Checking for Collateral Damage January 10, 2013

After a bounce on the relief from the fiscal cliff deal that took place on New Year’s Day, the stock market has been in a sideways holding pattern. Investors are waiting to see if there was some collateral damage from the battle over the fiscal cliff. This week, we will begin to see if any damage was done to corporate profits in the fourth quarter of 2012. 

Macroeconomic factors have been the key driver of the market lately, but microeconomics will begin to garner investors’ attention in the coming weeks as companies begin to release their fourth quarter earnings reports. Four times a year, investors focus on the most fundamental driver of investment performance: earnings. While only a handful of S&P 500 companies report fourth quarter 2012 results this week, earnings reports will be issued from big U.S. companies including Alcoa, Constellation Brands, Monsanto, and Wells Fargo, among others as the fourth quarter earnings season kicks off.

While the fiscal cliff battle ultimately ended in a modest deal to avert some of the worst consequences to the economy, the related caution, contingency planning, special dividend distributions, and other distractions may have restrained business results. There is some reason to believe the fiscal cliff issues may have had some impact. While Friday’s (January 4, 2013) employment report for December 2012 reflected another month of  modest job growth and broad economic indicators show little measurable effect of the concern over the fiscal cliff, we saw weak business investment act as a drag on growth in the third quarter of 2012. This generally extended into the fourth quarter as corporate leaders were more likely to sit on cash, or return it to shareholders in the form of dividends and share buybacks, rather than make longer term commitments by increasing capital expenditures or ramping up hiring. For example, new orders for business investment were only up 0.5% year-over-year in November 2012, according to the latest U.S. Commerce Department data. Excluding transportation equipment, orders for business spending were  flat. 

Expectations for profit growth among S&P 500 companies in the fourth quarter of 2012 are down to about 3% year-over-year, sharply lower than the 10% growth expected at the start of the quarter. While the estimates are now in line with our long-held outlook*, two sectors are expected to provide double-digit gains and may still present some risk of disappointment [Figure 1].

• ƒƒThe strong gains in the consumer discretionary sector — largely driven by strong demand for autos and housing — may be at risk due to disappointing retail sales reported during the holiday shopping season as consumers fretted over tax increases.
• ƒƒ The strong performance by financial stocks backed by similarly strong earnings growth — driven by mortgage lending, securities gains, and cost cutting at the big diversified financial services companies — may be at risk with relatively weak demand for credit, low interest rates  along a flat yield curve, and large insurance losses.

On the other hand, the industrials sector — expected to post the biggest year-over-year earnings decline (-5.6%) among S&P 500 sectors, may offer

the potential for an upside surprise. Industrial production has been solid and exceeded economists’ estimates in the latest data reported for November 2012. Also, in the jobs report for December 2012 released on Friday, January 4, 2013, manufacturing job growth turned much more positive after weak numbers in the prior four months. Renewed hiring among industrial companies may be a sign of confidence by management in the recently improving trend.

Wall Street analysts‘ consensus forecast of S&P 500 earnings per share for the fourth quarter of 2012 is $25.56. If accurate, this will be the lowest quarterly total for earnings per share in  2012. This is unusual; fourth quarter profits during a year of growth are typically the highest of the year. While this week  – the week that Alcoa reports its earnings — is most often referred to as the start of the reporting season, some companies  have already provided their fourth quarter numbers and confirmed a soft environment for profits. For example, FedEx Corporation reported in mid-December 2012 and missed expectations, posting a 12% decline from a year ago, reflecting a weak global economic backdrop and the impact of Superstorm Sandy.

While the results reported for the fourth quarter are important in measuring the impact of the fiscal cliff battle, so will the profit guidance for the coming quarters provided by corporate leaders. Earnings per share for 2012 are expected to end up 3.7% above the total for 2011. We expect another year of lackluster profit growth again in 2013. However, the consensus of Wall Street analysts’ expectations is for 10% growth. The coming weeks may provide insight on the trajectory of profits in 2013.

The focus on microeconomic data in the coming weeks leads us to expect a relatively range-bound market in the near term. However, when the earnings season winds down in February 2013, the fiscal cliff battle part II may emerge as we approach the limit on U.S. borrowing authority, known as the debt ceiling, along with the end of the delay to the spending sequester on February 28 and funding of the U.S. government on March 27. These factors may weigh on the confidence of business leaders to employ capital in the first quarter and extend the sluggish profit  environment.

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.

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 investing involves risk, including the risk of loss.

Consumer Discretionary Sector: 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.

Consumer Staples Sector: 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.

Energy Sector: 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. The exploration, production, marketing, refining and/or transportation of oil and gas products, coal and consumable fuels.

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

Industrials Sector: 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.

Materials Sector: Companies that are engaged 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.

Information Technology: Companies include those 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, including manufacturers and distributors of communications equipment, computers and peripherals, electronic equipment and related instruments, and semiconductor equipment and products.

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

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

Earnings per share (EPS) is the portion of a company’s profit allocated to each outstanding share of common stock. EPS serves as an indicator of a company’s profitability. Earnings per share is generally considered to be the single most important variable in determining a share’s price. It is also a major component used to calculate the price-to-earnings valuation ratio.

INDEX DEFINITIONS:
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

Shareholders’ “Powerball” Payout December 7, 2012

Weekly Market Commentary from Garrett & Robinson

Last week’s record $587 million Powerball jackpot grabbed headlines. But some shareholders may get their own “Powerball” payout in the next few weeks as companies seek to distribute special dividends that may total a record $100 billion to shareholders ahead of the likely expiration of the Bush-era 15% top tax rate on dividends at the end of the year. Cash has built up with companies hesitant to spend on hiring and new equipment, given fiscal cliff concerns and stalling earnings growth. Companies are paying out a record amount of this cash to shareholders this quarter in the form of regular and special dividends.

Special dividends are one-time cash distributions companies make to shareholders outside of regular dividend payouts. Dividends are currently taxed at 15% based on the Bush tax cuts passed 10 years ago in 2003. However, dividends will likely revert to the prior 39.6% rate at the end of this year and rise to 43.4% for households earning more than $250,000, due to the added investment tax from the Affordable Care Act (ACA). That potential tripling of tax rates on dividends has prompted a response among corporations.

Last week saw Whole Foods and Las Vegas Sands among the latest companies to announce a special dividend. In addition, some companies, such as Wal-Mart Stores Inc., have moved up their regular quarterly dividend payments to the end of December from the beginning of January to get ahead of the potential tax changes. Companies are scrambling to distribute dividends — even if they do not have the cash to do it. Dividends are typically paid out of earnings, but Costco’s $7 per share special dividend is largely funded by a new bond issue.

Will such payouts become rarer after the rates go up? That may depend on where the rates go. The dividend payout ratio (the percent of earnings paid out to shareholders as a dividend) has been volatile due to recessions that cut earnings while companies often maintain dividend payouts. Examining the trend over a long period reveals that the dividend payout ratio appeared to stabilize following a 50-year decline after dividend tax rates were lowered in 2003, but has not started to trend higher [Figure 1]. Much higher tax rates on dividends — going from 15% to 43.4% — would make it less likely that payout ratios will rebound much beyond this quarter.

However, we do not expect dividend tax rates will nearly triple in 2013. Instead, the tax bill that passed the Democratic-led Senate this summer had a top rate for capital gains and dividends of 20% (plus 3.8% for the ACA). If the Republican-led House were to pass this bill — or a similar one in a lame duck session compromise — it could be quickly signed by the President to turn a massive dividend tax surge into a modest rise that may not have much of a discernible effect on corporate or investor behavior in 2013.

No matter how much dividend tax rates go up in the quarters ahead, companies may find it more efficient to return capital through share buybacks than dividends. The dividend yield of the companies in the S&P 500 has nearly intersected with A rated corporate bond yields. The gap has shrunk from 5% to about 0.5% over the past four years, as you can see in Figure 2. If this gap closes further — a possibility if we go over the fiscal cliff — companies may find not only is it more tax efficient to buy back shares in order to return cash to shareholders, but it may actually generate more cash for companies to substitute lower yielding debt for stock. And some companies may be doing just that. Investment-grade bond issuance exceeded $120 billion in November 2012, the second largest on record, as share buybacks are on the rise.

High dividend-yielding U.S. stocks, particularly in the telecommunications services, consumer staples, and utilities sectors, could now take advantage by issuing debt to buy back shares to conserve cash and seek to maximize shareholder returns. So if you are looking for yield, stocks are becoming more attractive relative to bonds for both investors and for corporate leaders.

The stock market capitalization weighted debt rating of the S&P 500 companies is as follows:

• 42% of the market capitalization of the S&P 500 is rated A;
• 23% rated higher (AAA or AA);
• 26% rated lower (BBB or worse); and
• 9% are not rated

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.

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 investing involves risk, including the risk of loss.

Investment-grade corporate bonds: The risks associated with investment-grade corporate bonds are considered significantly higher than those associated with first-class government bonds. The difference between rates for first-class government bonds and investment-grade bonds is called investment-grade spread. The range of this spread is an indicator of the market’s belief in the stability of the economy.

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

Dividend-paying stock payments are not guaranteed. The amount of a dividend payment, if any, can vary over time and issuers may reduce dividends paid on securities in the event of a recession or adverse event affecting a specific industry or issuer.

An obligation rated ‘AAA’ has the highest rating assigned by Standard & Poor’s. The obligor’s capacity to meet its financial commitment on the obligation is extremely strong.

An obligation rated ‘AA’ differs from the highest-rated obligations only to a small degree. The obligor’s capacity to meet its financial commitment on the obligation is very strong.

An obligation rated ‘A’ is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligations in higher-rated categories. However, the obligor’s capacity to meet its financial commitment on the obligation is still strong.

An obligation rated ‘A’ is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligations in higher-rated categories. However, the obligor’s capacity to meet its financial commitment on the obligation is still strong.

All company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL financial does not provide research on individual equities.

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.

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