1. LPL FINANCIAL RESEARCH
MARKET INSIGHT
Third Quarter 2011
Market Insight
Table of Contents
2 Introduction 4–5 Commodities Asset Classes
3–4 Stock Markets 5–6 Fixed Income –Taxable
4 Economy 6 Fixed Income –Tax-Free
2. 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
3. MARKET INSIGHT
Stock Markets
The U.S. stock market, as measured by the S&P 500 Index, posted its first
quarterly loss since the second quarter of 2010 and its largest quarterly 1 S&P 500 Q3 Performance
decline since the depths of the Great Recession in the fourth quarter of 2008 S&P 500 Index
with a loss of 13.9% in the third quarter of 2011. The Index had increasingly 1350
larger declines in each month of the third quarter, with the 7.0% decline
1300
in September marking the fifth consecutive monthly decline for the Index
and the largest one-month decline since the 8.0% decline in May 2010; the 1250
Index declined 2.0% in July and 5.4% in August [Chart 1]. Some of the same
issues that impacted the market during the second quarter of 2010, notably 1200
the European debt problems, had a similar impact in the third quarter of 2011.
1150
For the year thus far, the S&P 500 Index has posted a -8.7% return.
1100
The third quarter was a battle between the strongest quarter of economic 06/30/11 07/31/11 08/31/11 09/30/11
growth this year and the increasingly negative investor and consumer Source: LPL Financial, Bloomberg 09/30/11
sentiment. Economic data, while not pointing to robust economic growth, The S&P 500 Index is an unmanaged index, which cannot be
suggested the economy continues to expand, albeit at a painfully slow pace invested into directly. Past performance is no guarantee of
that 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 many
investors. Those feelings were reflected in consumer and investor sentiment
surveys that were decidedly pessimistic in the third quarter. However, the
gap between what investors say they are doing (i.e., consumer sentiment)
and what they are actually doing (i.e., consumer spending) is wide. On
balance, negative sentiment overwhelmed the market in the third quarter and Negative sentiment overwhelmed
remains an overhang for investors as the fourth quarter begins. the market in the third quarter and
remains an overhang for investors as
In dissecting sector performance of the U.S. equity markets, defensive
sectors 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 interest
rates below 2.0%, investors have looked to the Utilities sector given its
defensive nature and healthy dividend yield of approximately 4.4% (as of
September 30, 2011). The notable outperformer among cyclicals in the third
quarter on a relative basis was the Technology sector, which posted a decline 2 Q3 2011 and Year-to-Date Performance of
of -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 YTD
more than 20% in the quarter on concerns of a global economic slowdown.
Utilities 1.6 10.7
Materials was the worst performing sector in the third quarter with a drop of
Consumer Staples - 4.2 3.4
more than 24%.
Information Technology -7.7 -5.8
From a market capitalization perspective, large-cap stocks outperformed their
Telecommunications -8.0 -1.5
mid-cap and small-cap counterparts as large caps tend to be more defensive
in nature. From a style perspective, there was not much of a distinction in Health Care -10.0 2.5
returns between growth and value. The Russell 1000 Growth Index, a proxy Consumer Discretionary -13.0 -5.7
for Large Growth stocks, was the best performing domestic asset class in Energy -20.5 -11.4
the third quarter with a return of -13.1%, as Technology stocks significantly Industrials -21.0 -14.7
outperformed. The Russell 2000 Growth Index, a proxy for Small Growth
Financials -22.8 -25.2
stocks, had the biggest decline among the nine style boxes with a drop of
22.3% in the quarter. Materials -24.5 -21.8
Source: LPL Financial, FactSet 09/30/11
For the second consecutive quarter, U.S. stocks outperformed their Large
Because of their narrow focus, sector investing will be subject to
Foreign and Emerging Market counterparts on a relative basis, though the
greater volatility than investing more broadly across many sectors
magnitude of outperformance was far greater in the third quarter. The MSCI and companies.
LPL Financial Member FINRA/SIPC page 3 of 8
4. Stock Markets (continued)
EAFE Index, a proxy for developed foreign markets, declined 19.0% in the
3 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 more
16000
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 third
14000
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.
12000
10000
Economy
8000
01 02 03 04 05 06 07 08 09 10 11 Much like the second quarter, economic reports in the third quarter were
Source: 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 11
Source: 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 they
5 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 decline
Source: LPL Financial, Bloomberg 09/14/11
page 4 of 8 LPL Financial Member FINRA/SIPC
5. MARKET INSIGHT
Commodities Asset Classes (continued)
occurred late in the quarter, following a downgrade of the economy from
Federal Reserve (Fed) Chairman Ben Bernanke at the September Federal 6 West Texas Intermediate Crude
Open Market Committee (FOMC) meeting. Bernanke cited “significant Crude Price
downside risks” to the Fed’s more optimistic view of the economy and a $102
more benign inflation view going forward. Given mixed economic data, the $98
assessment was not surprising and partially served to justify the Fed’s launch
$94
of “Operation Twist”, a program intended to stimulate growth by keeping
interest rates low through the purchase of longer-dated Treasury securities. $90
However, not all commodities asset classes moved in lockstep during the $86
quarter, leading to divergent performance. Commodities like oil and copper, $82
which are typically more sensitive to economic activity, continued to move
$78
lower on concerns of an economic slowdown. West Texas Intermediate 06/30/11 07/31/11 08/31/11 09/30/11
crude oil started the quarter near $98, and climbed as high as $101 in late Source: LPL Financial, Bloomberg 09/30/11
July 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 to
energy costs.
7 Gold
On the other hand, precious metals, generally viewed as a safe haven in Gold Price
times of uncertainty, were mixed during the quarter. The ride for gold was $1900
again volatile, as the yellow metal surged to yet another all-time high in late $1850
August near $1,900 [Chart 7]. Gold was moving back to the $1,800 range in $1800
early September before a precipitous decline late in the month to near $1,600. $1750
Despite the late-quarter decline, gold still increased 7.8% in three months. $1700
$1650
Silver also fell sharply following the downgrade of the economy from the Fed. $1600
Silver began the month near $35, rallied as high as $43 in late August and $1550
finished the quarter near $30 [Chart 8]. $1500
$1450
06/30/11 07/31/11 08/31/11 09/30/11
Source: LPL Financial, Bloomberg 09/30/11
Fixed Income –Taxable
The broad bond market, as measured by the Barclays Capital Aggregate
Bond Index, followed a strong second quarter with a solid gain of 3.8% in
the third quarter, the best quarterly return since the fourth quarter of 2008. 8 Silver
July was a particularly strong month for high-quality bonds, as the Index
Silver Price
gained 1.6%, the best month for the Index in exactly two years. For the
$44
second consecutive quarter, investors generally avoided riskier sectors of the
$42
bond market and sought the comfort of high-quality bonds. As was the case
$40
in the second quarter, the 10-year Treasury yield again moved lower in the
$38
third quarter, hitting an all-time low of 1.7% in late September before ending
the quarter near 1.9% [Chart 9]. $36
$34
Long-term high-quality bonds, as measured by the Barclays Capital $32
Government/Credit Long Index, posted a 15.6% return in the third quarter.
$30
Among other high-quality bond sectors, Treasury Inflation Protected
$28
Securities (TIPS) posted strong returns in the quarter (4.5%), as did 06/30/11 07/31/11 08/31/11 09/30/11
Mortgage-Backed Securities (2.4%). Given the flight-to-safety rally in the Source: LPL Financial, Bloomberg 09/30/11
bond market, more credit-sensitive areas of the market underperformed the
The fast price swings in commodities and currencies will result in
broad 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 and
with 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
6. Fixed Income –Taxable (continued)
Other credit-sensitive fixed income sectors, such as Bank Loans (-4.4%) and
9 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 in
Source: 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 your
principal back sooner than the stated maturity, extension risk, the
opposite of prepayment risk, and interest rate risk.
Treasury inflation-protected securities (TIPS) help eliminate inflation
risk to your portfolio as the principal is adjusted semiannually for
inflation based on the Consumer Price Index - while providing a real
rate 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-grade
companies for short-term funding purposes with higher yield than
short-term debt and involve risk.
High-Yield/Junk Bonds are not investment-grade securities,
involve substantial risks, and generally should be part of the
diversified portfolio of sophisticated investors.
Municipal bonds are subject to availability, price, and to market and
interest rate risk if sold prior to maturity. Bond values will decline as
interest rate rise. Interest income may be subject to the alternative
minimum tax. Federally tax-free but other state and local taxes may apply.
International and emerging markets investing involves special
risks such as currency fluctuation and political instability and may
not be suitable for all investors.
page 6 of 8 LPL Financial Member FINRA/SIPC
7. MARKET INSIGHT
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.
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 to
availability 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 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.
Materials Sector: Companies that are engaged in a wide range of commodity-related manufacturing. Included in this sector are companies that manufacture
chemicals, 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 equipment
and other energy-related service and equipment, including seismic data collection. The exploration, production, marketing, refining and/or transportation of
oil 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-related
services, including distributors of health care products, providers of basic health care services, and owners and operators of health care facilities and
organizations. 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, beverages
and 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, media
production 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 and
investment, and real estate, including REITs.
Industrials Sector: Companies whose businesses manufacture and distribute capital goods, including aerospace and defense, construction, engineering and
building products, electrical equipment and industrial machinery. Provide commercial services and supplies, including printing, employment, environmental
and 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, and
semiconductor 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 is
approximately 20 years.
The University of Michigan Consumer Sentiment Index (MCSI) is a survey of consumer confidence conducted by the University of Michigan. The Michigan
Consumer 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 global
emerging 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
8. LPL FINANCIAL RESEARCH
M 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
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