Market Summary

The major market indices posted solid gains during July: the S&P 500 advanced 7.4% and the NASDAQ Composite climbed 7.8% (all performance numbers are on an appreciation-only basis, before dividends). On a year-to-date basis for the first seven months of 2009, these two indices grew by 9.3% and 25.5%, respectively. These returns through the July 31 close look even more spectacular if measured from the 2009 intra-day lows: the S&P 500 has advanced 48.1% from its 2009 intra-day low on March 6 (of 666.79) and the NASDAQ Composite has surged 56.3% from its 2009 intra-day low on March 9 (of 1265.52).

In July, investors have enjoyed stronger than expected June quarterly earnings even though most companies have been reporting weak revenues and sluggish new order bookings. Cost reduction and operational streamlining has, in many cases, helped offset the effects of slowing or even declining revenues. Of course, some sectors, like the banks and other financial institutions, are continuing to take additional loan loss reserves and larger write-offs on loans and other investments that are in many cases obliterating pre-write-down operating earnings.

Investors have seen some recent improvements in auto sales and monthly home sales, and single-family home prices rose for the first time in more than three years in May. Still, with unemployment rising and credit availability tight, the sustainability of monthly gains in consumer spending-driven high ticket items are likely to be erratic from month to month well into next year.

I admit I am surprised by the magnitude of this five-month rally without any significant intervening market corrections. The worst month of the last five was June, when the S&P 500 rose a microscopic 0.02%, which was followed by a reacceleration of gains in July. Investors will continue to worry about current and future government spending, along with rising federal budget deficits and surging federal debts coupled with continuing tight consumer bank credit and weak consumer spending. These factors tend to magnify market risks. President Obamas proposed reforms for the healthcare system remain controversial and potentially very expensive for the U.S. government. Conditions in the Middle East remain tenuous and volatile and economic conditions in most foreign countries remain weak, yet financial markets around the world have been improving in recent months on prospects for better trends by 2010.

While inflationary worries remain effectively neutralized in the short term by weak demand, excess capacity and improving productivity trends, investors long-term concerns wont be eliminated here as long as the U.S. government and its entities like Fannie Mae, Freddie Mac and The Pension Benefit Guaranty Corporation are dealing with growing deficits and record debt levels. As an example, The Pension Benefit Guaranty Corporation (the PBGC is a federal agency) just agreed to take on $6.2 billion in pension liabilities from bankrupt auto supplier Delphi Corporation. This represents taking over the obligations for paying 70,000 workers and retirees for a plan that is believed to have been under-funded. The PBGC has been running annual operating deficits since fiscal 2002, but deficits exceeded $30 billion (a record) for 1H09 according to information The Wall Street Journal received from the PBGC. This agency also assumed pension liabilities and plan responsibilities for such bankrupt companies as Lehman Brothers, Circuit City and Milacron this year. This is just another example of the growing debts and other liabilities being incurred and assumed by the federal government and its agencies.

Investors have been recently looking more for the positives while discounting the negatives and the risks that could include relatively slow GDP growth in 2010. It appears more likely that the weak U.S. economic recovery expected next year will push back (maybe into 2011) higher tax rates on higher wage earners, capital gains and corporations. Consumers have been saving more and trying to work down debt levels as millions of Americans deal with job losses, under-employment, reduced weekly work hours, and salary and bonus reductions. Also, most retirees and 65-and-older employees face reduced retirement assets in their pension and 401(k) plans following the collapse in equity markets between mid-October 2007 and early March of 2009. These individuals along with the unemployed, the under-employed and those suffering from reduced income, are now retrenching. These issues continue to negatively impact consumer spending and consumer confidence and will likely limit the pace of the economic recovery.

Obviously, the problems arent gone, but investors appear to believe that positive equity price momentum is your friend and returns on equities over the last five months have made short-term money market returns look even more miniscule comparatively. According to Standard and Poors Index Services, the analysts composite 2010 operating EPS estimate for the S&P 500 is now $74.38, which currently represents a 34.6% increase over the latest aggregate 2009 analysts operating EPS estimate of $55.25. Strong expectations for an earnings resurgence have clearly supported the last five months of market gains in the major indices. However, with the consumer spending ramp likely to be muted in 2010, the magnitude of the 2010 earnings rebound expected for many consumer-spending sensitive companies may prove excessive despite widespread corporate cost reduction and productivity-enhancing initiatives. We continue to recommend that investors and financial advisors be attentive to our equity research releases and particularly to those company comments rated Strong Buy and Outperform or where a rating change is being made.

This commentary is excerpted from the Raymond James Focus List and Market Commentary written by David A. Henwood, CFA, Chief Investment Officer.

All expressions of opinion reflect the judgment of the Research Department of Raymond James & Associates, Inc. (RJA) as of the date stated above and are subject to change. Information has been obtained from third-party sources we consider reliable, but we do not guarantee that the facts cited in the foregoing report are accurate or complete.

Past performance is not indicative of future results. Investing involves risk and investors may incur a profit or a loss.

Reassessing Your Risk Tolerance

The potential return from any investment can generally be linked to the amount of risk the investor is willing to assume. Finding that balance between the return you desire and the risk you can handle has never been easy. What makes this problem even trickier is that your financial goals–and thus your risk tolerance–inevitably change throughout your life. Therefore, the investment that was right for your goals yesterday may not be so appropriate today.

It is a good idea to review your investments periodically with risk tolerance in mind. If you heed the advice of your financial advisor, you probably already review your account statements on a regular basis to monitor performance and change any investment whose time has passed. Take some extra time when doing this to screen your investments for inappropriate levels of risk.

Most people identify risk management with safety of principal. This is true to an extent–a dollar locked in a safety deposit box for 10 years will most likely be worth a dollar when it is taken out.

Of course, that dollar is not likely to have as much purchasing power in 10 years as it does today. In other words, locking your money away exposes it to inflation risk. What you gained in stability, you lost in buying power.

Like that dollar in the box, some investments are also exposed to inflation risk. There are many other types of risk as well, which apply to different securities. The following are some of the types of investment risk you should keep in mind.

• Market risk – the possibility that an investment may lose its value when traded in the financial markets.
• Credit risk – the possibility that the issuer of an investment (a corporate bond, for example) may not live up to its financial obligations and cause you to lose your invested capital or not receive expected interest payments.
• Interest rate risk – the risk that, if interest rates rise, the price (value) of an investors bond holdings and certain stocks will decline.
• Reinvestment risk – the possibility that interest rates will fall as a fixed income investment matures and cause you to be unable to reinvest matured assets at an attractive rate of return.

• Liquidity risk – the risk that you will be unable to liquidate an asset (such as real estate, collectibles or thinly traded stocks) when you want and at the price you want.

While the variety of risks is substantial, you should not let risk management intimidate you. People participate in the financial markets because the rewards have often enough outweighed the risks. By carefully assessing all the risks an investment offers and periodically reviewing the holdings in your portfolio with your financial advisor in consideration with your risk tolerance, you should be able to find a level of risk that is appropriate for meeting your investment goals.

This material was prepared by Raymond James for use by its financial advisors.

Active vs. Passive Portfolio Management

One of the longest-standing debates in investing is over the relative merits of active portfolio management versus passive management. With an actively managed portfolio, a manager tries to beat the performance of a given benchmark index by using his or her judgment in selecting individual securities and deciding when to buy and sell them. A passively managed portfolio attempts to match that benchmark performance, and in the process, minimize expenses that can reduce an investor’s net return.

Each camp has strong advocates who argue that the advantages of its approach outweigh those for the opposite side.

Active investing: attempting to add value

Proponents of active management believe that by picking the right investments, taking advantage of market trends and attempting to manage risk, a skilled investment manager can generate returns that outperform a benchmark index. For example, an active manager whose benchmark is the Standard & Poor’s 500 Index (S&P 500) might attempt to earn better-than- market returns by overweighting certain industries or individual securities, allocating more to those sectors than the index does. Or a manager might try to control a portfolio’s overall risk by temporarily increasing the percentage devoted to more conservative investments, such as cash alternatives.

An actively managed individual portfolio also permits its manager to take tax considerations into account. For example, a separately managed account can harvest capital losses to offset any capital gains realized by its owner, or time a sale to minimize any capital gains. An actively managed mutual fund can do the same on behalf of its collective shareholders.

However, an actively managed mutual fund’s investment objective will put some limits on its manager’s flexibility; for example, a fund may be required to maintain a certain percentage of its assets in a particular type of security. A fund’s prospectus will outline any such provisions, and you should read it before investing.

Passive investing: focusing on costs

Advocates of unmanaged, passive investing–sometimes referred to as indexing–have long argued that the best way to capture overall market returns is to use low-cost market-tracking index investments. This approach is based on the concept of the efficient market, which states that because all investors have access to all the necessary information about a company and its securities, it’s difficult if not impossible to gain an advantage over any other investor. As new information becomes available, market prices adjust in response to reflect a security’s true value. That market efficiency, proponents say, means that reducing investment costs is the key to improving net returns.

Indexing does create certain cost efficiencies. Because the investment simply reflects an index, no research is required for securities selection. Also, because trading is relatively infrequent– passively managed portfolios typically buy or sell securities only when the index itself changes–trading costs often are lower. Also, infrequent trading typically generates fewer capital gains distributions, which means relative tax efficieny.

Popular investment choices that use passive management are index funds and exchange-traded funds (ETFs). However, some actively managed ETFs are now being introduced, and index funds and ETFs can be used as part of an active manage’s strategy.

Note. Before investing in either an active or passive ETF or mutual fund, carefully consider the investment objectives, risks, charges and expenses, which can be found in the prospectus available from the fund. Read it carefully before investing.

Active Management