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Market Commentary (updated: 08.23.11)

What are you doing this weekend?

With summer winding down, most of us have plans for barbeques, picnics and baseball games this weekend. Unfortunately, our friends at the Federal Reserve (Fed) are not so lucky. Beginning this Friday, Fed Chairman Ben Bernanke is headed to Jackson Hole, Wyoming, as part of the annual Kansas City Fed economic symposium. Growth concerns evidenced recently by weak labor market readings, poor new home sales data, and worse-than-expected regional readings on manufacturing activity are pressuring Bernanke to find ways to jumpstart this frail economy. At the same meeting last August, Bernanke paved the way for a second round of quantitative easing with his Jackson Hole speech.

In a nutshell, quantitative easing is an attempt by the Fed to stimulate both inflation and the economy by weakening the US dollar. By purchasing government securities, such as Treasuries, from banks and through the open market, the Fed attempts to increase the money supply. Using the basics of supply and demand, the greater the money supply, the weaker the US dollar. The weaker US dollar makes our exports more attractive (cheaper!) and increases inflation. The latter is important because lower inflation, or worse deflation, can be a drag on economic growth as consumers postpone purchases in anticipation of lower prices in the future. If postponing purchases becomes a trend, this can be a drag on the economy. Keep in mind that about 70% of US economic growth is consumer driven. On the business side of the equation, higher inflation allows companies to pass on costs to consumers, leading to increased profit margins. Ideally, increased profit margins should spur hiring and eventually drive consumer spending.

Speculation surrounding what Bernanke will announce regarding a possible third round of quantitative easing (QE3) or other accommodative monetary policy actions has pushed equities higher today. To understand investment performance following previous QE announcements (QE1 and QE2 were officially announced in March of 2009 and September of 2010), the table below shows three-month and six-month performance of major investments:

Not surprisingly, beneficiaries of quantitative easing have been commodities. Most commodities are priced in US dollars and a weaker dollar increases their price. Also, within commodities, those with an industrial use, such as copper and oil, have outperformed precious metals, such as gold. As investors become more optimistic about the economy, they tend to target economically sensitive investments. On the other hand, gold, which offers many safe-haven characteristics, tends to underperform as investor confidence grows. Also, small-cap equities have outperformed large-cap equities.

As we have highlighted in previous commentaries, we do not believe a double-dip recession is in the cards. In our view, while a recession cannot be ruled out, a more likely economic scenario is one characterized by a sustained period of sub-par, though positive growth. If Bernanke were to hint at QE3 this weekend, we believe the likelihood of a recession will dip, though the odds still are against a period of significant growth. We will continue to monitor our indicators and provide updates going forward.

This information is compiled by Cetera Financial Group from source material obtained or provided by US federal and state departmental websites, equity index sponsors Standard & Poor's, Dow Jones, and NASDAQ, credit ratings agencies Standard & Poor's, Moody's Ratings, & Fitch Ratings, domestic and foreign corporate issued newswires and press statements, and from referenced compilations and index readings by Bloomberg Professional. The information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The information has been selected to objectively convey the key drivers and catalysts standing behind current market direction and sentiment.

No independent analysis has been performed and the material should not be construed as investment advice. Investment decisions should not be based on this material since the information contained here is a singular news update, and prudent investment decisions require the analysis of a much broader collection of facts and context. All economic and performance information is historical and not indicative of future results. Investors cannot invest directly in indices. This is not an offer, recommendation or solicitation of an offer to buy or sell any security and investment in any security covered in this material may not be advisable or suitable. Please consult your financial professional for more information.

While diversification may help reduce volatility and risk, it does not guarantee future performance. Additional risks are associated with international investing, such as currency fluctuations, political and economic instability, and differences in accounting standards.

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