Market Commentary - March 5, 2012

Haven’t We Seen This Before? A Market Pullback is Possible.

For investors, 2012 has started off quite well as most major equity indices are in positive territory. Improving economic data, most notably in housing and labor, some clarity on European debt issues and another positive earnings season have all driven investor confidence that, in turn, has led to higher markets. In fact, this year’s gains have pushed the S&P 500, a broad measure of U.S. equity performance, nearly 25 percent higher than its most recent low point set last October 3rd. As we look at this year’s gains, we have to ask ourselves: doesn’t this market pattern seem familiar and haven’t we seen this before?

The answer is yes. The chart below shows the price movement of the S&P 500 so far this year and during the first six months of last year. As you can see in the area highlighted by the box, the first ten weeks of this year and last year have produced a very similar pattern for the S&P 500. Unfortunately, if stocks continue this pattern, they are set up for a modest decline and increased volatility.

Source: St. Louis Federal Reserve; Data from 12/31/2010 to 6/30/2012

Late last year in the 2012 Market Outlook, we predicted that U.S. equity markets would provide mid- to upper-single digit returns but produce an elevated level of volatility in 2012. If the year ended today, we would be half right. The returns are consistent with our prognosis, but market volatility, as measured by common volatility indices, is approaching mid-summer 2011 lows. This combination of positive returns and decreased volatility is primarily the byproduct of investor optimism towards the numerous economic reports portraying a better-than-expected start to the economy in 2012.

Though there have been clear signs of improvement in the economic picture, most notably in the labor and housing markets, manufacturing, and readings on consumer sentiment, we believe many indicators may have painted too rosy a picture of the U.S. economy. Using better-than-expected economic data as a reason to buy, investors have pushed markets higher. With that said, we have grown increasingly concerned that the financial markets may have gotten a little ahead of themselves and may follow the pattern seen last year. We continue to believe portfolios should be positioned for some equity growth and some market opportunities, but now is not necessarily the time to back up the truck and become aggressively positioned.

We believe a modest pullback in the equity markets would not be a surprise. Outside of mimicking the market pattern seen last year, there are other factors that could pressure stocks in the near-term:

• Sharp rise in gas prices may curtail consumer spending.
• Rising geo-political events in the Middle East and increased political rhetoric out of Washington in advance of the November elections may become a drag on consumer sentiment.
• Growing fiscal imbalances here and lingering debt concerns across the Atlantic may increase market risk premiums.
• Corporate earnings growth has been a primary foundation of stock market returns following the Great Recession, but the end of the current earnings season may eliminate that as market driver.
• We may see some soft readings on the economy that may ratchet down some overly optimistic growth projections.

Despite these near-term concerns, we want to stress that we are not bearish on the financial markets. Instead, despite the recent lull in volatility, we believe the pattern of market swings and gyrations established over the last couple years will continue and investors should be prepared. In our opinion, preparation includes not being too aggressive and keeping equity exposure in line with investment objectives, increasing the allocation to income solutions (such as corporate bonds and dividend paying stocks) which may help to mitigate some anticipated volatility, and expanding portfolio diversification through the use of alternative investment strategies. Because of their low correlation to traditional stocks and bonds, alternative investments may improve diversification.

We remain committed to our original 2012 market prognosis of mid- to upper-single digits equity market returns with elevated levels of volatility. While the equity markets have come out the gate quickly this year and reached our year-end estimates, volatility has dropped. We do not expect that scenario to continue and would not be surprised by a modest market pause, accompanied by greater volatility. In this anticipated environment, investors should remain true to their investment objectives and not take the recent market run-up as an all-clear signal.

This information is compiled by Cetera Financial Group from source material obtained or provided by US federal and state departmental websites, equity index sponsors Standard & Poor’s, Dow Jones, and NASDAQ, credit ratings agencies Standard & Poor’s, Moody’s Ratings, & Fitch Ratings, domestic and foreign corporate issued newswires and press statements, and from referenced compilations and index readings by Bloomberg Professional. The information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The information has been selected to objectively convey the key drivers and catalysts standing behind current market direction and sentiment.

No independent analysis has been performed and the material should not be construed as investment advice. Investment decisions should not be based on this material since the information contained here is a singular news update, and prudent investment decisions require the analysis of a much broader collection of facts and context. All economic and performance information is historical and not indicative of future results. Investors cannot invest directly in indices. This is not an offer, recommendation or solicitation of an offer to buy or sell any security and investment in any security covered in this material may not be advisable or suitable. Please consult your financial professional for more information.

While diversification may help reduce volatility and risk, it does not guarantee future performance. Additional risks are associated with international investing, such as currency fluctuations, political and economic instability, and differences in accounting standards.

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