Money Matters with Rose Greene » LPL Financial Research

LPL Financial Weekly Market Commentary for January 31, 2012

Rose Greene, CFP — Tue, 31 Jan 2012 19:41:22 +0000

January May Seem “Super,” but Don’t Be Bowled Over

Jeffrey Kleintop, CFA
Chief Market Strategist
LPL Financial

Highlights
The upcoming Super Bowl will test the stock market’s historical correlations with the calendar and events that proved rewarding to investors in 2011.
Investors’ New Year’s resolution may have been to buy stocks after five years of selling nearly every month. However, we are afraid this may turn out to be like most resolutions and fade come February.
We expect volatility to return and the stock market to shed some recent gains. But we adhere to our outlook for 8 – 12%* gains for the year for stocks.
* LPL Financial Research provided this range based on our earnings per share growth estimate for 2012, and a modest expansion in the price-to-earnings ratio.

Last week, the Dow Jones Industrial Average (DJIA) hit a new three-and-a-half-year intraday high [Chart 1]. Earnings, gross domestic product (GDP), and consumer spending are already back to new highs, so seeing the stock market return to pre-financial crisis levels seems reasonable.

January’s gain sets a positive tone for the year. When January was positive for the S&P 500, the year as a whole ended with a gain 90% of the time since WWII. This historical relationship is called the “January effect.” Last year, each of these time-worn axioms based on the calendar actually worked for investors. For example:

“Sell in May and go away,” which suggests investors sell and avoid the summer months, worked with stocks peaking for the year on April 29.
October, the “bear killer” month when stock market downturns famously end and reverse in the month of October, ended the 19% peak-to-trough stock market decline with stocks bottoming for the year on October 3.
A “Santa Claus rally” in December produced gains in the week between Christmas and New Year’s.

Although not based on the calendar, and more than a little bit tongue-in-cheek, another classic stock market indicator worth mentioning this week is the “Super Bowl indicator.” Last year, both teams were original NFL teams and the DJIA posted a modest gain for the year. The Super Bowl indicator shows that the DJIA goes up for the year as a whole when the winner comes from the original NFL (NFC team or an AFC team from the pre- 1970-merger NFL — like the Steelers or Colts). But when an original AFL or expansion team wins, the DJIA falls. Going into the 1998 Super Bowl when the underdog Denver Broncos defeated the Green Bay Packers, the Super Bowl indicator had been correct in 28 of 31 years.

However, since 1998, the Super Bowl indicator has had a poor record; it has only been correct about 50% of the time over the past 13 years. The most notable failure was the New York Giants’ upset win in 2008 over the New England Patriots, which was supposed to bring about a bull run for stocks — instead the Dow plunged that year as the financial crisis took hold. This year’s rematch of the 2008 contest will be on Sunday, February 5. While a win for the Giants would suggest gains for stocks in 2012, using longer-term history as a guide, it is unlikely that this event holds any significance for the stock market. In fact, make that highly unlikely.

Individual investor buying is more likely to empower a rally than historical correlations with the calendar or a sporting event. Investors’ New Year’s resolution may have been to buy stocks. Individual investors appear to be beginning to “put a toe back in” to the stock market after five years of selling stocks nearly every month. Data on mutual fund cash flows for the month of January suggests that investors are finally once again buying U.S. stock mutual funds — or have at least temporarily stopped selling them [Chart 2]. However, we are afraid this may turn out to be like most resolutions and fade come February.

We expect volatility to return and the stock market to shed some recent gains. But we adhere to our outlook for 8 – 12% gains for the year for stocks driven by 7% earnings growth and a slight improvement in valuations. In the near term, the recent four weeks of back-to-back gains may give way to a modest pullback, but we expect several factors to mitigate the extent of the slide including upcoming rate cuts in China, solid manufacturing and employment data in the United States, and further steps toward stability in Europe.

IMPORTANT DISCLOSURES

Share this article:

LPL Financial Weekly Market Commentary for January 25, 2012

Rose Greene, CFP — Wed, 25 Jan 2012 21:28:29 +0000

State of the Union Preview

Jeffrey Kleintop, CFA
Chief Market Strategist
LPL Financial

Highlights
President Obama’s State of the Union (SOTU), scheduled for Tuesday, January 24, is unlikely to be a big market mover.
In fact, most SOTU speeches see less than a 1% move in the stock market on the following day.
However, the themes and philosophy presented may shape the market’s movements in the months to come with implications for Financial and Industrial companies and oil prices.

President Obama’s State of the Union (SOTU), scheduled for Tuesday, January 24, is unlikely to be a big market mover. In fact, most SOTU speeches see less than a 1% move in the stock market on the following day and the average move is only 0.14% [Chart 1]. However, the themes and philosophy presented may shape the market’s movements in the months to come.

Rather than break new ground, the SOTU address is likely to echo the President’s December 6 speech in Osawatomie, Kansas. That speech was modeled after President Theodore Roosevelt’s 1910 historic address in that city on economic and social equality that led into 20th century progressivism, the central philosophy of Obama’s presidency.

The many topics of the speech — and their market impacts — can be broken down in terms of what will happen, what will not happen, and what could happen in 2012.

What Will Happen

In the SOTU address, Obama is very likely to highlight the immediate need for Congress to come together to extend the payroll tax cut and unemployment insurance benefits through 2012. In December 2011, a bitterly divided Congress could not come together on how to pay for a year-long extension and so only extended them for two months. We expect Congress to further extend these stimulus measures before they expire at the end of February, but the hostile negotiations — something the markets have had a break from in recent weeks — are likely to garner attention and help to renew market volatility after a remarkably stable advance in the first few weeks of the year.

Regulatory policy, an area where the executive branch is less dependent upon Congress’ leadership, will be a key part of the speech. The President is likely to highlight revamped housing programs, such as the Home Affordable Refinance Program (HARP), and announce a settlement that would end long running negotiations among Obama administration officials, state attorneys general and at least five of the nation’s largest financial services companies over “robo-signing” and questionable foreclosure practices. The settlement could be good news for Financials, one of the top performing sectors this year.

What Will Not Happen

The President is likely to call for increased infrastructure investment in the U.S. economy, including school construction, roads and bridges, and high-speed rails. Congress is unlikely to appropriate the funding to meet the President’s call on these items. Companies in the Industrial sector have performed well so far this year, but do not appear to be pricing in increased domestic infrastructure spending.

Job growth is key to the President’s re-election chances. As you can see in Chart 2, inflation-adjusted, after-tax income growth of about 3% appears to be the threshold for incumbents to get 50% of the popular vote. Currently, this measure of per capita income is only growing at 0.1%.

While factors other than jobs have a bearing on the election, job creation may be the key measure by which Obama’s presidency will be judged. However, much like infrastructure initiatives, measures to stimulate job growth presented in the SOTU are unlikely to be funded.

The President will likely address eliminating the so-called Bush tax cuts for higher earners, especially those making $1 million or more a year. In addition, given the recent attention to Mitt Romney’s tax filings, the President may call for applying income taxes to carried interest. With the President due to release his budget on February 6, he may also address overseas corporate tax breaks. However, with the House in Republican hands, none of these tax proposals will pass this year.

What Could Happen

This SOTU may foreshadow the President tilting his focus away from domestic politics to foreign affairs over the course of 2012. In doing so, he is shifting from the area where the President is institutionally weak (domestic policies) to the place where the President is institutionally strong (foreign policy). A Congress divided into two houses, a Supreme Court, and the states limit the President dramatically in domestic politics. However, the Constitution and American tradition give the President tremendous power in foreign policy. The President will surely highlight the U.S. withdrawal from Iraq and the winding down of the war in Afghanistan. Another foreign policy matter that may move the oil markets will be his discussion about Iran and the potential impact of U.S., Japanese, and European sanctions on Iranian oil.

Obama’s re-election strategy may be one of opposition to Congress. Essentially, this was Bill Clinton’s strategy in 1996 with a Republican Congress and it worked. Going into opposition against Congress could energize the President’s base, but that base is in the low to mid-40s. By itself, this may not be enough. Instead, over the next 10 months, Obama’s strategy may be to shift from the domestic aspects of the presidency where he is weaker to the stronger part, foreign policy, where a president can generally act decisively without congressional backing.

The critical issue for post-Iraq war foreign policy may be the U.S. relationship with Iran. An often rumored “October” surprise is the idea of attacking Iran’s nuclear facilities. But a precise strike can be messy since it carries the risk of Iranian retaliation in the Strait of Hormuz through which a meaningful percentage of the world’s oil travels. An approach with less chance for global economic disruption is a generalized air campaign against both Iran’s nuclear and military sites. But, in our view, starting a war is a huge risk. Setting aside all other considerations, from a political point of view, it would alienate Obama’s political base, many of whom supported him because he would not undertake the unilateral military moves of his predecessor. This is not intended to imply President Obama would consider starting a war for political ends, but merely to show that even if it were a consideration it is unlikely to be a successful strategy.

However, there is another foreign policy option, one that would appeal both to Obama’s political philosophy and to his political situation: pulling a Nixon. In February 1972, the last year of his first term as he ran for re-election, President Richard Nixon visited China in a grand diplomatic gesture even while Chinese weapons were being used to kill American soldiers in Vietnam. In another interesting parallel that rings with echoes of the themes of Obama’s SOTU address, President Theodore Roosevelt did the same thing with the Soviets in 1941. A diplomatic engagement with Iran would seem to appeal to the President and his political base and rejuvenate some of the energy around a theme that helped him win the election in 2008.

We will be listening to the SOTU for clues as to the President’s foreign policy initiatives. If the President were to pursue this foreign policy choice, it may have the effect of sharply lowering oil prices — and help to stimulate the U.S. economy — as geopolitical risk fades and added supply returns with the potential for a lift of the long-running embargo that has blocked critical parts and equipment needed to ramp up Iranian oil output. While a gesture by no means guarantees a resolution, the markets may welcome news of a potential arrangement with Iran.

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.
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.
International and emerging markets investing involves special risks, such as currency fluctuation and political instability, and may not be suitable for all investors.

Share this article:

LPL Financial Weekly Market Commentary for January 18, 2012

Rose Greene, CFP — Wed, 18 Jan 2012 22:05:20 +0000

European Upgrade

Jeffrey Kleintop, CFA
Chief Market Strategist
LPL Financial

Highlights
S&P’s downgrade overshadowed meaningful developments over the past two weeks in Europe which we would call an upgrade in dealing with the debt problems.
The events of the past week show that the rating change at S&P, while warranted, is a lagging indicator of a situation that has been something less than AA-rated for a long time, but has been improving in recent months with more progress made in the past two weeks.
While we have become more positive about the path Europe is taking, these efforts virtually assure a mild recession for Europe in 2012, and reinforce our belief that better investment opportunities lie in the United States and Emerging Markets.

On Friday, Standard & Poor’s Ratings Services, one of the three major U.S. ratings agencies, downgraded France and Austria from AAA to AA+ and downgraded seven others (Malta, Slovakia and Slovenia by one notch and Italy, Spain, Portugal and Cyprus by two notches). The downgrades contributed to the second down day for the S&P 500 Index in 2012. However, the S&P downgrades are likely to have a limited impact for a number of reasons:

The warning on December 5 by S&P that a downgrade of European countries was coming helped to keep it from being a surprise.
The downgrade is a lagging indicator of credit risk in Europe the markets had already priced in. For example, AAA-rated France and Austria had 10- year yields that were over 100 basis points higher than AAA-rated Germany.
Not all downgrades are created equal when it comes to their market impact. The downgrade of the United States was a major blow to confidence in a political environment of inaction. Not true in Europe where confidence has been affected by its fiscal situation for some time, and now new governments are taking substantive actions to address it.
France continues to hold AAA ratings from Fitch Ratings and Moody’s Investors Service.
The headline impact of the downgrade of France may weigh on French Republic President Nicholas Sarkozy’s bid for reelection in April. He is already trailing the Socialist party candidate, Francois Hollande. The uncertain impact of a major shift in France’s leadership during this critical transition for the eurozone may weigh on the markets, but this is not new news for the markets since Sarkozy has been trailing in the polls for some time now.
While largely priced in, there was some risk to the stock market that the European Financial Stability Facility (EFSF) would be downgraded due to the downgrade of some of the six EFSF guarantor members currently rated AAA (Germany, France, the Netherlands, Finland, Austria and Luxembourg) before steps toward greater fiscal integration occur.

The last point may warrant further explanation. The leaders of the eurozone decided this past fall to leverage the available resources of the EFSF in part by using it to provide insurance for bond investors. The idea is that the EFSF will take on the first losses, up to a maximum, that investors would face in the event of a sovereign default. The insurance would apply to newly issued debt sufficient to cover debt newly issued by many troubled European nations over the next few years. A downgrade does not change the overall amount of guarantees provided or the amount of debt issuance covered; but it does suggest a change in the risk profile of these guarantees and a smaller recovery value. Consequently, the yield markets demand may be higher to reflect the higher credit risk of the guarantees. However, the markets are way ahead of the rating agencies on this, and these impacts have already been felt for some time.

S&P’s downgrade overshadowed meaningful developments over the past two weeks in Europe, which we would call an upgrade to the efforts to deal with the debt problems.

Last week’s meeting between Italian Prime Minister Mario Monti and German Chancellor Angela Merkel was significant. In exchange for Monti’s passing recent austerity measures, Merkel agreed to an early implementation of the bailout fund known as the ESM (European Stabilization Mechanism), successor to the existing and temporary EFSF, which had been planned to go into effect in July of this year. The key to getting it up and running is German funding, which seems to have been secured this week.
A second draft of the Merkel-Sarkozy designed “fiscal compact” was presented on Friday, January 6. This agreement on tighter fiscal integration, to be signed no later than March 25, 2012, will establish a credible and enforceable budget discipline across the eurozone in an effort
to avoid future debt problems. The second draft of the original German/ French-crafted agreement defines key provisions such as what constitutes a “balanced budget” (a deficit of less than 0.5% of GDP), a target of 60% debt-to-GDP ratio (and a pathway to get there of as slow as one-twentieth per year), and allows for an appeals process for those member countries found in violation of the treaty.
Recent bond auctions in Europe have gone well. Italy auctioned bills and bonds this week at much lower yields than just a month ago. Spain and Germany also had solid auctions last week and received more bids than the amounts they targeted in their debt sales. This is encouraging since Italy alone needs to issue 220 billion euros of bonds this year.

The events of the past week show that the rating change at S&P, while warranted, is a lagging indicator of a situation that has been something less than AAA-rated for a long time, but has been improving in recent months with more progress made in the past two weeks. With little move in the stock or bond market on the news of the downgrades, it is clear that markets had already made the credit adjustment and are now recognizing improvement. The irony is that the downgrade comes just as the debt situation in Europe is now getting better — not worse.

S&P has assigned more than a dozen European countries a negative outlook, indicating at least a one-in-three chance of a further downgrade in the next two years. The key will be for the eurozone to continue to respond with actions. European leaders are set to meet at a summit on January 30 to discuss how to boost growth and jobs, and Merkel’s words on Saturday suggest she will also be looking for faster progress on tighter common fiscal rules.

While we have become more positive about the path Europe is taking, these efforts virtually assure a mild recession for Europe in 2012, and reinforce our belief that better investment opportunities lie in the United States and Emerging Markets.

To download a complete copy of the commentary click here

Share this article:

LPL Financial Weekly Market Commentary for January 12, 2012

Rose Greene, CFP — Wed, 11 Jan 2012 22:27:39 +0000

What Investors Should be Watching This Earnings Season

Jeffrey Kleintop, CFA
Chief Market Strategist
LPL Financial

Highlights
This week is the start of the fourth quarter 2011 earnings reporting season with big, well-known companies like Alcoa and JPMorgan Chase due to report fourth quarter results.
This is the first quarter in over two years that S&P 500 profit growth is not expected to be in the double-digits.
During this earnings season we are paying special attention to revenues and how companies are putting cash to work either by spending or by returning it to shareholders

U.S. stocks rose last week by 1.7%, as measured by the S&P 500 Index, getting 2012 off to a solid start. A combination of solid and better-than-expected economic data, a quiet week in Europe, and few negative earnings pre-announcements drove the rebound.

While macroeconomic factors are likely to remain key drivers of the market this week, microeconomics will also garner investors’ attention as companies begin to release their fourth quarter earnings reports. Four times a year investors focus on the most fundamental driver of investment performance: earnings. While only five S&P 500 companies report fourth quarter results this week, bringing the total to 31, this week is the start of earnings season with big, well-known companies like Alcoa and JPMorgan Chase due to report fourth quarter results.

The consensus of analysts tracked by Thomson Financial expects operating earnings growth of 8% in the fourth quarter of 2011(compared to the fourth quarter of 2010), as profits end the year at new all-time highs. This is the first quarter in over two years profit growth is not expected to be in the double-digits. If the profits of S&P 500 companies match expectations in the fourth quarter, they will have grown about 10% for 2011, in line with our forecast established a year ago.

In 2012, we expect a slower pace of profit growth of about 7%, modestly below the analyst consensus of 10%. In contrast, market participants have priced no growth in profits into stock market valuations with price-to-earnings ratios at levels not seen since the recession of 1990-91, when earnings fell 20%. We believe earnings expectations will continue to be revised modestly lower and market participants are starting to price in a less dire outlook for profits as results are reported and corporate leaders provide guidance on coming quarters.

In recent weeks, stocks have been rising even as fourth quarter earnings estimates have been falling. Of the 129 companies that pre-announced fourth quarter earnings guidance in recent weeks, the ratio of negative-to-positive news was 3.3, worse than the average ratio of 2.3 since 1995, and the worst ratio since the 3.4 in the fourth quarter of 2008, during the peak of the financial crisis.

The fourth 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 revenues and how companies are putting cash to work either by spending or by returning it to shareholders.

Revenues and Emerging Markets Drivers – Revenue growth is driven by global economic activity and is expected by analysts to be around 6%. With profit margins near peaks, profits will more closely track revenues in coming quarters. Economic growth is likely to be below average in the United States over the next year, and Europe is on the edge of recession. About 46% of S&P 500 profits come from foreign markets with just under a third of foreign profits derived from Europe. Fortunately, a meaningful and growing portion of profits come from rapidly growing emerging markets. We will be closely watching the impact of the rapidly changing regional composition of revenue and profits in the S&P 500. It is worth noting that in 2012, emerging market countries will for the first time make up more of global GDP (gross domestic product) than developed markets, according to data from the IMF (International Monetary Fund).
How Businesses Are Returning Cash to Shareholders – The first quarter is when companies most often increase or initiate a dividend. While first quarter bank stress tests need to be completed before the traditionally high-yielding Financials sector can be expected to boost payouts, pressure is building for other companies to increase their dividends as U.S. companies sit on record cash stockpiles and payouts remain at all-time lows. S&P 500 companies paid out about 25% of earnings in the form of dividends over the past year, down from 30% for much of the 2000s and below the 30-year average of 40%. Company cash and equivalents have soared to record highs even as companies have paid down debt in a dramatic deleveraging over the past few years. A return to higher dividend payouts would help attract investors seeking income in an environment of very low bond yields. The S&P 500’s dividend yield stands at 2.1%, above the yield on the 10-year Treasury for one of the few times in history. Announcing share repurchases
is another way corporate leaders may put cash to work.
How Businesses Are Spending – While investor attention is often directed on consumer spending as a driver of profits, we will be watching business-spending-driven industries more closely. Business spending and commodity prices are major drivers of S&P 500 profit growth while discretionary consumer spending has a much smaller contribution to the S&P 500. During the fourth quarter, commodity prices generally rose and manufacturing rebounded from the summer weakness, according to the ISM Index (Institute for Supply Management Purchasing Managers Index), supporting modest profit growth for S&P 500 companies [Chart 1] We will be watching to see how effectively this translated into profits for the Information Technology, Industrial, Energy, and Materials companies for clues as to how rapidly their profit growth may slow in 2012.

For S&P 500 companies that have reported fourth quarter earnings so far, 14 of 26 (54%) have exceeded estimates, while 12 have missed estimates. 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 fourth quarter of 2011 are shaping up until early February 2012, when about half of the S&P 500 companies will have reported.

To download a complete copy of the commentary click here

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.
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 P/E ratio (price-to-earnings ratio) is a measure of the price paid for a share relative to the annual net income or profit earned by the firm per share. It is a financial ratio used for valuation: a higher P/E ratio means that investors are paying more for each unit of net income, so the stock is more expensive compared to one with lower P/E ratio.
International and emerging markets investing involves special risks, such as currency fluctuation and political instability, and may not be suitable for all investors.
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.
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.
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.
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.

Share this article:

LPL Financial Weekly Market Commentary for January 4, 2012

Rose Greene, CFP — Wed, 04 Jan 2012 21:35:34 +0000

Stock Market’s Flat 2011 May Suggest Booming 2012

Jeffrey Kleintop, CFA
Chief Market Strategist
LPL Financial

Highlights
During the last trading day of 2011, volatility drove the S&P 500 down in the final seconds to leave the Index unchanged from where it started the year and the total return at a mere 2%.
There have been four years since WWII when the total return for the S&P 500 was roughly flat. All three of these years that preceded 2011 were followed by strong gains in the following year, averaging 38%.
While the historical pattern suggests that a strong 2012 may follow a flat 2011, our outlook remains for an average gain of about 8 – 12% in 2011

The last trading day of 2011 seemed to be a fitting way to end the year. The S&P 500 Index remained in positive territory for the year until the last seconds of the day when a batch of sell trades produced the quick drop that left it to close at 1,257.60. This left the S&P 500 to end 2011 unchanged from the 1,257.64 closing level of 2010.

The volatility on the final day of 2011 was characteristic of a year in which the daily volatility of the S&P 500 was nearly double the average since WWII. Stocks produced gains early in the year and rose to a three-year high of 1,363.61 at the end of April, up about 9% for the year. Then the Index began a rocky decline that culminated at the beginning of October, at 1099.23, down about 12% for the year, before climbing back to where it began the year. While the Index price was unchanged in 2011, the total return for the S&P 500, which includes dividends received, was a mere 2% [Chart 1].

This reflects a stall in what had been a powerful two-year winning streak for the stock market as it rebounded most of the way back from a closing low of 676.53 to the peak of 1565.15 that preceded the financial crisis.

Does the pattern of performance exhibited by stocks in 2011 bode ill for 2012? Not historically, as the last time we saw a year with similar performance was 1994. Similar to 2011, in 1994:

The S&P 500 was basically unchanged for the year with a total return of 1.32%
Earnings for S&P 500 companies grew at a double-digit rate
Defensive sectors, such as Consumer Staples and Health Care outperformed

While things may have looked bleak in 1994, it turned out to be far from the end of the business cycle. In fact, 1994 turned out to be the set up for the strongest five-year run in history for stocks as valuations soared, starting with a 38% total return in 1995. Recall that as of the end of 1994, the price-to-earnings ratio measured on the past four quarters of earnings, had fallen below average [Chart 2] and was setting up for a surge in valuations in the years ahead.

Moreover, valuations, as measured by the forward price-to-earnings ratio on the consensus forecast for the next four quarters of earnings, had dropped to 12.4 as of the end of 1994. This is a similar level to today’s 11.7.

Looking back further, we can see that in total there have been four years since WWII when the total return for the S&P 500 was basically flat: 1953, 1960, 1994, and 2011. All three of these years that preceded 2011 were followed by strong gains in the following year, averaging 38%.

While the historical pattern suggests that a strong 2012 may follow a flat 2011, our outlook remains for an average gain for the S&P 500 of about 8 – 12% in 2011, as detailed in our 2012 Outlook publication. We see these gains supported by a slight improvement in valuations and mid-to-high single-digit earnings growth as the pessimistic outlook for profits reflected in the markets rise to converge with a slide in the lofty expectations for earnings projected by Wall Street analysts.

To download a complete copy of the commentary click here

Share this article:

LPL Financial Weekly Market Commentary for December 20, 2011

Rose Greene, CFP — Tue, 20 Dec 2011 20:17:43 +0000

Apocalypse Soon

Jeffrey Kleintop, CFA
Chief Market Strategist
LPL Financial

Highlights
The purported end of the world falls exactly one year from this Wednesday, December 21, 2011. Like a primeval Y2K event, 2012-ers believe that one year from now the earth will experience a catastrophe or an enlightenment.
Surprisingly, we agree. The year 2012 will be one of transformation: politically, fiscally, and economically, with profound impacts for investors.

A search of the bestsellers with “2012” in their title does not offer the books you might expect such as travel guides, how to crack the SAT exam, or the best new cars to buy. Instead, the top books on the list are among the thousands of books, films, videos, seminars, and websites tied to doomsday predictions about 2012 [see accompanying Table]. In fact, the first non-end of the world entry to make the list does not show up until number 27 when the Dilbert calendar makes the list — then again, the Dilbert universe sure seems like purgatory. Specifically, according to these sources, the apocalypse comes on December 21, 2012 — the purported end of the world falls exactly one year from this Wednesday.

Where does this 2012/end of the world stuff all come from? The Mayans, who spread across Central America from about 2000 B.C. to 900 A.D., used a unique Mesoamerican “long count” calendar that marked time in long cycles lasting 394.3 years called b’ak’tun. A “sun”, or era, may be defined as 13 b’ak’tun cycles. The Mayan creation date was in 3114 B.C. and the 13th b’ak’tun cycle will end next year — on December 12, 2012.

The 2012-ers have pulled together Mesoamerican archaeology, stories about extraterrestrials, New Age spirituality, and pseudo-scientific analysis to produce a prophecy that on December 21, 2012 a profound transformation will occur. Like a primeval Y2K event, they believe that one year from now the earth will experience a catastrophe or enlightenment.

Surprisingly, we agree. The year 2012 will be one of transformation: economically, fiscally, and politically with profound impacts for investors.
The global economy is emerging. While we expect the U.S. economy to grow about 2% in 2012, the emerging markets will grow much faster. By the end of 2012, emerging market economies will reach 50% of the world’s gross domestic product (GDP) [Chart 1]. The non-advanced economies made up only 38% of global GDP 10 years ago, but reached 49% in 2011 (with currency adjusted for purchasing power parity), according to data from the International Monetary Fund.
We believe a mild recession emerges in Europe and the debt dilemma continues to grab headlines and move markets as will the outlook for growth and financial stress in China.
In addition, the party that emerges in control following the November 2012 elections in the United States will forge the decisions that will represent one of the biggest shifts in federal budget policy since World War II.

Consumer sentiment, business leaders, policymakers and geopolitics are going to have a significant impact on the investment environment in 2012. While volatility is likely to remain elevated, we do not see an end-of-the-world scenario for investors. In fact, the markets may fare better in 2012 than they did in 2011 with stocks posting solid gains (for deeper insight into our 2012 prophesies see our 2012 Outlook).

Works from the Mayans, prophesies of UFO cults, and even films from Hollywood (I Am Legend, Blade Runner, The Running Man) all suggest 2012 is likely to be fraught with danger. However, they also appear to feature flying cars — so it may not be all bad. Here is hoping that a transformational new era emerges in 2012 where politicians, business leaders, and individuals’ interests align to produce an environment of respect and much needed action.

To download a complete copy of the commentary click here

IMPORTANT DISCLOSURES

Share this article:

LPL Financial Weekly Market Commentary for December 13, 2011

Rose Greene, CFP — Tue, 13 Dec 2011 19:54:17 +0000

New Ideas Are Not Just for Europe

Jeffrey Kleintop, CFA
Chief Market Strategist
LPL Financial

Highlights
The weaker pace of productivity in recent years could mean slower profit growth ahead for S&P 500 companies.
Fortunately, business spending on research and development (R&D) has improved, and patent grants are now on the rise. It typically takes about three years for patent grants to result in improved productivity for businesses.
We believe that productivity and innovation are due for a comeback, helping to support profit growth.

Developing new solutions to battle the debt problems in Europe has been important to making substantive progress toward a long-term solution. Last week’s European summit produced progress in the form of a landmark agreement to strengthen budget rules. While the accord addresses the long-term problems facing Europe, the spending cuts are likely to slow growth and produce a mild European recession in 2012. The breakthrough finally opens the door for the European Central Bank (ECB) to intensify its efforts to stimulate growth and stabilize the debt markets beyond last week’s rate cut.

While the headlines on Europe continue to garner nearly all of the market’s attention, it is worth noting the changes in the trend of innovation since developing new solutions to drive productivity will be important to generating profits in the years ahead for the benefit of investors.

Developing new products and finding new, more productive ways to employ resources to create them is critical to sustaining the growth of a business. The ingredients for innovation are often in the form of patents, copyrights, and licenses to support economic interest in developing new technologies and processes. Competition intensifies companies’ push for cost-saving productivity enhancements through implementation of new technologies and processes.

Post-World War II economic growth has averaged 3.2% on a real (net of inflation) basis annually. Most of this growth has come from increasing productivity rather than using more resources. Productivity growth, measured by industrial production per worker, has averaged 2.2% over the past 100 years. The only notable pauses in this trend were the result of the Great Depression and the inflation spiral of the 1970s, in the latter case, rapidly rising prices masked the benefits of improving efficiency.

New successful consumer products, such as smart phones and internet search engines, are often what come to mind when we think about innovation. It is the broad implementation of new technologies by businesses that accounts for many of the recent advances in productivity. A key component of rising productivity in the 1980s and 1990s was the implementation of just-in-time inventory management systems. The advent of radio frequency identification (RFID) tags allowed the trend to extend further. Putting RFID tags on products enables many types of companies to manage their inventory more efficiently through real-time integration with suppliers. Advanced asset tracking enhances operational efficiency.

Supply chains can be optimized, thereby reducing the risk of input shortages without holding excess (and potentially perishable or obsolescent) critical supplies. This is especially valuable for health-care and manufacturing companies. For retailers there are additional benefits, such as the potential to eliminate the traditional checkout areas, reduced customer wait times, and improved theft detection. This is just one of the new technologies that help to drive productivity.

Productivity is critical to sustaining growth in profits. Over the long-term, S&P 500 company profits have risen by about 7% per year, on average. This rate also happens to be our forecast for profit growth in 2012 (for more details on earnings growth and other aspects of what we envision for 2012 see the 2012 Outlook publication). However, during the past decade, there has been a slowdown in productivity to less than half the historical trend rate. Weaker productivity could mean slower profit growth for S&P 500 companies in the years ahead. The reasons for declining productivity include: the slower pace of business spending, lower tolerance for risk-taking in corporate America, and the stall in patent grants.

One way to measure the potential pace of productivity and innovation in the coming years is to look at spending on research and development (R&D) and the growth in patent grants. Growth in spending in these areas tends to support ongoing productivity growth. After surging in the late 1990s amid the technology boom, business R&D spending as a percentage of gross domestic product (GDP) peaked in 2000. Patent grants soon began to fade and business productivity slumped starting in late 2004.

Fortunately, spending has since improved and patent grants are now on the rise. It typically takes about three years for patent grants to result in improved productivity for businesses [Chart 2].

During the next 10 years, innovative business operations are essential for creating investor wealth. We believe productivity both in and outside the United States will rise in the coming years. Keeping up with the pace of change will be a challenge facing individual companies. The period of competitive advantage offered by a better mousetrap is shrinking. Faster development of products and services means companies must constantly innovate to stay on top. For instance, automobiles go from the design stage to production and the showroom floor in much less time than they did 10 years ago. Companies — and countries — must adapt or face extinction.

Technology and communications have made it cheaper and easier than ever before for someone with an idea to disseminate and develop it. Access to credit was severely curtailed during and after the financial crisis of 2008 – 09; however, credit and capital to finance new ideas have now become more abundant. And, while funding for the patent office had been in doubt as part of reducing overall spending, a November 2011 compromise secured funding through the end of the 2012 fiscal year. We believe that productivity and innovation are due for a comeback in the years ahead.

To download a complete copy of the commentary click here

Share this article:

LPL Financial Weekly Market Commentary for December 6, 2011

Rose Greene, CFP — Tue, 06 Dec 2011 19:24:39 +0000

A European Christmas Carol

Jeffrey Kleintop, CFA
Chief Market Strategist
LPL Financial

Highlights
Europe’s leaders have seen the ghost of Christmas Past (2008), Present (Greece, etc.) and Yet to Come (break up).
Their pursuit of Scrooge-like austerity measures may allow the leaders of Germany and France to see the light and let the ECB buy the turkey (troubled debt) in the window for the troubled countries (Spain, Italy, etc.).
If not, it will scare the Dickens out of the market.

Last week, the stock market had the best week since the week ending March 13, 2009, which marked the beginning of the rebound from the long 2007 – 2009 bear market. The S&P 500 Index regained 7.4% last week after a similarly steep slide in the prior week and a half. Volatility remains high as investors focus on every development in Europe.

With the holiday season arriving, Europe appears to be experiencing a transformation worthy of a classic tale. Europe’s leaders have seen the ghost of Christmas Past (in the form of the financial crisis of 2008), Present (the spreading troubles plaguing Greece, Portugal, Spain, Italy and others) and Yet To Come (the possibility of a break up of the eurozone has been discussed). While these countries are pursuing Scrooge-like austerity measures as they cut spending to close their budget deficits, the market recognized last week that the leaders of France and Germany may have seen the light. German Chancellor Merkel and French President Sarkozy are pursuing treaty changes to enforce budget limits that they continue to hint will allow them to permit the European Central Bank to buy the turkey (troubled debt) in the window for the troubled countries (Spain, Italy, etc.).

The ongoing European debt dilemma will continue to affect the market in 2012, as it did in 2010 and 2011. In 2012, we expect:

The U.S. economy to grow about 2%, while emerging markets post stronger growth and Europe experiences a mild recession.
The U.S. stock market is likely to post an 8 – 12%* gain, supported by a boost from a slight improvement in valuations and mid-to-high single-digit earnings growth.
Corporate bonds post modest single-digit gains as interest rates rise and credit spreads narrow. The yield on the 10-year Treasury is likely to end the year around 3%.

For further insight into what 2012 holds for investors, please see the 2012 Outlook, published last week. This comprehensive take on 2012 reveals what investors can expect in the coming year and how to position to seek to profit from the opportunities and protect from the risks.

While the S&P 500 ended November basically unchanged, it took a wild ride during the month as a number of major events played out. The event calendar for December is not as prone to disappoint or create as much volatility as November did. For example, November saw government changes in Italy and Spain, a large number of European bond auctions, and the super committee failure in the United States. In December, no elections in Europe, fewer bond auctions will be held, and the likelihood of a relatively quiet passage of year-end business in Washington (a continuing resolution to extend government funding and legislation to extend payroll tax cuts and unemployment benefits along with the annual AMT and physician Medicare fixes) may make for a quieter month for investors.

However, there is a risk that the market rebound and decline in European bond yields takes some pressure off of the efforts to cut spending and risks the loss of critical momentum. The leaders of the troubled countries — especially those with new governments — must continue these efforts in order to secure support from Germany and France. If not, it will scare the Dickens out of the market.

To download a complete copy of the commentary click here

Share this article:

LPL Financial Weekly Market Commentary for November 29, 2011

Rose Greene, CFP — Tue, 29 Nov 2011 19:53:44 +0000

Black Friday Caps a Dark Week for Investors

Jeffrey Kleintop, CFA
Chief Market Strategist
LPL Financial

Highlights
It was a black Friday for investors as the holiday week closed with the S&P 500 turning in its worst performance during the week of Thanksgiving since 1932.
Fear gripped the market that the risk of a default by a major European government that would trigger a financial crisis was rising.
It is likely to take years to resolve the debt problems in Europe; however as with the lingering U.S. subprime mortgage debt and housing problems, merely stabilizing the problem may allow markets and the economy to heal from the damage.
As progress in managing risks and efforts toward fiscal sustainability meets with setbacks and disruptions, expect continued market volatility — but not all of it to the downside as in the past seven trading days.

It was a black Friday for investors as the holiday week closed with the S&P 500 turning in its worst performance during the week of Thanksgiving since 1932. Despite strong retail sales indications and solid readings on U.S. economic growth, worsening sentiment on the European debt problems — combined with a failure of the super committee in the United States to agree on deficit cuts — pulled the S&P 500 down 4.7% adding to the cumulative decline of 7.9% in just the past seven trading days.

U.S. economic data was solid again last week with claims for unemployment benefits falling further below the 400,000 level, home sales rising over 13% year-over-year, and a 12% year-over-year rise in orders for durable goods excluding the volatile transportation (airplane) orders in October. This week’s ISM reading on Thursday and the employment report on Friday will be closely watched. Fourth quarter gross domestic product (GDP) is on pace to top the third quarter’s growth rate.

In addition, retail sales during Thanksgiving weekend climbed 16% as more shoppers hit the stores and spent more money, according to the National Retail Federation, wildly exceeding consensus estimates. Retail sales matter to the stock market mainly because they reflect the health and sentiment of the consumer and investor [Chart 1], but also because they contribute to growth of the economy and corporate profits.

The market knew going into last week it was a long shot that the super committee would produce a deal for the $1 trillion-plus in deficit reduction with which they had been tasked. However, some disappointment over the failure that may have affected markets was that it dimmed the prospects for getting those items passed that have greater near-term consequences for the economy and markets. The real deal Congress must pass before year end is some combination of these expiring programs:

Payroll tax cuts
Unemployment benefits extension
The 100% depreciation of new capital spending for businesses
The annual physician Medicare fix and the AMT fix

Although these extensions are by no means off the table and it is still likely some of these pass in an end-of-year session, the odds that Congress cannot reach any agreement have risen.

The main driver of last week’s market action was the fear among some market participants that the risk was rising of a default by a major European government that would, in turn, trigger the collapse of financial institutions and a crisis throughout Europe and beyond. This potential path echoes the chain reaction that followed the bankruptcy of Lehman Brothers in September 2008 that led to a global financial crisis.

In late October 2011, European policymakers crafted a ground-breaking agreement that addressed recapitalizing the banking system, created an orderly default by Greece, and provided financial buffers against losses on future bond issuance among eurozone members. All of these steps are in an effort to reverse the tide of money that has flowed out of the European sovereign bond market and pushed up borrowing costs. These actions averted a 2008-like financial crisis. However, concerns remain about the outlook for economic growth in Europe and the ability of some countries to meet budget targets. As hurdles to implementation of the debt plan are materializing, bond yields of some European nations have risen to levels that make progress on balancing budgets very difficult. There are eight European countries with yields over 6% [Chart 2]. Last week, Italy saw its 10-year borrowing cost rise above the 7% threshold that forced Greece, Ireland, and Portugal to seek bailouts in 2010.

There are many technical factors driving yields higher, including European bank asset sales as these institutions raise required capital. However, fundamental factors lie at the heart of the rise, particularly for the eight European nations with yields over 6%.

The troubles of Greece, Portugal and Ireland are no secret. These three nations were granted bailouts in 2010 that continue to provide ongoing support. The worst off is Greece, which, despite a landmark debt deal, still faces years of economic decline. The best off is Ireland which has proven itself as the bailout country most loyally implementing austerity and markets are responding. Irish yields have fallen from 13.8% to 9.3% over the past four months and the economy has produced solid economic growth. Fortunately, the bond markets of these nations are relatively small and banks have largely insulated themselves from the impact of a default.
Hungary is part of the European Union and received IMF funding, but does not use the euro and cannot until 2020 at the earliest.
Italy has implemented spending cuts and is running a primary surplus, meaning that the borrowing is to cover their debt costs and not to fund new spending. Italy’s budget deficit is less than 5% of its GDP, lower than France’s 7% and close to Germany’s 4%. However, Italy has over 2 trillion euros in debt totaling about 120% of GDP. In an effort to lower debt, Italy has cut government workers, raised revenue with closing some tax breaks, and sold some government assets. With the recent change in power in the Itailian government, more cuts are on the way.
In some ways, Spain is better positioned than other European countries. It has shown a greater tolerance for cutting spending and last week’s election generated a strong majority for the incoming ruling party which has emphasized further fiscal reform. Fortunately, Spain’s debt-to-GDP is only half that of Italy. On the negative side, its budget deficit is twice Italy’s and its banking sector is perhaps the most damaged in Europe, other than Greece.
While Iceland does not use the euro and is not even a member of the European Union, Iceland suffered a banking collapse in 2008 and required support from the IMF. Iceland has made some progress. Notably, Iceland had its credit rating outlook raised last week by Standard and Poor’s and bond yields have declined to 7% from about 13% at the peak in 2008.
While a bond yield of 6.1% may seem high, Poland’s borrowing costs are in line with the average of the past 10 years and well below recent peaks and therefore likely to remain manageable.

As many European countries (eight), have yields below 3% as above 6%. Although these countries do not share the same fiscal position, they are not immune to the economic impact of contagion in the region. The troubles with Greece, Italy, and Spain lie at the heart of the problem for all of Europe. The long-term success of rescue efforts is dependent upon European nations taking additional steps to adhere to their plans for achieving financial stability and deficit reduction. It is no coincidence all of these three countries have seen a change to their governments in 2011 to those willing to take more aggressive actions.

Lack of enforcement of budget rules is a big part of what drove Europe to the current state. Going forward, the European policymakers want to ensure important steps are taken before extending additional support to halt the slide in the markets. While it will take years to resolve the debt problems in Europe, with the lingering subprime mortgage debt and housing problems in the United States, merely stabilizing the problem can allow markets and the economy to heal from the damage. We expect the passage of the difficult, but necessary, reforms among the troubled nations, during the coming weeks and months.

As progress in managing risks and efforts toward fiscal sustainability meet with setbacks and disruptions, expect continued market volatility — but not all of it to the downside as in the past seven trading days. Hopefully, as we leave black Friday and the month of November behind the market has a brighter start to December.

To download a complete copy of the commentary click here

Share this article:

LPL Financial Weekly Market Commentary for November 22, 2011

Rose Greene, CFP — Tue, 22 Nov 2011 22:56:19 +0000

Super Committee: Go Big or Go Home?

Jeffrey Kleintop, CFA
Chief Market Strategist
LPL Financial

Highlights
Even with no agreement from the super committee, an end-of-year deal may still take place that may pair a smaller deficit reduction package of a few hundred billion dollars with the extension of the expiring payroll tax cut and federal unemployment benefits.
With no debt ceiling, default or downgrade threat, the market impact of this week’s public unveiling of the super committee’s recommendations is likely to be muted relative to the debt ceiling debacle of late July and early August.
Congress’ record-low 9% approval rating reflects the low bar of expectations for the super committee. The market expects the default cuts of $1.2 trillion will do the bulk of generating the required savings.

With the congressional super committee’s deadline on finding $1.5 trillion in deficit reduction this week, the markets want to know if they will go big or just go home for the Thanksgiving recess.

The debt ceiling debacle that came to a head in early August 2011 left a lasting impression on the stock market. The S&P 500 index plunged 17% from July 22 to August 9, in part driven by Washington’s inept handling of the increase of the country’s debt limit and the subsequent downgrade of the U.S. credit rating by Standard and Poor’s on August 5.

Fortunately, this week’s public unveiling of the proposals from the super committee tasked with finding the required $1.5 trillion in deficit reduction over 10 years is unlikely to spark the same violently negative market reaction. There are two key reasons the market reaction is likely to be much more muted:

First, there is no debt ceiling or potential default looming this time. This is because the budget act put in place in August 2011 triggers automatic cuts — also called sequester — totaling $1.2 trillion over nine years beginning in 2013, in the event the super committee fails to come up with $1.5 trillion in proscribed savings. This pushes the time frame when the United States will again bump up against the debt ceiling to early 2013 — after the next election.
Second, we are unlikely to see a debt downgrade of the United States this time. In recent months it has become clear through public comments that the major rating agencies are unlikely to downgrade the U.S. credit rating on a failure of the super committee to agree on the deficit reduction as long as they do not remove the sequester that invokes the automatic $1.2 trillion in cuts and do not circumvent the size of the cuts through budget accounting gimmicks. The next credit event is likely not until 2013, under a new Congress. Fitch may move the U.S. credit outlook to negative implying a bias to downgrade and both S&P and Moody’s have said a downgrade is likely absent a major fiscal consolidation package in 2013.

With no agreement, $1.2 trillion in deficit savings will result from the automatic discretionary spending cuts through program spending caps known as sequestration. However, it is unlikely that the cuts triggered by the automatic sequester will actually take place come 2013. This is because there is likely to be a major deficit reduction package in 2013 under a new GOP-dominated Congress following the 2012 elections. This plan will significantly alter the pro-rata allocation of cuts across discretionary spending programs that would take place under the automatic sequester. This base case results in an outcome for the markets that is muted — especially relative to this summer’s reaction.

Congress’ 9% approval rating [Chart 1] highlights the low expectations for the super committee to bridge the partisan divide and craft a ground-breaking deal that addresses the nation’s debt that crossed the $15 trillion threshold last week. However, the failure to come to an agreement does not mean that Congress goes home with no plan to take any fiscal action this year. An end-of-year deal may still take place that may pair a smaller deficit reduction package of a few hundred billion dollars with the extension of the expiring payroll tax cut and federal unemployment benefits.

To download a complete copy of the report click here

Share this article: