Bank Loan Bashing June 24, 2014

Bashing bank loans has become popular in recent weeks and months, but we disagree with the negative headlines. Several weeks of mutual fund outflows, following robust inflows in 2013, and liquidity concerns (i.e., the ease with which an investment can be bought or sold) highlight investor fears. Mutual fund outflows and liquidity risks are not unique to bank loans, however, and current concerns may be overblown. We continue to find the asset class one of the more attractive in the fixed income markets based on our outlook for the economy and corporate bond markets over the remainder of 2014.

Valuations suggest that bank loans have not reached the “frothy” price levels typical of overcrowded investments. Bank loans pay a floating rate of interest tied to Libor (the London Interbank Offered Rate), an overnight lending rate very similar to the target fed funds rate set by the Federal Reserve (Fed). The greater the yield advantage, or spread, that bank loans pay relative to Libor, the more attractive bank loans are and vice versa. The average spread of bank loans is approximately 4.3%, which has declined in recent years much like yield spreads across fixed income markets, but is well above the average 2.0% yield advantage that persisted prior to the financial crisis. Current yield spreads remain far away from those during the overheated market of 2006 – 07.

The average price of a bank loan is still lower today than in 2007 and has remained relatively stable near 99 in recent weeks compared with the average of just above par value (100) from late 2006 through late 2007, according to the Credit Suisse Leverage Loan Index. If bank loans were an overheated market, yield spreads and prices would likely resemble pre-crisis levels. But both metrics remain far below levels that precipitated sharp price declines.

Large leveraged buyout (LBO) transactions typified some of the excesses of the pre-financial crisis corporate bond markets. Loans issued by heavily debt-burdened companies coupled with expensive valuations led to weakness in many lower rated bonds, not just bank loans. LBO issuance has increased recently along with an improving economy that has spurred merger and acquisition activity, but as a percentage of issuance LBOs remain well below 2007 levels [Figure 1].

Refinancing still comprises the largest use of proceeds and accounts for almost 20% of new loan issuance. Refinancing is a healthy use of proceeds as it helps companies cut interest costs, which in turn can boost profitability. From 2006 to 2008, refinancing accounted for only 10% of new issuance and was behind both LBOs and outright acquisition-related loan issuance as a driver of new issuance. On a dollar volume basis LBO-related issuance exceeded $180 billion in 2007, while 2014 is on pace to finish the year near $80 billion (according to S&P LCD data as of 06/16/14) — still a stark contrast to the excesses of 2007.

The bank loan market has grown significantly in recent years, but last year’s growth was not simply due to investor mutual fund inflows. In addition to acquisitions and refinancing, a loan can be issued simply for general corporate purposes. A still low interest rate environment, a growing economy, and strong demand for floating rate debt have all fueled growth in the bank loan market. A corporate debt issuer is naturally going to be inclined to sell debt where demand is strong, and this has aided the growth of the market along with several large high profile issues. Bank loan terms can also be a viable option for companies to refinance fixed-rate debt into floating rate obligations.

Covenant Lite 

The favorable terms for issuers present a longer-term risk for investors. Over 50% of loan market issues are “covenant lite” and have relaxed legal protections for investors to the benefit of issuers. By themselves relaxedprotections do not necessarily pose a problem if corporate bond markets function smoothly and demand remains steady. However, should market conditions deteriorate, weaker covenants can lead to conditions that make it easier for a company to default. At the margin, this is a risk investors must pay attention to as it raises default risks for 2015 and beyond.

Liquidity

Bank loans are one of the few fixed income categories that have recently been subject to mutual fund outflows, raising fears that additional outflows may lead to price declines due in part to their lesser liquidity. This may be a delayed reaction to investors seeking more interest rate sensitive sectors and chasing year-to-date bond market strength, which we believe is illtimed. Reduced liquidity can be a risk in other markets such as high-yield bonds and municipal bonds. Less liquid markets can contribute to greater price declines in a pullback and played a role in 2013 bond market weakness.

Outflows in combination with heavy new issuance weighed on bank loan prices in April, but since then the market has marched higher despite continued mutual fund outflows. That is partially because mutual funds comprise roughly 25% of the market and therefore are not a dominant driver. Institutional collateralized loan obligations (CLO) represent the majority buyer at approximately 50%. CLOs are investment pools that purchase floating rate loans and repackage the securities, depending on risk, to institutional investors. Demand from CLOs has been strong and can help buffer the loan market when individual investor demand is weak.

Rising Rates

Floating rate loans benefit investors most when interest rates rise, as their interest payments ratchet higher, but the current structure of the bank loan market suggests several Fed rate hikes may be necessary before interest income increases. The use of a minimum interest rate, known as a Libor floor, averages 1.0% currently, indicating the Fed would have to increase the fed funds rate to a similar level before bank loan payments increased. Under a Fed rate hike scenario, many other bond prices would likely be pressured, so we do not view this as a negative since bank loans have no interest rate sensitivity. Current floors are boosting yields now and would still provide an attractive source of return in a rising rate environment.

In a fixed income world with scarce opportunities, we believe bank loans could be one of the more attractive options. Demand for all types of non-Treasury securities has been robust, leaving valuations compressed across the bond market. Relative to high-yield bonds, bank loan investors have been giving up relatively little yield [Figure 2]. At the same time, high quality bonds remain expensive with yields remaining near the low end of the range, providing little room for stronger economic growth, a rise in inflation, or bearish rhetoric from this week’s Fed meeting. Although we acknowledge bank loans’ risks, we believe they are overstated and the asset class remains attractive.

 

IMPORTANT DISCLOSURES
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. Past performance is no guarantee of future results.

The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Stock and mutual fund investing involves risk including loss of principal.

INDEX DESCRIPTIONS
The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

Add More Bond – James Bond – to Your Portfolio February 11, 2014

It was 1964, 50 years ago, that the film Goldfinger debuted. It is the quintessential James Bond film and the first one to win an Academy Award. In Goldfinger, Q — the head of the gadget-making “Q-Branch” — presents Bond an alternative to the traditional car. It can emit an oil slick and has a battering ram, a pop-up rear bulletproof screen, and even an ejector seat. These gadgets helped Bond make the best of some risky situations. Now, 50 years later, bonds are facing a risky situation — and alternative investments may help to make the best of it.

Although not part of the overall bond market measured by the Barclays Capital Aggregate Bond Index, the high-yield and municipal bonds we favor for 2014 are considered traditional investments. As your “Q-Branch,” LPL Financial Research would like to present you with some alternatives to traditional investments that may be helpful in 2014 as faster growth may lead to higher interest rates and flat returns for the bond market: bank loans, business development companies (BDCs), real estate investment trusts (REITs), and master limited partnerships (MLPs).

• Bank loans. Bank loans are an alternative that seeks to offer an attractive yield and less interest rate risk for 2014. The interest rates on these loans made to businesses float higher with short-term interest rates. While bank loans can suffer losses when economic growth deteriorates and negatively impacts the ability of companies to repay their borrowings, we expect solid economic growth in 2014. Finally, they behaved well in last year’s interest rate run-up from May to July, as you can see in Figure 2.

• BDCs. Business development companies function like banks by lending money to businesses. BDCs have flexibility to go beyond the most senior structured loans, so they can have more credit risk if the economy deteriorates, resulting in companies being unable to repay their debts. Illustrating this heightened leverage and credit exposure, the Wells Fargo BDC Index has behaved like 2.25 times the Barclays Capital High Yield Bond Index, as you can see in Figure 3. It is a good idea to keep the 2.25 factor in mind when considering weighting and overall portfolio credit exposure. \

• REITs. Looking back over the past 20 years, REITs (measured by the NAREIT Index) have generally provided solid yields and strong total returns with the exception of poor relative returns in 1998 – 99, 2007 – 08, and 2013. In 2013, REIT returns were similar in magnitude to 2002 and 1994, when they outperformed stocks and bonds, but in 2013 the S&P 500 Index outperformed REITs by a margin of about 30 percentage points. In 2007 – 08, credit conditions and the bursting of a real estate bubble were the problems contributing to REIT losses — something we do not expect to see in 2014. However, in 1998 – 99 and in 2013, we saw rising interest rates and a move by the Federal Reserve to become less bond market friendly. We expect that to be the case in 2014 as well. In 2013, interest rates went up in the late spring and early summer without being accompanied by better economic growth and that led to poor returns for REITs and remains a risk for 2014. However, in 2014 we expect better growth to accompany the rise in rates — making a better environment for REITs as occupancy and rents rise. From a valuation perspective, REITs are fairly valued on historical metrics like discount to net asset value, price to funds from operations, and spreads to BBB bonds. While they may fare better in 2014 than in 2013, REITs still face headwinds from rising interest rates, making REITs likely to underperform stocks, but outperform bonds.
• MLPs. In comparison to REITs, rising U.S. liquid fuel transportation needs may make MLPs that operate pipelines able to re-price rents and keep up with rising rates in 2014. A key beneficiary of the American energy renaissance, pipelines are seeing strong volume growth. In 2013, MLPs provided solid mid-single digit yields and posted double-digit total returns that nearly kept up with the soaring stock market (the Alerian MLP Index produced a total return of 27.6% in 2013, less than 5% below the 32.4% for the S&P 500). The U.S. Energy Information Agency forecasts transportation of U.S. crude oil production will continue to grow in 2014 near last year’s growth rate of 16%. Rising transportation demand may help to support another year of solid performance for MLPs in 2014 despite the risk posed by higher interest rates and some degree of commodity price sensitivity.

The alternative features installed in his car that helped to make Bond safer were not safety equipment. But used in the right way, they did help to protect him and provided an advantage when facing certain risky situations. The alternative investments featured here are not safer investments. But, used the right way, they may provide some protection from the risks and the potential to capitalize on the opportunities we believe investors face in 2014.

_____________________________________________________________________________________________________________________________

IMPORTANT DISCLOSURES

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. Past performance is no guarantee of future results.

The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Stock and mutual fund investing involves risk including loss of principal.

High yield/junk bonds (grade BB or below) are not investment grade securities, and are subject to higher interest rate, credit, and liquidity risks than those graded BBB and above. They generally should be part of a diversified portfolio for sophisticated investors.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

_____________________________________________________________________________________________________________________________

INDEX DESCRIPTIONS

The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The S&P/LSTA U.S. Leveraged Loan 100 Index is designed to reflect the largest facilities in the leveraged loan market. It mirrors the market-weighted performance of the largest institutional leveraged loans based upon market weightings, spreads, and interest payments. The index consists of 100 loan facilities drawn from a larger benchmark, the S&P/LSTA (Loan Syndications and Trading Association) Leveraged Loan Index (LLI).

The Barclays Aggregate Bond Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment-grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities.

The Wells Fargo BDC Index is a float adjusted, capitalization-weighted Index that is intended to measure the performance of all Business Development Companies that are listed on the New York Stock Exchange or NASDAQ and satisfy specified market capitalization and other eligibility requirements. To qualify as a BDC, the company must be registered with the Securities and Exchange Commission and have elected to be regulated as a BDC under the Investment Company Act of 1940.

The Barclays Capital High Yield Index covers the universe of publicly issued debt obligations rated below investment grade. Bonds must be rated below investment-grade or high-yield (Ba1/BB+ or lower), by at least two of the following ratings agencies: Moody’s, S&P, and Fitch. Bonds must also have at least one year to maturity, have at least $150 million in par value outstanding, and must be US dollar denominated and non-convertible. Bonds issued by countries designated as emerging markets are excluded.

______________________________________________________________________________________________________________________________

This research material has been prepared by LPL Financial.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and makes no representation with respect to such entity.

Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by any Government Agency | Not a Bank/Credit Union Deposit

Member FINRA/SIPC

2014 Fixed Income Outlook December 3, 2013

In 2014, interest rates are likely to continue to move higher and bond prices lower in response to improving economic growth, reduced Federal Reserve (Fed) bond purchases, and the likelihood of an interest rate hike in 2015. Even though a Fed rate hike is a 2015 event, bond prices are likely to decline and yields increase as valuations remain expensive to historical averages and forward-looking markets prepare for a rate hike. We view the start of interest rate hikes as more important than the pace of tapering, but tapering will mark the first step in bond prices and yields returning to historical norms. We see a defensive investment posture focused on less interest rate sensitive sectors as the most prudent way to invest in 2014.

Yielding to Growth

Longer-term bond yields have historically tended to track the change in gross domestic product (GDP) growth absent the influence of Fed actions. Our expectation for a 1% acceleration in U.S. GDP over the pace of 2013 suggests a similar move for the bond market. This would prompt a rise in the yield on the 10-year Treasury from around 2.75% as of mid-November 2013 to about 3.25% to 3.75% in 2014.

On the Horizon

While investors may see the Fed end direct involvement in the bond market in 2014 as the bond-buying program comes to a close, the Fed may make its presence felt again in 2015 with a series of rate hikes. The expectation for rate hikes in 2015 may also lead to rising pressure on bond yields in 2014. Each period of Fed interest rate hikes is different, but by evaluating key metrics such as short-term Treasury yields, the shape of the yield curve, and inflation-adjusted yields prevalent at the start of prior Fed rate hikes, we can approximate the trajectory of yields in 2014 as the market braces for a potential interest rate hike in 2015.

Given the Fed’s current guidance for a mid-2015 start to interest rate hikes, supported by our outlook for stronger GDP and job growth in 2014, we may expect at least an 18-month path of reduced Fed involvement in the bond market from around the start of 2014 to mid-2015. This reinforces the fundamental case for the 10-year Treasury yield rising by 0.5% to 1.0% as yields rise to more “normal” valuation levels that would translate to a 10-year Treasury yield at the end of 2014 of 3.25% to 3.75%. Total returns may be roughly flat under that scenario  [Figure 1].

It is possible that yields could increase by 1.0% to 3.75% should inflation-adjusted yields return to more normal levels. Under that scenario, high-quality bond total returns would be negative, as indicated by Figure 1.  However, we see a move of this magnitude as less likely unless the markets expect an earlier start to Fed rate hikes. Instead, we think it is more likely the Fed may wait longer than mid-2015 to raise interest rates, which supports a more modest rise in the 10-year of 0.50% to 0.75%.

A number of factors indicate yields may rise less than our forecasts, and this is the primary risk to our bond outlook.

• Low Inflation. Inflation is an enemy of bondholders since it makes fixed payments worth less over time. While inflation is likely to pick up modestly in 2014, fortunately, it is likely to remain historically low. Bond valuations may therefore remain historically expensive. The lower the pace of inflation, the less bond yields will need to rise in response.
• Disappointing growth.  Slower-than-expected growth may reinforce the low inflation environment and delay the timing of eventual Fed rate hikes — both of which are positives for bond prices. Should the economy grow at a slower pace than anticipated in 2014, bond prices may similarly prove more resilient.
• Fed delays.  Our interest rate forecast is based upon the Fed gradually tapering bond purchases in 2014 and market participants’ expectation for a potential interest rate hike in June 2015. If these are pushed back, yields may rise less than our base forecast and bond prices may prove more resilient. Low single-digit returns may result if it becomes clear the Fed may wait longer than mid-2015 to raise interest rates.

Stay in the Middle

Among high-quality bonds we prefer intermediate-term bonds, which possess far less interest rate risk compared with long-term bonds [Figure 2].  The yield curve remains relatively steep today. A positive factor for intermediate-term bonds is that they include the steepest portion of the yield curve. A yield curve is a chart of bond yields from the shortest-maturity issues to the longest-maturity ones. The steepest point is that which offers the biggest increase in yield per additional increase in term.

While short-term bonds offer the least interest rate risk, their low yields make them less attractive. We believe intermediate-term bonds possess a better combination of interest rate risk mitigation and reward in the form of yield under a range of outcomes.

Intermediate-term bonds have the ability to generate modestly positive returns despite a fair rise in interest rates. Importantly, given their position on the yield curve, intermediate-term bonds can also provide some defensive properties to a portfolio [Figure 3].  Immediate-term, high-quality bond returns turn negative with a 1.0% rise in interest rates — just above the high end of the most likely range we expect for intermediate-term bonds in 2014. However, they can produce mid-single-digit gains if interest rates are unchanged or even decline slightly — driven by disappointing economic growth or a negative event causing investors to take a temporary defensive stance. In that event, intermediate-term bonds may provide a gain offsetting losses in the event of a stock market pullback — a key reason for holding bonds in a portfolio.

Harvesting Yield

A rising interest rate environment presents a challenge to bond market investors. Investors must seek to minimize interest rate driven losses and at the same time focus opportunistically on sectors that have traditionally produced gains during rising rate environments.

High-yield bonds and bank loans are two sectors that have historically proven resilient and often produced gains during periods of rising interest rates. In 2013, both sectors were among the leaders of bond sector performance during a year of higher interest rates.

High-yield bonds and bank loans are attractive bond sectors for 2014. Deteriorating credit quality and rising defaults are the key risks to investors in these lower-rated bonds, but we believe these risks will be manageable in 2014 as growth picks up. The global speculative default rate was a low 2.8% at the end of October 2013 — well below the historical average of 4.5%. Moody’s forecasts a low default environment to persist through 2014, a forecast we agree with given the limited number of maturing bonds in 2014. In addition to a low default environment, both high-yield bonds and bank loans remain supported by good fundamentals. Company leverage has increased over recent quarters, but the cost to service that debt remains quite manageable with interest coverage near post-recession highs.

High-yield bonds and bank loans are likely to produce low- to mid-single-digit returns in 2014. High-yield bond valuations are more expensive heading into [Figure 4]. As 2014 progresses, yield spreads may increase as investors begin to demand greater compensation for a potential  increase in defaults in 2015. Bank loans may also be impacted by investors bracing for higher defaults, but less than high-yield bonds due to their shorter-term nature and higher  seniority.

Among high-quality bonds we favor investment-grade corporate and municipal bonds. Investment-grade corporate bonds are likely to be impacted by rising interest rates, but still yield, on average, 1.3% more than comparable Treasuries. In a rising rate environment, interest income can be a buffer against price declines associated with rising interest rates. The higher yield potential of investment-grade corporate bonds, which remain supported by good credit quality fundamentals, may therefore be able to provide better protection than Treasuries.

Corporate bond sectors, both investment-grade and high-yield, have historically provided better protection against rising interest rates [Figure 5].  During periods of rising Treasury yields, corporate yields tend to rise less and corporate bond prices have been more resilient.  Figure 5 illustrates how the yield differential, or spread, between Treasuries and  investment-grade corporate bonds and high-yield bonds has generally narrowed when Treasury yields rose. Since 2000, investment-grade corporate bond yield spreads have narrowed in all but two periods of rising Treasury yields and all but one for high-yield bonds.

Among high-quality bonds, we also find municipal bonds attractive, favoring intermediate-term rather than traditional long-term municipal bonds.

International Debt

Emerging market debt (EMD) is another way to add higher income generating potential to portfolios. In general, EMD issuers have lower debt burdens and stronger economic growth than their developed market peers. In addition, valuations are attractive as 2013 winds down with an average yield spread of 3.6% to comparable Treasuries, near the upper end of a four-year range. Better valuations set the foundation for a better 2014, following a difficult 2013. However, not all EMD issuers are alike. In the face of relatively sluggish global demand in recent years, some emerging market countries have relied on extraordinary liquidity provided by the world’s central banks to grow their economies at the cost of running current account deficits as they increasingly borrow to import more than they export. As global credit conditions tighten and developed market bond yields rise, some EMD issuers have suffered as investors find more attractive yields in more financially secure markets. As these EMD issuers adjust to the lessened liquidity provided by central banks, they become increasingly attractive. Emerging market debt is increasingly attractive in 2014, but we remain cautious on developed foreign bond markets given weak growth and unattractive valuations.

Opportunities in a Less Liquid Market

Like 2013, 2014 may also provide investors with opportunities created by volatility. In 2013, the 10-year Treasury yield fell as low as 1.6% and also rose as high as 3.0% — a remarkably wide range given the steady and sluggish pace of economic growth and lack of abrupt changes by the Fed. Although these movements may seem dramatic in a historical context, they may become the norm as recent financial regulations discourage traditional market-making firms from participating in the bond market. As a result, these less liquid markets can experience sharp swings up or down and temporarily take prices and yields beyond levels warranted by fundamentals. Tactical investors may harvest opportunities that could arise in a low-return, volatile market. This may be experienced more dramatically in less liquid markets, such as emerging market debt and municipal bonds among others.

______________________________________________________________________________________________________________________________

IMPORTANT DISCLOSURES

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indexes are unmanaged and cannot be invested into directly.

The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values and yields will decline as interest rates rise, and bonds are subject to availability and change in price.

Gross Domestic Product (GDP) is the monetary value of all the finished goods and services produced within a country’s borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory.

Government bonds and Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate.

Treasuries are marketable, fixed-interest U.S. government debt securities. Treasury bonds make interest payments semi-annually, and the income that holders receive is only taxed at the federal level.

International and emerging market investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors.

Preferred stock investing involves risk, which may include loss of principal.

High-yield/junk bonds (grade BB or below) are not investment grade securities, and are subject to higher interest rate, credit, and liquidity risks than those graded BBB and above. They generally should be part of a diversified portfolio for sophisticated investors.

International and emerging market investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors.

Preferred stock investing involves risk, which may include loss of principal.

 ______________________________________________________________________________________________________________________________

INDEX DESCRIPTIONS

The Barclays Capital Aggregate Bond Index is an unmanaged market capitalization-weighted index of most intermediate-term U.S. traded investment-grade, fixed rate, non-convertible and taxable bond market securities including government agency, corporate, mortgage-backed, and some foreign bonds.

The Barclays Capital High Yield Index covers the universe of publicly issued debt obligations rated below investment-grade. Bonds must be rated below investment-grade or high-yield (Ba1/BB+ or lower), by at least two of the following ratings agencies: Moody’s, S&P, Fitch. Bonds must also have at least one year to maturity, have at least $150 million in par value outstanding, and must be US dollar denominated and nonconvertible. Bonds issued by countries designated as emerging markets are excluded.

______________________________________________________________________________________________________________________________

This research material has been prepared by LPL Financial.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and makes no representation with respect to such entity.

Not FDIC/NCUA Insured | Not Bank/Credit Union Guaranteed | May Lose Value | Not Guaranteed by any Government Agency | Not a Bank/Credit Union Deposit

Member FINRA/SIPC

Navigating the Markets April 23, 2013

Navigating the Markets

Compass Changes

• ƒUpgraded health care to neutral from negative/neutral
• Upgraded emerging market debt to neutral/positive from neutral
• Upgraded oil commodity from neutral/negative to neutral
• Downgraded precious metals commodities from neutral/positive to neutral
• Downgraded technology from neutral/positive to neutral

Investment Takeaways

• ƒOur near-term stock market view is slightly cautious, given our Base Path expectation for modest single-digit returns in 2013.*
• We continue to favor cyclical sectors over defensives over the balance of the year, but our near-term views are balanced.
• Higher-yielding, fundamentally sound segments of the bond market remain attractive, but low yields and valuations temper our enthusiasm.
• We upgraded our emerging market debt view following under performance during the first quarter.
• We see the oil commodity as near fair value following the latest correction, while deteriorating technicals drive our lowered precious metals view.
• From a technical perspective, the S&P 500 may turn lower over the next few weeks; next support is at 1540, followed by 1500.

Broad Asset Class Views

LPL Financial Research’s views on stocks, bonds, cash, and alternatives are illustrated below. The positions of negative, neutral, or positive are indicated by the solid black compass needle, while an outlined needle shows a previous view.

Equity & Alternative Asset Classes

Maintain Slightly Cautious Stock Market View as S&P 500 Remains Near All-Time Highs

Our near-term stock market view is slightly cautious, given our Base Path expectation for modest single-digit returns in 2013.*
ƒ
Our views are generally aligned across market cap, with a slight preference for large and mid caps. In our Base Path scenario in Outlook 2013, we expect the market to favor the stability, lower valuations, and higher yields associated with large caps.
ƒ
We maintain a modest preference for growth over value due to growth’s potential to perform well in slow-growth environments, although our conviction has lessened as our sector views have become more balanced.
ƒ
Our neutral emerging markets (EM) view reflects higher near-term risks as China implements measures to curb its property markets and has produced uneven growth.
ƒ
Our large foreign view is neutral. Although bold policy actions and valuations are supportive, and the outlook in Japan has improved, Europe remains mired in recession and the Eurozone debt crisis is not yet over.
ƒ
Fed policy remains supportive of precious metals, but US dollar gains, little inflation pressure, and the rotation into equities have driven a technical breakdown in the gold commodity price.
ƒ
Now that the oil commodity has pulled back into the high $80s, we believe it is near fair value.

All performance referenced herein is as of April 16, 2013, unless otherwise noted. * LPL Financial Research provided these forecasts based on: a low-single-digit earnings growth rate supported by modest share buybacks combined with 2% dividend yields and little change in valuations for the S&P 500. Please see our Outlook 2013 for details.

Real Estate/REITs may result in potential illiquidity and there is no assurance the objectives of the program will be attained. The fast price swings of commodities will result in significant volatility in an investor’s holdings. International and emerging markets involve special risks such as currency fluctuation and political instability. The price of small and mid-cap stocks are generally more volatile than large capstocks. Value investments can perform differently from the market as a whole. They can remain undervalued by the market for long periods of time. Precious metal investing is subject to substantial fluctuation and potential for loss. These securities may not be suitable for all investors. Alternative strategies may not be suitable for all investors and should be considered as an investment for the risk capital portion of  the investor’s portfolio. The strategies employed in the management of alternative investments may accelerate the velocity of potential losses. Stock investing may involve risk including loss of principal.

Equity Sectors

More Balanced Sector Mix After Health Care Upgrade to Neutral

We continue to favor cyclical sectors over defensives over the balance of the year, but our near-term views are balanced as we anticipate a modest pullback in the S&P 500.

While we continue to expect a pickup in business spending, our lowered technology view reflects a weaker earnings outlook and deteriorating technicals. Industrials is our favored way to play a potential pickup in business spending.

Our recent decision to lower our materials view reflected the risk to China’s growth and strength in the US dollar amid concerns that the Federal Reserve (Fed) will soon pare back  stimulus.

Our energy view remains neutral due to our expectation that elevated inventories will prevent a rebound in crude oil prices from current levels in the high $80s.

Our upgraded, neutral health care view reflects our desire to balance out the economic sensitivity of our sector mix, policy clarity, and a strong technical picture.

Our utilities view is modestly negative due to interest rate risk and rich valuations, although our outlook is less negative amid improved technicals.

Our consumer staples view is neutral despite rich valuations due to the potential to benefit from lower commodity prices and the potential for a pullback.

Our financials view is modestly negative. Bank fundamentals have improved some, but the challenging regulatory and interest rate environment persists and loan growth is stalling.

Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.

Fixed Income

Focus on Higher-Yielding Segments Due to Better Valuation and as Buffer Against Rise in Rates

• A range-bound environment persists in the bond market. Lingering uncertainties augur for a stable rate environment, which favors intermediate bonds that still possess a substantial yield advantage relative to short-term bonds.
• By committing to refrain from raising interest rates until unemployment falls to 6.5%, intermediate maturity bonds may also benefit from Fed policy as investors seek higher yields amid a low-yield world.
• We continue to find municipal bonds among the more attractive high-quality bond options, and valuations remain attractive following a difficult March.

Focus on Higher-Yielding Segments Due to Better Valuation and as Buffer Against Rise in Rates

• We upgrade emerging market debt following underperformance during the first quarter relative to other higher-yielding segments of the bond market, thereby providing an opportunity for investors.
• Higher-yielding, fundamentally sound segments of the bond market such as high-yield bonds, bank loans, and preferred securities remain attractive, but we temper our enthusiasm due to a strong start to 2013. Lower yields and higher valuations augur for lower returns going forward.
• Bank loans remain attractive due to a much narrower yield differential to high-yield bonds.

All bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and are subject to availably and change in price. High-yield/junk bonds are not investment-grade securities, involve substantial risks, and generally should be part of the diversified portfolio of sophisticated investors. Mortgage-backed securities are subject to credit, default risk, prepayment risk that acts much like call risk when you get your principal back sooner than the stated maturity, extension risk, the opposite of prepayment risk, and interest rate risk. International and emerging market investing involves risks such as currency fluctuation and political instability and may not be suitable for all investors. Bank loans are loans issued by below investment-grade companies for short term funding purposes with higher yield than short-term debt and involve risk. Treasury inflation-protected securities (TIPS) help eliminate inflation risk to your portfolio as the principal is adjusted semiannually for inflation based on the Consumer Price Index – while providing a real rate of return guaranteed by the U.S. government. Corporate bonds are considered higher risk than government bonds but normally offer a higher yield and are subject to market, interest rate and credit risk as well as additional risks based on the quality of issuer coupon rate, price, yield, maturity and redemption features. Foreign Bonds – Hedged: Non-U.S. fixed income securities generally from investment-grade issuers in developed countries, with hedged currency exposure. Foreign Bonds – Unhedged: Non-U.S. fixed income securities normally denominated in major foreign currencies.

DEFINITIONS:

EQUITY AND ALTERNATIVES ASSET CLASSES
Large Growth: Stocks in the top 70% of the capitalization of the U.S. equity market are defined as Large Cap. Growth is defined based on fast growth (high growth rates for earnings,
sales, book value, and cash flow) and high valuations (high price ratios and low dividend yields).

Large Value: Stocks in the top 70% of the capitalization of the U.S. equity market are defined as Large Cap. Value is defined based on low valuations (low price ratios and high dividend
yields) and slow growth (low growth rates for earnings, sales, book value, and cash flow).

Mid Growth: The U.S. mid-cap range for market capitalization typically falls between $1 billion and $8 billion and represents 20% of the total capitalization of the U.S. equity market.
Growth is defined based on fast growth (high growth rates for earnings, sales, book value, and cash flow) and high valuations (high price ratios and low dividend yields).

Mid Value: The U.S. Mid Cap range for market capitalization typically falls between $1 billion and $8 billion and represents 20% of the total capitalization of the U.S. equity market. Value
is defined based on low valuations (low price ratios and high dividend yields) and slow growth (low growth rates for earnings, sales, book value, and cash flow).

Small Growth: Stocks in the bottom 10% of the capitalization of the U.S. equity market are defined as Small Cap. Growth is defined based on fast growth (high growth rates for earnings,
sales, book value, and cash flow) and high valuations (high price ratios and low dividend yields).

Small Value: Stocks in the bottom 10% of the capitalization of the U.S. equity market are defined as Small Cap. Value is defined based on low valuations (low price ratios and high
dividend yields) and slow growth (low growth rates for earnings, sales, book value, and cash flow).

U.S. Stocks: Stock of companies domiciled in the U.S.

Large Foreign: Large-cap foreign stocks have market capitalizations greater than $5 billion. The majority of the holdings in the large foreign category are in the MSCI EAFE Index.
Small Foreign: Small-cap foreign stocks typically have market capitalizations of $250M to $1B. The majority of the holdings in the small foreign category are in the MSCI Small Cap EAFE Index.

Emerging Markets: Stocks of a single developing country or a grouping of developing countries. For the most part, these countries are in Eastern Europe, Africa, the Middle East, Latin
America, the Far East and Asia.

REITs: REITs are companies that develop and manage real-estate properties. There are several different types of REITs, including apartment, factory-outlet, health-care, hotel, industrial, mortgage, office, and shopping center REITs. This would also include real-estate operating companies.

Commodities – Industrial Metals: Stocks in companies that mine base metals such as copper, aluminum and iron ore. Also included are the actual metals themselves. Industrial metals
companies are typically based in North America, Australia, or South Africa.

Commodities – Precious Metals: Stocks of companies that do gold- silver-, platinum-, and base-metal-mining. Precious-metals companies are typically based in North America, Australia, or South Africa.

Commodities – Energy: Stocks of companies that focus on integrated energy, oil & gas services, oil & gas exploration and equipment. Public energy companies are typically based in North America, Europe, the UK, and Latin America.

Merger Arbitrage is a hedge fund strategy in which the stocks of two merging companies are simultaneously bought and sold to create a riskless profit. A merger arbitrageur looks at
the risk that the merger deal will not close on time, or at all. Because of this slight uncertainty, the target company’s stock will typically sell at a discount to the price that the combined
company will have when the merger is closed. This discrepancy is the arbitrageur’s profit.

Long/Short is an investment strategy generally associated with hedge funds. It involves buying long equities that are expected to increase in value and selling short equities that are
expected to decrease in value.

EQUITY SECTORS

Materials: Companies that engage in a wide range of commodity-related manufacturing. Included in this sector are companies that manufacture chemicals, construction materials, glass,
paper, forest products and related packaging products, metals, minerals and mining companies, including producers of steel.

Energy: Companies whose businesses are dominated by either of the following activities: The construction or provision of oil rigs, drilling equipment and other energy-related service and equipment, including seismic data collection or the exploration, production, marketing, refining and/or transportation of oil and gas products, coal and consumable fuels.

Industrials: Companies whose businesses: Manufacture and distribute capital goods, including aerospace and defense, construction, engineering and building products, electrical
equipment and industrial machinery; provide commercial services and supplies, including printing, employment, environmental and office services; provide transportation services,
including airlines, couriers, marine, road and rail, and transportation infrastructure.

Consumer Discretionary: Companies that tend to be the most sensitive to economic cycles. Its manufacturing segment includes automotive, household durable goods, textiles and apparel, and leisure equipment. The service segment includes hotels, restaurants and other leisure facilities, media production and services, consumer retailing and services and education services.

Technology: Companies that primarily develop software in various fields such as the Internet, applications, systems and/or database management and companies that provide information technology consulting and services. Technology hardware & equipment include manufacturers and distributors of communications equipment, computers and peripherals, electronic equipment and related instruments, and semiconductor equipment and products.

Financials: Companies involved in activities such as banking, consumer finance, investment banking and brokerage, asset management, insurance and investment, and real estate, including REITs.

Utilities: Companies considered electric, gas or water utilities, or companies that operate as independent producers and/or distributors of power.

Health Care: Companies in two main industry groups: Healthcare equipment and supplies or companies that provide healthcare-related services, including distributors of healthcare
products, providers of basic healthcare services, and owners and operators of healthcare facilities and organizations or companies primarily involved in the research, development,
production and marketing of pharmaceuticals and biotechnology products.

Consumer Staples: Companies whose businesses are less sensitive to economic cycles. It includes manufacturers and distributors of food, beverages and tobacco, and producers of non-durable household goods and personal products. It also includes food and drug retailing companies.

Telecommunications: Companies that provide communications services primarily through a fixed line, cellular, wireless, high bandwidth and/or fiber-optic cable network.

FIXED INCOME

Credit Quality: An individual bond’s credit rating is determined by private independent rating agencies such as Standard & Poor’s, Moody’s and Fitch. Their credit quality designations
range from high (‘AAA’ to ‘AA’) to medium (‘A’ to ‘BBB’) to low (‘BB’, ‘B’, ‘CCC’, ‘CC’ to ‘C’).

Duration: A measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. Duration is expressed as a number of years. Rising
interest rates mean falling bond prices, while declining interest rates mean rising bond prices. The bigger the duration number, the greater the interest-rate risk or reward for bond prices.

Munis – Short-term: Bonds issued by various state and local governments to fund public projects. The income from these bonds is generally free from federal taxes. These bonds generally have maturities of less than three years.

Munis – Intermediate: Bonds issued by various state and local governments to fund public projects. The income from these bonds is generally free from federal taxes. These bonds
generally have maturities of between 3 and 10 years.

Munis – Long-term: Bonds issued by various state and local governments to fund public projects. The income from these bonds is generally free from federal taxes. These bonds generally
have maturities of more than 10 years.

Munis – High-yield: Bonds issued by various state and local governments to fund public projects. The income from these bonds is generally free from federal taxes. These bonds generally
offer higher yields than other types of bonds, but they are also more vulnerable to economic and credit risk. These bonds are rated BB+ and below.
Treasuries: A marketable, fixed-interest U.S. government debt security. Treasury bonds make interest payments semi-annually and the income that holders receive is only taxed at the federal level.

TIPS (Treasury Inflation Protected Securities): A special type of Treasury note or bond that offers protection from inflation. Like other Treasuries, an inflation-indexed security pays interest every six months and pays the principal when the security matures. The difference is that the underlying principal is automatically adjusted for inflation as measured by the consumer price index (CPI).

Mortgage-Backed Securities: A type of asset-backed security that is secured by a mortgage or collection of mortgages. These securities must also be grouped in one of the top two ratings as determined by a accredited credit rating agency, and usually pay periodic payments that are similar to coupon payments. Furthermore, the mortgage must have originated from a regulated and authorized financial institution.

Investment-Grade Corporates: Securities issued by corporations with a credit ratning of BBB- or higher. Bond rating firms, such as Standard & Poor’s, use different designations consisting of upper- and lower-case letters ‘A’ and ‘B’ to identify a bond’s investment-grade credit quality rating. ‘AAA’ and ‘AA’ (high credit quality) and ‘A’ and ‘BBB’ (medium credit quality) are considered investment-grade.

Preferred Stocks: A class of ownership in a corporation that has a higher claim on the assets and earnings than common stock. Preferred stock generally has a dividend that must be paid
out before dividends to common stockholders and the shares usually do not have voting rights.

High-Yield Corporates: Securities issued by corporations with a credit rating of BB+ and below. These bonds generally offer higher yields than investment-grade bonds, but they are also
more vulnerable to economic and credit risk.

Bank Loans: In exchange for their credit risk, these floating-rate bank loans offer interest payments that typically float above a common short-term benchmark such as the London
interbank offered rate, or LIBOR.

Foreign Bonds – Hedged: Non-U.S. fixed income securities generally from investment-grade issuers in developed countries, with hedged currency exposure.

Foreign Bonds – Unhedged: Non-U.S. fixed income securities normally denominated in major foreign currencies.

Emerging Market Debt: The debt of sovereigns, agencies, local issues, and corporations of emerging markets countries and subject to currency risk.

______________________________________________________________________________________________________________________________________________

IMPORTANT DISCLOSURES

The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indexes are unmanaged and cannot be invested into directly.

Past performance is no guarantee of future results.

For the purposes of this publication, intermediate-term bonds have maturities between 3 and
Stock investing involves risk including loss of principal.

Preferred stock investing involves risk, which may include loss of principal.

Distressed investing involves significant risks, including a total loss of capital. The risks associated with distressed investing arise from several factors including: limited diversification,
the use of leverage, limited liquidity, and the possibility that investors may be required to accept cash or securities with a value less than their original investment and/or may be required to accept payment over an extended period of time.

The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate
market value of 500 stocks representing all major industries.

This research material has been prepared by LPL Financial.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not
an affiliate of and makes no representation with respect to such entity.

Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by any Government Agency | Not a Bank/Credit Union Deposit