Money Matters with Rose Greene » stock market

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.

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

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

LPL Financial Weekly Market Commentary for November 15, 2011

Rose Greene, CFP — Tue, 15 Nov 2011 22:05:22 +0000

The Best Year-End Strategy May be to Invest by the Book

Jeffrey Kleintop, CFA
Chief Market Strategist
LPL Financial

Highlights
All of the time-worn stock market trading axioms based on the calendar actually were worth following this year, including the “January effect”, “sell in May and go away” and October the “bear killer” month.
This textbook pattern of calendar-driven performance by the stock market may mean that the best year-end strategy is to invest by the book as a “Santa Claus rally” unfolds in December.

It has been a textbook year. That is, if your textbook is the Stock Trader’s Almanac. The old stock market chestnut “sell in May and go away” proved to be good advice this year. But that was not the only old adage of Wall Street traders that worked in 2011 — they all worked.

This has been the year of the stock market cliché in that all of the time-worn axioms based on the calendar actually were worth following this year:

The “January effect” (the market tends to rise in January attributed to individual investors putting money to work after taking tax losses in December) worked this year as the S&P 500 posted a 2.3% gain in January. The “January barometer” (stock gains in January often lead to a gain for the year) and the overlapping “first five days” indicator (stocks rising during the first five days of the year indicate a high probability for a gain for the year) have both proven accurate, so far.
“Sell in May and go away” (suggests investors sell and avoid the summer months) worked with stocks peaking for the year on April 29.
October, the “bear killer” month (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.

If this “year of the market axiom” pattern continues, what comes next? Perhaps a “Santa Claus rally” is in store for December. Markets must still move past the uncertainty of November that includes key policy events:

Government transitions in Europe.
Action by Congress to avoid a government shutdown.
The Super Committee proposals to find $1.5 trillion in deficit reduction measures.

But then a year-end “Santa Claus rally” may cap off a volatile year of modest single-digit returns for stock market investors.

What may be the trigger for the textbook year-end rise in the market known as a “Santa Claus rally?”

A rebound in investor sentiment as Europe takes long overdue actions to avoid a financial crisis.
Improvement in the job market as foreshadowed by the recent decline in initial jobless claims below the 400,000 level in recent weeks.
The holiday shopping season surprises by exceeding retail sales estimates, as it did last year.

This textbook pattern of calendar-driven performance by the stock market may mean that the best year-end strategy is to invest by the book.

To download a complete copy of the commentary click here

LPL Financial Weekly Market Commentary for November 8, 2011

Rose Greene, CFP — Tue, 08 Nov 2011 20:26:06 +0000

Kicking the Cannes

Jeffrey Kleintop, CFA
Chief Market Strategist
LPL Financial

Highlights
Stock market volatility was driven by last week’s political brinkmanship derailing plans to secure funding support from China and other countries for the European debt rescue plan, kicking the implementation of the plan down the road well past the G20 meeting in Cannes.
With every move in the stock market seeming to coincide with a headline coming out of Europe, it would be easy to conclude that this is the only issue that matters to investors.
By stepping back from the day-to-day and week-to-week trading, it appears the issues in Europe over the past couple of years have merely created volatility around the true focus of investors on the fundamental economic backdrop that continues to slowly improve.

The S&P 500 Index had a bumpy ride last week as it tumbled 5% in the first two days on the eve of the Group of 20 summit in Cannes, France, as the Greek Prime Minister proposed a referendum on the European debt deal. This political move risked scuttling the hard-fought deal that had been unveiled the prior week that contributed to the powerful stock market rally. Stocks recovered most of the lost ground later in the week as the Prime Minister withdrew his call for a referendum and moved toward establishing a new government for Greece that is very likely to approve the controversial debt rescue package.

However, the political brinkmanship derailed plans by the leaders of Germany and France to showcase the new plan in order to secure funding support from China and other countries.The French President said it may take until February 2012 for a funding deal to be reached, kicking the implementation of the plan down the road well past the meeting in Cannes.

While hurdles to implementation of the debt plan are materializing, Italy’s 10-year borrowing costs are slowly nearing the 7% threshold that forced Greece, Ireland and Portugal to seek bailouts last year. The yield on Italy’s 10- year bond rose to 6.35%, the highest since the creation of the euro currency in January 1999. We expect the delay will force changes in the Italian government and result in the passage of the difficult, but necessary reforms to return to a sustainable fiscal path.

With every move in the stock market seeming to coincide with a headline coming out of Europe, it would be easy to conclude that this is the only issue that matters to investors. By stepping back from the day-to-day and week-to-week trading, we can see a different, longer-term pattern of performance emerging — one that reflects a different focus entirely.

If we look back at the past five years, we can see that stocks have very closely tracked real-time economic data, as measured by the weekly tally of initial claims for unemployment benefits as seen in Chart 1. It appears the issues in Europe over the past couple of years have merely created volatility around the true focus of investors on the fundamental economic backdrop that continues to slowly improve.

What else does this chart tell us? That the October rally was justified based on the underlying economic fundamenta

ls and that stocks may have additional modest gains in the months ahead — barring distractions thatcause stocks to again deviate from the underlying driver. In fact, based on this relationship, if initial jobless claims fall to a more normal level of 350,000 by year-end 2012, the S&P 500 would be around 1400, well above Friday’s closing level of 1253.

This would seem to suggest that what the market really cares about are jobs. But we believe that would put too fine a point on it. Initial jobless claims do measure the conditions in the job market, but they are also a real-time, weekly reflection of economic conditions. While the President and GOP presidential candidates focus on promoting their job plans, we think it is important to keep in mind that job growth does not make for a healthy economy; a healthy economy makes jobs grow. The health of the economy reflected in initial jobless claims is critical to gauging the outlook for the magnitude and sustainability of profit growth critical to long-term stock market performance.

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 Group of Twenty (G-20) Finance Ministers and Central Bank Governors is the premier forum for our international economic development that promotes open and constructive discussion between industrial and emerging-market countries on key issues related to global economic stability. By contributing to the strengthening of the international financial architecture and providing opportunities for dialogue on national policies, international co-operation, and international financial institutions, the G-20 helps to support growth and development across the globe.
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.

LPL Financial Weekly Market Commentary for November 1, 2011

Rose Greene, CFP — Tue, 01 Nov 2011 19:55:03 +0000

Trick or Treat

Jeffrey Kleintop, CFA
Chief Market Strategist
LPL Financial

Highlights
Investors were treated to powerful gains last week as European policymakers crafted a deal to avoid a 2008-like financial crisis and economic and profit reports in the United States reflected solid growth.
We believe last week’s European rescue deal is more treat than trick, but the devil is in the details. Over the long-term, concerns remain about the tricky outlook for economic growth in Europe and the ability of some peripheral countries to meet budget targets.
While the stock market is likely to hang on to the powerful gains made in October, there are still a few of scares coming in November that may spook the markets and reintroduce some familiar volatility.

Was last week’s market rally a Halloween trick or a treat for investors? European leaders announced a deal last week that produced a sigh of relief felt around the world as markets welcomed the news of a breakthrough in what had been the biggest threat to the global economy and markets since the 2008 financial crisis.

In general, markets last week provided a treat to investors:

The S&P 500 climbed 4% putting the gain for the month of October on track to be the best month since October 1974 [Table 1].
Stocks rose sharply in Europe and Asia, led by the banks.
High Yield corporate bonds rose 2%.
Commodities surged with oil rising 7% and copper surging 15%.
Reflecting a mostly positive outlook for growth, the yield on the 10-year Treasury note rose 12 basis points and traded as high as 2.40% for the first time since early August.

We believe the deal is more treat than trick, but the devil is in the details — many of which remain undisclosed in the statement released by European policymakers last week. There are three broad components of the rescue package:

Greece’s debt burden is reduced by a 50% “haircut” on Greek bonds.
European banks will be required to raise 106 billion euros to temporarily maintain a higher buffer against additional losses on their bond holdings.
The rescue fund will provide guarantees against the first 20 – 25% of losses on about one trillion euros of European government debt.

Over the long-term, concerns remain about the tricky outlook for economic growth in Europe and the ability of some peripheral countries to meet budget targets. Reflecting these lingering concerns and fearing a trick, many investors in European government bonds sold their positions pushing Italian and Spanish bond yields higher for the week. Europe appears headed for a recession as seen in last week’s data included weak readings on employment, economic growth (as measured by GDP), and heavy truck sales in Europe.

The long-term success of the European rescue is dependent upon the members of the Eurozone taking additional steps to adhere to their plans for achieving financial stability and deficit reduction. Skepticism lingers that some nations will successfully hit the targets they have set especially in light of the recession that many European countries are likely to experience next year.

Despite the long-term concerns, the stock market may hang on to the gains it has achieved in the month of October which were supported by other positive news that continued last week:

The string of solid and better-than-expected economic data in recent weeks was capped by last week’s third quarter GDP coming in at 2.5% and a new all-time high in real GDP. (See this week’s Weekly Economic Commentary for details).
Strong and better-than-expected corporate earnings reports are on track for a 16.3% year-over-year increase with revenues up 10%. Of the 315 companies in the S&P 500 that have reported earnings to date for the third quarter, 71% have reported earnings above analyst expectations.
Additional policy actions outside of Europe also helped lift markets. Japan boosted economic stimulus, Turkey cut reserve requirements, and China pushed lending support for small firms as they prepare to reverse efforts undertaken in the past couple of years to tighten credit.

We expect these trends to continue into November. As November gets underway, this week there are several potentially positive drivers for the markets:

Important economic data is due to be released including the October readings on jobs (employment report from the Department of Labor), business sentiment (ISM), and consumer spending (vehicle sales and retail chain-store sales). This data should be solid — certainly relative to investor and consumer confidence readings, but it is getting harder to surprise to the upside after so many weeks. (See this week’s Weekly Economic Commentary for details).
On November 3, the European Central Bank (ECB) is set to meet. The next step in a successful plan to stabilize Europe is for the European Central Bank to cut rates soon to promote growth and lending and reverse the two rate hikes they made earlier this year. A rate cut by new ECB head Mario Draghi would be welcomed by markets. In addition, the Reserve Bank of Australia, Australia’s central bank, may cut rates this week.
Small components of President Obama’s jobs bill with a higher likelihood of passing Congress may be proposed this week.

However, there are some potential negatives on the calendar for November.

The government is funded through a continuing resolution that runs out November 18 and will result in a government shutdown if not extended.
The November 23 deadline is looming for the super-committee to vote on a plan with $1.5 trillion in deficit reduction.

So there are still a few scares coming in November that may spook the markets and reintroduce some familiar volatility.

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.
International and emerging markets investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors.
The ISM index is based on surveys of more than 300 manufacturing firms by the Institute of Supply Management. The ISM Manufacturing Index monitors employment, production inventories, new orders, and supplier deliveries. A composite diffusion index is created that monitors conditions in national manufacturing based on the data from these surveys.

LPL Financial Weekly Market Commentary for October 25, 2011

Rose Greene, CFP — Tue, 25 Oct 2011 21:54:19 +0000

The Greek Haircut

Jeffrey Kleintop, CFA
Chief Market Strategist
LPL Financial

Highlights
Despite all the headlines, yields for Italy, Spain, Portugal and Ireland’s sovereign debt are at or below where they were in mid- July when the second rescue package for Greece was drafted.
While the second Greek rescue stemmed the decline in the sovereign bond market, as intended, stocks have plunged since then as investors increasingly priced in a greater “haircut” the banks may have to take on their Greek bond holdings.
The stock market’s rise, despite no resolution on the terms of the comprehensive rescue package, appears tied in part to the increased clarity around limiting the amount of the haircut, lowering the odds of further bank failures and a 2008-style financial crisis.

The euro was born in January 1999, which means the European common currency will turn 13 in January. When I was 13, I never wanted my hair cut as short as my mother did. So we would negotiate — sometimes right down to the final snip in the barber chair. Neither of us was happy, but we could both live with the outcome. This appears to be the key issue for the stock market as it reacts to the amount of the “haircut” in the ongoing Greek debt negotiations.

The S&P 500 Index gained for a third consecutive week, marking the first time that has happened since February. Last week once again featured solid and better-than-expected economic data and earnings reports and no breakthroughs on European debt problems — although discussions seemed to progress on the amount of the Greek bond “haircut”. The S&P 500 Index closed the week at 1238, basically flat for the year, and up 13% from the low of October 3.

Another European summit is set for this week, as European policymakers move toward finalizing the details of the grand plan to deal with the debt problems that were promised by the leaders of Germany and France for early November. The fact that the various factions could not reach an agreement on the exact elements of the plan this weekend is obviously a negative. Yet, the policymakers would not have scheduled a second summit if they did not have the urgency and the political will to come to an agreement very soon, which could be viewed as an offsetting positive. In addition, there is the possibility that there could be support from international sources, such as the International Monetary Fund (IMF) or China. The IMF has about $650 billion in uncommitted resources that could be directed towards bolstering the rescue plan.

The sticking point in the deliberations seems to be Germany’s insistence that the rescue fund (The European Financial Stability Facility, or EFSF) be denied the ability to borrow potentially limitless sums from the European Central Bank, as France has favored. The final plan to contain the problem is likely to have two key components:

First, the EFSF will be used to guarantee investors against principal losses on government bond sales or to set up an EFSF-insured fund that would allow for private investors to participate. The resources of the EFSF will offer insurance on new government debt issues by Italy and Spain likely covering the first 20 – 30% of any principal losses in a default or restructuring. This guarantee could cover all the sovereign debt issuance of Italy and Spain for the next several years as they regain the market’s confidence in their fiscal health, while still providing assistance to Greece, Portugal and Ireland.
Second, a program for bank recapitalization to fill a shortfall resulting from the “haircut” taken by the banks on holdings of Greek debt. The bank capital needs are dependent upon additional debt relief for Greece in the form of a deeper, voluntary haircut on government debt. To meet the requirement that a debt exchange be voluntary and avoid a technical default that would trigger other problems, the haircut will likely be limited to the 40-50% range, rather than the 60%-plus demanded by Germany earlier this month. The bank recapitalization would be met first by banks themselves then by national governments and then possibly some ECB or IMF contributions.

This haircut issue is a major one for the stock market. The draft agreement on a second rescue package for Greece (to cover 2012 and 2013 funding) took place on July 21, 2011. It was a big event in terms of halting the contagion. So big, in fact, that it stabilized yields for other European countries: Spain, Italy, Ireland and Portugal [Chart 1]. Despite all the headlines, yields for these countries’ sovereign debt are at or below where they were in mid-July. However, while that massive policy action stemmed the decline in the sovereign bond market as intended, as you can see in Chart 1, stocks plunged following that day [Chart 2].

The stock market slide that began after the second bailout deal for Greece on July 21 may have been driven by the unrelated debt ceiling debacle in late July and the first few days of August and the ensuing downgrade of U.S. sovereign debt by S&P in early August. But, following these events, a key contributor to the stock market decline may have been the actual terms of the bailout deal. There were over a dozen points to the bailout agreement. One of these was that banks and other private bondholders would voluntarily agree to contribute to the rescue package for Greece in the form of debt exchanges targeting losses of 21% in a one-off, voluntary haircut.

Investors have been pricing in the risk that banks will ultimately be faced with a greater haircut. These rising bank losses have kept the European banks pulling the stock market lower and raising fears of more bank failures and a 2008-style financial crisis erupting in Europe.

On October 3, German officials suggested the haircut may have to be increased — from 21% possibly to as much as 60% — in light of a new funding shortfall and changed market conditions. As these statements were made stocks broke through the early August 2011 low and marked the low point of the year as the market feared bigger and bigger haircuts and the application of those haircuts to the debt of every entity receiving aid from the EFSF.

The stock market’s rise last week, despite no resolution on the terms of the comprehensive rescue package in Europe, appears to be tied in part to the increased clarity around the amount of the haircut banks will be forced to “voluntarily” take being more limited than what Germany was pushing for. This is viewed by markets as reducing the odds of additional bank failures and a 2008-style financial crisis. Ultimately, it may be that finding the haircut that all parties, including the European Central Bank, Germany, France and others, could agree to — if not be happy about — may be the key to restoring confidence.

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.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values and yields will decline as interest rates rise and bonds are subject to availability and change in price.
Government bonds and Treasury Bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of a fund shares is not guaranteed and will fluctuate.
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 International Monetary Fund (IMF) is an organization of 187 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world.
International and emerging markets investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors.

LPL Financial Weekely Market Commentary for October 18, 2011

Rose Greene, CFP — Tue, 18 Oct 2011 23:27:55 +0000

A More Durable Rally

Jeffrey Kleintop, CFA
Chief Market Strategist
LPL Financial

Highlights
There are several reasons why this stock market rally may be more durable than those that preceded it in recent months.
It is possible that the substantial developments in Europe are taking the fear of a repeat of the financial crisis of 2008 off the table and solid economic data in the United States is taking the fear of a double-dip recession off the table.
Other signs that this rally may be more durable include: global cyclical sector leadership, declining European “TED spread”, and the rising yield on the 10-year Treasury note.

The stock market, as measured by the S&P 500 Index, has returned to the high-end of the trading range of the past two months, as you can see in Chart 1. This is the fourth time the Index has rebounded to around the 1220 level. Each of the prior three rebounds were reversed as the market was pulled lower again by fears of financial crisis and recession. Rather than retreat back to the low end of the trading range over the next week or two, there are several reasons why this rally may be more durable than those that preceded it in recent months and may sustain much of the of the gains, as the S&P 500 Index takes a volatile path back toward a modest, single-digit gain for the year.

The substantial positive policy developments in Europe are taking the fear of a repeat of the financial crisis of 2008 off the table. In addition, solid economic data in the United States are taking the fear of a double-dip recession off the table. These positive developments may allow the stock market to breakout of the range to the upside, given support from still very low valuations.

Other signs that this rally may be more durable that those that preceded it over the past couple of months include:

Global cyclical sector leadership-The global economically sensitive

Energy and Materials sectors have led the rally while these sectors were in the middle of the pack during prior rallies.

Declining European “TED Spread”-The key gauge of stress in the financial sector during the financial crisis in 2008 was the widely-watched TED Spread, which measured banks’ willingness to lend to one another. The European equivalent of the TED Spread (EURIBOR less the EONIA rate) had been rising during the stock market rallies that failed to break out of the trading range over the past couple of months. However, over the past three weeks, the European “TED Spread” has been on the decline as financial risks recede in Europe, as illustrated in Chart 2.

Rising yield on 10-yearTreasury note-The 10-yearTreasury note yield had been steadily declining during the summer stock market rallies that failed to break out of the trading range. Stocks are unlikely to make a sustainable rebound when yields are low and falling. The fear of impending economic doom in the United States weighed on the yield, pulling it to levels last seen just prior to the United States entering VWVII. However, economic data providing evidence that the United States was not in a recession nor likely to experience a return to recession anytime soon helped to change the direction ofTreasury yields. [Chart 3]

While the current stock market level has marked an attractive point to sell over the past couple of months as stocks returned to the lows of the year, we believe signs increasingly point to a market that is likely to retain much of the powerful 10% gain achieved over the past two weeks as it begins a volatile, upward-sloping path back to a gain for the year. Key drivers to watch this week regarding the prospects for a breakout are: the start of the flood of third-quarter corporate earnings reports and announcements surrounding the October 23 European summit.

To download a complete copy of the commentary click here

IMPORTANT DISCLOSURES
The op1n1ons vo1ced 1n th1s mateml are for general 1nformat1on only and are not Intended to prov1de spec1f1c adv1ce or recommendations for any 1nd1V1dual To determine wh1ch 1nvestmentlslmay be appropmte for you, consult your financial adv1sor pnor to 1nvest1ng All performance reference IS h1stoncal 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 st rateg1es promoted will be successfuI
Bonds are subject to market and Interest rate nsk 1f sold pnorto matur1ty Bond values and y1elds will decline as
Interest rates nse and bonds are subject to availability and change 1n price

Government bonds and Treasury Bills are guaranteed by the US government as to the t1mely payment of pnnc1pal and Interest and, 1f held to matunty,offer a f1xed rate of return and f1xed pnnc1pal value However,the value of a fund shares IS not guaranteed and willfluctuate
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 1n the aggregate market value of 500 stocks representing allmajor 1ndustr1es
Stock Investing may Involve r1sk 1nclud1ng loss of pnncipal

Because of the1r narrow focus,sector 1nvest1ng will be subject to greater volat1l1ty than 1nvest1ng more broadly across many sectors and companies

Consumer D1scret1onary Sector Com pan1es that tend to be the most sens1t1ve to econom1c cycles Its manufactunng segment Includes automotive,household durable goods,textiles and apparel,and le1sure equipment The serv1ce segment Includes hotels, restaurants and other le1sure fac111t1es. media production and services, consumer retailing and serv1ces and education serv1ces
Consumer Staples Sector Companies whose busmesses are less sens1t1veto economic cycles It Includes manufacturers and drstnbutors of food, beverages and tobacco,and producers of non-durable household goods
and personal products It also rncludes food and drug retailing companies

Energy Sector Com panres whose busrnesses are dom rnated by erther of the followrng actrvrtres The constructron or provrsron of oil rrgs,drr lling equrpment and other energy-related servrce and equrpment rncludrng sersm rc data collection The exploratron, productron,marketrng, refrnrng and/or transportailon of oil and gas products,coal and consumable fuels
Financrals Sector Companres rnvolved rn actrvrtres such as bankrng,consumerfrnance, rnvestment bankrng and brokerage, asset management insurance and rnvestment and real estate,rncluding REITs
Health Care Sector Com panres are rn two main rndustry groups-Health Care equrpment and supplies or companres that provrde health care-related servrces, rncludrng distrrbutors of health care products, providers of basic health care services,and owners and operators of health care facilities and organizatrons Companres prrmarily rnvolved rn the research,development productron,and marketrng of pharmaceutrcals and brotechnology products
lndustnals Sector Companies whose busrnesses manufacture and distnbute caprtalgoods,includrng aerospaceand defense,constructron,engrneenng and bulidrng products,electneal equrpment and rndustnal machrnery Provrde commercral servrces and supplies,rncludrng pnntrng,employment envrronmentaIand offrce servrces Provrde transportatron servrces,rncludrng arrilnes,couners,manne,road and rail,and transportatron Infrastructure
Matenals Sector Com panres that are engaged rna wrde range of commodrty-related manufacturrng Included rn thrs sector are com panres that manufacture chem rcals,constructron matenals,glass,paper,forest products and related packagrng products,metals,mrnerals and mrnrng companres,rncludrng producers of steel
Technology Software & Servrces Sector Com panres rnclude those that pnmanly develop software rn varrous frelds such as the Internet applicatrons, systems and/or database management and companres that provrde rnformatron technology consultrng and servrces,technology hardware & Equrpment rncludrng manufacturers and drstributors of comm unrcatrons equr pment computers and penpheraIs, electronrc equrpment and related rnstruments,and semrconductor equipment and products
Telecommunrcatrons Servrces Sector Companres that provrde communrcatrons servrces pnmanly through a frxed line,cellular, wrreless, hrgh bandwrdth and/or frber-optrc cable network

Utriltres Sector Com panres consrdered electrrc. gas or water utrlitres,or com panres that operate as
rndependent producers and/or distrrbutors of power

LPL Financial Weekly Market Commentary for October 5, 2011

Rose Greene, CFP — Wed, 05 Oct 2011 22:14:46 +0000

The Pink Swan

Jeffrey Kleintop, CFA
Chief Market Strategist
LPL Financial

Highlights
A “black swan” event — a rare, unexpected event that has a major impact — is most often referred to as something with negative consequences. Investors have sharply discounted the odds of a positive surprise, or “pink swan” event.
While investors fret over black swans, there are a number of potential pink swans that could take place and grab investors’ attention in the weeks ahead.
While they may be hard to see at the moment, there are potential pink swans that could result in stronger-than-expected growth over the longer term: a clear path to U.S. fiscal sustainability could emerge in the next few years; China’s consumers could begin to become a powerful force and drive global demand growth; and new technologies could greatly improve resource productivity.

A “black swan” event — a rare, unexpected event that has a major impact — is most often referred to as something with negative consequences. The near-record low investor confidence readings and double-digit decline in the stock market during the third quarter reflect concern that the odds have sharply increased that a black swan event may take place. It is easy to cite a few of them: a European financial crisis; a U.S. recession; a fiscal debacle in Washington. However, investors have just as sharply discounted the odds of a positive surprise, or “pink swan” event. Given the pessimistic tone of investors, the pink swan may have the bigger potential market impact.

Last week the U.S. economic data came in better than expected and progress was made on the European debt problem with Germany’s ratification of the expansion of the European Financial Stability Facility. However, this provided little relief to investors as stocks were basically unchanged on the week and remained near the low end of the 1100 to 1200 range the S&P 500 Index has been stuck in for the past two months. While investors fret over black swans, there are a number of potential pink swans that could take place and grab investors’ attention in the weeks ahead:

The employment report is released this week and could surprise to the upside. Recent economic data has been better than expected, with the index of leading indicators rising for the fourth consecutive month and initial claims for unemployment benefits falling below 400,000 last week for the first time since April. These indicators may surprise investors braced for weak data.
Next week the third quarter earnings reporting season gets underway. Corporations were able to post double-digit earnings per share gains in the first and second quarters despite U.S. gross domestic product (GDP) growth that averaged less than 1%. Third-quarter GDP may have been more than twice the first half average, supporting continued solid earnings growth despite low expectations by investors priced into stock valuations.
Further signs may emerge in the coming weeks that Germany is supporting the euro zone as evidenced by the wide margin of passage on the German vote for the expansion of the European Financial Stability Facility (EFSF). Based on the success in Germany of the EFSF vote, the European Commission may introduce a proposal for so-called eurobonds to the parliament. The potential for the adoption of a long-term solution to the European debt problems would be a confidence boost where it is needed most.
China may surprise by cutting rates. After hiking rates and restraining growth and inflation pressures over the past couple of years, China has recently declared victory over its inflation problem and could return to a more pro-growth policy after economic growth slowed from about 12% to 9% in the past year and a half. This would be a surprise positive for the markets — particularly commodities.

The Federal Reserve’s last effort to help the economy, the so-called Operation Twist, could spur home buying as it creates the lowest mortgage rates in history. Already low rates helped to lift existing home sales 18% over the past year and new home sales are up 6%. A rise in home prices, with median home prices basically unchanged since the free-fall ended in early 2009 [Chart 1], would be a welcome surprise.
It is possible that the “super committee” tasked with finding the minimum of $1.5 trillion in deficit reduction by the end of this year as part of the debt ceiling legislation passed in August may succeed and recommend real fiscal reform. The bar is low. Many political pundits expect the group to fail by only finding a fraction of the intended deficit reduction, resulting in an automatic sequester to discretionary spending, the outcome largely reflected by markets.
Over the past 50 years, when stocks post a double-digit decline in a quarter they typically rebound 6% during the following quarter. Out of the 16 times the S&P 500 has registered a double-digit loss during a quarter, 13 of those times — or over 80% of the time — the following quarter posted a gain and those gains averaged 9%. It is worth noting that the month of October is historically the month that typically ends stock market slides as the market begins to reverse declines.

Looking beyond the next several weeks or months, we continue to expect a below average growth environment in the years ahead. However, while they may be hard to see at the moment, there are potential pink swans that could result in stronger-than-expected growth.
A clear path to U.S. fiscal sustainability could emerge in the next few years. The current political gridlock may give way to action after the 2012 elections as rising interest costs force broad fiscal reforms.
China’s consumers could begin to become a powerful force and drive global demand growth rather than just the growth in the global supply of goods. Employment and incomes are rising sharply in China. While domestic consumer spending currently only accounts for about one-third of China’s GDP it is rising quickly. The United States is the world’s largest manufacturer. U.S. companies would benefit from solid growth in Chinese consumer spending.
New technologies could greatly improve resource productivity. There is a correlation between patent grants and productivity a few years later [Chart 2]. The United States is currently saddled with a backlog on new patent requests; however, this logjam is beginning to break. If recent efforts at patent reform are combined with an increased emphasis on providing protection to new ideas we could see an explosion of efforts driving innovation and creating new products.

With consumer, business, and investor confidence readings near historic lows it is hard for negative black swan events to surprise an unprepared marketplace. Alternatively, with so few expecting positive developments it is more likely that a pink swan event is the true outlier with the most potential market impact.

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.

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.

Correlation is a statistical measure of how two securities move in relation to each other. Correlations are used in advanced portfolio management.

The Federal Open Market Committee action known as Operation Twist began in 1961. The intent was to flatten the yield curve in order to promote capital inflows and strengthen the dollar. The Fed utilized open market operations to shorten the maturity of public debt in the open market. The action has subsequently been reexamined in isolation and found to have been more effective than originally thought. As a result of this reappraisal, similar action has been suggested as an alternative to quantitative easing by central banks.

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

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.

LPL Financial Weekly Market Commentary for September 27, 2011

Rose Greene, CFP — Tue, 27 Sep 2011 20:43:47 +0000

Europe’s Problems Are Manageable, but They Need to Be Managed

Jeffrey Kleintop, CFA
Chief Market Strategist
LPL Financial

Highlights
Stock markets around the world lost over $3 trillion last week and entered a bear market as fear of default among some troubled European nations increased once again.
The S&P 500 Index has remained range bound for the past seven weeks. This is most likely due to the fact that a sharp downturn in earnings is already priced in combined with the prospect for earnings growth if a crisis is averted.
Europe’s problems are manageable, but they require management. The market moves seen last week push policymakers closer to the tough decisions needed to regain the confidence of investors.

Last week, the S&P 500 Index dropped 6.5% to 1,136. The Index gave back the 5.4% gain achieved in the prior week, the third-biggest weekly gain since 2009, which had lifted the Index to the top end of the range at 1216. The volatility continues within the range of about 1120 to 1220 on the S&P 500, a range that has prevailed since early August as you can see in Chart 1.

The declines were not restricted to the U.S. markets as the concerns remain focused on the European debt problems. Based on the MSCI All-Country World Index, stock markets around the world lost over $3 trillion last week (by comparison, all of Greece’s government debt totals about $200 billion) and entered a bear market as fear of default among some troubled European nations increased once again. This was the third largest weekly decline since the global recovery began in March 2009.

It is no surprise that the market appears to be demanding a policy response to the debt problems in Europe. All of the major European stock markets are in a bear market, having declined by about 30% from the peak in early May. However, many of the world’s largest markets have avoided a 20% or more decline defined as a bear market, such as those of the United States, United Kingdom, Canada, Singapore and New Zealand. The losses in Europe have been, in general, twice as large as those in non-European nations. They are more severe than even the 21% decline from the peak in Japan which suffered a devastating earthquake and tsunami earlier this year.

While stock values have been affected by the negative sentiment, analyst earnings estimates, in contrast, have remained resilient. In fact, there is not a single nation among the largest 24 whose companies are expected by analysts to produce a loss in aggregate during the coming fiscal year. For example, in the United States, the estimated earnings growth rates for the S&P 500 for the coming four quarters are in the double-digits: 14%, 15%, 11% and 15%. Even in Europe any losses are expected to be temporary and give way to double-digit earnings growth in the coming fiscal year, as you can see in Chart 2.

While U.S. stocks have fallen 15%, analysts’ earnings estimates have only been trimmed by about 2%. While we continue to believe, as we have all year, that earnings estimates are a bit too high, we do not believe the major decline priced in by the market is likely. The earnings outlook remains supported by company guidance and world industrial output that remains close to all-time highs. In Europe, earnings growth also remains positive. Market participants have priced in an expectation that earnings will suffer double-digit declines as a recession and financial crisis erupts, rather than double-digit gains in the coming year as a crisis is averted.

Despite all the negative news, the S&P 500 Index has remained range bound for the past seven weeks. This is most likely due to the fact that a sharp downturn in earnings is already priced in combined with the prospect for earnings growth if a crisis is averted.

There are several ways a crisis may be averted. While euro-zone members have yet to ratify the changes proposed to the European Financial Stability Facility (EFSF) this summer, we believe they will do so with votes scheduled in the coming weeks. Once ratified, a concern market participants have with the EFSF is its limited size of about 440 billion euros. A plan championed by U.S. Treasury Secretary Geithner to address the size of the facility that is winning some support in Europe is to allow the EFSF to borrow from the European Central Bank (ECB), multiplying the funds at its disposal and the impact it can have. The leveraged EFSF funds could be used to buy substantial amounts of troubled European nation debt, making the debt a collective obligation of the euro zone and essentially providing a bridge to eurobond issuance down the road. This form of rescue plan also has the added benefit of acting as stimulus in the form of quantitative easing for the euro zone. These assets can also be used to recapitalize banks that may suffer losses from a partial default by Greece. This is just one of several plans being discussed in Europe to avert a crisis.

Europe’s problems are manageable, but they need to be managed. The market moves seen last week push policymakers closer to the tough decisions needed to take decisive action and regain the confidence of investors.

To download a complete copy of the commentary click here

IMPORTANT DISCLOSURES

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.

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.

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

The MSCI World Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets. As of June 2007 the MSCI World Index consisted of the following 23 developed market country indices: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, the United Kingdom, and the United States.