Happy Days

Jeffrey Kleintop, CFA
Chief Market Strategist
LPL Financial

Highlights

• Recent news regarding a number of key market factors has been generally positive and our main concerns are beginning to lift

• For the past 12 months, the S&P 500 Index has been tracking its pattern of 60 years ago.

• If the pattern holds — and the big issues overhanging the market are resolved or deferred — we may be due for a nice stock market rally in the coming months.

Recent news regarding a number of key market factors has been generally positive and our main concerns are beginning to lift.

• The Federal Reserve’s (Fed) QE2 program ended without any disturbance in bond yields.
• Corporate earnings and guidance on future earnings from corporate leaders is better than expected, thus far.
• The economic soft spot appears to be dissipating as Japan, the world’s third largest economy, comes back online.
• While a deal is not yet in hand, we have seen increased clarity regarding the debt ceiling debate around a $1.5 to 2.7 trillion package of spending cuts.
• A breakthrough on the Greek debt problems in Europe has taken place with a second rescue package.

The changing environment may inspire investors to re-engage the markets and reduce defensive positions. The S&P 500 posted a gain of 2.2% last week, reversing the prior week’s losses. A further rally may be in store for stocks as the headwinds fade and happy days return with growth and employment picking up in the second half of the year.

It seems the market may be looking to the 1950s for inspiration. A potential path for stocks in the second half of the year may be that they continue to follow the path of 1951.

For the past 12 months, the S&P 500 Index has been tracking its pattern of 60 years ago. While much of it may be owed to coincidence, there are a number of market influencing factors that echo 60 years ago that may make it more than just a coincidence. The similarities to 1951 include the following:

• Europe is mired in debt.
• Tax receipts amount to 16% of GDP.
• Federal debt as a percent of GDP is north of 80%, the last time it was this high was 1951 [Chart 2].
• It is the third year of the Presidential cycle.
• It is two years after the end of a recession.
• The growth rate of corporate earnings is slowing.
• There is fading resolve to continue fighting a foreign war.
• Commodity prices have rebounded powerfully from the lows of the recession.
• A gallon of gas costs a 1951 quarter.

Ok, that last one is a little bit of humor. But it is true. Hard to believe that a gallon of gas today costs the same quarter (i.e. 25 cents) it cost in 1951? It does. You just have to melt down the coin. In fact, a 1951 quarter will buy you twice as much gas today as it did in 1951 when a gallon cost 25 cents. Quarters in 1951 weighted 6.25 grams and were made of 90% silver and 10% copper. At today’s metal prices a 1951 quarter, like all quarters minted from 1932 – 64, have a metal value worth about $7.25, based on Friday, July 22, 2011 metal prices. That will get you about two gallons of gas at last week’s national average price of $3.68.

Of course, there are lots of differences between now and 60 years ago. As with the 1950s-based sitcom Happy Days, the past looks different when looking back selectively. However, if the pattern holds — and, importantly, the big issues overhanging the market are resolved or deferred — we may due for a nice stock market rally in the coming months, happy days indeed.

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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.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and are subject to availability and change in price.
International and emerging markets investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors.
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 a fund shares is not guaranteed and will fluctuate.
Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.
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.
Debt-to-GDP is a measure of a country’s federal debt in relation to its gross domestic product (GDP). By comparing what a country owes and what it produces, the debt-to-GDP ratio indicates the country’s ability to pay back its debt. The ratio is a coverage ratio on a national level.
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.
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.
Stock investing may involve risk including loss of principal.
The fast price swings in commodities and currencies will result in significant volatility in an investor’s holdings.
Precious metal investing is subject to substantial fluctuation and potential for loss.

The LPL Financial Current Conditions Index is a weekly measure of the conditions that underline our outlook for the markets and economy. The CCI provides real-time context and insight into the trends that shape our recommended actions to manage portfolios. This index has been a useful tool for investment decision making.

Over the past week, the LPL Financial Current Conditions Index rose slightly to 236, the highest level in the past year. The stock market has tracked the CCI closely this year as it did last year reflecting the attention investors are paying to real time measures of economic and market conditions as they assess the likelihood of a successful transition from recovery to sustainable growth. The level of the Current Conditions Index indicates an environment fostering strong growth in the economy and markets. We expect that the CCI may weaken in the latter half of 2010 to reflect an environment of slow growth.

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The CCI component that demonstrated the most improvement during the week was Shipping Traffic as inventory restocking continues along with rising demand. Retail Sales also improved with sales on a year-over-year basis jumping to 4.6% last week from 4.0% the prior week. Business Lending demonstrated some improvement in each of the past two weeks. While still down 18% year-over-year, bank loans have demonstrated a modest pick-up for the first time since early January. Disappointingly, Mortgage Applications deteriorated slightly in the past week even as interest rates fell slightly and the looming expiration of the first time homebuyer tax credit (buyers must have a signed agreement of sale by April 30 to qualify).

Events and data in recent weeks have prompted market participants to view the tailwinds that caused the markets to go sailing higher for much of 2009 as beginning to fade. They now view them as having become more balanced with the rising headwinds associated with increasing global frictions.

We continue to expect the powerful economic and profit growth to weaken in the second half of 2010. The weakening is likely to result from the fading of the extraordinary global policy efforts that created a tailwind for growth and the rise of new headwinds as some actions are reversed. The early stage of this transition is already underway leading to heightened market volatility. While there is still plenty of good news acting as tailwinds for the markets, there is increasingly more of a balance with the bad news, or headwinds. The winds of change blowing in the markets include the following:

Tailwinds

1. -The Federal Reserve (the Fed) is our friend (for now)
2. -U.S. Gross Domestic Product (GDP) growth is above average
3. -S&P 500 earnings growth is strong
4. -Credit and housing markets continue to heal
5. -China’s double-digit GDP growth (but slowing loan growth)
6. -Steep yield curve
7. -Massive global fiscal stimulus in the pipeline

Headwinds
-No job growth (yet)
-Federal, state and local budgets are awful
-Anti-business tone in Washington
-Commercial real estate woes remain
-China and India inflation risks
-European debt problems exacerbated by weak economies
-Bank lending is weak

These are not in any particular order since the importance placed on them by the market varies from day to day. Some of them will switch from being tailwinds to headwinds this year, like the actions of the Federal Reserve, while others may switch from being headwinds to tailwinds such as job

Want more details?  Click here to explore each of the winds that are currently driving the choppy market environment.

LPL Financial Research Weekly Market Commentary

Over the past week, the LPL Financial Current Conditions Index rose by 0.2 to 1.6, making a new high for the year. The index reflects current conditions aligned with the high end of our base case outlook and low end of our bull case outlook, established at the end of last year. Consistent with this outcome, the markets have achieved gains better than our original base case outlook for 2009, but not as strong as those in our bull case.

The improvement in the index can be primarily attributed to Retail Sales and Shipping Traffic. Most components of the CCI have improved substantially since the start of the year.

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The LPL Financial Current Conditions Index is a weekly measure of the conditions that underpin our outlook for the markets and economy. The CCI provides real-time context and insight into the trends that shape our recommended actions to manage portfolios. This index has proven to be a useful tool for investment decision-making. This weekly index is not intended to be a leading index or predictive of where conditions are headed, but a coincident measure of where they are right now. We want to track the conditions in real-time to aid in investment decision making.

There are thousands of indicators-some lead the economy, some lag, while others merely offer a lot of statistical noise. We chose to create our own index tailored to the current environment to provide the clearest and most useful way to track how conditions are aligned with the expectations embedded in our investment recommendations. The components of the CCI are periodically changed to retune the index to those factors most critical to the markets and economy over the next year so it may continue to be a valuable investment decision-making tool. 

Current Conditions Index 

Over the past week, the LPL Financial Current Conditions Index rose by 0.1 to 1.4, making a new high for the year. The CCI has had a late year growth spurt over the past several weeks. The index refl ects current conditions aligned with the high end of our base case outlook, established at the end of last year, for mid-teen gains in the stock market and mid-single digit gains in the bond market in 2009, as measured by the S&P 500 index and the Barclays Aggregate Index respectively. The markets have already achieved these gains. However, the CCI implies the economy and markets are on track for an outcome somewhat better than our original base case outlook for 2009.ver the past week, the LPL Financial Current Conditions Index rose by 0.1 to 1.4, making a new high for the year. The CCI has had a late year growth spurt over the past several weeks. The index refl ects current conditions aligned with the high end of our base case outlook, established at the end of last year, for mid-teen gains in the stock market and mid-single digit gains in the bond market in 2009, as measured by the S&P 500 index and the Barclays Aggregate Index respectively. The markets have already achieved these gains. However, the CCI implies the economy and markets are on track for an outcome somewhat better than our original base case outlook for 2009.