LP L FINANCIAL R E S E AR C H
Weekly Market Commentary
v4
Jeffrey Kleintop, CFA
Chief Market Strategist
LPL Financial
Highlights
The year got off to a brutal beginning as the
subprime mortgage meltdown turned into a
full-blown financial crisis. By the end of the
first half of the year there were some signs
that the intensity of the crisis was fading, but
the lingering effects continued to weigh on the
Financial sector and combined with surging oil
prices to pull the overall stock market down to
end the first half of the year revisiting the lows of
mid-March.
We look forward to the rewarding remainder of
the year after a brutal beginning. The summer
stock market volatility, while frustrating, is
likely to remain range-bound and give way to a
fourth quarter rally. By the fourth quarter, the
uncertainty surrounding the election, energy
prices, the economy and earnings is likely to
have lessened. It is worth noting that in every
presidential election year since WWII, the S&P
500 has posted a gain in the fourth quarter, with
the only exception being 2000.
June 30, 2008
Mid-Year Outlook
At the halfway point for the year, we review and update our outlook for key
market drivers and market performance for the second half of the year. At
the beginning of the year we expected:
ƒ U.S. stocks will generate a mid double digit total return,
ƒ Bonds to provide total returns of in the low to mid single digits and
ƒ Cash equivalents will yield in the low to mid single digits
Much has happened in the financial markets since November of last year.
It now appears that the return on bonds and cash may fall short of our
forecast range for 2008 with returns in the low single-digits now appearing
more likely. While the risk that stocks will fall well short of our target has
certainly increased, we believe that stocks still may reach the low end of the
forecast range. We had forecast that the gains for the stock market in 2008
would all come in the fourth quarter and we continue to believe the end of
the year will provide a rally as our outlook unfolds with the Fed raising rates,
the dollar strengthening, oil prices receding (even if only temporarily), the
economy avoiding recession, earnings growth beginning to reaccelerate, and
election uncertainty fading.
Brutal Beginnings
The year got off to a brutal beginning as the subprime mortgage meltdown
turned into a full-blown financial crisis resulting in the collapse of a venerable
Wall Street institution, Bear Stearns. In response to the unfolding crisis, the
Federal Reserve cut interest rates aggressively and took unprecedented
actions to extend credit to liquidity-starved investment banks. The actions
initially boosted the stock market, with the markets rebounding to about
where they started the year by mid-May. By the end of the first half of the
year, there were some signs that the intensity of the crisis was fading. With
existing home sales stabilizing, the economy avoided recession with modest
GDP growth of 1–2% likely to be reported for the second quarter after a rise
of 1% in the first quarter, and credit spreads – a key measure of fear in the
bond market – receding from the peak of mid-March. In mid-May we wrote
that the stock market rally back to the levels at which the year began was
likely to be over and give way to a volatile, range-bound summer. Indeed,
stocks did return to the lows of the year’s range by the end of the first half.
The lingering effects of write-downs and dilutive capital raises continued
to weigh on the Financial sector and helped to pull the overall stock market
down to end the first half, revisiting the lows of the year. We expect these
pressures to ease in the second half, with dwindling write-downs and
sufficient capital to avoid having to offer substantial discounts to capital
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 W E E KLY MARKE T CO MME N TAR Y

1 Credit Crisis investors. Stability in the dollar may attract foreign capital into U.S. financial
Lehman Brothers High Yield Bonds Index Spread to 5 Year T-Note services firms, as it has happened in the past. [chart 1]
12
Another reason for the brutal first half of the year was the rise in energy
10 prices. Oil prices surged into bubble territory in the first half of 2008. [chart
8
2] The parabolic move in oil prices echoes that of the NASDAQ bubble that
peaked in March of 2000. The price of oil has risen 50% in the past four
6
months and more than doubled in the past year. The price rose even as
4 inventories of crude oil were building to well above average levels, demand
2 declined in developed nations, and demand slowed in emerging market
countries like China. Recently, the Department of Transportation reported
0
Jan 2 Jan 11 Jan 10 Jan 9 Jan 11 Jan 10 Jan 8 Jan 7 that Americans drove 30 billion fewer miles than they did a year earlier – the
2001 2002 2003 2004 2005 2006 2007 2008 decline is the first year-on-year decline since the 1979 oil shock and the
Source: LPL Financial, Haver sharpest decline ever. The conundrum of higher prices despite weakening
demand and abundant supply can be explained by recognizing that while the
physical commodity remains in balance with regard to supply and demand
- the financial commodity of oil is clearly out of balance, with far more
investment demand for commodities than supply.
During the buildup of the NASDAQ bubble those later called speculators
2 Bubble Territory
NASDAQ and Oil Prices considered themselves, at the time, to be long-term investors. Today,
with all the talk of speculation in the commodity markets, the buyers of
Oil Past 10 Years NASDAQ From 10 Years Prior to Peak
1200% commodities also consider themselves to be long-term investors. Many
1000% investors have been increasing their portfolio allocation to commodities.
800% When an investor, like the California Public Employees’ Retirement System
600% (CalPERS), for example, increases their commodities allocation from $450
400% million to $7.2 billion, it goes to commodity futures contracts rather than
200% actual physical commodities. (CalPERS announced this shift in February
0%
of this year with the intention of implementing a 16-fold increase in their
allocation to commodities by 2010.) Far more barrels of oil change hands in
-200%
Mar-90 Mar-92 Mar-94 Mar-96 Mar-98 Mar-00 Mar-02 the form of futures contracts than in the physical trading of oil; as a result,
Source: LPL Financial, Bloomberg the price of oil is set in the futures market. Of the total volume of trading
in commodities futures markets, 80% is in energy contracts. Commodity
indexes such as the Goldman Sachs Commodity Index (GSCI) are volume
weighted – since volume is a measure of liquidity. The billions of dollars
flowing into commodities are going into just a handful of futures contracts
(dominated by the crude oil contracts). As a result, the supply and demand
3 Fed Rate Hikes Have Ended Past Asset Bubbles for the financial investment in commodities is out of balance – billions of
Federal Funds Target Rate and Peak of Past Asset Bubbles Labeled – demand but relatively few futures contracts to be bought – pushing the
Forecast in Orange price into bubble territory and a decoupling from the fundamentals of the
25
Gold at $835
physical commodity.
20 When will the bubble pop? Past bubbles have required rate hikes by the
“Nifty Fifty” Dollar Peak
Japanese Internet Federal Reserve to end them. Looking back at the past 40 years of asset
15 Stocks Bubble
Mexican bubbles, we can see that about every five years a bubble develops and
Debt Housing
10
Peak bursts. Typically, the Fed lowers rates to limit economic damage in the
Oil
Top? aftermath of the bursting of a bubble; these low interest rates then sow the
5 seeds of the next bubble. The bubbles burst as the Fed hikes the Federal
funds rate. [chart 3] The Fed is expected to begin to hike rates later this year.
0
1971 1975 1979 1983 1987 1991 1995 1999 2003 2007 2011 Until then, it is possible oil prices will continue to climb and contribute to
Source: LPL Financial, Bloomberg market volatility in the coming months.

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 W E E KLY MARKE T CO MME N TAR Y

While the third quarter may continue the volatility seen in the first half, with
the key risks of financial crisis and soaring oil prices easing in the fourth
quarter, the stock market may finally reward patient investors.

Presidential Pattern of Performance

The market pullback since mid-May is typical for the pattern of market
performance during the summer of a presidential election year. We
have frequently highlighted the pattern of stock market performance in
presidential election years and forecast that this year was likely to track the
typical volatile, but range-bound, pattern of performance followed by a break
out to the upside as the election uncertainty fades. The summertime blues
typically kept the S&P 500 within a range of about 7.3% during the summer
(June 1 to September 30) of the past five presidential election years, with
an average peak to trough decline of about 6.3%. We believe that this
year’s heightened uncertainty surrounding the four “E”s – Election, Energy,
Economy, and Earnings may lead to even more volatility than seen during
the summer of most election years. The stock market is down about 10%
since the recent peak of May 19, as measured by the S&P 500 index.

S&P 500 SUMMERTIME PERFORMANCE

During Past Five Presidential Election Years
Range of Return Maximum Decline Total Return
2004 7.3% -7.1% +0.0%
2000 6.9% -6.2% -0.5%
1996 9.2% -7.6% +3.5%
1992 5.9% -3.9% +1.8%
1988 7.1% -6.8% +3.2%
Average 7.3% -6.3% +1.6%

The summer volatility, while frustrating, is likely to remain range-bound and

give way to a fourth quarter rally. By the fourth quarter, the uncertainty
surrounding the four “E”s is likely to have lessened. It is worth noting that
in every presidential election year since WWII, the S&P 500 has posted a
gain in the fourth quarter as the uncertainty surrounding the outcome of the
4 Presidential Pattern of Performance
S&P 500 Total Return During Presidential Election Years
election fades, with the only exception being 2000. [chart 4]
1992 1996 2000 2004 2008 The timing of the market break out of the range in an election year depends
30%
upon when the election outcome becomes obvious. Recent elections have
20% shown both an early and late conclusion to the election uncertainty. For
10%
example, in July 1996 Clinton‘s standing as of the Democratic National
Convention in July removed most doubt as to the election outcome, and
0%
markets began to rise well ahead of the actual election. In contrast, the
-10% 2004, the outcome was unclear until the election, and the rally began in late
-20% October, just ahead of the election.
-30% The polls coming out of the nomination contest are starting to show a
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec strong bounce for Obama - who already polled ahead of McCain despite
Source: LPL Financial, Bloomberg the lengthy primary process for the Democrats. Vice-President selections
in July are unlikely to conclusively widen the spread between the two
candidates. However, by the time of Obama’s nomination at the convention
on August 28 (the 45th anniversary of Dr. Martin Luther King’s “I Have a

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 W E E KLY MARKE T CO MME N TAR Y

Dream” speech) the outcome may be clear. It is possible that the timing of
the break out of range may be in early September; however, it is far too early
to be sure of any outcome – even that a consensus will emerge around the
frontrunner by the start of September.
According to recent polls, the economy has replaced the war in Iraq as
the number one issue with voters, and so it is likely that economic issues
with a direct impact on businesses will receive a lot of attention from the
candidates. This focus may magnify the typical volatility characteristic of
the summer of an election year – especially in industries that are particularly
sensitive to the political climate surrounding trade/protectionism, climate
change, and health care.
We look forward to a rewarding remainder of the year after a brutal
beginning. The second half of 2008 is likely to be more rewarding for
investors. We expect to see the market respond to improvement in the four
“E”s in the fall:
ƒ Election uncertainty will be likely past the peak.
ƒ Energy prices may recede as a result of fourth quarter rate hikes by the
Federal Reserve.
ƒ Economic and earnings growth may reaccelerate from the lagged
impact of Fed rate cuts, tax rebate checks, fading commodity prices, and
dwindling subprime-related losses.
In the meantime, the summer may remain frustrating for investors and an
emphasis on alternative investments to take advantage of volatility is likely
to prove valuable.

IMPORTANT DISCLOSURES
This report has been prepared by LPL Financial from sources believed to be reliable but no guarantee can be
made as to its accuracy or completeness. The opinions expressed herein are for general information only, are
subject to change without notice, and are not intended to provide specific advice or recommendations for any
individuals. Please contact your advisor with any questions regarding this report.
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.
Stock investing involves risk including loss of principal Past performance is not a guarantee of future results.
Indices are unmanaged and cannot be invested into directly

This research material has been prepared by LPL Financial.

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