The Market’s March Madness March 21, 2013

It has been a sweet sixteen weeks for the S&P 500. The broad stock market index has had only three down weeks out of the past sixteen. While
this stretch is tied by the same period a year ago, it is important to note that there has not been a sixteen-week period with fewer weeks of losses in
over 20 years — since the period ending September 1, 1989.

March has been maddening for investors in the past few years (2010 – 2012) as the S&P 500 raced higher in March only to reverse all of those gains in a pullback of about 10% that began in late March or April. It later took stocks at least five months to climb back to the peaks of March.

As the NCAA tournament gets down to its own sweet sixteen at the end of this week, it is a good time to reflect on the competing drivers of the markets that may make for an exciting showdown in the weeks and months to come.

As we narrow down stocks’ “sweet sixteen” potential drivers this year, the four “regions” of market-moving factors vying for investor attention are: economy, policy, fundamentals, and market dynamics.

Economy

• „Employment – Job growth has been picking up with more than 200,000 jobs created in three of the past four months and first-time filings for unemployment benefits have started to fall after stabilizing around 350,000 for over a year.
• Housing – The powerfully rebounding housing market, as seen in data such as housing starts and building permits, is a positive for growth.
• Confidence – Last week’s University of Michigan data showed that consumer confidence fell sharply in the preliminary reading for March to the lowest level in over a year.
• Gasoline Prices – Retail gasoline prices are back up near the “danger zone” that coincided with stock market pullbacks in each of the past few years.

Policy

• „Federal Reserve – “Don’t Fight the Fed” rally is intact, but as the Federal Reserve publicly contemplates ending the latest stimulus program, the stock market may suffer the same sell-off that surrounded the ending of prior quantitative easing programs, so-called QE1 and QE2.
• Europe – With the Eurozone back in recession, an inconclusive election leaving no government in Italy, a political scandal hampering the ability to implement needed reforms in Spain, Greece unlikely to meet the terms of its own bailout, and Germany pushing hard terms on any aid ahead of its fall elections, the events in Cyprus could provide the catalyst for another Europe-driven spring slide in the world’s stock markets.
• Geopolitics – The hot spots are heating up again given the power grab following the death of Chavez in Venezuela, the coming elections in Iran, different factions vying for power in war-torn Syria, and North Korea annulling its cease fire agreement.
• Fiscal Cliff – A fiscal drag on gross domestic product (GDP) of about 2%, and showdowns over the continuing resolution funding the government and the debt ceiling still to come, may weigh on investor sentiment as the recently implemented sequester threatens to halt labor market improvement with an estimated cost of 750,000 jobs, according to the Congressional Budget Office.

Fundamentals

• „Earnings – Earnings are the most fundamental of all drivers of stocks.  Earnings growth has been the most consistent factor driving the markets in recent years, but growth has now slowed to the low-single digits for S&P 500 companies.
• Valuations – The price-to-earnings ratio of the S&P 500, at around 15 on the past four quarters’ earnings, is well below the 17 – 18 seen at the end of all prior bull markets since WWII.

• Credit – Demand for credit has improved and credit spreads have

  narrowed; both trends are key supports to growth.

• Corporate Cash – Strong cash balances provide a cheap source of

  capital to invest and incentive to buy back shares to boost earnings per s

  hare growth.

Market Dynamics

• „Momentum – Stocks have been on a strong winning streak that could continue.
• Volume – Trading volume in the markets has been light this year, 10 – 15% below last year, traditionally seen as a sign that a trend has become vulnerable.
• Volatility – Investors have once again become net sellers of U.S. stock mutual funds in the past two weeks, according to data from the Investment Company Institute (ICI), despite strong and steady gains. A return to more volatile markets may further undermine individual investor support.
• Interest Rates – Interest rates are on the rise, potentially acting as a drag on everything from housing to the U.S. budget, but from very low levels.

There are quite a few listed here, but these certainly are not all the factors that are influencing the markets.

The key message for investors in considering these factors is: don’t be too confident in any particular outcome. Respect the complexity of the situation. This is a time for caution and taking some profits, not for indiscriminate selling. It is a time to nibble at opportunities as they emerge; it is not a time to jump in with both feet.

Investing is not a game, but it is important also to remember that forecasting is not an exact science, and many factors can affect outcomes that are hard to predict. Two years ago, the Japanese earthquake had a big impact on markets and natural disasters — despite tremendous advances in technology — are very hard to predict with any degree of accuracy. Geopolitical outcomes can also be hard to foresee as we look to the stresses in the Middle East. For example, the outcome of the Arab Spring uprisings and the changes they have led to in countries including Syria and Egypt were hard to foresee. The markets rarely offer perfect clarity on their direction because they are driven by these factors as well as many others. Even this week’s NCAA March Madness can be seen as a reminder of how it can be notoriously hard to predict winners. Historically, a team’s ranking has meant nothing after getting down to the elite eight.

These factors will play out in the markets over the course of the year, not just in the coming weeks. This means there will likely be some upsets that result in volatility and pullbacks as these factors face off against each other. In the end, we expect a positive year with many opportunities for investors.

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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 and mutual fund investing involves risk, including the risk of loss.

The Standard & Poor’s 500 Index is an unmanaged index, which cannot be invested into directly. Past performance is no guarantee of future results.

Quantitative easing is a government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity.

The Congressional Budget Office is a non-partisan arm of Congress, established in 1974, to provide Congress with non-partisan scoring of budget proposals.

The P/E ratio (price-to-earnings ratio) is a measure of the price paid for a share relative to the annual net income or profit earned by the firm per share. It is a financial ratio used for valuation: a higher P/E ratio means that investors are paying more for each unit of net income, so the stock is more expensive compared to one with lower P/E ratio.

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.
The Investment Company Institute (ICI) is the national association of U.S. investment companies, including mutual funds, closed-end funds, exchange-traded funds (ETFs) , and unit investment trusts (UITs). Members of ICI manage total assets of $11.18 trillion and serve nearly 90 million shareholders.

The credit spread is the yield the corporate bonds less the yield on comparable maturity Treasury debt. This is a market-based estimate of the amount of fear in the bond market Bass-rated bonds are the lowest quality bonds that are considered investment-grade, rather than high-yield. They best reflect the stresses across the quality spectrum.

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

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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.

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„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

Beige Book Bounce-Back March 13, 2013

Positive Tone; More Modest Expansion 

Our proprietary “Beige Book Barometer” ticked up to +66 in March 2013 (from +56 in January 2013), continuing the rebound from a Superstorm Sandy-related dip to +30 in November 2012. Despite the post-Sandy bounce, our Barometer remains well below its recent high of +101, hit in April 2012, and describes an economy that is growing — but only modestly. The improvement in our Barometer since November 2012 has come as the number of positive words in the Beige Book surged to a nine-month high. The number of negative words ticked up slightly between the January and March 2013 Beige Books, but remains well below the levels seen just after Superstorm Sandy hit.

Our Barometer, a diffusion index that measures the number of times the word “strong” or its variations (stronger, strength, strengthen, etc.) appear in the Beige Book less the number of times the word “weak” or its variations (weaken, weaker, etc.) appear, is displayed in Figure 1. The barometer is an effective, quantitative way to derive the shades between strong and weak in the predominately qualitative Beige Book report.

Still Bouncing Back From the Fiscal Cliff and Sandy

When we wrote about the Beige Book in early December 2012, we noted that despite the tepid reading of our Barometer in November 2012 (+30), there was some reason for modest optimism on the economic outlook. First, the Barometer generally suggested the economy was stronger during the summer and early fall of 2012, prior to the impact of Superstorm Sandy and uncertainty ahead of the fiscal cliff than it was in early 2011, before the bruising debt ceiling debate. In addition, we noted that many of the factors that weighed on our Barometer in November 2012 appeared to be temporary. Indeed, with key indicators like consumer sentiment hitting a five-year high, a sustainable housing recovery in place, and the private economy adding more than 200,000 jobs per month in four of the past five months, the U.S. economy is now on a firmer footing than it was in the summer and fall of 2011. A big driver of the uncertainty in the November 2012 Beige Book was Superstorm Sandy, which had 48 mentions, and virtually all of the mentions were associated with disruptions to economic activity.

In contrast, nearly every one of the 25 mentions of Sandy in January 2013 and all but one of the 11 mentions in the March 2013 edition of the Beige Book was associated with a rebound in, or resumption of, economic activity that was disrupted by the storm in late 2012. Because of the timing of the collection of comments for the January 2013 Beige Book (comments from contacts in the business and banking community were collected throughout December 2012 and in the first few days of January 2013), we noted that the Beige Book likely overstated the impact of the fiscal cliff on economic activity in early 2013. Indeed, there were 38 mentions of the word “fiscal” in the January 2013 Beige Book, and almost every mention was accompanied by a word like “uncertainty.” Clearly, the uncertainty was a drag on economic activity among consumers and businesses alike as 2012 drew to a close.

The word “fiscal” appeared just 17 times in the March 2013 Beige Book, and almost all of them were used in a negative context. Looking ahead, the word “sequester” (across the board federal spending cuts that began to go into effect on March 1, 2013) is likely to make a prominent appearance in the next several Beige Books. However, with the debt ceiling debate and possible government shutdown now pushed back until August or September 2013, fiscal uncertainty outside of the impact of the sequester may fade in upcoming Beige Books. The rebound from Sandy will also likely fade in the coming months, although rebuilding from the storm may take years.

While the fiscal cliff debate and the sequester — along with the impact of Sandy may be temporary, though significant — other more persistent factors have weighed on the Barometer since it peaked in April 2012. The ongoing recession in Europe, the economic slowdown in China, the severe damage to the agricultural economy as a result of the drought, and a return to “normal” weather all helped to push the Beige Book Barometer down from +101 in April 2012 to around +50 over the summer and early fall of 2012.

As we expected, the uncertainty surrounding the fiscal cliff and the disruptions caused by Sandy have reversed in recent Beige Books, and our Barometer has returned to the +60 range seen over the spring and summer of 2012. A quick look at Figure 1, however, reveals that our Barometer remains below the range seen in 2005 and 2006, the years just prior to the Great Recession. In short, the Barometer is consistent with other more quantitative metrics on the U.S. economy that suggest that the economy rebounded from the impact of Sandy in early 2013, but is still not back to “normal,” where normal is defined as the pre-Great Recession years of 2005 – 2006, where real gross domestic product (GDP) growth averaged between 2.5% and 3.0%.

Word Clouds Show Modest Expansion

The nearby word clouds are dominated by words describing the tone of the economy when the Beige Books were published. Below are some observations on the current Beige Book (released on March 6, 2013) relative to other recent editions of the Beige Book.

• The economy continued to expand at a “modest to moderate pace” in February and early March 2013. Although the Beige Book corroborates other, more quantitative evidence that the economy is expanding modestly, it is not doing so at a pace that would concern the Federal Reserve that there is upward pressure on wages or prices, which in turn might cause the Fed to slow down or stop its latest round of quantitative easing. The latest Beige Book described wages pressures as “mostly limited” and pricing pressures as “modest.”
• In the Beige Books released in late November 2012 and early January 2013, economic uncertainty surrounding the fiscal cliff and the rebound from the economic disruption wrought by Superstorm Sandy dominated. There were 43 mentions of “uncertainty,” 25 of “Sandy,” and 38 of “fiscal” in the January 2013 Beige Book, and 26 mentions of “uncertainty,” 48 of “Sandy,” and 15 of “fiscal” in the November 2012 Beige Book. In the latest Beige Book, there were just 26 mentions of “uncertainty,” only 11 of “Sandy,” and just 17 of “fiscal.” While the battle over the sequester (and impact on the economy) is likely to begin appearing in the Beige Books released over the next few quarters, all of these words will likely fade as concerns. However, the debt ceiling debate is likely to heat up again in mid-to-late summer 2013, and could once again return fiscal uncertainty to the pages of the Beige Book.
• The word “confidence” appeared 11 times in the latest Beige Book. However, unlike in 2011 and most of 2012, when the word was used in a negative context (i.e., lack of confidence, weak confidence), nine of the 11 mentions in the latest Beige Book were in a positive context. Thus, over the past few Beige Books since Superstorm Sandy, business and banking contacts have generally seen increased confidence in the recovery, especially in housing. This suggests that a sustained, multiyear recovery in the housing market is likely underway.
• Health care, health insurance, and the Affordable Care Act (ACA) were mentioned a total of 15 times in the latest Beige Book, up from eight mentions in the January 2013 Beige Book. In contrast, those words were found just three times in the Beige Book released a year ago (February 2012). We will continue to monitor these health care words closely in the upcoming Beige Books, as the economy continues to adjust to the impact of the ACA.
• In the Beige Book released in January 2013, China received no mentions, marking the first time since early 2012 that China was not mentioned by business and banking contacts. In the March 2013 edition, China had six mentions, many related to the timing of the Chinese Lunar New Year in 2013 (February) versus 2012 (January). Over the course of 2012, the financial media was chock full of stories on the economic slowdown in China and the recession and debt crisis in Europe. The Beige Book suggests that while those issues have not entirely disappeared from Main Street’s radar, they are far less of a concern than the media makes them out to be. Indeed, the last time China warranted as many as six mentions was in January 2012, as fears of a “hard landing” in China began to gather steam. The Chinese economy appeared to have bottomed out in late 2012, avoiding a “hard landing.” The recent data suggest that China’s economy is re-accelerating as 2013 begins, although, as the Beige Book points out, the timing of the Lunar New Year this year, which can impact economic data, is making it difficult to draw any conclusions about the health of the Chinese economy right now.
• Despite the recent flare-up in Europe, related to the lack of a clear winner in the Italian presidential elections, there were only six mentions of Europe in the latest Beige Book, down from eight in January 2013’s Beige Book. The six mentions in March’s Beige Book were well below the 15 – 20 mentions seen in the summer and fall of 2012, as Europe struggled through elections in Greece and increased fears of a break-up. Not surprisingly, nearly all of the mentions of Europe in the latest Beige Book were in a negative context. Perhaps business and banking contacts on Main Street are not as exposed to Europe as some of the larger businesses and financial institutions on Wall Street that dominate media coverage. But it is also worth noting that the European debt crisis is in its fourth year, and Main Street may be getting used to it now.

_______________________________________________________________________________________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.

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.

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 loss of principal.

The Federal Open Market Committee action known as Operation Twist began in 1961. The intent was to flatten the yield curve in order to promote capital inflows and strengthen the dollar. The Fed utilized open market operations to shorten the maturity of public debt in the open market. The action has subsequently been reexamined in isolation and found to have been more effective than originally thought. As a result of this reappraisal, similar action has been suggested as an alternative to quantitative easing by central banks.

The Federal Open Market Committee (FOMC), a committee within the Federal Reserve System, is charged under the United States law with overseeing the nation’s open market operations (i.e., the Fed’s buying and selling of United States Treasure securities).

_______________________________________________________________________________________INDEX DESCRIPTIONS

Purchasing Managers Index (PMI) is an indicator of the economic health of the manufacturing sector. The PMI index is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment.

The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.

_______________________________________________________________________________________ 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

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www.garrettandrobinson.com

Investor’s Guide to the State of the Union Address February 12, 2013

Investor’s Guide to the State of the Union Address

President Obama’s State of the Union (SOTU), scheduled for Tuesday, February 12, is unlikely to be a big market mover. In fact, most SOTU speeches see less than a 1% move in the stock market on the following day, and the average move is only 0.15% [Figure 1].

In his SOTU address on Tuesday, President Obama will present key themes that may impact certain industries and asset classes. While gun control and immigration will likely comprise important themes, they have minor market impact. The two major themes that we will be listening for with potential to impact the markets are: the fiscal cliff and energy independence.

Fiscal Cliff Part II

Early in his speech, the President will be forced to talk about the fiscal cliff part II. There are three remaining components to the fiscal cliff that are yet to be resolved: the sequester taking effect March 1, the government shutdown set for March 27, and the debt ceiling to be hit on May 19.

• The President will likely restate his recent comments about replacing the spending cuts that kick in on March 1, known as the sequester, with some combination of tax increases and spending cuts. However, this has little chance of passing the House after Republicans supported tax increases in the first fiscal cliff deal. The Congressional Budget Office estimates that the fiscal drag from the sequester in 2013 would be about $85 billion, or about 0.5% of gross domestic product (GDP.) This adds to the roughly 1.5% drag on the economy from the fiscal cliff tax increases that went into place January 1. That is a materially negative impact for an economy that registered a contraction in the fourth quarter and is on track for only sluggish growth in the current quarter.

Comments that suggest the President is open to mitigating the defense cuts in exchange for cuts elsewhere, rather than tax increases, may be a positive for the markets — especially for stocks in the defense industry, which have been pulling back lately as the cuts have loomed. Unless changed, defense spending (other than for military personnel) will be cut by around 8% across the board, while nondefense funding that is subject to the automatic reductions will be cut by between 5% and 6%.

• The continuing resolution funding the government expires on March 27 and could prompt a government shutdown (though certain essential components like the armed forces will continue to operate). While tax collections will be reaching their seasonal peak as the April 15 deadline approaches, tax refunds processed by the IRS may take much longer than usual and could cause consumer spending to drop and negatively impact stocks in the consumer discretionary sector. In 2012, the average tax refund check was nearly $3,000, all together totaling $175 billion. The drag on incomes could be felt since consumers have lacked the confidence to fund spending with credit cards in recent years [Figure 2]. During the previous two government shutdowns, it was short-lived. It lasted five days in November 1995 and was followed by 21 days in January 1996. As long as talks are proceeding, we expect another continuing resolution to be passed to fund the government for a few more months or until September 30 to avoid a lengthy shutdown.

• While the debt ceiling has been pushed back to May 19, it will soon be upon us again. If no further action is taken before May 19, the Treasury will once again resort to extraordinary measures to allow the government to continue operating. As precursor to restating these negotiations, President Obama will likely talk about a “balanced package” of spending cuts and tax increases to reduce the deficit and need for additional borrowing. With the potential for additional tax rate increases on the horizon, high dividend-paying stocks and municipal bonds (given the potential elimination of some deductions) could react negatively, which may present a buying opportunity.

These fiscal cliff issues leave little likelihood that other recurring themes in the President’s SOTU address see any legislative action that otherwise could impact certain asset classes. For example, the President is likely to again tout the need for greater infrastructure investment — a potential positive for some stocks in the industrial and materials sectors were it to actually take place. Another example is a new program to modify underwater mortgages that could act as a negative for mortgage-backed securities, if implemented.

Energy Independence

The President is likely to highlight the need for U.S. energy independence, noting the increasing domestic oil and gas production and voicing his continued support for sources of clean energy. Given their dependence on federal support programs, the stocks of producers of wind, solar, and other clean energy sources often tend to be volatile around the SOTU addresses in recent years — sometimes seeing a big bounce that soon fades.

Regarding traditional sources of energy, investors are unlikely to hear anything on natural gas or coal that may turn around slumping coal stocks, but probably nothing that would accelerate their decline either. However, the President will likely highlight energy tax incentives for elimination known as the “percentage depletion allowance” and “expensing of intangible drilling costs.” These incentives exist to encourage small companies to produce oil from marginal wells that become profitable with the tax breaks. These marginal wells are old or small wells that do not produce much oil individually, but in total constitute most of the U.S.’s domestic oil and gas production. The percentage depletion allowance was eliminated in 1975 for the major oil companies, and their ability to expense intangible drilling costs expensing is very limited. Therefore, the potential elimination of these tax breaks would be unlikely to have a major negative effect on the major companies in the energy sector. However, the exploration and production industry of the energy sector could be negatively impacted, were these incentives to be eliminated, which we doubt will happen in 2013.

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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 loss of principal.

The commentary expresses the political view of the author and in no way represents the views of LPL Financial. The assumptions made are based upon approvals by Congress and are subject to change. While individual advisors and investors may of course have their own personal views or preferences when it comes to matters of public and political policy, the author is trying to provide insights from the available data, allowing readers to make fully informed decisions.

Municipal bonds are subject to availability and change in price. They are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Interest income may be subject to the alternative minimum tax. Municipal bonds are federally tax-free but other state and local taxes may apply.

Mortgage-Backed Security (MBS) is 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.

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.

Investments in specialized industry sectors have additional risk such as credit, regulatory, operational, business, economic and political risk which should carefully be considered before investing.

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.

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.

Industrials Sector: Companies whose businesses manufacture and distribute capital goods, including aerospace and defense, construction, engineering and building products, electrical equipment and industrial machinery. Also, companies that provide commercial services and supplies, including printing, employment, environmental and office services, or 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.

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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

Member FINRA/SIPC

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RES 4079 0213

Tracking #1-141165 (Exp. 02/14)

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Overcoming the Twin Ceiling Conundrum January 29, 2013

The so-called fiscal cliff, a series of economically devastating tax increases and spending cuts that were due to come on line at the start of 2013, was temporarily averted after a last-second deal in Congress. The compromise, known as the American Taxpayer Relief Act of 2012, is not the grand solution to our nation’s surging debt issues that many had hoped for. Rather, it is more like a temporary Band-Aid that resolved most of the revenue (tax) elements of the fiscal cliff, but delayed addressing and resolving the tougher decisions surrounding spending cuts and raising the debt ceiling until later in 2013.

This leaves the market held hostage by the resolution of part of the fiscal problem, and the anxiety of knowing that the rest of the problem will be looming over the next few months. In a sense, the market faces a period of the dreaded no-man’s-land — sandwiched between partial clarity and nervous unknown.

I have always felt that markets (and unfortunately our government) are great parallels to raising children. In particular, market recoveries remind me somewhat of parental advice I once received from my grandmother, who said: “you know your kids are growing up when they stop asking you where they came from and start refusing to tell you where they are going.”

You see, many investors often miss the early parts of market rallies coming out of the recessions, including the most recent Great Recession of 2008. This is because, similar to the quote above, early in a market recovery investors are often focused on where the market has been and less on where it is going. As a result, the backward glance creates a slow re-engagement in the markets for many investors.

But like kids growing up, eventually investor focus turns to where the market is going. However, as a market rally matures, the future direction becomes cloudier as the market’s growth climbs higher toward the “ceiling” that eventually caps all recoveries. In a sense, a mature market rally resembles teenagers — still growing, but increasingly mysterious and quite volatile.

And, like my and your kids, the market isn’t going to tell you where it’s going.

It Is 11PM. Do You Know Where Your Market Rally Is?

The level of mystery related to the eventual resolution of the nation’s fiscal dilemma comes as the market, as measured by the S&P 500 Index, currently sits close to its all-time highs (the ceiling) established in 2000 and again in 2007. Therefore, as Figure 1 illustrates, during this 15-year time period the market has rallied twice only to find an invisible, albeit solid, ceiling that has limited further market advances. The levels were 1527 in 2000 and 1565 in 2007. The question remains: can the market finally break through the ceiling and find new market highs given the level of lingering uncertainty?

2013 may indeed see the market challenge its all-time “ceiling,” which is currently about 5% away. However, it is our opinion that this will not happen until all of the components of the fiscal cliff are resolved — including the spending/debt ceiling questions that loom as a specter over this market.

This is the Twin Ceiling Conundrum: the irony that resolving the impending debt dilemma may be the catalyst to lift the market to further gains. But, until that happens: what is the best strategy to navigate this “teenaged” market that is bouncing up against a price ceiling that is hard to crack and being pushed down by concern over a debt ceiling that will be challenging to fix?

The Twin Ceiling Investment Strategy

Despite the fact that unknowns remain, there are plenty of investment strategies to effectively navigate the current twin ceiling environment. Frankly, uncertainty breeds opportunity, which a resourceful and adaptive investment strategy uses to its advantage. Our preferred strategies for this period are:

• Managing the Trading Range
• Recognizing the Decision Box
• Seeking Clear Winners

Managing the Trading Range

We believe that the market will remain relatively range-bound over the near term, which refers to a type of market that seems to oscillate within a relatively confined price or trading range. Similar to a bouncy ball within a box, a trading range-bound market will simply “bounce” from the ceiling (top of the range) to the floor (bottom of the range).

Trading range markets often occur when there are conflicting positive and negative forces that keep the balance of power between bulls and bears at a standoff in a competitive bout of tug-of-war. On the upside, cheap valuations, a recovering U.S. housing market, steady employment gains, and the resurgence of China’s growth should provide enough positive ammunition to keep the bulls active. But the bears also have a powerful tug-of-war position, given the looming debt ceiling battle and slowing corporate earnings growth.

The end result is likely a stalemate over the near term, as any upper hand by either the bulls or the bears is quickly reversed. The result could be a relatively narrow trading range for the market. This certainly requires a different strategy for investors. First of all, if the market is confined to a range, the investment strategy that may work best is having the discipline to trim risk near the top end of the range and adding risk near the lower end of the range. Using a tactical approach, when the bulls get a temporary upper hand, a slight trim of risk is prudent, just as an addition to risk is likely a good approach to short-term market pullbacks.

Currently, the top end of the trading range is around 1527 on the S&P 500 Index, which is the 2000 market peak and a level that serves as a form of resistance that may prove difficult for the market to pass. The lower end of the trading range is around 1423 — a level that represents the average price level for the S&P 500 Index over the last 50 trading days (otherwise known as the 50-day simple moving average). In general, previous market peaks and key moving average levels are often boundaries for market moves, and in this case, likely serve as the ceiling and floor for our temporary trading range.

Recognizing the Decision Box

While we expect this market to be confined to a trading range over the near term, which could allow tactical allocators to add value, trading ranges do not last forever. And, you need to make sure you realize when you are really in one versus when you think you are in one. While the trim-at-the-top-and-add-at-the-bottom strategy works well in the trading range, any breakout or a pullback outside of the range needs to be watched for. In other words, the key is to know if the ceiling and floor of the trading range are made of wood or tissue paper.

While trading range markets can exist for lengthy periods of time, eventually, the balance of positive to negative news tips, and the tug-of-war turns from a stalemate to a trending market in one direction or the other. Essentially the strong ceiling or floor turns from wood to tissue paper. It is for this reason that a trading range is often referred to by market technicians — those investors that study market movements — as a decision box.

A decision box implies that when the market is in a trading range, it is essentially bouncing in a zone until there is a trend of good or bad news that creates a break out of the range — either to the upside or the downside. Therefore, with the current trading range serving as a decision box between the levels 1423 and 1527 for the S&P 500 Index, any sustained move outside of the boundaries would be considered a breakout. In a sense, it would be a decision made by the market that either the bulls or the bears have regained control.

There are certainly many factors that could drive this market out of its trading range, including better or worse news from the current earnings season, Europe, China, or a wide number of market-moving events. However, the most likely factors will be the ongoing battle and potential resolution of the debt ceiling that looms over the next few months. A shift and favorable resolution to the debt ceiling battle could result in a measured move by the market above the upper threshold levels of the decision box, while a drawn-out battle or even the failure to resolve the debate could be a bearish outcome of the decision box.

Seeking Clear Winners

Over long periods of time, factors like demographic trends, earnings, and valuations are the primary drivers of investment winners and losers. These macroeconomic forces shape the overall direction of the market and end up as the currents that push investment ideas to either strong or weak results. However, over shorter periods, like when in the decision box, these broad

macroeconomic forces take a back seat to more short-term, microeconomic factors that end up driving market behavior. Usually these micro themes are derived from economic data, short-term market-moving events, central bank activity, or geopolitical events.

In this current decision box, we see the following micro factors having the most significant impact on the market:

1. Taxes: Given the early January compromise to avert a portion of the fiscal cliff by raising taxes on many Americans, there are some likely benefactors that could continue to post solid results including municipal bonds and master limited partnerships (MLPs). Both of these investments maintained their positive tax benefits and, as such, should demand a premium price in an environment of rising taxes.
2. China and Emerging Markets: With developed markets facing austerity-related growth anchors, emerging markets have continued to benefit from robust organic growth.
3. Industrials and Manufacturing Sectors: Higher taxes for the wealthiest Americans (who are also the largest spenders) combined with the elimination of the payroll tax cuts that affect nearly every worker could result in sluggish consumer spending. However, robust growth from China and a resurgence of business spending could boost manufacturing-related industries including infrastructure and transportation names, automotive-related companies, and industrials.
4. Homebuilders: Despite uncertainty in the market, homebuilders appear to have turned the corner, as strong demand for new homes are beginning to emerge. The inventory of unsold existing homes now stands near 10-year lows, prompting demand for new building.

Stay Disciplined but Be Prepared to Duck

Over the short run, the market appears to be pinned in a decision box bound on the upside by an invisible ceiling but buoyed on the downside by a resurgent economy. As a result, the tug-of-war between bulls and bears will likely keep the market somewhat range-bound. Regardless, there are several themes that appear to have favorable short- and long-term investment potential that warrant consideration for opportunistic investors, including strategies benefitting from an environment of higher taxes, the soft-landing in China, the manufacturing renaissance, and the housing recovery.

As we started 2013, the bulls have had the upper hand, and as a result, the market currently stands closer to the top end of the decision box, suggesting that portfolio discipline remains a good strategy. After all, as a relatively tall guy that too often has to navigate tight spaces on planes and in cars, I can speak to my fair share of noggin bumps and bruises. Thus, as I have learned the hard way, the closer the ceiling, the more ready I need to be to duck. The same can be said for how to navigate this market and the fast approaching twin ceilings — stay disciplined in following your investment plan but just in case, be prepared to duck.

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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.

Tactical portfolios are designed to be monitored over a shorter time frame to potentially take advantage of opportunities as short as a few months, weeks, or even days. For these portfolios, more timely changes may allow investors to benefit from rapidly changing opportunities within the market.

Investing in foreign securities involves special additional risks. These risks include, but are not limited to, currency risk, political risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks.

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

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

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.

Municipal bonds are subject to availability, price, and to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rate rise.

Interest income may be subject to the alternative minimum tax. Federally tax-free but other state and local taxes may apply.

Master Limited Partnership (MLP) is a type of limited partnership that is publicly traded. There are two types of partners in this type of partnership: The limited partner is the person or group that provides the capital to the MLP and receives periodic income distributions from the MLP’s cash flow, whereas the general partner is the party responsible for managing the MLP’s affairs and receives compensation that is linked to the performance of the venture.

There is no assurance that the techniques and strategies discussed are suitable for all investors or will yield positive outcomes.

The purchase of certain securities may be required to effect some of the strategies. Investing involves risks including possible loss of principal.

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 loss of principal.

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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.

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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

 

Beige Book Rebounds January 24, 2013

Weekly Market Commentary from Garrett and Robinson

Modest Expansion

Despite elevated levels of uncertainty surrounding the debate over the fiscal cliff in December 2012 and in the first few days of January 2013, our proprietary “Beige Book Barometer” moved up to +56 in January 2013, rebounding from a Superstorm Sandy-related dip to +30 in November 2012. Still, our Barometer remains well below its recent high of +101, hit in April 2012. The improvement in our barometer between November 2012 and January 2013 was largely the result of a drop in the number of negative words in the Beige Book; there was only a modest change in the number of positive words in the Beige Book between November 2012 and January 2013. Our Barometer, a diffusion index that measures the number of times the word “strong” or its variations (stronger, strength, strengthen, etc.) appear in the Beige Book less the number of times the word “weak” or its variations (weaken, weaker, etc.) appear, is displayed in Figure 2. The barometer is an effective, quantitative way to derive the shades between strong and weak in the predominately qualitative Beige Book report.

Bouncing Back From the Fiscal Cliff and Sandy

When we last wrote about the Beige Book in early December 2012, we noted that despite the tepid reading of our Barometer in November 2012 (+30), there was some reason for modest optimism on the economic outlook. First, the Barometer generally suggested the economy was stronger heading into the debate around the fiscal cliff and Sandy in the summer and fall of 2012 than it was in early 2011, ahead of the bruising debt ceiling debate. In addition, many of the factors that weighed on our Barometer in November 2012 appeared to be temporary. Indeed, with key indicators like consumer sentiment hitting a five-year high and initial claims for unemployment benefits hitting a five-year low in late 2012, the U.S. economy is now on a firmer footing than it was in the summer and fall of 2011. A big driver of the uncertainty in the November 2012 Beige Book was Superstorm Sandy, which had 48 mentions, and virtually all of the mentions were associated with disruptions to economic activity.

In contrast, nearly every one of the 25 mentions of Sandy in January 2013 was associated with a rebound in, or resumption of, economic activity that was disrupted by the storm in late 2012.  Because of the timing of the collection of comments for the January 2013 Beige Book (comments from contacts in the business and banking community were collected throughout December 2012 and in the first few days of January 2013), the latest Beige Book likely overstated the impact of the fiscal cliff on economic activity in early 2013. However, there were 38 mentions of the word “fiscal” in the January 2013 Beige Book, and almost every mention was accompanied by a word like “uncertainty.” Clearly, the uncertainty was a drag on economic activity among consumers and businesses alike as 2012 drew to a close.

While the fiscal cliff debate and the impact of Sandy may be temporary, though significant, other more persistent factors have weighed on the Barometer since it peaked in April 2012. The ongoing recession in Europe, the economic slowdown in China, the severe damage to the agricultural economy as a result of the drought, and a return to “normal” weather all helped to push the Beige Book Barometer down from +101 in April 2012 to around +50 over the summer of 2012.

Even if the uncertainty surrounding the fiscal cliff and the disruptions caused by Sandy reversed, and our Barometer returned to the +60 range seen over the spring and summer of 2012, it would still remain below the range seen in 2005 and 2006, the years just prior to the Great Recession. In short, the Beige Book Barometer is consistent with other more quantitative metrics on the U.S. economy that suggest that the economy is in recovery, and growing at around 2.0% (as measured by gross domestic product [GDP]) but is still not back to “normal,” where normal is defined as the pre- Great Recession years of 2005 – 2006, where real GDP growth averaged between 2.5% and 3.0%.

Word Clouds Show Modest Expansion

The nearby word clouds are dominated by words describing the tone of the economy when the Beige Books were published. Below are some observations on the current Beige Book (released on January 16, 2013) relative to other recent editions of the Beige Book.

• The  economy is expanding at a modest pace, perhaps a step up from the measured pace seen in November 2012, representing a rebound in activity after the disruption caused by Superstorm Sandy.
• The latest Beige Book was dominated by uncertainty surrounding the fiscal cliff and the rebound from the economic disruption wrought by Superstorm Sandy. There were 43 mentions of “uncertainty,” 25 of “Sandy,” and 38 of “fiscal” in the January 2013 Beige Book.
• The word “confidence,” which was used 11 times in the September 2011 Beige Book amid the worst of the situation in Europe, appeared just five times in the latest Beige Book. During the summer and fall of 2011, the word confidence appeared an average of eight times in each Beige Book. Increased uncertainty (Sandy and fiscal cliff), rather than lack of economic confidence, seems to best describe the current economic environment on Main Street in late 2012/early 2013.
• The lack of rain and concerns over the drought in the midsection of the United States made another significant appearance in the latest Beige Book, although these concerns have faded in recent Beige Books. The word “drought” was mentioned 11 times in January 2013, 18 times in November 2012, 19 times in October 2012, and 22 times in August 2012. Drought warranted only a handful of mentions in the Beige Books released in late 2011 and early 2012. The word “crop” was mentioned 16 times in the January 2013 Beige Book after 20 mentions in the November 2012 Beige Book. Crop warranted 26 mentions in October 2012 and 22 in August 2012. A look back to the Beige Books of a year ago (July 2011 through January 2012) finds that drought was also a concern (mentioned 37 times in those four Beige Books). However, in the last five Beige Books (July 2012 through January 2013), the word drought appeared 73 times.  Looking ahead, we would expect drought and the damage to crops due to the lack of rain this past summer in the Midwest to continue to impact the Beige Book in the coming months, and the economy could begin to see higher prices for some foods as soon as this spring.
• For the first time since the February 2012 Beige Book, China received no mentions in the Beige Book. Over the course of 2012, the financial media was chock full of stories on the economic slowdown in China and the recession and debt crisis in Europe. The Beige Book suggests that while those issues have not entirely disappeared from Main Street’s radar, they are far less of a concern than the media makes them out to be. China had no mentions in the latest Beige Book, two in the November 2012 Beige Book, and just one mention in the August 2012 and October 2012 Beige Books. The recent peak for mentions of China was six in the January 2012 Beige Book. The Chinese economy appeared to have bottomed out in late 2012, avoiding a “hard landing.” The recent data suggest that China’s economy is re-accelerating as 2013 begins.
• There were just eight mentions of Europe in the latest Beige Book, up from seven in November 2012, but down from 12 in October 2012 and 20 in August 2012. Not surprisingly, all of the mentions of Europe in the latest Beige Book were in a negative context. Perhaps business and banking contacts on Main Street are not as exposed to Europe as some of the larger businesses and financial institutions on Wall Street that dominate media coverage. But it is also worth noting that the European debt crisis is in its fourth year, and Main Street may be getting used to it now.

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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.

* 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.

^ Federal Funds Rate is the interest rate at which depository institutions actively trade balances held at the Federal Reserve, called federal funds, with each other, usually overnight, on an uncollateralized basis.

† Private Sector – the total nonfarm payroll accounts for approximately 80% of the workers who produce the entire gross domestic product of the United States. The nonfarm payroll statistic is reported monthly, on the first Friday of the month, and is used to assist government policy makers and economists determine the current state of the economy and predict future levels of economic activity. It doesn’t include:

• general government employees
• private household employees
• employees of nonprofit organizations that provide assistance to individuals
• farm employees

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 loss of principal.  International investing involves special risks, such as currency fluctuation and political instability,  nd may not be suitable for all investors.

The Federal Open Market Committee action known as Operation Twist began in 1961. The intent was to flatten the yield curve in order to promote capital inflows and strengthen the dollar. The Fed utilized open market operations to shorten the maturity of public debt in the open market. The action has  subsequently been reexamined in isolation and found to have been more effective than originally thought. As a result of this reappraisal, similar action has been suggested as an alternative to quantitative easing by central banks.

The Federal Open Market Committee (FOMC), a committee within the Federal Reserve System, is charged under the United States law with overseeing the nation’s open market operations (i.e., the Fed’s buying and selling of United States Treasure securities).

The index of leading economic indicators (LEI) is an economic variable, such as private-sector wages, that tends to show the direction of future economic  activity.

International Monetary Fund (IMF) is an international organization created for the purpose of promoting global monetary and exchange stability, facilitating the expansion and balanced growth of international trade, and assisting in the establishment of a multilateral system of payments for current transactions.

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INDEX DESCRIPTIONS

Purchasing Managers Index (PMI) is an indicator of the economic health of the manufacturing sector. The PMI index is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment.

The Richmond Manufacturing Index is a composite index that represents a weighted average of the shipments, new orders and employment indexes. Each index is a diffusion index, i.e., it is equal to the percentage of responding firms reporting increases minus the percentage reporting decreases, with results based on responses from 80 out of 110 firms surveyed.

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

Market Insight – Fourth Quarter 2012 January 15, 2013

Stocks Limped to the Finish but Delivered Solid Double-Digit Returns in 2012

The U.S. economy faces the weakest global backdrop since the Great Recession of 2008 – 09, as the drag from the so-called fiscal cliff — the combination of tax increases and spending cuts — looms in 2013. Also contributing to subpar economic growth at the end of the year was the ongoing recession in Europe and the impact of Superstorm Sandy in the northeastern United States. The benefits of Federal Reserve (Fed) stimulus and the positive consumer wealth effect of the rebounding housing and stock markets provided a partial offset, but the economy remained on a path of weak economic growth as 2013 approached.

Stocks limped to the finish as 2012 ended but delivered solid double-digit returns in 2012, consistent with our forecast as laid out in our Outlook 2012 publication. Several challenges prevented the S&P 500 in the fourth quarter from building on the strong gains in the first nine months of the year, most notably the fiscal cliff. In late October, the massive disruption from Superstorm Sandy put downward pressure on the economy, followed by a post-election slide in early November ahead of the contentious lame duck session in Congress that increased stock market volatility in December.
The Barclays Aggregate Bond Index eked out a marginal 0.2% return in the fourth quarter, which brought the total return for the broad bond market index in 2012 to 4.2%, consistent with our forecast for low to mid-single-digit total returns initially noted in our Outlook 2012. The quarter and the year were led by more economically sensitive and higher yielding bond sectors, such as high-yield and investment-grade corporate bonds and emerging market debt.

Commodities were unable to build on solid third quarter gains, as the Dow Jones-UBS Commodity Index fell 6.4% during the fourth quarter. The commodity index followed the equity market for the majority of the quarter, before diverging starting in late November, as stocks grinded higher in anticipation of a budget compromise in Washington while commodities fell. For the year, commodities were essentially flat as lower crude oil prices offset gains in natural gas, metals, and agriculture.

Economy – Fiscal Cliff Uncertainty, Superstorm Sandy Weigh on Economic Growth

The U.S. economy faces the weakest global backdrop since the Great Recession of 2008 – 09, as the drag from the so-called fiscal cliff — the combination of tax increases and spending cuts — looms in 2013. Also contributing to subpar economic growth at the end of the year was the ongoing recession in Europe and the impact of Superstorm Sandy in the northeastern United States. The benefits of Federal Reserve (Fed) stimulus and the positive consumer wealth effect of the rebounding housing and stock markets provided a partial offset, but the economy remained on a path of weak economic growth as 2013 approached.

Third quarter gross domestic product (GDP) did surprise on the upside, with the latest revision showing a 3.1% annualized growth rate after an initial reading of 2.0%, and up from 1.3% in the prior (second) quarter [Figure 1]. The upward revision was driven by government spending and higher inventories, neither of which are likely to be sustained. Government spending actually grew 3.9% in the quarter, the fastest in more than three years, ahead of looming spending cuts prescribed by the Budget Control Act of 2011. Consumer spending continued to hang in, growing 1.6% in the quarter, while housing construction was a bright spot. Trade was a positive contributor to growth, as imports fell marginally and exports rose modestly as the US dollar stabilized and Europe fears abated.

Lower business investment was a drag on growth in the third quarter. Budget uncertainty in Washington following the status quo election outcome in the White House and Congress led company management teams 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. A decline in farm inventory related to the summer drought was also a drag on growth during the quarter.

Core inflation moderated from 1.7% to 1.1%, providing a favorable backdrop for additional bond purchases from the Fed announced in December. Aggressive stimulus from the Fed in the form of additional quantitative easing (fresh purchases of Treasuries and mortgage-backed securities [MBS]) has kept mortgage and other borrowing costs low while supporting exports by limiting appreciation of the US dollar versus those of our key trading partners.

Data available for the fourth quarter suggest the sluggish growth experienced in the first half of 2012 — at or below a 2% pace — will continue. The Fed and the recovery in the housing markets remain supportive, but with higher taxes and spending cuts looming in 2013, even with greater budget certainty, any meaningful pickup in consumer or business spending beyond 2% to close out 2012 and as 2013 gets underway appears unlikely.

The sluggish pace of growth reflected in recent data is not sufficient to drive a meaningful pickup in the labor market. Job growth has improved marginally but remains lackluster while the unemployment rate remains stubbornly high. In addition to policy uncertainty, Superstorm Sandy has had a negative impact, although job losses from the storm should reverse in the coming months as the rebuilding effort gathers steam. The economy created an average of about 180,000 private sector jobs in September through December, still below the pace that would typically be seen at this stage of an economic recovery, but a bit better than the pace of the spring and summer months. (See our January 7, 2013 Weekly Economic Commentary: Full Speed Recovery? for a comparison of the current economic recovery versus previous recoveries.) The unemployment rate has been below 8.0% since September, but a shrinking labor force continues to drive the modest improvement (the dominator in the unemployment rate calculation). On the bright side, the December 2012 reading of 168,000 new private sector jobs represented a positive surprise.

Despite sluggish job growth, marginal improvement (at best) in the stubbornly high unemployment rate, disruptions from Superstorm Sandy, and prospects for higher taxes in 2013, consumers hung in at the end of 2012 [Figure 2]. Total retail sales in November, as reported by the U.S. government, rose a respectable 3.7% year-over-year, as the wealth effect from higher stock and home prices and the start of Sandy rebuilding efforts helped offset the hit to consumer traffic in the early part of the month in the aftermath of the storm. Sales in the 2012 holiday shopping season were disappointing, only matching lowered expectations, not surprising given the impact of Sandy and the uncertainty surrounding the fiscal cliff negotiations. Looking forward, leading indicators continue to point toward growth, not recession [Figure 3].

Stock Markets – Fiscal Cliff Uncertainty Prevents Stocks From Building on 2012 Gains

Stocks limped to the finish as 2012 ended, but delivered solid double-digit returns in 2012, consistent with our forecast as laid out in our Outlook 2012 publication. Several challenges prevented the S&P 500 in the fourth quarter from building on the strong gains in the first nine months of the year [Figure 4], most notably the fiscal cliff — the combination of tax increases and spending cuts scheduled to take effect after year-end. In late October, the massive disruption from Superstorm Sandy put downward pressure on the economy, followed by a post-election slide in early November, which based on the status quo outcome, set the stage for the contentious lame duck session in Congress that increased stock market volatility in December.

Besides complacency among market participants, the primary factor offsetting the downward pressure on the economy and markets late in 2012 was the Fed. After announcing a third round of quantitative easing (QE3) in September under which the Fed would purchase $40 billion in MBS each month, it followed that with an additional $45 billion of fresh Treasury purchases announced in mid-December, which confirmed the market’s expectation that the program would be maintained for the foreseeable future. These moves are expected to keep interest rates and borrowing costs low, and continue to push investors further out on the risk spectrum away from Treasuries and other high-quality fixed income investments, and cash. Meanwhile, looking outside the United States, relative stability in Europe and an improved growth outlook for China following its leadership transition also helped offset the drag from U.S. policy uncertainty and prevent stocks from suffering more than a modest fourth quarter decline.

The fourth quarter started off on a down note with a 1.8% decline in October — the worst month since May — amid election uncertainty and the impact of Sandy. The selling pressure then accelerated after the election, pushing the S&P 500 to its low for the quarter on November 15, 2012, at 1353. Stocks then staged an impressive turnaround, rallying 7% over the next month to the high at 1447, supported by confidence that a deal to avert the fiscal cliff would be reached before year-end. After a modestly positive November in which the S&P 500 returned 0.6%, stocks edged slightly higher in December as the market expressed confidence that a budget deal in Washington would be reached.

Heightened fears that the U.S. economy would go over the fiscal cliff led to an increase in stock market volatility in late December. The VIX, a measure of expected stock market volatility, remained low relative to its historical averages — in the mid-to-high teens — throughout much of the quarter before jumping to over 20 in the last week of the year for the first time since July. Looking at volatility another way, after just two days in which the S&P 500 lost more than 1% in the third quarter, investors experienced six such days in the fourth quarter, including three in the week following the election on November 6, 2012.

More economically sensitive, or cyclical, sectors generally fared better than defensive sectors again in the fourth quarter after re-establishing leadership during the third [Figure 5]. Financials topped S&P sectors in the quarter with a 5.9% return amid stability in Europe, resilient earnings, attractive valuations, and the ongoing housing recovery. The industrials sector was also a solid performer, as prospects for growth in China improved and the market priced in less onerous spending cuts than those prescribed in the sequestration comprising a portion of the fiscal cliff. While the best-performing sectors were cyclical, technology was a disappointment, weighed down by the more than 20% decline in Apple shares. Despite the 5.7% loss in the quarter, the technology sector still finished the year with a 14.8% return, trailing the S&P 500 by just over 1%. Other sector losers in the quarter included telecom and utilities, which fell 6.0% and 2.9%, respectively, and were hurt by prospects for higher dividend tax rates in 2013.

A strong fourth quarter cemented financials’ place as the biggest sector winner in 2012. The sector was buoyed by stability in Europe, support from the Fed, and an improving housing market, which combined to drive a strong year for the stock and credit markets in 2012. Led by home improvement and internet retailers and media companies, the consumer discretionary sector outperformed for the fifth straight year with a stellar 23.8% return. Consumer spending continued to hang in there with help from higher stock and home prices, the so-called wealth effect, despite only modest gains in consumer incomes and employment. On the downside, it was a tough year for the utilities sector amid the challenging regulatory environment, lackluster growth, Superstorm Sandy disruptions, and prospects for higher dividend tax rates.

Like sector performance, market cap performance also revealed investors’ preference for a bit more cyclicality and market sensitivity in the fourth quarter. Mid cap stocks performed best in the quarter, as the Russell Midcap Index returned 2.9%, outpacing both the large cap Russell 1000 Index (+0.1%) and the small cap Russell 2000 Index (+1.9%). Mid caps also benefited from an increase in merger and acquisition activity, while weakness in technology dragged the large cap benchmark lower. The strong performance by mid caps in the fourth quarter reversed the third quarter pattern, which saw large caps lead the way as investors preferred the stability and more attractive valuations offered by larger companies. For the year, capitalization was not much of a driver of relative performance with large, mid, and small each generating returns of 16 – 17%.

In terms of style, value made a strong fourth quarter comeback to pull slightly ahead of growth for the year across market capitalizations. Gains for the Russell 1000 Value Index, Midcap Value Index, and Russell 2000 Value Index were 1.5%, 3.9%, and 3.2%, respectively, each ahead of their respective growth counterparts, which returned -1.3%, 1.7%, and 0.5% in the quarter. The relatively strong finish helped value end the year ahead of growth across all market capitalizations, by between 2% and 3%. The biggest driver of the strength in value, particularly late in the year, was the market-leading performance by the financial sector, the biggest weight in the value indexes, coupled with underperformance by the technology sector, the biggest growth sector.

The improved performance by international equities that began in the summer gathered momentum late in 2012, as the MSCI EAFE handily outpaced the broad U.S. market averages with a 6.6% return in the fourth quarter. Relative stability in Europe as the Eurozone continued to make progress toward fiscal and monetary integration, along with policy optimism and a weaker yen in Japan, were among the key drivers of this strength in foreign markets. Emerging markets also performed very well, returning 5.6% in the quarter as the growth outlook for China in 2013 has improved, consistent with fresh stimulus and the political leadership transition. The strong finish for international markets, supported by attractive valuations and less policy uncertainty, pushed both benchmarks ahead of the S&P 500 Index for the year, with the MSCI EAFE and Emerging Markets Indexes returning 17.8% and 18.6%, respectively, in 2012, compared to 16.0% for the S&P 500 Index.

Commodities Asset Classes: Down Fourth Quarter Leads to Flat 2012

Commodities were unable to build on solid third quarter gains as the Dow Jones-UBS Commodity Index fell 6.4% during the fourth quarter. The commodity index followed the equity market for the majority of the quarter, before diverging starting in late November, as stocks grinded higher in anticipation of a budget compromise in Washington while commodities fell.

Late-year weakness was concentrated in natural gas and agriculture. For the year, commodities were essentially flat as lower crude oil prices offset gains in natural gas, metals, and agriculture.

For commodity investors, fourth quarter performance was disappointing because of the tailwinds that were in place. Perhaps the biggest tailwind has been the Fed. After announcing another round of bond purchases in September, the central bank added more purchases in December. This stimulative monetary policy has not put meaningful incremental pressure on the US dollar (in no small part due to similar actions by other countries’ central banks), nor has it increased near-term inflation expectations, dampening the potential upward pressure on commodity prices, particularly precious metals.

The other tailwind for commodities that has not translated into gains has been the stabilization and early signs of a pickup in the Chinese economy. Chinese policymakers took a number of measures to stimulate their economy in 2012 and achieve a so-called soft landing, including reducing bank reserve requirements and interest rates. These efforts, combined with other targeted fiscal initiatives, have begun to take effect and show up in improving Chinese economic data. The recently completed leadership transition improves the growth outlook for the world’s second-largest economy as the outward focus is renewed.

Looking at individual commodities, energy was volatile during the quarter, but crude oil [Figure 6] and natural gas prices both ended roughly where they started near $92 per barrel (West Texas Intermediate) and $3.30 per btu (Nymex), respectively. The two commodities took very different paths to get there, with natural gas rising sharply in the first part of the quarter before forecasts for a relatively warm winter took it down sharply over the last six weeks of the year. Conversely, crude oil fell along with stocks in the early part of the quarter amid concerns on both the demand and the supply side, including the impact of Superstorm Sandy, before rallying back to breakeven as the equity markets moved higher, the growth outlook for both the United States and China improved, and tensions in the Mideast escalated. For the year, crude oil ended down 7% while natural gas rose 1%.

Precious metals’ performance during the fourth quarter was particularly disappointing, given the additional stimulus provided by the Fed. Gold lost about $100, or 5.5%, to end the year at $1676 [Figure 7], while silver fell 12%. The US dollar was only marginally lower in the quarter as central banks around the world are engaging in similarly aggressive stimulus. But the gold thesis is broader than just the US dollar and includes emerging market demand and low interest rates, factors that remained supportive throughout much of the quarter. However, these factors had little impact on the precious metal, which trailed the equity market rebound in December. Gold still managed its twelfth straight annual gain despite the lackluster finish, ending 2012 up 7%. Industrial metals did not fare much better in the fourth quarter, as copper lost 3%, but still ended the year with a 6% gain.

Agriculture gave back all of its third quarter gains as the Dow Jones-UBS Agriculture Index lost 10% during the fourth quarter [Figure 8]. After sharp increases in grain prices over the summer due to the significant crop damage from the Midwest droughts, the supply picture in the United States became a bit less dire. International harvest prospects also improved late in the year, in Latin America especially, while key export partners including China increasingly balked at higher U.S. prices. These factors contributed to sharp declines in corn, wheat, and soybeans during the quarter of between 8% and 14%, although wheat and soybeans still posted double-digit gains in 2012, and corn rose 8%. The broad agriculture index still rose 4% for the year, despite the steep fourth quarter losses.

Fixed Income – Taxable: Investors Continued to Favor Higher Yielding Fixed Income Over High Quality

The Barclays Aggregate Bond Index eked out a marginal 0.2% return in the fourth quarter, the sixteenth gain out of the past 17 quarters for the index. Fourth quarter gains brought the total return for the broad bond market index in 2012 to 4.2%, consistent with our forecast for low to mid-single-digit total returns initially noted in our Outlook 2012,                        published in November 2011, and reiterated in our Mid-Year Outlook 2012 publication.

The quarter and the year were led by more economically sensitive and higher yielding bond sectors, such as high-yield and investment-grade corporate bonds and emerging market debt, while high-quality bonds including U.S. Treasuries and MBS underperformed. Investors continued to be attracted to the additional income provided by these bond sectors relative to high-quality bonds, as expanded bond purchases by the Fed continued to push investors into higher yielding areas of the bond market. Treasuries fell marginally during the quarter, as the modest income component was not sufficient to offset the slight rise in yields. The 10-year Treasury yield increased 13 basis points during the quarter but remained low by historical standards near 1.8% [Figure 9] as the Fed, subpar economic growth, and benign inflation continued to exert downward pressure on yields and offset the slight improvement in the U.S. growth outlook that helped push yields higher in December.

High-yield corporate bonds and emerging market debt topped the major taxable fixed income sectors in the fourth quarter, as each generated solid returns of 3.3% based on the Barclays High-Yield Index and the J.P. Morgan Emerging Markets Bond Index, as investors were attracted to the higher yields these bond sectors provide. High-yield corporate bonds benefited from spread narrowing as corporate credit metrics continued to improve. Emerging market debt was buffeted by stronger economic growth outlooks, and less policy uncertainty (no fiscal cliff), in key markets in Asia and Latin America, which attracted investors to emerging market equities as well. For the year, emerging market debt topped all taxable bond sectors with a tremendous 18.4% return, followed by high-yield corporate bonds (+15.8%).
Among corporate bonds, longer term bonds fared a bit better as the Barclays Credit Long Index returned 1.3% in the quarter, compared to the 1.1% return for the broad investment-grade corporate benchmark, the Barclays U.S. Corporate Bond Index. Unhedged foreign bonds were hurt by low yields (extreme valuations) and a firm US dollar, losing 2.4% based on the Citigroup non-U.S. World Government Bond Index, although the hedged version of that index managed a respectable 1.2% return in the quarter as conditions in Europe stabilized and growth prospects in Japan improved related to the change in leadership. For the year, the hedged foreign bond benchmark returned 5.5%, while the unhedged index returned just 1.5%.

Among high-quality taxable bond sectors, Treasury inflation protected securities (TIPS) generated the best return at 0.7%, outpacing the marginal loss generated by U.S. Treasuries given the benefit of the inflation protection. MBS were the worst-performing bond sector in the quarter with a 0.2% loss, based on the Barclays U.S. MBS Index, as the modest income premium versus Treasuries failed to offset the impact of heavy prepayment activity. For the year, TIPS were the best-performing high-quality taxable fixed income sector, returning 7.0%, nearly 3% better than the Barclays Aggregate and well ahead of the meager 2.6% and 2.0% returns for MBS and U.S. Treasuries, respectively.

Fixed Income – Tax-free: Continued Municipal Bond Outperformance Though With Higher Volatility

Municipal bonds continued to perform well relative to their taxable high-quality bond counterparts with a 0.7% return in the fourth quarter, based on the Barclays Municipal Bond Index. Municipals continued to benefit from attractive valuations and a yield advantage versus U.S. Treasuries in outperforming the Barclays Aggregate Bond Index, although concerns about a potential cap on tax-exempt interest as part of tax reform did contribute to higher volatility in the fourth quarter and limit returns. Fundamentals are not particularly strong, with defaults starting to increase, though still at relatively low levels. But investors continue to enjoy an even more attractive tax benefit, which becomes more valuable at higher tax rates in 2013. The lower end of the quality spectrum fared best again this quarter, with the Barclays Capital High-Yield Municipal Bond Index returning 3.7% in the quarter to top all major bond sectors, taxable or non-taxable, bringing the 2012 return to a stellar 18.1%.

_____________________________________________________________________________________________

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.

Stock investing may involve risk including loss of principal.

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 doesn’t provide research on individual equities.

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

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.

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

Precious metal investing is subject to substantial fluctuation and potential for loss.

The fast price swings in commodities and currencies will result in significant volatility in an investor’s holdings.
Correlation is a statistical measure of how two securities move in relation to each other. Correlations are used in advanced portfolio management.

Currency Risk is a form of risk that arises from the change in price of one currency against another. Whenever investors or companies have assets or business operations across national borders, they face currency risk if their positions are not hedged.

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.

Quantitative easing is a government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity.

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.

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.

Health Care Sector: Companies are in two main industry groups—Health care equipment and supplies or companies that provide health care-related services, including distributors of health care products, providers of basic health care services, and owners and operators of health care facilities and organizations. Companies primarily involved in the research, development, production, and marketing of pharmaceuticals and biotechnology products.
Utilities Sector: Companies considered electric, gas or water utilities, or companies that operate as independent producers and/or distributors of power.

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.

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.

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

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.

Technology Software & Services Sector: 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.

_____________________________________________________________________________________________

INDEX DEFINITIONS
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 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.

The Barclays Capital High Yield Municipal Bond Index is an unmanaged index made up of bonds that are non-investment grade, unrated, or rated below Ba1 by Moody’s Investors Service with a remaining maturity of at least one year.

The Barclays Capital Long Government/Credit Index measures the investment return of all medium and larger public issues of U.S. Treasury, agency, investment-grade corporate, and investment-grade international dollar-denominated bonds with maturities longer than 10 years. The average maturity is approximately 20 years.

The Barclays Corporate Index is an unmanaged index of publicly issued U.S. corporate and specified foreign debentures and secured notes that meet the specified maturity, liquidity, and quality requirements. To qualify, bonds must be SEC-registered. The index includes both corporate and non-corporate sectors. The corporate sectors are Industrial, Utility, and Finance, which include both U.S. and non-U.S. corporations. The non-corporate sectors are Sovereign, Supranational, Foreign Agency, and Foreign Local Government. Bonds must have at least one year to final maturity, must be dollar-denominated and non-convertible, and must have at least $250 million par amount outstanding. Bonds must be rated investment-grade (Baa3/BBB- or higher) by at least two of the following ratings agencies: Moody’s, S&P, Fitch. If only two of the three agencies rate the security, the lower rating is used to determine index eligibility. If only one of the three agencies rates a security, the rating must be investment-grade.

The Barclays Mortgage-Backed Securities Index includes 15- and 30-year fixed-rate securities backed by mortgage pools of the Government National Mortgage Association (GNMA), Federal Home Loan Mortgage Corporation (FHLMC), and Federal National Mortgage Association (FNMA).

The Barclays Municipal Bond Index is a market capitalization-weighted index of investment-grade municipal bonds with maturities of at least one year. All indices are unmanaged and include reinvested dividends. One cannot invest directly in an index. Past performance is no guarantee of future results.

The Citigroup World Government Bond Index is a market-capitalization-weighted index consisting of the government bond markets. Country eligibility is determined based on market capitalization and investability criteria. All issues have a remaining maturity of at least one year.

The Dow Jones – UBS Commodity Index is composed of futures contracts on 19 physical commodities. Unlike equities, which entitle the holder to a continuing stake in a corporation, commodity futures contracts specify a delivery date for the underlying physical commodity.

The JPMorgan Emerging Markets Bond Index Global (“EMBI Global”) tracks total returns for traded external debt instruments in the emerging markets, and is an expanded version of the JPMorgan EMBI+. As with the EMBI+, the EMBI Global includes U.S. dollar-denominated Brady bonds, loans, and Eurobonds with an outstanding face value of at least $500 million. It covers more of the eligible instruments than the EMBI+ by relaxing somewhat the strict EMBI+ limits on secondary market trading liquidity.

MSCI EAFE is made up of approximately 1,045 equity securities issued by companies located in 19 countries and listed on the stock exchanges of Europe, Australia, and the Far East. All values are expressed in US dollars. All values are expressed in US dollars. Past performance is no guarantee of future results.

The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets. As of May 2005, the MSCI Emerging Markets Index consisted of the following 26 emerging market country indices: Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Israel, Jordan, Korea, Malaysia, Mexico, Morocco, Pakistan, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, Turkey, and Venezuela.

Russell 1000® Growth Index measures the performance of those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values.

Russell 1000® Value Index measures the performance of those Russell 1000 companies with lower price-to-book ratios and lower forecasted growth values.

Russell 2000® Growth Index measures the performance of those Russell 2000 companies with higher price-to-book ratios and higher forecasted growth values.

Russell 2000® Value Index measures the performance of those Russell 2000 companies with lower price-to-book ratios and lower forecasted growth values.

The Russell Mid Cap Value Index offers investors access to the mid cap value segment of the U.S. equity universe. The Russell Mid Cap Value Index is constructed to provide a comprehensive and unbiased barometer of the mid cap value market. Based on ongoing empirical research of investment manager behavior, the methodology used to determine value probability approximates the aggregate mid cap value manager’s opportunity set.

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

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

Sandy Clouds the Beige Book December 4, 2012

Tepid, but Points to Modest Optimism

Heavily influenced by the impact of Superstorm Sandy and the uncertainty generated by the election and fiscal cliff debate, our proprietary Beige Book Barometer (at +30), is down from a recent high in the April 2012 Beige Book (+101). The Barometer is now back down to the levels seen in the summer and fall of 2011, amid the disruptive debt ceiling debate in the United States and the fiscal and financial worries in Europe. Our “Beige Book Barometer,” a diffusion index that measures the number of times the word “strong” or its variations (stronger, strength, strengthen, etc.) appears in the Beige Book less the number of times the word “weak” or its variations (weaken, weaker, etc.) appears, is displayed in Figure 1. The Barometer is an effective, quantitative way to derive the shades between strong and weak in the predominately qualitative, overall report.

Rebuilding and Recovery Likely Ahead

Despite the tepid reading of our Beige Book Barometer, there is some reason for modest optimism. First, the Barometer generally suggested that the economy was stronger heading into the fiscal cliff and Sandy in the summer and fall of 2012 than it was in early 2011, ahead of the debt ceiling debate. Our Barometer averaged just over +60 in the spring and summer of 2012, well above the +40 reading seen, on average, in the first half of 2011. In addition, many of the factors weighing on our Barometer based on the most recent Beige Book appear to be temporary. The base path in our 2013 Outlook suggests that the economy will mostly avoid the fiscal cliff, and that in our view, the resolution of the debate around the fiscal cliff will likely lift some, but not all, of the uncertainty emanating from Washington. In addition, the significant disruption caused to the economy by Sandy that is reflected in the most recent Beige Book is likely to soon give way to rebuilding and recovery, and generate more positive words for our Barometer.

While the fiscal cliff debate and the impact of Sandy may be temporary, though significant, other more persistent factors have weighed on the Barometer since it peaked at +101 in April 2012. The ongoing recession in Europe, the economic slowdown in China, the severe damage to the agricultural economy as a result of the drought, and a return to “normal” weather all helped to push the Beige Book Barometer from +101 in April 2012 to around +50 over the summer of 2012.

Even if the uncertainty surrounding the fiscal cliff and the disruptions caused by Sandy reversed, and our Barometer returned to the +60 range seen over the spring and summer of 2012, it would still remain below the range seen in 2005 and 2006, the years just prior to the Great Recession. In short, the Beige Book Barometer is consistent with other more quantitative metrics on the U.S. economy that suggest that the economy is in recovery, and growing at around 2.0% (as measured by gross domestic product [GDP]) but is still not back to “normal,” where normal is defined as the pre-Great Recession years of 2005 – 2006, where real GDP growth averaged between 2.5% and 3.0%.

 

 

 

 

 

 

 

 

 

 

 

 

Word Clouds Show Measured Expansion

The nearby word clouds are dominated by words describing the tone of the economy at the time the Beige Books were published. Below are some observations on the current Beige Book (released on November 28, 2012) relative to other recent editions of the Beige Book.

• The economy is expanding at a measured pace, perhaps just a step down from the modest pace of expansion seen in the prior few Beige Books released over the summer and early fall of 2012.
• The latest Beige Book was dominated by uncertainty surrounding the fiscal cliff and the damage and disruption wrought by Superstorm Sandy, but nevertheless, described an economy that was growing, but severely impacted by uncertainty (26 mentions), Sandy (48), storm (44), and the fiscal cliff (15).
• The word “confidence,” which was used 11 times in the September 2011 Beige Book amid the worst of the situation in Europe, appeared just four times in the latest Beige Book. During the summer and fall of 2011, the word confidence appeared an average of eight times in each Beige Book. Increased uncertainty (Sandy, fiscal cliff, and election), rather than lack of economic confidence, seems to best describe the current economic environment on Main Street.
• The lack of rain and concerns over the drought in the midsection of the United States made another significant appearance in the latest Beige Book. The word “drought” was mentioned 18 times in November 2012, 19 times in October 2012, and 22 times in August 2012. Drought warranted only a handful of mentions in the Beige Book in early 2012. The word “crop” was mentioned 20 times in the November Beige Book, after 26 mentions in October and 22 in August. A look back to the Beige Books of a year ago (July – November 2011) finds that drought was also a concern (mentioned 31 times in those four Beige Books). However, in the last four Beige Books (July – November 2012) the word drought appeared 62 times. Looking ahead, we would expect drought and the damage to crops due to the lack of rain this past summer in the Midwest to continue to impact the Beige Book in the coming months.
• The financial media is chock full of stories on the economic slowdown in China and the recession and debt crisis in Europe. The Beige Book suggests that while those issues have not entirely disappeared from Main Street’s radar, they are far less of a concern than the media makes them out to be. China was mentioned just twice in the latest Beige Book, up from one mention in each of the past two Beige Books (August 2012, October 2012). The recent peak for mentions of China was six in the January 2012 Beige Book. We continue to expect a soft landing, not a hard landing, in China. Recent data in China has helped to corroborate that view.

 

• There were just seven mentions of Europe in the latest Beige Book, down from 12 in October 2012 and 20 in August 2012. Perhaps business and banking contacts on Main Street are not as exposed to Europe as some of the larger businesses and financial institutions on Wall Street that dominate media coverage. But it is also worth noting that the European debt crisis is now entering its fourth year, and Main Street may be getting used to it now.

 

 

Beige Book Background

The Beige Book compiles qualitative observations made by community bankers and business owners about economic (labor market, prices, wages, housing, nonresidential construction, tourism, manufacturing) and banking (loan demand, loan quality, lending conditions) conditions in each of the 12 Fed districts (Boston, New York, Philadelphia, Kansas City, etc.). This local color that makes up each Beige Book is compiled by one of the 12 regional Federal Reserve districts on a rotating basis — the report is much more “Main Street” than “Wall Street” focused. It provides an excellent window into economic activity around the nation using plain, everyday language. The report is prepared eight times a year ahead of each of the eight Federal Open Market Committee (FOMC) meetings. The next FOMC meeting is December 11 – 12, 2012.

The previous word clouds or text clouds, which are a visual format useful for quickly perceiving the most important words in a speech, text, report, or other transcript, are culled from the Fed’s Beige Books published last week (November 28, 2012) and the prior month (October 10, 2012). In general, the more often a word appears in a speech, text, report or other transcript, the larger that word appears in the word cloud. The word clouds show the top 50 words for each of the two Beige Books mentioned above. Similar words are grouped together and common words like “the,” “and,” “a,” and “is” are excluded, as are words that appear frequently in all Beige Books (Federal, district, loan, level, activity, sales, conditions, firms, etc.).

 

 

 

 

 

 

 

 

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.

* 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.

^ Federal Funds Rate is the interest rate at which depository institutions actively trade balances held at the Federal Reserve, called federal funds, with each other, usually overnight, on an uncollateralized basis.

† Private Sector – the total nonfarm payroll accounts for approximately 80% of the workers who produce the entire gross domestic product of the United States. The nonfarm payroll statistic is reported monthly, on the first Friday of the month, and is used to assist government policy makers and economists determine the current state of the economy and predict future levels of economic activity. It doesn’t include:

• general government employees
• private household employees
• employees of nonprofit organizations that provide assistance to individuals
• farm employees

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 loss of principal.
International investing involves special risks, such as currency fluctuation and political instability, and may not be suitable for all investors.

Quantitative Easing is a government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity.

The Federal Open Market Committee action known as Operation Twist began in 1961. The intent was to flatten the yield curve in order to promote capital inflows and strengthen the dollar. The Fed utilized open market operations to shorten the maturity of public debt in the open market. The action has subsequently been reexamined in isolation and found to have been more effective than originally thought. As a result of this reappraisal, similar action has been suggested as an alternative to quantitative easing by central banks.

The Federal Open Market Committee (FOMC), a committee within the Federal Reserve System, is charged under the United States law with overseeing the nation’s open market operations (i.e., the Fed’s buying and selling of United States Treasure securities).

INDEX DESCRIPTIONS
Purchasing Managers Index (PMI) is an indicator of the economic health of the manufacturing sector. The PMI index is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment.

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

Outlook 2013 | The Path of Least Resistance – Part I November 29, 2012

This is the first of a 6 part series focused on the Outlook for 2013.

The series is broken down as follows:

Part 1 – The Path of Least Resistance

Part 2 – The Base Path:  The Compromise

Part 3 – The Bear Path:  Going Over the Cliff

Part 4 – The Bull Path:  The Long-Term Solution

Part 5 – The Paths for Europe, Central Banks, and Geopolitics

Part 6 – Over the (Capitol) Hill:  A View from the End of the First Quarter of 2013

In 2013, many different forces will combine to influence the direction of the markets to follow the path of least resistance leading to modest single-digit returns in the U.S. stock and bond markets.* The path for the year may be set at the end of 2012, or in early 2013, as critical decisions are implemented:

• Washington will likely finally rise to the challenge of this self-imposed crisis and form the compromise between the parties that will meet the least resistance — extending some of the Bush-era tax cuts and cancelling some of the scheduled spending cuts. However, going down this path risks delaying progress toward a more permanent solution that makes the government’s finances sustainable.
• The Federal Reserve (Fed) is likely to continue its bond-buying program of quantitative easing (QE). This open-ended QE is the path of least resistance among Fed decision makers and one which will buy the Fed more time to determine if more aggressive monetary policy easing is needed or if the economy can withstand a lessening of stimulus.
• Major hurdles to further European integration overcome in 2012 set the stage for progress toward a tighter fiscal, economic, and banking union. A high degree of resistance to splitting apart counterbalanced with strong stances against unconditional support is likely to keep Europe on a middle path toward slow continued integration.
• The U.S. economy faces the weakest global economic backdrop since the Great Recession of 2008 – 09 heading into the looming fiscal drag of tax increases and spending cuts. These forces are only partially offset by the benefits of Fed stimulus, the positive consumer wealth effect driven by the rebounding housing and stock markets, and the lifting of business uncertainty as the budget decisions are resolved. The combination is likely to result in a path leading to flat-to-weak growth for the U.S. economy.

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.

*Equity market forecast is for the S&P 500 Index and is based upon a low-single-digit earnings growth rate supported by modest share buybacks combined with 2% dividend yields and little change in valuations.  Bond market forecast is for the Barclays Aggregate Index and is based upon <1% rise in rates, with price declines offset by interest income.

Our base case path is supported by our view that key decision makers will find it is better to determine a way to overcome an avoidable and unnecessary economic recession, buy time to actually propose and vote on competing long-term fiscal visions, and do something to help restore confidence in Washington’s ability to govern. Ideally, this could help maintain investors’ appetites for U.S. equities and Treasuries. For the markets, the path of least resistance is likely to include modest single-digit returns for stocks as sluggish profit growth dampens stronger gains, but prices are supported by low valuations and improving clarity as uncertainties begin to fade. Bond yields may rise only slightly, restrained by sluggish growth and a Fed committed to keeping rates low, leaving returns to be limited to interest income at best. However, there are paths that differ from this base case outcome: a bear path where the consequences of fiscal contraction damage confidence as well as the economy, and a bull path where an historic opportunity to address the U.S.’s long-term fiscal challenges is embraced and leads to sustainable solutions. Which of these three is the path of least resistance is likely to be determined by the end of the first quarter of 2013.

The Base, Bull, and Bear Case Paths

The hard-fought election will likely be followed by more fighting in a divisive and bitter “lame duck” session in Congress running through year-end 2012. The stakes are high as those on Capitol Hill seek to mitigate the budget bombshell of tax increases and spending cuts, known as the fiscal cliff, due to hit in January 2013. The two parties have very different visions of what a deal should look like. Failure to reach a compromise in the coming months could lead to a recession and bear market for U.S. stocks in early 2013.

However, a deal is in the best interest of those on Capitol Hill. The Republicans have a lot of items that are important to them to lose in foregoing a deal with Democrats: the Bush tax cuts would expire and the looming spending cuts hit defense spending hard while not really impacting the big entitlement programs (such as Social Security, Medicare, Medicaid, and the Affordable Care Act). To avoid being blamed for a return to recession on their watch, Democrats may only need to compromise on extending the middle-class tax cuts, which President Obama already communicated his support of during his campaign, and delaying the impact of some of the spending cuts. The path to a deal may not be a straight line, but is the outcome we view as most likely and upon which we base our expectation of modest returns for stocks and bonds — with no bear or bull
market — in 2013.

While a deal may be likely, there are risks for investors. In October 2012, with the S&P 500 having risen back to within 10% of all-time highs, markets seemed confident that the Senate Democrats would quickly find a compromise with House Republicans to avoid going over the fiscal cliff. However, a compromise may be hard to reach. Recall that the gridlock in Washington was no help to markets in 2011, as the unwillingness to compromise on both sides of the aisle led to the debt ceiling debacle in August 2011, which sent the S&P 500 down over 10% in a few days despite the ultimate approval of the increase to the debt ceiling. A bear market and recession could be looming if policymakers choose this path.

Despite the risks, there is room for guarded optimism. If there ever were a time to enact long-term fiscal discipline, now is that time. The United States’ large and unsustainable budget deficits helped push total U.S. debt over 100% of Gross Domestic Product (GDP) in 2012.  Previously unmentionable as part of the “third-rail” of politics, wide-reaching bipartisan proposals have been unveiled to put the United States back on a path to fiscal sustainability. A long-term solution of permanent changes to tax rates and entitlement programs as well as ending the battles over the debt ceiling could emerge in 2013. This path would be welcomed with a bull market and lift the uncertainty plaguing business leaders and investors alike.

The battle is likely to result in a compromise that averts the worst-case outcome, but the negotiations themselves, coming on the heels of hard-fought election battles, may drive market swings. Fortunately, the lowest valuations for stocks in 20 years may help to limit downside and create potential investment opportunities. Which of these three paths will prevail is largely driven by the compromise — or lack thereof — in Washington.

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 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.

Investing in specialty market and sectors carry additional risks such as economic, political or regulatory developments that may affect many or all issuers in that sector.

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

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.

Municipal bonds are subject to availability, price, and to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rate rise. Interest income may be subject to the alternative minimum tax. Federally tax-free, but other state and local taxes may apply.

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.

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: 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.

Quantitative easing is a government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity.

The P/E ratio (price-to-earnings ratio) is a measure of the price paid for a share relative to the annual net income or profit earned by the firm per share. It is a financial ratio used for valuation: a higher P/E ratio means that investors are paying more for each unit of net income, so the stock is more expensive compared to one with a lower P/E ratio.

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.

Default rate is the rate in which debt holders default on the amount of money that they owe. It is often used by credit card companies when setting interest rates, but also refers to the rate at which corporations default on their loans. Default rates tend to rise during economic downturns, since investors and businesses see a decline in income and sales while still being required to pay off the same amount of debt.

Index Definitions
The IS M index is based on surveys of more than 300 manufacturing firms by the Institute of Supply Management. The IS M Manufacturing Index monitors employment, production inventories, new orders, and supplier deliveries. A composite diffusion index is created that monitors  conditions in national manufacturing based on the data from these surveys.

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.

Dow Jones Industrial Average (DJIA ): The Dow Jones Industrial Average Index is comprised of U.S.-listed stocks of companies that produce other (non-transportation and non-utility) goods and services. The Dow Jones Industrial Averages are maintained by editors of The Wall Street Journal. While the stock selection process is somewhat subjective, a stock typically is added only if the company has an excellent reputation, demonstrates sustained growth, is of interest to a large number of investors, and accurately represents the market sectors covered by the average. The Dow Jones averages are unique in that they are price weighted; therefore, their component weightings are affected only by changes in the stocks’ prices.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

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