Weekly Market Commentary, May 24, 2010
Jeffrey Kleintop, CFA
Chief Market Strategist
LPL Financial

Highlights

• We believe this pullback is merely part of the higher volatility in the markets we have been expecting this year to accompany the transition from recovery to sustainable growth.
• We offer ten reasons why we expect the markets to rebound during the second quarter.
• We still believe that while the next week or two could be up or down a little, four or six weeks from now stocks will be up and headed back near the highs of April.

Our outlook for 2010 remains for modest gains in the stock and bond markets, accompanied by a lot of volatility. Over the last couple of months, we presented our reasons for why we believed the stock market, as measured by the S&P 500, was due for another 5-10% pullback. While the current pullback that began on April 24 came as no surprise, the month long decline has exceeded our expectations with a peak-to-trough decline of 12%. Nevertheless, we continue to believe it is a pullback and not the start of a new bear market. This pullback is merely part of the higher volatility in the markets we have been expecting this year to accompany the transition from recovery to sustainable growth.

The market pullback has a number of drivers:

• Financial reform legislation has weighed on the Financials sector.
• China’s measures to slow growth have been raising fears that the sudden withdrawal of stimulus to one of the world’s biggest growth engines may be premature and tip the global economy back into recession.
• Last week’s decline in the Index of Leading Indicators, the first decline in a year, is a sign that economic growth may be slowing.
• However, the big issue affecting the market has been the debt problems in Europe and fear of another global credit crisis.

We expect the markets to rebound during the second quarter for the following ten reasons:

1. Although unlikely to improve much in the near-term, the European debt and deficit problems are unlikely to get much worse. The trillion dollar rescue package has been passed ensuring adequate capital to meet the financing needs over the next few years for Europe’s most troubled economies. Europe has some silver lining to the problems they are facing since the lower euro is a boost to the competitiveness of European exports helping to balance out weaker domestic growth.
2. The derivatives and leverage tied to the sovereign debt is very different than the financial crisis of 2008 (for example, debt-to-GDP (gross domestic product) for Greece is 1-to-1, while at Bear Stearns and Lehman Brothers it was 40-to-1). The smaller magnitude of the debt problem is unlikely to lead to another global financial crisis.
3. The concerns over the debt problems in Dubai and Iceland faded quickly after a month or two of intense concern last year. The budget and debt problems now weighing on Greece are an aftershock of the global financial crisis and not a sign of a new crisis developing. The problems are akin to what many people and businesses that overindulged during the credit boom are now experiencing, as the negative consequences of the global recession have forced belt tightening to try to make ends meet while restructuring debt. That is what happens at the end of a credit crisis and recession, rather than at the beginning.
4. Fortunately for investors, expectations for the Eurozone are low and do not need to be cut drastically leading to further declines in markets. For example, U.S. exports to Europe, European oil consumption, and Europe’s GDP are all already expected to be very low or negative.
5. The problems in Europe are good for the U.S. consumer by putting more cash in consumers’ pockets. The falling price of oil is pulling down gasoline prices as we head in to the peak demand summer driving season and the money flowing into Treasuries is leading to lower mortgage rates and a new wave of refinancing
6. As indicated by the LPL Financial Current Conditions Index, conditions remain favorable for growth.
7. Stock market valuations are now low at a forward price-to-earnings ratio of about 13 times. Also, the stock market is technically oversold by even more than it was overbought in mid-April when we were concerned about a pullback, suggesting selling may soon stall and buyers attracted by value will re-emerge.
8. China’s growth remains on track and the weakness in Europe may keep Chinese officials from invoking further measures to slow their economy in the second quarter.
9. Financial reform legislation may see a lot of changes to moderate it in conference before it is signed by the President, given some objections by the Fed and Treasury. This may help stabilize the Financials sector which has been one of the sectors that has led the stock market lower.
10. The outlook for The Federal Reserve (Fed) rate hikes may now be pushed out with the futures markets now pricing in the first hike not taking place until 2011

We still believe that while the next week or two could be up or down a little, four or six weeks from now stocks will be up and headed back near the highs of April.

What would change our minds? Not a level in the stock market, but a level on spreads and other indicators of contagion like borrowing rates in Europe and signs of bank stress. Material deterioration in indicators of contagion such as:

• The TED spread, a measure of stress in the banking system based on the willingness of banks to lend to each other, has risen this year to a slightly above average 35 basis points (bps), but remains well off of the crisis peak of 463 bps in 2008 and below the levels of 2008 that led up to the peak of the crisis in October 2008.
• The level of European interest rates and credit default swaps, which haveboth declined from the peak levels prior to the announcement of the rescue plan, but some southern European countries are elevated from levels at the start of the year.
• The value of the euro, which has fallen sharply this year but has stabilized in the past two weeks around $1.24.
• Corporate bond issuance, which has contracted sharply reflecting tighter financing conditions.
• The volume of central bank liquidity swaps, which has picked up reflecting the need for dollar-based financing overseas.

These factors would prompt us to re-evaluate our outlook and may warrant a more defensive investment stance.

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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.

Stock investing involves 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.

Investing in international and emerging markets may entail additional risks such as currency fluctuation and political instability. Investing in small-cap stocks includes specific risks such as greater volatility and potentially less liquidity.

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.
A basis point is a unit relating to interest rates that is equal to 1/100th of a percentage point. It is frequently but not exclusively used to express differences in interest rates of less than 1%.

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Main Street’s anger over Wall Street reaches the Senate floor.
Provided by Financial Planner, Rose Greene, CFP®

Another reform bill is now making its way through the Senate – a bill that would reregulate the financial services industry with a few goals in mind:

1) Preventing failures of large banks and financial services firms, or at least insulating taxpayers and the economy in such an emergency
2) Creating a new financial watchdog agency to protect consumers
3) Tightening regulations on derivatives
4) Banning banks from proprietary trading (with the “Volcker Rule”)
5) Increasing transparency_1,2,3

Anger on Main Street, while palpable, won’t pass these reforms. In the Senate, Democrats are largely driving them; Republicans want to see them altered. Let’s look at them briefly.

The bailout issue. The bill introduced by Senate Banking Committee Chairman Chris Dodd (D-CT) would set up an “orderly liquidation fund” – $50 billion deep – to help the federal government wind down any big banks that threaten to go belly up.₃ Senate Republicans argue that this would amount to a permanent “bailout fund” that would implicitly encourage federal bank rescues. Some Republicans think it perpetuates the “too big to fail” mentality.

A group of Congressional Democrats have introduced the S.A.F.E. Banking Act, which would cap bank size: no U.S. bank or bank holding company could hold more than 10% of the country’s insured deposits. The S.A.F.E. Act would also hold the amount of non-deposit liabilities at financial institutions at 2% of GDP for banks, and set a 6% leverage limit for bank holding companies.₄

The bill introduced by Senate Banking Committee Chairman Chris Dodd (D-CT) would set up an "orderly iquidation fund" - $50 billion deep - to help the federal government wind down any big banks that threaten to go belly up.

The proposed new Bureau. The reform bill proposes creating a Bureau of Consumer Financial Protection, possibly as an offshoot of the Federal Reserve. It would watch over banks and credit unions with $10 billion or more in assets, as well as major investment firms and mortgage lenders apart from the banking industry. In addition to trying to protect people from predatory or discriminatory practices, the BCFP would also seek to better inform consumers via an Office of Financial Literacy.₂ Skeptics see this as another multibillion-dollar layer of bureaucracy, a “fifth wheel” whose mission could just as well be handled by an augmented Fed.

Crackdowns on derivatives & proprietary trading. Ah yes, derivatives – those investments no one really understood. Or watched closely. The reform bill would require banks to build a wall between their derivatives trading and their commercial banking operations – in other words, the “Volcker Rule” would be the law. Well, banks do make a lot of money through proprietary trading in their own accounts. In late April, JP Morgan analysts concluded that if the Volcker Rule went into effect, the six biggest global investment banks would need $85 billion more to capitalize the new investment banking divisions they would need to create. According to the JPMorgan scenario, Deutsche Bank would have to grab $26 billion alone and BNP Paribas would have to come up with $21.1 billion.₅

A better understanding for all? If the reforms become law, regulators would work to make the “fine print” that comes with a credit card, a mutual fund or a mortgage product clearer, so that fees and other quietly assessed charges would become easier to understand. Hedge funds would have to register with the federal government. Certain Democrat-driven amendments would even demand more transparency at the Federal Reserve. As Sen. Bernard Sanders [I-VT] remarked in late April, “During the bailout, the Fed lent trillions of dollars at zero or near-zero interest rates to large financial institutions. During the Budget Committee hearing, I asked Chairman Bernanke who received that money, [and] he refused to tell us.”

A new chapter, or a whole new book? You could argue – convincingly – that a loosely regulated Wall Street caused or least exacerbated the “Great Recession”. In the aftermath of that downturn, we may see the biggest rewrite of financial rules and regulations since the Great Depression coming before 2010 ends.

Rose Greene is a Representative with Rose Greene Financial and may be reached at www.rosegreene.com, (310)399-1200 or rose@rosegreene.com.

This material was prepared by Peter Montoya Inc, and does not necessarily represent the views of the presenting Representative or the Representative’s Broker/Dealer. This information should not be construed as investment advice. Neither the named Representative nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information. petermontoya.com, montoyaregistry.com, marketinglibrary.net

Citations
1 – msnbc.msn.com/id/36770907/ns/business-us_business/ [4/27/10]
2 – csmonitor.com/USA/Politics/2010/0429/Financial-reform-bill-101-what-it-means-for-consumers [4/29/10]
3 – csmonitor.com/USA/Politics/2010/0428/Financial-reform-four-sticking-points [4/28/10]
4 – memphisdailynews.com/editorial/Article.aspx?id=49660 [4/29/10]
5- reuters.com/article/idUSN2924718120100429 [4/29/10]
6 – csmonitor.com/USA/Politics/2010/0428/Republicans-relent-clear-financial-reform-bill-for-debate/%28page%29/2 [4/28/10]

Quote of the week.

“Nothing in life is to be feared. It is only to be understood.”– Marie Curie

Reforms become law. President Obama signed his long-envisioned health care reforms into law on March 23, and he will sign the amendments to the bill into law on March 30. Most of the major changes will take effect in 2014, when health insurance will become compulsory for nearly all Americans. New taxes will help fund the reforms. The Congressional Budget Office estimates that the modifications will cut the federal deficit by $118 billion by 2020._1,2,3

Home sales still underwhelming. Existing home sales dipped 0.6% for February while new home sales slipped 2.2% to another all-time low (although data only goes back to 1964). Any positives in the new Commerce Department report? Yes. The median sale price of new homes was about 5% above where it was a year ago.₄

A gain in durable goods orders. The 0.5% rise in February was accompanied by news that durable goods inventories increased by 0.3%, the best such gain since December 2008.₅

USDI surges north. When the U.S. Dollar Index is up 1.10% for the week (and 4.82% for the month), what happens with gold and oil? Well, gold and oil prices respectively fell 0.30% and 1.20% last week, with crude futures at exactly $80.00 per barrel at Friday’s close on the NYMEX.₆

Source: CNBC.com. BigCharts.com, usteas.gov, bls.gov, 3/26/10)8,9,10. Indices are unmanaged, do not incur fees or expenses, and cannot be invest into dircetly. These returns do not include dividends.

S&P 500 climbs 5.62% in 4 weeks. Stocks had another fine week from March 22-26, with the NASDAQ advancing 0.87%, the Dow 1.01% and the S&P 500 0.58% as part of a great 4-week run.₇

Riddle of the week. Two-and-a-half artists spend two-and-a-half hours painting two-and-a-half models on two-and-a-half canvases. How many artists would be necessary to paint 24 models on 24 canvases in 20 hours?

Contact my office or see next week’s Update for the answer.

Last week’s riddle: Is there a number made of eleven tens of thousands, eleven thousands, eleven hundreds and eleven units? If so, what is it??

Last week’s riddle answer: Yes – the number is 122,111. 110,000 + 11,000 + 1,100 + 11 = 122,111.
___________________________________________________________________
Rose Greene is a Registered Representative with, and securities are offered through LPL Financial, Member FINRA/SIPC.

This was prepared by Peter Montoya Inc., and not the presenting Representative or the Representative’s Broker/Dealer, and should not be construed as investment advice. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The NASDAQ Composite Index is an unmanaged, market-weighted index of all over-the-counter common stocks traded on the National Association of Securities Dealers Automated Quotation System. The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is not possible to invest directly in an index. NYSE Group, Inc. (NYSE:NYX) operates two securities exchanges: the New York Stock Exchange (the “NYSE”) and NYSE Arca (formerly known as the Archipelago Exchange, or ArcaEx®, and the Pacific Exchange). NYSE Group is a leading provider of securities listing, trading and market data products and services. The New York Mercantile Exchange, Inc. (NYMEX) is the world’s largest physical commodity futures exchange and the preeminent trading forum for energy and precious metals, with trading conducted through two divisions – the NYMEX Division, home to the energy, platinum, and palladium markets, and the COMEX Division, on which all other metals trade. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information. Additional risks are associated with international investing, such as currency fluctuations, political and economic instability and differences in accounting standards. www.montoyaregistry.comwww.petermontoya.com

Citations.

1 nytimes.com/2010/03/23/health/policy/23health.html?ref=us [3/23/10]
2 voices.washingtonpost.com/44/2010/03/obama-to-sign-health-care-fixe.html?wprss=44 [3/26/10]
3 cnn.com/2010/POLITICS/03/21/health.care.main/?hpt=Sbin [3/21/10]
4 foxbusiness.com/story/markets/industries/industrials/february-new-home-sales–annual-rate/ [3/24/10]
5 reuters.com/article/idUSN239670720100324?type=marketsNews [3/24/10]
6 cnbc.com/id/36057788/page/2/ [3/26/10]
7 blogs.wsj.com/marketbeat/2010/03/26/data-points-us-markets-221/ [3/26/10]
8 bigcharts.marketwatch.com/historical/default.asp?detect=1&symbol=DJIA&close_date=3%2F26%2F09&x=0&y=0 [3/26/10]
8 bigcharts.marketwatch.com/historical/default.asp?detect=1&symbol=COMP&close_date=3%2F26%2F09&x=0&y=0 [3/26/10]
8 bigcharts.marketwatch.com/historical/default.asp?detect=1&symbol=SPX&close_date=3%2F26%2F09&x=0&y=0 [3/26/10]
8 bigcharts.marketwatch.com/historical/default.asp?detect=1&symbol=DJIA&close_date=3%2F25%2F05&x=0&y=0 [3/26/10]
8 bigcharts.marketwatch.com/historical/default.asp?detect=1&symbol=COMP&close_date=3%2F25%2F05&x=0&y=0 [3/26/10]
8 bigcharts.marketwatch.com/historical/default.asp?detect=1&symbol=SPX&close_date=3%2F25%2F05&x=0&y=0 [3/26/10]
8 bigcharts.marketwatch.com/historical/default.asp?detect=1&symbol=DJIA&close_date=3%2F27%2F00&x=0&y=0 [3/26/10]
8 bigcharts.marketwatch.com/historical/default.asp?detect=1&symbol=COMP&close_date=3%2F27%2F00&x=0&y=0 [3/26/10]
8 bigcharts.marketwatch.com/historical/default.asp?detect=1&symbol=SPX&close_date=3%2F27%2F00&x=0&y=0 [3/26/10]
9 ustreas.gov/offices/domestic-finance/debt-management/interest-rate/real_yield.shtml [3/26/10]
9 ustreas.gov/offices/domestic-finance/debt-management/interest-rate/real_yield_historical.shtml [3/26/10]
10 treasurydirect.gov/instit/annceresult/press/preanre/2000/ofm11200.pdf [1/12/00]

How effectively could it address America’s unemployment rate?

provided by Los Angeles Financial Planner, Rose Greene, CFP®

How about a tax break for companies that hire? A new jobs bill introduced by Sen. Majority Leader Harry Reid (D-NV) proposes major tax incentives for hiring businesses. If the bill becomes law, will these incentives make a dent in the unemployment rate? Or will they matter little? Not everyone is optimistic.

On February 24, the $15 billion job creation measure passed 70-28 in the Senate and headed for the House of Representatives.₁ Just what is in this Senate bill?

The big perk: the “Hire Now” tax cut. If the bill becomes law, a business that hires someone who has worked less than 40 hours in the previous 60 days could skip paying its share of the new hire’s Social Security tax for the rest of 2010. That’s 6.25% of the employee’s salary. Companies could realize a payroll tax savings of up to $6,622 per new hire. (In case you are wondering, the federal government would reimburse the SSA for the lost taxes.) _2,3,4

If the new employee lasted 52 weeks on the job, the business would get a $1,000 tax credit on its 2011 federal return.₃

In Need Of Repair

The other perks. The Section 179 deduction limit for small business capital purchases was raised to $250,000 for 2009, and this bill would keep the limit at $250,000 for the 2010 tax year. The “Build America” bond program would be extended and expanded – that’s the program created to help state and local governments raise funds for infrastructure projects. The current federal subsidy for state highway spending would also be extended._1,2

The fine print. Any private-sector employer, any non-profit organization and any public-sector college or university would qualify for the “Hire Now” tax break. While a business that owes no tax could not get the $1,000 new-hire tax credit for 2011, it would be allowed to carry that credit forward to the future. There would be no limit on the amount of new employees a business could hire en route to claiming the credit.₈

Is this really going to make a difference? Well, Sen. Reid believes that the bill could create and save as many as 1 million jobs. Analysts feel that may be stretching it. Economic Policy Institute economist Heidi Shierholz thinks the measure could result in “tens of thousands of jobs, but it is absolutely nowhere near big enough” to reduce the unemployment rate.₃

Under the bill, a “new” hire does not have to be an additional employee. It can also be a worker replacing someone who quit or was fired.₃ So service sector businesses with high turnover might get some major tax breaks. There might be a lot of hiring among such companies, but not a lot of net job creation.

Is another bill just ahead? According to The Atlantic, Sen. Reid plans to introduce a second jobs bill with much greater scope. This proposed (and almost certainly more expensive) legislation would extend jobless benefits and COBRA for millions, as well as numerous tax credits and programs scheduled to sunset. State Medicaid funding would be extended and Medicare physician payments.

would be updated through this bill as well. While The Atlantic says it has copies of the bill, Sen. Reid’s office has not yet confirmed its contents. The Senator has mentioned rolling out multiple bills in the next few weeks to address the country’s unemployment problem.₅

Rose Greene is a Representative with Rose Greene Financial and may be reached at http://www.rosegreene.com, (310)399-1200 or rose@rosegreene.com

This material was prepared by Peter Montoya Inc., not the named Representative nor Broker/Dealer, and should not be construed as investment advice. Neither the named Representative nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information.

Citations.
1 marketwatch.com/story/senate-sends-15-billion-jobs-bill-to-house-2010-02-24 [2/24/10]
4 boston.com/business/personalfinance/managingyourmoney/archives/2010/02/tax_incentives.html [2/24/10]
2 sfgate.com/cgi-bin/article.cgi?f=/c/a/2010/02/24/BU3H1C6M8V.DTL [2/24/10]
4 online.wsj.com/article/SB20001424052748704240004575085410014175900.html [2/24/10]
5 politics.theatlantic.com/2010/02/the_next_jobs_bill.php [10/25/10]

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.

Download the full report

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. 

Overall, the buying and selling in the stock market has been balanced over the past month as the S&P 500 has remained in a range of 1090-1125. While there are many factors influencing our outlook for 2010, including the pace of economic and profit growth and the changes in global monetary and fiscal policy, we believe the buying power is likely to win out over the forces of  selling in the coming months.

Some Highlights:

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

- Since March of 2009, buying from individual investors has been rising and may mark a multiyear turning point for individual investor inflows.

- Purchases of U.S. stocks by foreigners have risen back to the prior peaks in 2000 and 2007.

- The sellers include companies and insiders, or top executives, of S&P 500 companies.

- We believe the buying power of individual investors is likely to win out over the forces of selling in the coming months.

Weekly Market Commentary 01_04_10

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.

Joblessness at 10.0%. This November figure is improved from October’s 10.2% mark. Another bright spot: payrolls slimmed by just 11,000 jobs last month.  (Analysts expected a reduction of around 125,000.)  Are we on the verge of  adding jobs to the economy?  The number of employed people rose by 227,000  last month, the first increase since April.1

Read here for the rest of this week’s economic update:

http://tinyurl.com/yhtom32