You may have heard the word stagflation before, but do you know what it is? Stagflation is a word penned from combining stagnation and inflation, and was first used in 1965 by a British politician by the name of Lain Macleod. He warned of a time when this could occur, where the inflation rate was higher than the rate of economic growth.

Relationship Between Unemployment and Inflation

At the time of Mr. Macleod’s statement, the United States was still going through a post war boom, and the government believed that the relationship between unemployment and inflation was stable and did not think there was anything to be worried about. A charting system called the Philip’s Curve showed that generally, as unemployment went down, inflation went up, and vice versa. So the government decided to boost the demand for goods and services while keeping unemployment low, thinking that this would create a safely rising inflation rate. Unfortunately though, this backfired on them. At first workers expected a higher pay due to the inflation rate and employers generally complied to this, but as the inflation rate got out of hand, workers didn’t want to work harder for less wages, and unemployment rose, while inflation was still rising as well.

Oil Embargo

This unbalanced relationship between wages and prices was not the only thing that caused the stagflation, however. In 1973, OPEC’s oil embargo raised oil prices to levels not seen before. This affected prices at the gas pumps and in various U.S. industries, and caused a lot of fuel shortages. From 1970 through 1979 the inflation rates continued to rise at exorbitant rates not seen before, and this time period also saw a halt to the stock market.

Government Spending and Borrowing

The federal government and President Carter tried several ways to bring stabilization back to the country, including a lot of government spending and borrowing, plus putting guidelines on wages and prices. These tactics only seemed to make matters worse. It took until 1979, when federal chairman Paul Vocker started raising interest rates, cutting the flow of money going to the economy. It caused high unemployment and a recession in the 1980’s, but eventually things evened out again, once again bringing the economy to a stable level.

Current Troubles

This past November in 2010, the Federal Reserve launched the latest stimulus, called QE2. The reason stated for this was that without more stimulation, the country could go into a period of falling prices. But instead this stimulus has caused global inflation, and some experts fear that this could put the U.S. into another time of stagflation. Other countries such as China are already seeing the results of the global inflation, with rioting breaking out in several major cities. With the already rapidly rising costs for fuel and food, some see a similar time in the U.S. to the period during the 1970’s, and believe we will have to brace ourselves for another stagflation. Some experts, however, say a stagflation is not possible because of the high unemployment rate since in order for it to be a true stagflation, employment would be high and rising along with the inflation.

What’s your thoughts?  Should we be worried about staglation?

photo credit: illustir

The Kentucky Derby, the first race of the Triple Crown of Thoroughbred Racing, took place this past weekend. The crowd favorite did not win, surprising many. That was much like last week’s performance Derby where the crowd favorite, commodities, suffered a stunning loss. It was a surprising show last week both on Wall Street and on the race track.

Big Brown

The record crowd at Churchill Downs, and many more on television, watched Animal Kingdom take the lead with 1/8 mile remaining and win by a sizeable 2 3/4 lengths. There was talk of Animal Kingdom being likely to run the next two races and try for the Triple Crown which has gone unclaimed for 33 years. The last horse that came close to taking the Triple Crown was Big Brown. Big Brown was the winner of the 2008 Kentucky Derby. He was the favorite to win and lived up to those expectations with a stunning win by nearly five lengths. He was the first horse since 1929 to win the race from the worst starting position — the 20th gate on the far outside. Remaining undefeated, he became an overnight pop culture phenomenon with New York Times profiles and his trainer made talk show appearances.

Just 10 days after the Kentucky Derby, in his fifth race, the 2008 Preakness Stakes, Big Brown was again the favorite. Big Brown won the second leg of the Triple Crown by more than 5 lengths, becoming only the fourth horse in 133 years to win both the Kentucky Derby and the Preakness while still undefeated. Big Brown, who was from New York, was being hailed as the biggest New York sports star of 2008 by sports writers.

photo credit: wallyg

Three weeks later, it was no surprise that Big Brown was again the favorite in the Belmont Stakes, the third and last race of the Triple Crown. Big Brown had become such a fad the betting odds were 1/4 to win the Belmont Stakes — that means you would only win $1 when you bet $4! Most of the horses had odds of 38/1 to 50/1 — meaning you would make $38 to $50 for every $1 bet. Betting became so popular bookmakers saw record-breaking interest as people who did not usually pay any attention to horse racing were caught up in Big Brown fever. Total wagering at Belmont that year was up nearly 50% over the year before. Bettors saw an amazing record of performance and saw what they thought was easy money. After all, there was no doubt the undefeated Big Brown would be the winner of the Belmont Stakes, by a wide margin and sweep the Triple Crown for the first
time in 40 years.

So what happened? Big Brown did not just lose the Belmont — he came in last by a wide margin. In the last turn Big Brown simply — and inexplicably — gave up. Big Brown became the first Triple Crown hopeful ever to finish last in the Belmont. A lot of people lost money that day and tore up their tickets in disgust.

Big Commodities

Many investors in commodities felt like they made a bad bet this past week. Commodity prices plunged nearly 10% — coming in a shocking last in the performance derby by a wide margin after a long series of wins. Many investors sold their stakes in disgust.

Investors had been big fans of commodities. Trading volumes were way up, especially for precious metals like gold. Commodities, measured by the Thomson Reuters Commodity Research Bureau Index, had put up an amazing record of performance leading into last week. Overall, commodities are up about 150% since the end of 2001, averaging about 10% a year, but precious metal commodity gains were far stronger with gold up about 500% over the same period. Prior to last week’s pullback, the past year saw the broad universe of commodities gain 33%, gold posted a similar gain, and silver was up 157%. This compares very favorably over the same period to stocks, measured by the S&P 500, which were up 17% and bonds, measured by the Barclays Capital Aggregate Bond Index, which were up 5%. Why the sudden disappointment for commodities last week after so many wins? There are several factors that drove last week’s reaction:

• Commodities had run up sharply setting the stage for volatility to the downside.
• Margin requirements were hiked sparking a catalyst for the pullback. The minimum amount of cash that must be deposited when borrowing from brokers to trade silver futures was increased to $21,600 a contract up from $11,745 two weeks ago. The sharp increase required investors to deposit 84% more cash to support their positions or sharply reduce their holdings of contracts. The new margin rules take effect today, Monday, May 9.
• Weak economic data added fuel to the selling. Economic data disappointed until Friday’s job report which led to a halt in commodities declines. Notably, the non-manufacturing ISM Index, the ADP payroll report, and most importantly initial jobless claims were all worse than expected.

As the economy, measured by weekly initial filings for unemployment benefits (one of the most timely barometers of economic activity), was strengthening, silver moved higher in lock step. When claims faltered, so did silver. We expect initial jobless claims to rebound as recent exceptional factors abate. With the death toll up over 350, the Alabama tornados were the deadliest national disaster since Katrina. In the wake of Katrina, unemployment claims soared 75,000. So, some of the recent increase in unemployment claims may be due to the storms. Claims may move back to around 400,000 soon supporting silver prices. There was no clear single reason why commodities fell so sharply. The leaders to the downside among commodities were precious metals as many investors simply gave up.

Is a Bubble Just Starting to Burst?

Gold has been in a bubble before — the bubble inflated through the 1970s, peaked in 1980, and fell by over 60% during the following two and a half years. Are commodities, perhaps best represented by gold, a bursting bubble now? If so, there are likely to be gains ahead than losses using history as a guide.

Gold prices have tracked the classic bubble pattern but have yet to enter the parabolic stage where the bursting of the bubble and the ensuing sharp losses begin to become a risk — which is after 10 years and a 1,000% gain. The investment bubbles of the past experienced far more inflating than what gold prices have experienced so far. The technology bubble of the 1990s (measured by the NASDAQ), the oil bubble of the late 1990s/early 2000s (measured by oil futures prices), and the housing bubble (measured by the S&P 500 Homebuilding Index) took 10 years and posted gains of about 1,000% before they burst and quickly surrendered most of those gains.

Gold’s rally is now just entering its tenth year, historically the best year for gains. If gold tracks the classic bubble pattern — and it has so far — instead of plunge, it would double in value this year. It is worth noting that gold’s March 1980 peak at $850 is about $2,400 in today’s dollars when adjusted for U.S. inflation — well above the current price and near where gold would be headed if it tracked this classic pattern, though past performance is no guarantee of future results.

However, we do not believe gold — or commodities in general — is in a bubble and most likely will not continue to track the classic pattern. But we do see potential for further modest gains for precious metals and other commodities in 2011, to be accompanied by volatility. The qualitative factors that are combining to allow gold’s shine to endure
include the following:

1. The declining dollar and outlook for rising U.S. inflation – The actions by the Fed to stimulate the economy have led to weakness in the dollar. As the dollar goes down, the price of gold in dollars goes up. While gold surged to an all-time high in dollar terms over the summer and fall of 2010, gold has been flat over the same period in euros and in yen. In
   Australian dollars, the peak in Gold was back in February of 2009 and is down about 10% since then. So part of our perception of the big surge in gold over the past year is in large part because we are measuring it in weakening US dollars.
2. Strong emerging market demand – In China and India gold is both a savings vehicle and a luxury for an emerging middle class. India and China  lead the world in terms of gold demand growth.
3. Central banks from sellers to buyers – The world’s largest central banks have been selling their gold reserves for decades after moving away from linking their currencies to gold. Most recently, Mexico, Russia and Thailand added to their gold reserves in February and March 2011. Given the current economic environment, we believe central banks may continue to add to their gold reserve base as further currency debasement and long-term inflation concerns persist. As the reserve currency status of the dollar comes into question, emerging economies are increasing their exposure to gold. With China and India holding relatively low levels of gold, a modest increase in their holdings as a percent of foreign reserves — as they diversify away from holdings of U.S. Treasuries – could easily account for 100% of current annual production.
4. Not just a defensive asset – Normally a beneficiary of a pullback in riskier investments, investors have often embraced gold as a perceived insurance policy against a return to recession. However, rather than act purely as a defensive investment, gold rose last year along side stocks and bonds.
5. Supply has been constrained – The supply-demand equation continues to provide a favorable tailwind for gold prices. After averaging growth of 4% annually since 1980, world production growth of gold has slowed considerably since 2001, averaging -1% annually over the past 10 years. To meet the gradual rise in demand, a steady increase in scrap supply has been needed. But scrap is falling short. It is getting more expensive to mine gold as the most accessible areas have been mined out and new mines are in increasingly remote or hard-to-mine locations. To meet the demand the major producers are pursuing digs formerly thought to not be economically viable at costs over $1000 per ounce.

Finally, with gold supported by multiple fundamental forces, one of our pre-conditions for a bubble is the asset has to be “over-owned.” All the gold produced around the world over the past 110 years (which accounts for more than 80% of all gold ever mined) at today’s prices is equivalent to only about 3.9% of the combined total value of stocks, bonds and cash around the world. While up from the 1.3% in 2000 when gold prices were depressed, it is similar to the 3.5% in 1990 and well below the whopping 12.1% in 1980 when gold traded near its last peak. While gold’s popularity is returning, it does not seem “over-owned.”

Come Back

After the stunning rout at the Belmont, Big Brown returned to racing in August of 2008 with a win in the $1 million Haskell Invitational Handicap at Monmouth Park, New Jersey. Big Brown’s last race was a month later with another win at the Monmouth Stakes. Big Brown then retired after winning 7 of his 8 career races having earned $3.6 million.

While precious metals may have lost during Derby week, they are not ready to be retired from portfolios. Big Brown came back to win again, it is likely
that commodities asset classes — including precious metals — will also come back to post gains again this year.

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.
• 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.
• 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 ISM index is based on surveys of more than 300 manufacturing firms by the Institute of Supply Management. The ISM Manufacturing Index monitors employment, production inventories, new orders, and supplier deliveries. A composite diffusion index is created that monitors conditions in national
• manufacturing based on the data from these surveys.
• The Thomson Reuters/Jefferies CRB Index is an objective and impartial and transparent benchmarks for the performance of the global commodities industry. The indices embrace most of the industry’s global market capitalization and have been structured to facilitate transactional efficiency. The index is comprised of 19 commodities: Aluminum, Cocoa, Coffee, Copper, Corn, Cotton, Crude Oil, Gold, Heating Oil, Lean Hogs, Live Cattle, Natural Gas, Nickel, Orange Juice, Silver, Soybeans, Sugar, Unleaded Gas and Wheat.
• The fast price swings in commodities and currencies will result in significant volatility in an investor’s holdings.
• Precious metal investing is subject to substantial fluctuation and potential for loss.
• Stock investing may involve risk including loss of principal.

photo credit: gregverdino

After being stuck in a tight range around 3.5% since mid-December, the yield on the 10-year Treasury note jumped higher to 3.65% last week. This rise was in response to the generally stronger economic data and the inflation signal coming from higher commodity prices. The yield on the 10-year Treasury note has risen by about 1.25% percentage points to 3.65% from 2.39% four months ago.

With yields now climbing towards 4%, investors are beginning to wonder when rising interest rates may start to negatively affect stock prices. Higher yields can slow borrowing and spending, weighing on economic and profit growth. If this pace of rising yields were to continue over the next four months, they could reach nearly 5% by this summer, a level not seen since July of 2007. While higher rates are bad news for bond investors, the good news is that rising yields may mean rising stock prices at least for some time yet. It is at 5% where yields begin to become a negative for stocks.

Historically, whenever the yield on the 10-year Treasury note was below 5% stock prices and bond yields moved in the same direction, as measured by a 52-week rolling correlation above zero. When the yield was below 5%, bond yields and stock prices rose together [Chart 1].

The opposite was true when yields were above 5%. Yields were above 5% during the period from the late 1960s through the end of the 1990s. Then, the correlation between stock prices and bond yields was below zero. In general, during that period as yields rose stock prices fell.

The reason for the different relationship above and below 5%, and why rising yields are good news for stocks right now, has to do with economic growth and inflation.

• When yields were rising from a low level they reflected improving growth and low inflation which was a favorable environment for stocks.
• When yields were rising above 5%, economic growth was accompanied by higher inflation which threatened future growth, eroded the present value of future earnings, and acted as a drag on stocks.

While rising interest rates may eventually pose a problem for stocks as the mountain of debt and rising commodity prices build, the tipping point of 5% is still a significant distance away. As economic data continues to reflect solid growth in the coming months, bonds yields and stock prices are likely to continue their climb.

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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.
• Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and are subject to availability and change in price.
• Government bonds and Treasury Bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value.

photo credit: doug88888

This week the attention of most market participants will be on what action Congress takes in their sole week of session for the month of November. The most important item facing Congress is the looming expiration of the Bush tax cuts. Some progress is likely this week with both parties facing a backlash if no action is taken and all tax rates revert to higher levels. We believe this week will set the stage for Congress to pass a one or two-year extension of all the Bush tax cuts, but, as we noted last week, it is a close call.

The uncertainty over the fate of the tax cuts, along with faster-than-expected inflation in China, stoking fears of a rate hike, and the ongoing debt problems in the eurozone, contributed to volatility last week. Stocks, as measured by the S&P 500, gave back 2.1% after gaining 3.6% in the prior week. Last week also saw two markets that have been immune to these considerations, demonstrate higher volatility:

• Gold prices fell 1.8% after gaining 2.5% the week before (according to Bloomberg data).
• Emerging market stocks, measured by the MSCI Emerging Markets index, were down 3.0% after being up 4.6% in the prior week.

The return of volatility to gold and emerging market stock prices has raised a question among some market participants: is the relentless climb pushing gold and emerging market stock prices into bubble territory? We do not think so. If they are bubbles, historically they still have a long way to inflate before they burst.

Gold Prices

As you can see in Chart 1, gold prices have tracked the classic bubble pattern but have yet to enter the parabolic stage where the bursting of the bubble and the ensuing sharp losses begin to become a risk. The investment bubbles of the past experienced far more inflation than what gold prices have experienced so far. The technology bubble of the 1990s (measured by the NASDAQ), the oil bubble of the late 1990s/early 2000s (measured by oil futures prices), and the housing bubble (measured by the S&P 500 Homebuilding Index) took 10 years and posted gains of about 1000% before they burst and quickly surrendered most of those gains.

What could push gold prices into historical bubble territory? While rising central bank demand, higher mining costs, and demand for gold as both a luxury and a savings vehicle from a rising middle class in China and India all help to support gold, the potential driver of a bubble would likely be driven by currency. Part of the rise in the price of gold is due to the decline in the value of the dollar. As the dollar goes down, the price of gold in dollars goes up. While gold has surged to an all time high over the past five months in dollar terms, gold denominated in euros remains below the levels reached five months ago. The move to record highs in the price of gold is more because we measure it in terms of a weakening US dollar. A sharp drop in the dollar would boost gold prices in dollar terms and may also result in upward pressure on interest rates and slow economic, growth boosting demand for gold as a perceived safe haven. While we expect the Federal Reserve’s (Fed) program of stimulus will continue to weaken the dollar well into 2011, we do not expect a sudden devaluation that would propel gold sharply higher.

Emerging Markets

Emerging markets suffered during the financial crisis of 2008-2009 when they experienced similar losses to developed markets. However, emerging market stocks have rebounded to prior peaks stoking fears of overvalued markets due for another sharp downturn. As you can see in Chart 2, emerging market stocks have not yet entered the parabolic stage where the bursting of the bubble historically becomes a risk.

What could push emerging market stocks into historical bubble territory? A flood of money has been pouring out of slow-growing developed economies into rapidly growing emerging market economies. As a result, the currencies of emerging market nations have been rising, elevating the risk of their exports, and becoming less competitive in world markets. As emerging market countries succumb to increasing pressure to reduce the strength of their currencies asset bubbles may inflate due to the excessive stimulus from domestic actions in addition to inflows from abroad.

Volatility

While not in historical bubble territory, gold prices and emerging markets do have risks. For example, a contraction in growth in the emerging markets would weigh on both asset classes. And, importantly, if gold and emerging market stocks continue to track the bubble pattern, they have reached the stage of the pattern where volatility picks up and sudden, sharp moves become more common as the bubbles inflate and risks build.

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IMPORTANT DISCLOSURES

photo credit: seequinn

The long-awaited events of last week included the mid-term elections and Federal Reserve (Fed) announcing the details of another stimulus program. Stock market momentum had stalled out in the two weeks leading up to last week as investors held their breath awaiting the outcome. The events unfolded just as the markets had anticipated and mostly priced in during the double-digit gain in the S&P 500 that took place during September and October. As investors breathed a sigh of relief last week, the stock market posted a solid 3.5% gain resulting in a new two-year high in the S&P 500 as pent-up demand for stocks was invested.

While the major headlines are out of the way, what happens in Washington during the remainder of the year will still hold influence over the markets. Some of the lame duck agenda items with potential market-moving impact include the expiration of unemployment benefits, government funding, and the Bush tax cuts.

Extended unemployment benefits will expire at the end of November if Congress fails to renew them in the coming weeks. People who exhaust their 26 weeks of regular state unemployment benefits can then receive up to 73 weeks of federally funded benefits, for a total of 99 weeks in high-unemployment states. This summer, when the emergency benefits were last renewed, Republicans temporarily allowed extensions to expire for nearly two months. They objected to the extension because the cost to do so was not offset by other spending cuts and therefore added to the federal deficit, in violation of the pay-as-you-go rules. Since Republicans gained seats in the Senate last week, it could be even tougher to pass a renewal of the program potentially leaving millions without benefits during the peak consumer spending holiday season, posing risks to retailers and overall economic growth.

Mid-Term Elections

Before the mid-term elections, Congress passed a resolution funding the government until December 3, setting up a showdown over spending in the lame duck session. Also, the fiscal commission established by President Obama is due to report on December 1. There are indications that leading Democrats on the panel are seeking to present major changes to Social Security intended to ensure the program is solvent for the long run.

The most important item facing Congress is the looming expiration of the Bush tax cuts. Congress is likely to address the tax cuts in some way. Both parties risk a huge backlash if no action is taken and all tax rates revert to higher levels, which puts pressure on the 70% of the economy that is driven by consumer spending. This is a concern given that current economic growth is already sluggish. We continue to believe it is likely that Congress will pass a one or two-year extension of all the Bush tax cuts during the lame duck session, but admit it is a close call.

What About Dividends?

The potential for extending the dividend tax rate at 15% (as opposed to reverting up to 39.6% for the top bracket) and the ability of the companies in the Financials sector to boost dividend payouts made the sector the best performer last week. Financial companies that received TARP money must get regulatory approval to boost their dividend which may soon be forthcoming. The first quarter of the year has traditionally been when companies announce increases to their dividend payments. Last week, the Energy, Materials, and Industrials sectors benefitted from the Fed’s actions on Wednesday that weakened the dollar.

Investors’ appetite for yield has prompted strong inflows into the high-yield bond market this year. Perhaps last week’s performance is a sign that investors may migrate from high-yield bonds toward high dividend-paying stocks, possibly ending the U.S. equity buyers’ strike that has resulted in outflows from U.S. equity mutual funds every week during the second half of 2010. We will be watching money flows closely to see how they react to the changes in Washington.

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IMPORTANT DISCLOSURES

photo credit: ajagendorf25

This week may be the most important of the year for the markets. The week starts off with the Monday release of the closely-watched Institute for Supply Management (ISM) report on U.S. manufacturing, followed by the mid-term elections on Tuesday, the Federal Reserve meeting on Wednesday, which is expected to reveal the Fed’s plan for another round of major stimulus for the economy, and finally on Friday, the employment report for the month of October is to be released providing an important reading on the state of the U.S. labor market. While the economic data and the Fed meeting will certainly have significant market impact, the event with the most far reaching implications is probably the mid-term elections.

Gridlock

The GOP is likely to take the majority in the House and hold about half of the Senate. The likely return to political balance between the parties in Washington may slow the pace of legislative change and result in the “gridlock” the market has historically favored.

The President’s party has traditionally lost seats in Congress during the mid-term elections making it harder to pass new legislation in the second half of the Presidential term. This pattern is magnified this year in terms of impact. Based on polling data, the 2010 mid-term elections are likely to mark a return to a balance across the aisles in Washington as the political pendulum swings back from the sweeping majority in the House and Senate the Democrats picked up in 2006 and consolidated in 2008. This balance lowers the probability of dramatic legislative changes and is likely to result in the return of gridlock.

Stock Market and Elections

Historically, the stock market has performed better under periods of gridlock, but this record is far from consistent. Not surprisingly, other factors appear to bear more weight than politics. On the other hand, the bond market clearly has performed much better during periods of gridlock, most likely because investors assign a lower probability to the passage of new spending initiatives that would increase the debt supply.

With the start of the fourth quarter, the stock market entered what has historically been the best four-quarter period of performance during the four-year presidential cycle. Since World War II, the stock market has always posted a double-digit gain from the end of the third quarter of year two to the end of the third quarter of year three of the presidential cycle, and that gain has consistently averaged an impressive 30%.

Historically, the presidential cycle of stock market performance has been driven largely by changes in monetary and fiscal stimulus to the economy. These changes are evident again in this cycle. Our outlook for the coming four quarters is for modest gains that are comparatively low for similar-period performance during the past five decades and we expect the gains to be accompanied by higher-than-average volatility.

Interestingly, the last time the market earned a gain of less than 15% during the four-quarter period that began at the end of the third quarter of a mid-term election year was 1978 — when inflation was soaring to double digits, the Fed was aggressively hiking rates, and economic growth was sliding into the recession that officially began in January 1980. While we expect a less than 15% gain in the stock market over the four-quarter period that began at the end of the third quarter of 2010, in contrast to 1978 the environment is much more favorable. For example, inflation is relatively tame today, the Fed is providing more stimulus rather than taking it away, and we do not expect the current period to close with the same economic fate.

Potential Positives

Two reasons that the market may follow the historical pattern with gains in the coming year are the support that may come from extending the Bush tax cuts and the potential for stronger job growth.

Buy the Rumor, Sell the News?

Since investors appear to have already bought into the rumor of a favorable outcome to the election given the gains of recent weeks investors might sell upon the news of the actual results. However, we believe that the election outcome is not fully priced into the stock market and could experience further gains if the GOP has a better-than-expected showing and takes the Senate.

Historically, the stock market has provided post-election gains. The stock market, measured by the S&P 500, in the fourth quarter of a mid-term election year has nearly always been positive and has posted an average gain of 7.9%. There were only two years when the market posted declines, 1978 and 1994, and in both of those years the Fed was hiking rates aggressively, an event that is highly unlikely this quarter. While it may appear that the fourth quarter has already posted solid gains in anticipation of the election outcome, the market typically provides additional gains following the mid-term elections.

One reason for additional gains for stocks this quarter is related to the prospects for tax cut extensions. We believe a positive impact of the resolution of uncertainty around tax rates is probable given that the outcome is likely to be better than what investors have priced in to the markets. However, a factor that could undermine the impact of any positive action on taxes is that the changes may not be permanent. A one-year extension of current tax rates may not be as welcome as a resolution of the tax rate uncertainty. Nevertheless, the resolution of the uncertainty with a late-year passage of an extension of the Bush tax cuts for 2011 would be welcomed by the markets.

Sector Implications

The stock market seems to have priced in the return of gridlock and the GOP potentially taking the House, but a surprise takeover of the Senate by the GOP could have further ramifications for some sectors.

While a strong showing by the GOP may not undo the reforms passed this year, it may reduce the risk of additional legislation that could harm corporate profitability in 2011. In addition, the slower and more moderate pace of legislation and regulation in Washington, along with the fading perception of an anti-business environment, may lift the uncertainty that is hurting investment and hiring — especially by smaller businesses less equipped to navigate the changes.

We believe the mid-term election outcome has the most significant longer-term market impact. However, the Fed meeting the day after the election holds major market-moving potential as the Fed has the potential to surprise or disappoint investors with the size and scope of the stimulus plan to be unveiled in its statement released at 2:15 PM ET on Wednesday. The mid-term election of 1994 is instructive on this point. It was a landslide win for Republicans and even had the upside surprise of the GOP also taking the Senate and not just the House, as had been expected. Yet stocks posted a modest loss from the time of the mid-term election through the end of the year as monetary policy dominated the election outcome with the Fed hiking interest rates and withdrawing stimulus from the economy.

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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.
• The ISM index is based on surveys of more than 300 manufacturing firms by the Institute of Supply Management. The ISM Manufacturing Index monitors employment, production inventories, new orders, and supplier deliveries. A composite diffusion index is created that monitors conditions in national manufacturing based on the data from these surveys.
• Energy Sector: Companies whose businesses are dominated by either of the following activities: The construction or provision of oilrigs, 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.
• 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.
• Health Care 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.
• 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.

photo credit: JoeInSouthernCA

Many of my clients (and me included) have been concerned about the expected rise of inflation. The problem is that we’ve been concerned for a few years and thus far, inflation has been a non-concern. What seems to be the new concern is deflation. Where deflation isn’t a typical concern for the average consumer, it has been a topic of concern for consumers and the Federal government at large for many years. Journalist Dave Carpenter refers to deflation as “Deflation is the potential new boogieman for consumers, replacing inflation.” So what exactly is this new boogieman? It is defined as the declining of prices of goods and services over time. Deflation is the direct opposite of inflation and occurs for one or more of the following reasons:

• The supply of money decreases
• The supply of other goods increases
• The demand for money increases
• The demand for other goods decreases

When Does Deflation Occur

Typically, deflation will occur when the supply of goods increases faster than the supply of money on hand. A good example of deflation can be explained using the advancement of technology. Years ago, personal computers cost a fortune because the technologies back then didn’t allow for an abundance of products to be on the market. Remember how much you paid for a computer 10 years ago? Over time, technology has advanced so much that the supply of computers increased at a faster rate than the demand for money, causing the prices of computers to drop drastically over the years. Now you can go to Wal-Mart and buy a mini laptop for a fraction of the cost.

Deflation is a natural part of the economy. When deflation occurs, the available amount of currency falls for each person, making money harder to come by but yet giving it more purchasing power. Consumers then pay less for goods and services. It may sound advantageous to get more power with every dollar but deflation also heightens the issue of debt because after a significant time of deflation, payments being made towards a debt represent an increased amount of money than when the initial debt was incurred.

The Bad Side of Deflation

There are a number of reasons to be concerned or at least aware of deflation. When consumers continually expect falling prices, they are less willing to spend or borrow money. This situation can depress the economy which allows the deflation cycle to continue. This leads to less jobs and a smaller cash flow for businesses and individual consumers. Additionally, deflation can spark higher interest rates, making credit less affordable and reduces activity and demand in the economy.

Should You Be Concerned About Deflation?

photo credit: B Rosen

The symptoms of deflation can be a detrimental to an individual especially if they are left without a job and by definition have not traditionally been savers. Consumers are directly involved in the health of the US economy and when faced with a period of deflation, it is not solely the Federal government who must step in to the rescue. Spending money to stimulate the economy is just as necessary as the government’s responsibility to keeping money in stock.

During the Great Depression in the 1930’s, the Federal Reserve allowed the money supply to shrink by 35%. Consumers could not afford to buy products or services, and businesses could not sell what they were producing. Jobs were difficult to come by. The Federal Reserve is currently placing its focus on the declining demand for goods, the decrease in prices, and lowered wages. The government has not looked this closely at deflation since 2003 and there is concern we are not out of the woods just yet.

sources:

http://www.msnbc.msn.com/id/38822584/ns/business-personal_finance/

photo credit: James Jordan

While information on the economy, European bank stress tests, and corporate earnings helped to lift the markets last week, it may have been the hint that tax rates may not be going up as much as expected in 2011 that got investors the most excited. Based on comments from last week, the party consensus among congressional Democrats on taxes seems to be eroding with some members increasingly in favor of extending the Bush tax cuts as the November elections loom.

Last week Senate Democrats Kent Conrad and Ben Nelson joined Senator Evan Bayh in saying they supported extending the Bush tax cuts for all earners — including those with the highest incomes. In addition, at least half a dozen House Democrats also have come out publicly in favor of postponing tax increases for higher earners. The comments from the senators represent a departure from what appeared to be an emerging unified Democratic stance on the Bush tax cuts, which held that those for the top earners should be allowed to expire and investor tax rates on dividends and capital gains should be lifted to 25%–28%.

The internal party debate increases the odds that Democrats will be unable to tackle the question of 2011 tax rates until after the November election. After the election they may choose to waive the PAYGO rules that require any tax cuts to be paid for through other tax hikes or spending cuts in order to amend tax rates in a lame duck session and avoid a 2011 tax hike back to pre-Bush levels.

The current S&P 500 price-to-earnings ratio on the next 12-month earnings expectations is around 12. This is well below the average of 15 and reflects not only the uncertainty of the transition in the global economy from recovery to sustainable growth, but also the transition in spending and tax policy.

Investor Tax Rate Changes.

In theory, stocks are valued by investors based on expected total return, net of applicable taxes. For example, if dividend and capital gains taxes were each set at 100%, stocks would have little value to a taxable investor. It is reasonable to believe that the lower the tax rate, the more a taxable investor would value stocks up to that of a non-taxable investor. Looking at the post-WWII relationship between investor tax rates and stock market valuations based on trailing price-to-earnings ratios, we can see that stocks appear to have already priced in a return to much higher investor tax rates.

Based on our analysis of the tax debate in Washington we place the highest probability on the dividend and capital gains tax rates both rising to 25%. But we also acknowledge 20% or 30% rates are also potential outcomes as is a reversion to the 39.6% and 20% rates that preceded the 2003 cuts or a one year extension of all current tax rates of 15%.

If we average the historical top dividend and capital gains tax rates together we find that during the post-WWII period a 25%–-30% combined investor tax rate was in effect only during 1991-92 and 1997-2002. During the later period, stock market valuation was at record highs, well above current levels, and does not serve as a good comparison due to the impact of the internet bubble distorting the overall market value. However, 1991-92 may offer a comparable period for analysis. During this period, the macroeconomic and geopolitical backdrop included the aftermath of the S&L crisis, sluggish economic growth, the first Gulf War, pessimistic consumers, and a weakening dollar.

During the 1991-92 period, the average top dividend and capital gains tax rate was between 25%–-30%, and stock market valuation, measured by the price-to-earnings ratio on the next 12 months expected earnings for the S&P 500 companies, was about 15. This figure is well above the current forward price-to-earnings ratio of about 12. While there are many factors that affect stock market valuation, the potential for higher tax rates on dividends and capital gains may already be fully discounted by the market. In fact, at 12 times forward earnings, stocks appear to be pricing in a return to when the average rate was around 35% suggesting a potential relief rally as the tax uncertainty is resolved.

Stock Market Impact of Investor Tax Changes

It is very difficult to determine how much of a market impact may be generated by the tax rate changes in the dividend and capital gains tax rates. It is hard to separate the impact of tax code changes from the economic backdrop for the stock market. For example, the capital gains tax rate went from 20% to 28% in 1987, when the 1986 tax reform act was passed. This did not stop the beginning of a rally in stocks that lasted for most of 1987, until the unrelated October 1987 crash. The market impact of the investor tax cuts in 2003 that lowered dividend and capital gains tax rates to 15% was difficult to discern, given the geopolitical and economic environment at the time, and the impact of the reversal of these provisions may be equally difficult to discern separately from their macro context. We can see this difficulty by looking back at the stock market’s reactions to the news of a proposed investor tax cut and then the passage of those cuts:

Initial details of the 2003 investor tax cuts began to appear in early December of 2002 with a statement from President Bush providing further insight into the package of tax cuts on January 7, 2003. Stocks slumped in December and January — even around the days details came to light — as investors were focused on the impending invasion of Iraq. The performance of both non-dividend paying and dividend-paying stocks was very similar, despite the prospects for a cut in the dividend tax rate.

Attention returned to the tax cuts in April 2003 as competing bills with various provisions moved through both houses of Congress. There was much uncertainty as to what the final tax cut elements were to be and whether any investor tax cuts were going to be passed. The tax bill narrowly passed in mid-May with Vice President Cheney breaking the tie in the Senate. The package, including the investor tax cuts, was signed by the President on May 28, 2003. In April and May (and over the rest of the year), the stocks of low or no dividend-paying companies outperformed high dividend payers as stocks rallied powerfully and the invasion of Iraq got underway.

During both of the above referenced periods, U.S. and non-U.S. stocks also performed very similarly, with the world focused on Iraq. The impact of the investor tax cuts in the U.S. did not result in U.S. stock market outperformance. Also, low and non-dividend paying stocks outperformed the high-dividend payers that would benefit most from the lower dividend tax rate. It appears that the tax cuts played little or no role in stock market performance. Possible reasons may be that investors discounted the effect on future dividends since the cuts were not made permanent or that the effects on after-tax returns were deemed negligible relative to the macroeconomic and geopolitical drivers.

We believe the heightened attention on taxes and the deficit is more of a concern than in prior episodes of tax rate change. Consequently, we believe a positive impact of the resolution of uncertainty around tax rates is probable given that the outcome is likely to be better than what investors have priced in to the markets. However, it is difficult to predict the magnitude. One factor that could undermine the impact of any positive action on taxes is that the changes to the dividend and capital gains tax rates may not be permanent.

A one year extension of current tax rates may not be as welcome as a resolution of the tax rate uncertainty. As the year-end expiration of the 15% capital gains tax rate looms investors may be prompted to sell to lock in the 15% rate. However, there are not a lot of long-term capital gains to be taken in the stock market with the major averages still down sharply from their 2007 highs. The selling would most likely take place in sectors that have generated the largest long-term capital gains for those investors who bought stocks in the first half of 2009, such as Financials.

A potential outcome of the year-end dividend rate tax hike could be a large number of public companies with a high concentration of family and closely held shares declaring and making a one-time, special dividend payment in the fourth quarter to be sure to take advantage of the 15% tax rate before it goes away.

Income Tax Changes

Historically, changes in income tax rates appear to have had little, if any, direct impact on government bond yields. Yields rose with inflation in the 1970s and fell as inflation fears receded over the vast majority of the last 30 years regardless of tax code changes or their impact on the deficit. To see why this relationship is similar for the stock market we can look at the two most important drivers of stock market return: earnings growth and valuations.

Impact of Income Tax Rates on Earnings Growth

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Generally, higher taxes mean less of an incentive for individuals to work, invest, take risks to create value and become entrepreneurs. It can also mean less disposable income to spend on goods and services. However, income tax changes have not had much measurable effect on earnings growth. Earnings growth is very cyclical — it falls sharply during recessions and rebounds early in expansions to average about a 7% growth rate over the full cycle. This has been consistent regardless of the prevailing tax rates. In fact, the growth rate of earnings from the peak of one business cycle to the next has consistently been about 7% over the six major earnings cycles spanning the past 50 years despite average top marginal income tax rates that ranged from 91% at the beginning of the period to the current 35%.

Impact of Income Tax Rates on Stock Market Valuation

Over the past 30 years, higher effective federal income tax rates for the top 20% of earners (who tend to make up the majority of individual investors) have not resulted in lower stock market valuations, measured by the forward price-to-earnings ratio (the current price divided by the next 12 months expected earnings) for the S&P 500 index. Counter-intuitively, periods of higher valuations were during periods of higher effective tax rates and lower valuations when tax rates were lower. However, much of this can be explained by cyclical factors. For example, in the late 1990s stock market
valuations rose to record highs despite relatively high marginal and effective tax rates.

Time is Short

On July 30, the House departs for the August recess and the Senate departs on August 8. They return in mid-September and only have a few weeks until early October before they adjourn to campaign for the November 2 mid-term elections. It is highly unlikely that a fractured majority party that is lagging in the polls and an opposing minority party can come together on such a controversial issue ahead of an election in three weeks this fall. The state of the soft spot in the economy may be a motivating factor pushing for an extension of the Bush tax cuts for a year.

Our base case is for a tax bill to be passed in November after the election that raises the top income tax rates to 39.6% and 36%, caps dividend and capital gains rates at about 25%, and the estate tax gets an exemption of $3.5 million and a 45% tax rate above that. However, last week’s news suggests the outcome may be for lower rates than we are forecasting and the market is discounting.

IMPORTANT DISCLOSURES

• This report was prepared by LPL Financial. 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.
• 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.
• This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
• The P/E ratio (price-to-earnings ratio) of a stock is a measure of the price paid for a share relative to the annual net income or profit earned by the firm per share. It is a financial ratio used for valuation: a higher P/E ratio means that investors are paying more for each unit of net income, so the stock is more expensive compared to one with lower P/E ratio.

photo credit: wstera2

With the markets’ movements in recent weeks driven almost entirely by news coming out of Europe it would seem that the European outlook must be central to the prospects for global economic and profit growth. However,evidence to the contrary was abundant last week as the stock, bond, and commodity markets posted a gain despite the ongoing growth and solvency risks among some European nations.

Recent economic and company reports reaffirm strong growth in Asia and solid growth here in the United States. This data helped to ease investor fears that a weak outlook for Europe spells the end of global economic and profit growth. Last week’s data included:

• The largest rise in China’s exports in six years was reported for bolstering confidence that global demand remains solid, fueling the
  fastest-growing major economy.
• Surging retail sales in the United States. While soft in May, sales at retail chain stores have rebounded sharply over the past two weeks posting the strongest weekly gains of 2010.
• The Organization for Economic Cooperation and Development (OECD) raised its forecast for global growth to 4.6% in 2010 and 4.5% in 2011.
  These forecasts are up from six months ago when it predicted growth of 3.4% this year and 3.7% in 2011. In addition, the OECD reported that unemployment among the 31 member countries may have peaked at around 8.5%, much lower than its previous prediction of almost 10%.
• The fastest rate of growth in Japan in three quarters. Japan’s Cabinet Office reported that the economy expanded at a strong 5% annualized
  rate in the first quarter driven by exports to Asia.
• Solid job growth in South Korea and Australia. South Korea’s unemployment rate declined to 3.2% in May, the lowest level since
  October 2008, down from 3.7% in April and a 10-year high of 4.8% in January. Australia’s unemployment rate fell to 5.2% from 5.4% as the
  strengthening global economy prompted companies to hire.
• Some economies are growing fast enough for policy makers to begin raising borrowing costs. New Zealand’s central bank increased the
  official cash rate to 2.75% from a record low 2.5%, the first boost in three years. New Zealand is joining other nations hiking rates including
  Australia and India.
• Analysts revised earnings for S&P 500 companies slightly higher last week. Upward revisions have continued even as stocks pulled back. Since the stock market peaked this year on April 23, S&P 500 earnings expectations for the next 12 months have risen 3.6% from $85.69 to $88.78. This has compressed the price-to-earnings ratio to just below 12, well below the historical average.
• There was no sign that emerging European banking problems are spreading beyond the Eurozone to the rest of the world. U.S. LIBOR
  has remained flat for the past two weeks after initially rising along with European LIBOR for much of May.

Europe may be sneezing, but the rest of the world does not appear to be catching the cold. We will continue to watch real-time indicators for the impact that Europe’s problems, and the efforts to combat them, are having on economic conditions. As more evidence of this nature mounts over the coming weeks, we expect the markets to rebound from the recent pullback.

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 involves risk including loss of principal.
• 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.
• London Interbank Offered Rate (LIBOR): An interest rate at which banks can borrow funds, in marketable size, from other banks in the London interbank market. The LIBOR is fixed on a daily basis by the British Bankers’ Association. The LIBOR is derived from a filtered average of the world’s most creditworthy banks’ interbank deposit rates for larger loans with maturities between overnight and one full year.

photo credit: emmerrrrrrr

Our outlook for 2010 remains for modest gains in the stock and bond markets, accompanied by a lot of volatility. Over the last couple of months, we presented our reasons for why we believed the stock market, as measured by the S&P 500, was due for another 5-10% pullback. While the current pullback that began on April 24 came as no surprise, the month long decline has exceeded our expectations with a peak-to-trough decline of 12%. Nevertheless, we continue to believe it is a pullback and not the start of a new bear market. This pullback is merely part of the higher volatility in the markets we have been expecting this year to accompany the transition from recovery to sustainable growth.

The market pullback has a number of drivers:

• Financial reform legislation has weighed on the Financials sector.
• China’s measures to slow growth have been raising fears that the sudden withdrawal of stimulus to one of the world’s biggest growth engines maybe premature and tip the global economy back into recession.
• Last week’s decline in the Index of Leading Indicators, the first decline in a year, is a sign that economic growth may be slowing.
• However, the big issue affecting the market has been the debt problems in Europe and fear of another global credit crisis.

We expect the markets to rebound during the second quarter for the following ten reasons:

1. Although unlikely to improve much in the near-term, the European debt and deficit problems are unlikely to get much worse. The trillion dollar rescue package has been passed ensuring adequate capital to meet the financing needs over the next few years for Europe’s most troubled economies. Europe has some silver lining to the problems they are facing since the lower euro is a boost to the competitiveness of European exports helping to balance out weaker domestic growth.
2. The derivatives and leverage tied to the sovereign debt is very different than the financial crisis of 2008 (for example, debt-to-GDP (gross domestic product) for Greece is 1-to-1, while at Bear Stearns and Lehman Brothers it was 40-to-1). The smaller magnitude of the debt problem is unlikely to lead to another global financial crisis.
3. The concerns over the debt problems in Dubai and Iceland faded quickly after a month or two of intense concern last year. The budget and debt problems now weighing on Greece are an aftershock of the global financial crisis and not a sign of a new crisis developing. The problems are akin to what many people and businesses that overindulged during the credit boom are now experiencing, as the negative consequences of the global recession have forced belt tightening to try to make ends meet while restructuring debt. That is what happens at the end of a credit crisis and recession, rather than at the beginning.
4. Fortunately for investors, expectations for the Eurozone are low and do not need to be cut drastically leading to further declines in markets. For example, U.S. exports to Europe, European oil consumption, and Europe’s GDP are all already expected to be very low or negative.
5. The problems in Europe are good for the U.S. consumer by putting more cash in consumers’ pockets. The falling price of oil is pulling down gasoline prices as we head in to the peak demand summer driving season and the money flowing into Treasuries is leading to lower mortgage rates and a new wave of refinancing.
6. As indicated by the LPL Financial Current Conditions Index, conditions remain favorable for growth.
7. Stock market valuations are now low at a forward price-to-earnings ratio of about 13 times. Also, the stock market is technically oversold by even more than it was overbought in mid-April when we were concerned about a pullback, suggesting selling may soon stall and buyers attracted by value will re-emerge.
8. China’s growth remains on track and the weakness in Europe may keep Chinese officials from invoking further measures to slow their economy in the second quarter.
9. Financial reform legislation may see a lot of changes to moderate it in conference before it is signed by the President, given some objections by the Fed and Treasury. This may help stabilize the Financials sector which has been one of the sectors that has led the stock market lower.
10. The outlook for The Federal Reserve (Fed) rate hikes may now be pushed out with the futures markets now pricing in the first hike not taking place until 2011

We still believe that while the next week or two could be up or down a little, four or six weeks from now stocks will be up and headed back near the highs of April.

What would change our minds?

Not a level in the stock market, but a level on spreads and other indicators of contagion like borrowing rates in Europe and signs of bank stress. Material deterioration in indicators of contagion such as:

• The TED spread, a measure of stress in the banking system based on the willingness of banks to lend to each other, has risen this year to a slightly above average 35 basis points (bps), but remains well off of the crisis peak of 463 bps in 2008 and below the levels of 2008 that led up to the peak of the crisis in October 2008.
• The level of European interest rates and credit default swaps, which have both declined from the peak levels prior to the announcement of the rescue plan, but some southern European countries are elevated from levels at the start of the year.
• The value of the euro, which has fallen sharply this year but has stabilized in the past two weeks around $1.24.
• Corporate bond issuance, which has contracted sharply reflecting tighter financing conditions.
• The volume of central bank liquidity swaps, which has picked up reflecting the need for dollar-based financing overseas. These factors would prompt us to re-evaluate our outlook and may warrant a more defensive investment stance.

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 involves risk including loss of principal.
• 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.
• Investing in international and emerging markets may entail additional risks such as currency fluctuation and political instability. Investing in small-cap stocks includes specific risks such as greater volatility and potentially less liquidity.
• Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and are subject to availability and change in price.
• A basis point is a unit relating to interest rates that is equal to 1/100th of a percentage point. It is frequently but not exclusively used to express differences in interest rates of less than 1%.

photo credit: n8kowald