September and October are usually thought to be bad months for stocks. Black Monday in 1987 and the Black Week selloff in 2008 both took place in October, and the events of September 11, 2001 resulted in a big drop as well. Historically, September is the worst month with an average decline of 1.5% since 1929. However, in 2010, this trend was bucked and stocks posted some of their best gains in more than a decade for this two month period.

One of the driving forces behind this movement has been corporate earnings. According to Bloomberg, S&P 500 earnings, excluding financials, are expected to show growth of 21.9% for the third quarter. As of October 26, 79% of companies in the S&P 500 who have reported third quarter earnings have exceeded analysts’ estimates. Companies have kept costs contained and productivity high, and many are also benefiting from emerging markets and international growth.

Another driving force of higher stock prices has been the expectation for a second round of quantitative easing from the Fed after their meeting November 2 and 3rd. Since the Fed Funds rate cannot be lowered because it is already near 0%, quantitative easing will consist of the Treasury issuing more government bonds and the Federal Reserve increasing their purchases of government bonds. This action will increase liquidity by lowering borrowing rates on longer term loans thereby giving corporations and individuals an incentive to borrow more and increase spending.

A third driving force has been the upcoming midterm elections. Republicans are expected to gain seats in both the House and Senate creating gridlock and resulting in new legislation not being passed as easily.

Although stocks have been strong the past two months, it is not time to ring the “all clear” bell yet. GDP growth for third quarter is estimated at 2.0%. While this is better than the 1.7% seen in second quarter, it is still not strong enough to create jobs and reduce unemployment significantly from its current 9.6%. With high unemployment, consumer spending may not pick up as people either do not have money to spend or are more interested in saving or paying down debt. Slow economic growth is expected to prevail even into next year and beyond.

Although quantitative easing may provide the means for people to spend more, it does not come without cost. Some analysts believe the government will spend another $1 trillion which will add substantially to the federal debt. While it will reduce the threat of deflation, inflation risks will rise again. Since Fed Chairman Bernanke has been hinting at it since August, the effects of quantitative easing may already be discounted. Gold and commodity prices have been increasing along with stock prices. These higher prices may start enticing investors to sell and take profits before the market can go down again. PIMCO’s Bill Gross, has recently surmised that the Fed’s purchases will be the end of the 30-year bull market in bonds. He even goes so far as to say that not only is it inflationary, it is “somewhat of a Ponzi scheme. It raises bond prices to create the illusion of high annual returns, but ultimately it reaches a dead end where those prices can no longer go up.”

Many people have been hopeful that Congress will extend the Bush tax cuts. Increasing taxes during a slow growth period would likely result in lower consumer spending which would continue to pressure economic growth and also corporate earnings. There has been some debate over whether to extend the tax cuts to everyone or only to those making less than $250,000 per couple annually. However, Congress may not address the issue before year-end and instead let the tax cuts expire, including the so-called marriage tax penalty and child tax credit. This issue does not appear on the agenda for the rest of the year so it may be up to the new Congress to decide. Even then, if the cuts were extended for everyone as Republicans desire, the President could veto the bill and it would be difficult for Congress to override it.

In addition, foreclosures are at all-time highs and banks have looked more vulnerable recently as they may be forced to repurchase bad loans they made in prior years. These factors continue to create instability in the housing market.

We have enjoyed the recent rally, but we expect volatility to continue and believe investors should remain cautious. It is not necessary to chase stocks higher as buying opportunities are expected to present themselves throughout the next year. If Bill Gross is right, government bonds may not be the safe investment they once were. To reduce risk, we believe broad diversification across many asset classes is the best strategy during these uncertain

times.

www.cambridgeadvisors.net

402-697-1166

17330 Wright Street, Suite 205

Omaha, Nebraska 68130

Lori L. Liffring, CFA

Michael L. Bridgman, ChFC

Gaylan C. Abood, CFA

Justin S. Anderson, MBA AAMS

Karen K. Benefiel, CPA AAMS

(c) Cambridge Advisors

www.cambridgeadvisors.net