Market Commentary - March 22, 2012

Some Potential Bumps in the Road

So far this year, the S&P 500, a broad measure of domestic equity performance, has provided investors a nice double-digit return. Market prognosticators must be surprised as most had expected the lingering effects of Europe, a slowdown in emerging markets, and weak economic data to act as an anchor on stocks. Instead, Europe seems to be making progress at getting its house in order, growth in emerging markets is not declining sharply, and improved economic readings on the labor and housing markets have provided a positive environment for equities.

With this said, does the all clear signal make sense at this time? Not necessarily. In our opinion, there are some key issues likely to affect the markets in the next few months:

1. Increased volatility ahead of the presidential election. Since 1900, with some exceptions, the stock market has demonstrated increased volatility during election years. While market volatility is currently subdued, it may only be taking a short breather.
    
2. Debt reduction in Europe and the United States. Debt issues abroad may begin to surface as Europe provides further details on debt reduction. Domestically, as investors begin to price in the end of Bush-era tax cuts and other stimulative measures, market turmoil may again appear.
    
3. Higher oil and gasoline prices. With gas prices on the rise again, the question is whether consumers will cut back on expenses to offset higher energy prices, reducing GDP growth in the process.
    
4. Inflation. The most recent consumer price and labor reports showed little sign that inflation is on the rise. Still, it would be foolhardy to believe that low inflation and low interest rates will persist forever. Case in point, the inflation rate the Treasury market expects to prevail over the next ten years (as implied by the difference between nominal Treasury and TIPS yields) has risen steadily in recent months, reflecting, in part, higher oil prices. If the market is right, it will not be long before it begins pricing in a Fed change in its intent to keep policy interest rates low until well into 2014.
    
5. Corporate profits. Since the Great Recession, corporate profit growth has been a key catalyst for stocks. Looking ahead, corporate earnings face some headwinds including difficult year-over-year comparisons, rising commodity/input costs, and lingering economic effects out of Europe. With first quarter earnings season set to commence in a couple weeks, a mixed bag of reports could elevate investor concerns.
    

Putting it all together, our view is that economic growth is picking up in the United States and that the economy and the markets still face headwinds. This argues for an allocation to equities in line with long-term investment objectives, for favoring bonds that provide a cushion in the form of a spread over U.S. Treasuries (such as corporate bonds), and for diversification into alternative investments.

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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