Monthly Market Monitor - May 2010

Budget Concerns
Despite many analysts’ repeated calls for a market correction, most major indexes continued to move higher in April. The rally was primarily driven by optimism over the economic recovery. One area of concern, albeit over the longer term, is the dramatic rise in the federal budget deficit. As the chart below indicates, the budget deficit at the end of March was more than $1.3 trillion. This amount dwarfs any previous total from the last 40 years. In addition, as a percentage of nominal GDP, the deficit stood at -9.5% in March. The shaded areas of the chart represent periods of recession as defined by the National Bureau of Economic Research. And the picture is not expected to improve for some time. The White House’s Office of Budget Management recently projected annual deficits of at least $700 billion all the way through 2020, with a total deficit of $8.5 trillion for the years 2011-2020. Nor do these figures include projected spending on Social Security and Medicare. So what does this mean for investors? Most analysts agree that one certainty is higher taxes, as additional revenue will be needed to support these deficits. Whether or not there is a resulting impact on economic growth is a debate that will likely continue for some time.

Earnings Again Surprising to the Upside
As of 04/26/10, roughly one-third of companies in the S&P 500 had reported earnings for the first quarter of 2010. In a trend similar to the last several quarters, many companies are reporting results that exceed the consensus analyst estimates. According to Ned Davis Research, 76% of the companies that have reported earnings managed to surpass estimates, while only 13% failed to meet expectations. This suggests that analysts have not accurately priced the economic recovery into their models.

And in another positive sign, many of these companies are exceeding revenue estimates as well. During the economic downturn, a large number of companies reduced their cost structure through layoffs. And in the past few quarters, positive earnings surprises were often the result of cost reduction initiatives. These are important drivers of operating leverage, but costs can only be reduced so far. Thomson Reuters recently noted that of the companies that have reported, 68% have exceeded the consensus revenue estimate. This implies that companies are generating earnings growth from both cost cutting and top-line revenue growth.

1. Wall Street Journal, 05/01/10

The views are those of Cameron Lavey, Senior Investment Analyst, Research Department, Cetera Financial Group, and should not be construed as investment advice.

All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. All economic and performance information is historical and not indicative of future results. The market indices discussed are unmanaged. Investors cannot directly invest in unmanaged indices. Please consult your financial advisor for more information.

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