indiscriminate selling. It is a time to nibble at opportunities as they emerge; it is not a time to jump in with both feet.

Investing is not a game, but it is important also to remember that forecasting is not an exact science, and many factors can affect outcomes that are hard to predict. Last year, the Japanese earthquake had a big impact on markets and natural disasters — despite tremendous advances in technology — are very hard to predict with any degree of accuracy in once we get location or timing. Geopolitical outcomes can also be hard to foresee as we look to the stresses in the Middle East. The markets also rarely offer perfect clarity on their direction because they are driven by these factors as well as many others. Even this week’s NCAA March Madness can be seen as a reminder of how it can be notoriously hard to predict winners. Historically, a team’s ranking has meant nothing after we get down to the elite eight.

These factors will play out in the markets over the course of the year, not just in the coming weeks. This means there will be some upsets that result in volatility and pullbacks as these factors face off against each other. In the end, we expect the positive factors are likely to win and help to support the strong gains we have already seen this year.

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IMPORTANT DISCLOSURES
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
The economic forecasts set forth in the presentation may not develop as predicted and there can be no guaran¬tee that strategies promoted will be successful.
* According to U.S. Bureau of Labor Statistics data.
** According to University of Michigan Survey data.
International and emerging markets investing involves special risks, such as currency fluctuation and political instability, and may not be suitable for all investors.
The fast price swings in commodities and currencies will result in significant volatility in an investor’s holdings.
The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The Standard & Poor’s 500 Index is an unmanaged index, which cannot be invested into directly. Past perfor¬mance is no guarantee of future results.
The Federal Open Market Committee action known as Operation Twist began in 1961. The intent was to flatten the yield curve in order to promote capital inflows and strengthen the dollar. The Fed utilized open market operations to shorten the maturity of public debt in the open market. The action has subsequently been reexam¬ined in isolation and found to have been more effective than originally thought. As a result of this reappraisal, similar action has been suggested as an alternative to quantitative easing by central banks.
Gross Domestic Product (GDP) is the monetary value of all the finished goods and services produced within a country’s borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory.
Quantitative Easing is a government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity.
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