3rd qtr 2011 market insight
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3rd qtr 2011 market insight 3rd qtr 2011 market insight Document Transcript

  • LPL FINANCIAL RESEARCH MARKET INSIGHTThird Quarter 2011Market InsightTable of Contents 2 Introduction 4–5 Commodities Asset Classes3–4 Stock Markets 5–6 Fixed Income –Taxable 4 Economy 6 Fixed Income –Tax-Free
  • News & Views from LPL Financial Research Market Insight is a quarterly publication intended to inform and empower your investment decision making. The S&P 500 Index endured its worst quarter in nearly three years during the third quarter of 2011. Investors had to deal with a number of issues — ongoing European debt concerns, the drawn-out debate on the debt ceiling, a downgrade of the U.S. credit rating — and embraced safe- haven assets as a result. Despite those concerns, the U.S. economy continued to expand, albeit at a slow pace. Investors are more pessimistic now, however, than at any point in the recent past, as reflected in consumer sentiment surveys, yet they continue to spend at a healthy pace. Such is the environment facing the market as the fourth quarter arrives — a tug-of-war between how investors say they are feeling and what they are actually doing. In the third quarter, sentiment dictated performance. With high-quality bonds recording a second consecutive strong quarter and the 10-year Treasury yield hitting record lows, significant gains likely will be hard to come by. But, with the S&P 500 Index near the lows for the year, we see more potential upside return than downside risk in equities between now and year-end given the likelihood that a credible European rescue plan emerges. Any plan is likely to be accompanied by the solid fundamental backdrop in the United States with corporate earnings remaining strong and supported by attractive valuations with the forward price-to-earnings ratio near 30-year lows. 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.page 2 of 8 LPL Financial Please note all return figures are as of September 30, 2011, Unless otherwise noted. Member FINRA/SIPC
  • MARKET INSIGHTStock MarketsThe U.S. stock market, as measured by the S&P 500 Index, posted its firstquarterly loss since the second quarter of 2010 and its largest quarterly 1 S&P 500 Q3 Performancedecline since the depths of the Great Recession in the fourth quarter of 2008 S&P 500 Indexwith a loss of 13.9% in the third quarter of 2011. The Index had increasingly 1350larger declines in each month of the third quarter, with the 7.0% decline 1300in September marking the fifth consecutive monthly decline for the Indexand the largest one-month decline since the 8.0% decline in May 2010; the 1250Index declined 2.0% in July and 5.4% in August [Chart 1]. Some of the sameissues that impacted the market during the second quarter of 2010, notably 1200the European debt problems, had a similar impact in the third quarter of 2011. 1150For the year thus far, the S&P 500 Index has posted a -8.7% return. 1100The third quarter was a battle between the strongest quarter of economic 06/30/11 07/31/11 08/31/11 09/30/11growth this year and the increasingly negative investor and consumer Source: LPL Financial, Bloomberg 09/30/11sentiment. Economic data, while not pointing to robust economic growth, The S&P 500 Index is an unmanaged index, which cannot besuggested the economy continues to expand, albeit at a painfully slow pace invested into directly. Past performance is no guarantee ofthat is well below historical averages at this point in an economic recovery. In future results.that sense, the slow pace of growth probably feels like a recession to manyinvestors. Those feelings were reflected in consumer and investor sentimentsurveys that were decidedly pessimistic in the third quarter. However, thegap between what investors say they are doing (i.e., consumer sentiment)and what they are actually doing (i.e., consumer spending) is wide. Onbalance, negative sentiment overwhelmed the market in the third quarter and Negative sentiment overwhelmedremains an overhang for investors as the fourth quarter begins. the market in the third quarter and remains an overhang for investors asIn dissecting sector performance of the U.S. equity markets, defensivesectors generally outperformed cyclical sectors in the third quarter. Utilities the fourth quarter begins.was the only sector to post a gain in the third quarter with a return of 1.6%[Table 2]. Utilities is the best performing sector in the S&P 500 Index year-to-date with a return of 10.7%. With the stock market lower and interestrates below 2.0%, investors have looked to the Utilities sector given itsdefensive nature and healthy dividend yield of approximately 4.4% (as ofSeptember 30, 2011). The notable outperformer among cyclicals in the thirdquarter on a relative basis was the Technology sector, which posted a decline 2 Q3 2011 and Year-to-Date Performance ofof -7.7%. The performance was notably worse among the other cyclical S&P 500 Sectors (% Returns)sectors — Energy, Materials, Industrials, Financials — which all declined Sector Q3 YTDmore than 20% in the quarter on concerns of a global economic slowdown. Utilities 1.6 10.7Materials was the worst performing sector in the third quarter with a drop of Consumer Staples - 4.2 3.4more than 24%. Information Technology -7.7 -5.8From a market capitalization perspective, large-cap stocks outperformed their Telecommunications -8.0 -1.5mid-cap and small-cap counterparts as large caps tend to be more defensivein nature. From a style perspective, there was not much of a distinction in Health Care -10.0 2.5returns between growth and value. The Russell 1000 Growth Index, a proxy Consumer Discretionary -13.0 -5.7for Large Growth stocks, was the best performing domestic asset class in Energy -20.5 -11.4the third quarter with a return of -13.1%, as Technology stocks significantly Industrials -21.0 -14.7outperformed. The Russell 2000 Growth Index, a proxy for Small Growth Financials -22.8 -25.2stocks, had the biggest decline among the nine style boxes with a drop of22.3% in the quarter. Materials -24.5 -21.8 Source: LPL Financial, FactSet 09/30/11For the second consecutive quarter, U.S. stocks outperformed their Large Because of their narrow focus, sector investing will be subject toForeign and Emerging Market counterparts on a relative basis, though the greater volatility than investing more broadly across many sectorsmagnitude of outperformance was far greater in the third quarter. The MSCI and companies.LPL Financial Member FINRA/SIPC page 3 of 8
  • Stock Markets (continued) EAFE Index, a proxy for developed foreign markets, declined 19.0% in the3 Gross Domestic Product quarter due in large part to the woes in Europe. France and Germany each Gross Domestic Product witnessed declines of more than 25% in their domestic stock markets during Seasonally Adjusted Annual Rate, Bil.$ the quarter and now reside in “bear market” territory with declines of more16000 than 20% in 2011. Similar to the second quarter, the MSCI Emerging Markets Free Index had the worst returns of the major world indexes in the third14000 quarter, declining 22.5%. Brazil’s stock market declined 17.5% in the quarter and is down 24.5% year-to-date, while China declined 14.5% in the quarter.1200010000 Economy8000 01 02 03 04 05 06 07 08 09 10 11 Much like the second quarter, economic reports in the third quarter wereSource: Bureau of Economic Analysis, Haver Analytics 10/02/11 again uneven, introducing fears of a global economic slowdown, which contributed to market volatility and overwhelmingly negative sentiment. While many of the reports came in below expectations, they did not suggest a return to recession. With regard to economic growth, gross domestic product (GDP) continued 4 Same-Store Sales, Excluding Wal-Mart to hit new all-time highs in the second quarter [Chart 3]. Second quarter ICSC: Comparable Store Sales Excluding Wal-Mart GDP was revised higher late in the third quarter from 1.0% to 1.3% annual Not Seasonally Adjusted, Year-Over-Year % Change growth. The third quarter is on pace to grow at a 2 – 2.5% rate, the strongest 12% growth rate so far this year. The second quarter revision was due in part 8% to better-than-expected consumer spending, which remains robust with 4.6% year-over-year growth in same-store sales as of the end of August 4% [Chart 4]. The Index of Leading Economic Indicators (LEI), which is a 0% grouping of several economic statistics that are usually predictive of future economic conditions, continued to suggest slow growth and not a double- -4% dip recession. In fact, LEI posted a solid and better-than-expected gain in September — the fourth straight month of re-acceleration in the year-over- -8% year growth of the LEI — which suggests that a recession is unlikely. Despite 01 02 03 04 05 06 07 08 09 10 11Source: ICSC, Haver Analytics 10/02/11 the lack of recessionary indicators, however, consumer sentiment was near 30-year lows in the third quarter, as measured by the University of Michigan Consumer Sentiment report [Chart 5]. Over time, these consumer spending and consumer sentiment measures are highly correlated as the more confident consumers feel, the more likely they5 University of Michigan Consumer are to spend money. However, the recent periods have seen a near historic Sentiment vs. LEI disconnect, as consumers are filling out surveys suggesting a dismal outlook, Consumer Confidence (Left Axis) but not significantly adjusting spending. Consumers are acting differently than Index of Leading Indicators (Right Axis) they are feeling. The fundamental data shows that consumers, which make 125 up nearly 70% of the U.S. economy, are going to the malls and spending 15 at levels not seen since 2007. However, that fundamental data flies in the 110 10 face of the sentiment data, which suggest consumers are as gloomy and 95 pessimistic as they were at the depths of the 2008 recession. 5 80 0 65 -5 Commodities Asset Classes 50 -10 Broad commodity prices declined for the second straight quarter, as 1981 1986 1991 1996 2001 2006 2011 the Commodity Research Bureau Index fell 7.7%. Much of the declineSource: LPL Financial, Bloomberg 09/14/11page 4 of 8 LPL Financial Member FINRA/SIPC
  • MARKET INSIGHTCommodities Asset Classes (continued)occurred late in the quarter, following a downgrade of the economy fromFederal Reserve (Fed) Chairman Ben Bernanke at the September Federal 6 West Texas Intermediate CrudeOpen Market Committee (FOMC) meeting. Bernanke cited “significant Crude Pricedownside risks” to the Fed’s more optimistic view of the economy and a $102more benign inflation view going forward. Given mixed economic data, the $98assessment was not surprising and partially served to justify the Fed’s launch $94of “Operation Twist”, a program intended to stimulate growth by keepinginterest rates low through the purchase of longer-dated Treasury securities. $90However, not all commodities asset classes moved in lockstep during the $86quarter, leading to divergent performance. Commodities like oil and copper, $82which are typically more sensitive to economic activity, continued to move $78lower on concerns of an economic slowdown. West Texas Intermediate 06/30/11 07/31/11 08/31/11 09/30/11crude oil started the quarter near $98, and climbed as high as $101 in late Source: LPL Financial, Bloomberg 09/30/11July before falling sharply in early August and settling into a range between$79 and $90 [Chart 6]. With oil prices at their lowest level in nearly a year,consumers are seeing some relief in the percentage of spending dedicated toenergy costs. 7 GoldOn the other hand, precious metals, generally viewed as a safe haven in Gold Pricetimes of uncertainty, were mixed during the quarter. The ride for gold was $1900again volatile, as the yellow metal surged to yet another all-time high in late $1850August near $1,900 [Chart 7]. Gold was moving back to the $1,800 range in $1800early September before a precipitous decline late in the month to near $1,600. $1750Despite the late-quarter decline, gold still increased 7.8% in three months. $1700 $1650Silver also fell sharply following the downgrade of the economy from the Fed. $1600Silver began the month near $35, rallied as high as $43 in late August and $1550finished the quarter near $30 [Chart 8]. $1500 $1450 06/30/11 07/31/11 08/31/11 09/30/11 Source: LPL Financial, Bloomberg 09/30/11Fixed Income –TaxableThe broad bond market, as measured by the Barclays Capital AggregateBond Index, followed a strong second quarter with a solid gain of 3.8% inthe third quarter, the best quarterly return since the fourth quarter of 2008. 8 SilverJuly was a particularly strong month for high-quality bonds, as the Index Silver Pricegained 1.6%, the best month for the Index in exactly two years. For the $44second consecutive quarter, investors generally avoided riskier sectors of the $42bond market and sought the comfort of high-quality bonds. As was the case $40in the second quarter, the 10-year Treasury yield again moved lower in the $38third quarter, hitting an all-time low of 1.7% in late September before endingthe quarter near 1.9% [Chart 9]. $36 $34Long-term high-quality bonds, as measured by the Barclays Capital $32Government/Credit Long Index, posted a 15.6% return in the third quarter. $30Among other high-quality bond sectors, Treasury Inflation Protected $28Securities (TIPS) posted strong returns in the quarter (4.5%), as did 06/30/11 07/31/11 08/31/11 09/30/11Mortgage-Backed Securities (2.4%). Given the flight-to-safety rally in the Source: LPL Financial, Bloomberg 09/30/11bond market, more credit-sensitive areas of the market underperformed the The fast price swings in commodities and currencies will result inbroad Aggregate Index. Notably, high-yield bonds had their worst quarter significant volatility in an investor’s holdings.since the fourth quarter of 2008 and fourth worst quarter in the past decade Precious metal investing is subject to substantial fluctuation andwith a return of -6.1%, as measured by the Barclays Capital High Yield Index. potential for loss.LPL Financial Member FINRA/SIPC page 5 of 8
  • Fixed Income –Taxable (continued) Other credit-sensitive fixed income sectors, such as Bank Loans (-4.4%) and9 10-Year U.S. Treasury Yield Preferred Securities (-4.2%), struggled in the third quarter, as did Emerging 10-Year Treasury Yield Market Debt (-1.8%). 3.3% 3.1% 2.9% 2.7% Fixed Income –Tax-free 2.5% Municipal bonds are arguably the best story of 2011 as the positive run 2.3% that began in the first half of the year continued in the third quarter. 2.1% Municipal bonds, as measured by the Barclays Capital Municipal Bond 1.9% Index, gained another 3.8% in the third quarter bringing the year-to-date 1.7% gain to an impressive 8.4%. On the lower end of the quality spectrum, 06/30/11 07/31/11 08/31/11 09/30/11 the Barclays Capital High-Yield Muni Bond Index posted a 3.3% return inSource: LPL Financial, Bloomberg 09/30/11 the quarter, and has also posted an 8.4% return year-to-date. As was the case in prior quarters, state and municipal budgets continued to improve through a combination of revenue increases and cost cuts, and fears of massive defaults among municipal issuers continued to abate. While some forecasters predicted defaults totaling hundreds of billions of dollars, thus far in 2011 the total amount of defaults is just $1.2 billion (as of September 22, 2011), on pace to finish well below the $3.6 billion in defaults in 2010.Mortgage-Backed Securities are subject to credit, default risk,prepayment risk that acts much like call risk when you get yourprincipal back sooner than the stated maturity, extension risk, theopposite of prepayment risk, and interest rate risk.Treasury inflation-protected securities (TIPS) help eliminate inflationrisk to your portfolio as the principal is adjusted semiannually forinflation based on the Consumer Price Index - while providing a realrate of return guaranteed by the U.S. Government.Preferred Stock investing involves risk which may include loss of principal.Bank Loans are loans issued by below investment-gradecompanies for short-term funding purposes with higher yield thanshort-term debt and involve risk.High-Yield/Junk Bonds are not investment-grade securities,involve substantial risks, and generally should be part of thediversified portfolio of sophisticated investors.Municipal bonds are subject to availability, price, and to market andinterest rate risk if sold prior to maturity. Bond values will decline asinterest rate rise. Interest income may be subject to the alternativeminimum tax. Federally tax-free but other state and local taxes may apply.International and emerging markets investing involves specialrisks such as currency fluctuation and political instability and maynot be suitable for all investors.page 6 of 8 LPL Financial Member FINRA/SIPC
  • MARKET INSIGHTIMPORTANT DISCLOSURESThe opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Todetermine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is noguarantee of future results. All indices are unmanaged and cannot be invested into directly.Stock investing may involve risk including loss of principal.International investing involves special risks, such as currency fluctuation and political instability, and may not be suitable for all investors.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 toavailability and change in price.Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.Precious metal investing is subject to substantial fluctuation and potential for loss.The fast price swings in commodities and currencies will result in significant volatility in an investor’s holdings.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 capitalinflows and strengthen the dollar. The Fed utilized open market operations to shorten the maturity of public debt in the open market. The action hassubsequently been reexamined in isolation and found to have been more effective than originally thought. As a result of this reappraisal, similar action hasbeen suggested as an alternative to quantitative easing by central banks.Materials Sector: Companies that are engaged in a wide range of commodity-related manufacturing. Included in this sector are companies that manufacturechemicals, construction materials, glass, paper, forest products and related packaging products, metals, minerals and mining companies, including producers of steel.Energy Sector: Companies whose businesses are dominated by either of the following activities: The construction or provision of oil rigs, drilling equipmentand other energy-related service and equipment, including seismic data collection. The exploration, production, marketing, refining and/or transportation ofoil and gas products, coal and consumable fuels.HealthCare Sector: Companies are in two main industry groups—Health Care equipment and supplies or companies that provide health care-relatedservices, including distributors of health care products, providers of basic health care services, and owners and operators of health care facilities andorganizations. Companies primarily involved in the research, development, production, and marketing of pharmaceuticals and biotechnology products.Utilities Sector: Companies considered electric, gas or water utilities, or companies that operate as independent producers and/or distributors of power.Consumer Staples Sector: Companies whose businesses are less sensitive to economic cycles. It includes manufacturers and distributors of food, beveragesand tobacco, and producers of non-durable household goods and personal products. It also includes food and drug retailing companies.Consumer Discretionary Sector: Companies that tend to be the most sensitive to economic cycles. Its manufacturing segment includes automotive,household durable goods, textiles and apparel, and leisure equipment. The service segment includes hotels, restaurants and other leisure facilities, mediaproduction and services, consumer retailing and services and education services.Telecommunications Services Sector: Companies that provide communications services primarily through a fixed line, cellular, wireless, high bandwidth and/or fiber-optic cable network.Financials Sector: Companies involved in activities such as banking, consumer finance, investment banking and brokerage, asset management, insurance andinvestment, and real estate, including REITs.Industrials Sector: Companies whose businesses manufacture and distribute capital goods, including aerospace and defense, construction, engineering andbuilding products, electrical equipment and industrial machinery. Provide commercial services and supplies, including printing, employment, environmentaland office services. Provide transportation services, including airlines, couriers, marine, road and rail, and transportation infrastructure.Technology Software & Services Sector: Companies include those that primarily develop software in various fields such as the internet, applications,systems and/or database management and companies that provide information technology consulting and services; technology hardware & equipment,including manufacturers and distributors of communications equipment, computers and peripherals, electronic equipment and related instruments, andsemiconductor equipment and products.MSCI EAFE is made up of approximately 1,045 equity securities issued by companies located in 19 countries and listed on the stock exchanges of Europe,Australia, and the Far East. All values are expressed in US dollars. All values are expressed in US dollars. Past performance is no guarantee of future results.The Barclays Capital Long Government/Credit Index measures the investment return of all medium and larger public issues of U.S. Treasury, agency,investment-grade corporate, and investment-grade international dollar-denominated bonds with maturities longer than 10 years. The average maturity isapproximately 20 years.The University of Michigan Consumer Sentiment Index (MCSI) is a survey of consumer confidence conducted by the University of Michigan. The MichiganConsumer Sentiment Index (MCSI) uses telephone surveys to gather information on consumer expectations regarding the overall economy.The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the globalemerging markets. As of May 2005 the MSCI Emerging Markets Index consisted of the following 26 emerging market country indices: Argentina, Brazil,Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Israel, Jordan, Korea, Malaysia, Mexico, Morocco, Pakistan, Peru, Philippines,Poland, Russia, South Africa, Taiwan, Thailand, Turkey and Venezuela.LPL Financial Member FINRA/SIPC page 7 of 8
  • LPL FINANCIAL RESEARCHM A R K ET I N S I G H T 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 CRB Commodities Index is a measure of price movements of 22 sensitive basic commodities whose markets are presumed to be among the first to be influenced by changes in economic conditions. As such, it serves as one early indication of impending changes in business activity. Russell 1000® Growth Index measures the performance of those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values. Russell 2000® Growth Index measures the performance of those Russell 2000 companies with higher price-to-book ratios and higher forecasted growth values. This Barclays Aggregate Bond Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment-grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities. The Barclays Capital High Yield Index covers the universe of publicly issued debt obligations rated below investment grade. Bonds must be rated below investment-grade or high- yield (Ba1/BB+ or lower), by at least two of the following ratings agencies: Moody’s, S&P, Fitch. Bonds must also have at least one year to maturity, have at least $150 million in par value outstanding, and must be US dollar denominated and non-convertible. Bonds issued by countries designated as emerging markets are excluded. The Barclays Capital High Yield Municipal Bond Index is an unmanaged index made up of bonds that are non-investment grade, unrated, or rated below Ba1 by Moody’s Investors Service with a remaining maturity of at least one year. This research material has been prepared by LPL Financial. To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and makes no representation with respect to such entity. The LPL Financial family of affiliated companies includes LPL Financial and UVEST Financial Services Group, each of which is a member of FINRA/SIPC. Not FDIC/NCUA Insured Not Bank/Credit Union Guaranteed May Lose Value Not Guaranteed by any Government Agency Not a Bank/Credit Union Deposit Member FINRA/SIPC www.lpl.com RES 3340 1011 Tracking #1-012002 (Exp. 10/12)