Market Commentary – October 27, 2011

Great News, But Let’s Look Before We Leap

Turn on CNBC, Bloomberg, or FoxNews the morning of October 27th and you witnessed a cheerful mood permeating across investors. The big three U.S. stock market indices, Dow Jones Industrial Average, S&P 500 and NASDAQ Composite, all jumped into positive territory. Helping to fan these optimistic fires were positive overnight news from Europe, surprisingly robust domestic economic data, and another quarter of solid corporate profits. While recent market positives are outweighing the negatives, before we flash the “all-clear” signal, keep in mind that we aren’t out of the woods yet and, consequently, market volatility may remain with us regardless of recent events.

On the morning of October 27th, the announcements out of the European debt crisis summit were better than many experts anticipated. While final details still need to be ironed out, some of the early highlights are that Greece will receive a new European Union/International Monetary Fund finance program totaling nearly 100 billion euros and the European Financial Stability Facility (EFSF) will be increased to approximately 1 trillion euros and used as first-loss insurance on sovereign debt. At present, the fund has about 250 billion euros after recent bailouts to Greece, Ireland, and Portugal. Private investors in Greek government debt will take a 50% write-down on the value of their holdings. In exchange for the bailout funds and other considerations, Greece will reduce its public debt to a more manageable 120% of gross domestic product by 2020. Interestingly, new euro-zone bank stress tests will be put into place, with a 9% pass/fail threshold and banks have until June 2012 to cover any capital shortfall. Without a 9% level in so-called “Tier 1” or low risk holdings, banks would face constraints in terms of paying dividends or awarding bonuses.

While the European news is the clear driver of recent positive market performance, solid domestic economic data has also helped market confidence. September new home sales data showed an increase of 313,000, better than the 296,000 seen in August and the 200,000 expected. The first reading of third-quarter Gross Domestic Product (GDP), which is a proxy for the entire output of the U.S. economy, showed an as-expected 2.5% growth rate. More importantly, within this report, consumer spending rose 2.4% (the biggest increase since the fourth quarter of 2010), sales of durable goods rose by 4.1%, and business investment rose by 16.3%. The weak dollar helped exports, which rose by 4%, accelerating from a 3.6% rise in the second quarter. News on the Greek front, stable economic data, and, according to Bloomberg, third-quarter corporate profits that have surpassed estimates by an average of 5.9% (through October 26th) are all very positive for the markets. However, we do not believe it is time to wave the all-clear signal.

In Europe, despite the good news, there are still many questions to be answered. With the Greek situation possibly settled, will the financial markets now target other perceived financially weak European nations (Italy, Portugal, Spain and Ireland)? Will future revisions to third-quarter GDP diminish some of the good economic news? In a low economic growth environment expected for 2012 and beyond, how will corporations continue to generate double-digit profit growth?

While we are not market cynics, we do want to stress that the “all-clear” signal is not yet there. Instead, we will be watching for more details from Europe and key economic data expected to be released in the first week of November (including October readings on manufacturing and labor).

Given the well-documented combination of good and bad news this year, not surprisingly we have seen sharp market swings in both directions. In their portfolios, it makes sense for investors to overweight to investments that have historically helped to mitigate this volatility (such as alternative strategies, corporate bonds and dividend-paying equities). From a broad portfolio perspective, in volatile times, another prudent strategy is to establish trading ranges for investments and take profits near the upper-end of the ranges, and vice-versa at the lower-end.

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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