Watch What the Fed Watches March 26, 2013

What constitutes a substantial improvement in the labor market?

On Wednesday, March 20, 2013,  Federal  Reserve (Fed) Chairman  Ben Bernanke held the first of four press conferences scheduled for this year at the conclusion of the Federal  Open  Market  Committee’s (FOMC) meetings on March 20, June 19, September 18, and December 18, 2013.  While Bernanke’s Q&A session generated plenty of headlines (and tweets), he really did not say anything the market did not already know about  the Fed’s

view on the economy, the fiscal situation, and more  importantly, on monetary policy, and in particular,  the latest round of bond purchases, quantitative easing (QE3).

Bernanke did, however, remind market participants of both the benefits:

• “…putting downward pressure on longer-term interest rates, including mortgage rates” which continues “to provide meaningful support to economic growth and job creation…”

and the costs:

• “adverse implications of additional purchases for the functioning of securities markets…”
• “…the potential effects — under  various scenarios — of a larger balance sheet on the Federal  Reserve’s earnings from its asset holdings and, hence, on its remittances to the Treasury.”
• ”…risks to financial stability, such as might arise if persistently low rates lead some market participants to take on excessive risk in a reach  for yield.”

of continuing QE3. In his prepared remarks just prior to answering reporters’ questions, Bernanke also made a point of reminding markets that the thresholds the Fed has set up for eventually raising rates — unemployment rate below 6.5% and inflation not higher than 2.5% — were not triggers, suggesting that the Fed may wait a while after these thresholds are crossed before raising rates.

The first question asked of Bernanke was whether or not the FOMC had spent any time discussing thresholds for ending or changing the pace  of QE3. Bernanke noted that the problem was “complex” but that the FOMC was:

“...looking for sustained improvement in a range of key labor market indicators, including obviously payrolls, unemployment rate, but also others like the hiring rate, the claims for unemployment insurance, quit rates,  wage rates,  and so on. We’re looking for sustained improvement across a range of indicators and in a way that’s taking place throughout the economy. And since we’re looking at the outlook, we’re looking at the prospects rather than the current state of the labor market, we’ ll also be looking at things like growth to try to understand whether there’s sufficient momentum in the economy to provide demand for labor going forward.”

The list of labor market indicators mentioned by Bernanke was basically the same list cited by Fed Vice Chairwoman Janet Yellen — who is a leading candidate to replace Bernanke when his term  as Chairman  ends on January 31, 2014 — in a speech she gave in early March 2013 to the National Association of Business Economists in Washington, D.C. Yellen’s list included:

• The unemployment rate;
• Payroll employment;
• The hiring rate;
• Layoffs/discharges as a share of total job separations;
• The “quit” rate as a share of total job separations; and
• Spending and growth in the economy. Yellen noted specifically that:

“I also intend to consider my forecast of the overall pace of when it is not accompanied by sufficiently strong growth, may not indicate a substantial improvement in the labor market outlook. Similarly, a convincing pickup in growth that is expected to be sustained could prompt a determination that the outlook for the labor market had substantially improved even absent any substantial decline at that point in the unemployment rate.”

Essentially, Yellen (who along with being one of the leading candidates to replace Bernanke as Fed chairman, is also at the Fed’s “center of gravity,”

with Bernanke and New York Fed President Bill Dudley) is saying that the

FOMC will need to see strong performance of the labor market AND solid gross domestic product (GDP) growth before it begins to scale back or eliminate QE.

Figures 1 – 5 show the labor market indicators mentioned by Bernanke last week and Yellen in early March.  A quick review of the figures suggests that Yellen and Bernanke — two of the three FOMC members of the “center of gravity” at the Fed — are not yet ready to begin scaling back QE.

• While down  from the peaks seen during the Great Recession of 2008 – 2009,  at 7.8%, the unemployment rate remains well above  the 6.5% threshold for raising rates, and also well above  the 5.5 – 5.75% rate the FOMC forecasts as the new  normal unemployment rate.
• It is well documented that the private sector economy has created more than 200,000 jobs in four of the past five months. However, the labor market turned in a similar performance in late 2011 and early 2012,  only to see a marked slowdown in job creation over the spring and summer of 2012.  Bernanke mentioned this during his Q&A, noting,  “So I think an important criterion would be not just the improvement (in the labor market) that we’ve seen, but is it going to be sustained for a number of months?”

• At 3.6%, the hiring rate — the level of new  hiring as a percent of total employment measured from the JOLTS data (see box on page5) — remains depressed, and well below the 4.5 – 5.0% hire rate seen prior to the onset of the Great Recession in 2007.  In her March 4, 2013 speech, Yellen noted, “the hiring rate remains depressed. Therefore, going forward,  I would look for an increase in the rate of hiring.”
• In that same speech, Yellen noted “layoffs and discharges as a share of total employment have already returned to their pre-recession level”. Indeed, Figure 3 shows that the discharge rate,  at 1.2%, is very close to an all-time low. A good proxy for this metric is the level of initial claims and the monthly Challenger layoff data,  both of which continue to show that companies are reluctant to shed more  workers at this point in the business cycle.

• The quit rate measures the percentage of people who leave their jobs voluntarily, presumably because they are confident enough in their own skills — or in the health  of the economy — to find another job. In the three months ending in January 2013 (the latest data available), 53%  of the people who were “separated” from their jobs (laid off, fired, retired, or left voluntarily) were job quitters. This was the highest reading on this metric since mid-2008, but remains well below its pre-Great Recession “normal” of 56 – 60%. Commenting on this metric in her March 4, 2013 speech, Yellen noted “a pickup in the quit rate,  which also remains at a low level, would signal that workers perceive that their chances to be rehired are good — in other  words, that labor demand has strengthened.” The final metrics mentioned by Yellen — consumer spending and overall economic growth — both remain  well below average, and indeed still point to an economy that is running at around  two-thirds speed.

As this document was being prepared for publication on Monday,  March 25, 2013,  Bill Dudley, the third member of the “center of gravity” at the Fed also hinted at his reluctance to remove the stimulus too soon. On balance, Dudley’s comments, along with last week’s appearance from Ben Bernanke echoed comments made in early March 2013 by Fed Vice Chair Yellen, suggest that the “center of gravity” at the Fed is not yet convinced that there has been “substantial improvement” in the labor market or economy. This should give market participants comfort that the Fed is not likely to begin removing QE anytime soon, but also raises the risk that the Fed may wait too long to remove the stimulus, which could lead to higher inflation and higher interest rates in the future.

About the  JOLTS Report

Each month, market participants and the  financial media obsess over the  monthly employment report  from the  Bureau of Labor Statistics ( BLS ) that  details how  many  jobs were added in the  economy, in what  industries the  jobs were added, how  much  workers were paid, and why workers were unemployed. That report  is typically released on the  first Friday of every  month. On the  other  hand,  the  monthly report  on job openings and labor turnover (the JOLTS data), released by the  same government agency — the  BLS — that  releases the  monthly jobs report, is met  with little, if any, fanfare  from the  financial markets or the  financial media. The JOLTS report  does not get  a lot of attention, mainly because it is dated. For example, the  market got detailed information on the  labor market for February  2013  on March  8, 2013  when the  monthly employment report  was released. The JOLTS report  for February  2013  isn’t due  out until April 9, 2013.  The JOLTS data  provide more  insight into the  inner workings of the  labor market than  the  monthly employment report  does. JOLTS provides data  on:

• The number of job openings by economy-wide, by firm size, and by region;
• The number of new  hires in a given month; and
• Job separations, and the various drivers of those separations (fired, laid off, retired, quit).

Please see our Weekly Economic Commentary from February  19, 2013  for more  insights from the  JOLTS report.

____________________________________________________________________

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.

Gross domestic product (GDP) is the monetary value of all the finished goods and services produced within

a country’s borders in a specific time period,  though  GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory.

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

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

Mortgage Backed Securities are subject to credit, default, 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, market and interest rate risk.

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).

Stock investing involves risk including loss of principal.

__________________________________________________________________

INDEX DESCRIPTIONS

The Chicago Area Purchasing Managers’ Index that is read on a monthly basis to gauge how manufacturing activity is performing. This index is a true snapshot of how manufacturing and corresponding businesses are performing for a given month. A reading of 50 or above is considered a positive reading. Anything below 50 is considered to indicate a decline in activity. Readings of the index have the ability to shift the day’s trading session one way or another based on the results.

Job Openings and Labor Turnover Survey (JOLTS) is a survey done by the United States Bureau of Labor Statistics to help measure job vacancies. It collects data from employers including retailers, manufacturers and different offices each month. Respondents to the survey answer quantitative and qualitative questions about their businesses’  employment, job openings, recruitment, hires and separations. The JOLTS data is published monthly and by region and industry.

__________________________________________________________________

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

The Inflation Situation Revisited March 20, 2013

We last wrote about the inflation outlook in the September 24, 2012 edition of the Weekly Economic Commentary: The Inflation Situation. Since then, while inflation and inflation expectations in the United States have remained in check, the Federal Reserve (Fed) has begun another round of bond purchases, known as quantitative easing (QE). This decision — along with the recent run-up in consumer gasoline prices and recent comments from some members of the Federal Open Market Committee (FOMC) that the costs of QE may soon begin to outweigh the benefits — has generated plenty of discussion of inflation among financial market participants and the media.

Our view remains that the economic backdrop does not support a sustained uptick in inflation anytime soon, although higher food and energy prices — as a result of last summer’s drought and recent geopolitical unrest — may push overall inflation readings modestly higher over the next several months. Finally, we examine some snippets from the Fed’s Beige Book — a qualitative assessment of economic, business, and banking conditions in each of the 12 Fed districts — relating to the inflation situation and compare them to similar comments from the Beige Books in the 1970s, when the pace of inflation surged, seemingly out of nowhere, and also to 2004, when the FOMC began raising rates it had lowered to combat the impact of the 2001 recession.

Inflation is a sustained, broad based increase in the general level of prices. As noted in Figure 1, inflation, the rate of change in the general level of prices as measured by the consumer price index (CPI), has been trending lower for more than 30 years. Inflation excluding food and energy (core inflation) has followed a similar path. Forecasts for inflation from the Fed, the consensus of economists and market participants, and the Congressional Budget Office all suggest ongoing tame inflation over the next several years and over the long term [Figure 2]. Some of the factors responsible for this well-established trend are:

• Low and stable inflation. Simply put, low and stable inflation fosters future low and stable inflation. At around 1.0% in the mid-1960s, inflation surged over the following 15 – 20 years, peaking at nearly 15% in 1980. Since then, inflation has moved sharply lower, and stayed there, with only a few blips higher over the past three decades. Neither overall inflation nor core inflation has moved much since our last update on inflation in September 2012.
• Low and stable inflation expectations. The public’s views (the general public and professional forecasters) on inflation are often cited by Fed Chairman Ben Bernanke and other Fed officials as one of the key weapons against inflation. Both measures have been low and stable for the past 13 years, and have been moving lower for 30 years. Since we last wrote about inflation in September 2012, long term inflation expectations have nudged down to 2.3% from the 2.4% reading in the third quarter of 2012 [Figure 2].
• Fed’s inflation-fighting credibility. In the early 1970s, the Fed had no experience or credibility with the public in keeping inflation low and stable. Indeed, the Fed generally kept rates lower than they should have been as the economy grew above its long-term potential in the mid-to-late 1960s and early 1970s [Figure 3]. By the end of the decade, the public had lost faith in the Fed, but the last 30 years has seen the Fed regain the public’s trust, often by “taking away the punchbowl” (i.e., raising rates) before the party got out of hand and inflation became problematic. Over the past six months, the Fed has maintained its inflation fighting credibility in the marketplace, but it must be prepared to act in order to convince the market that it will treat the threat of inflation the same way it dealt with the threat of deflation.
• Globalization. When inflation was surging in the mid-1960s through the early 1980s, the U.S. economy was relatively insular. Prices (and in some cases, wages) were made and set within our borders, and trade accounted for only a small portion of our gross domestic product (GDP). Today, the United States has a much more open economy, and there is now plenty of overseas competition in both wages and prices. In general, the push toward globalization has put downward pressure on prices.
• Spare capacity in product and labor markets. Related to the bullet above, slack in product and labor markets is one of the key drivers of low inflation today, despite the successive rounds of quantitative easing from the Fed and other central banks around the world. High unemployment rates here in the United States and in Europe, along with very high levels of unused factory and office space around the globe, make it very difficult to pass along higher input prices to end users. In contrast, as inflation surged higher in the 1960s and 1970s, there was very little, if any, spare capacity, and the unemployment rate was abnormally low. Since September 2012, the Chinese economy has reaccelerated, but the European economy remains mired in a deepening recession. But, according to the Federal Reserve, in the United States, capacity utilization rates have ticked up some (from 76.8 to 78.3) and the unemployment rate has dipped 0.1% to 7.7%, according to the Bureau of Labor Statistics (BLS). Neither reading is indicative of an overheating economy.

• Mobile workforce. In the United States, wages and salaries account for about two-thirds of business costs. In the 1960s and 1970s, low unemployment, the “closed” U.S. economy, and a less mobile workforce pushed wages sharply higher. Wages remain the most important factor in business costs and in determining the overall pace of inflation. Today, wage inflation is muted, as 30 years of globalization have led to wages being partially set overseas, where overall employment, not the pay scale, is often more important. Since we last wrote about inflation in September 2012, wage inflation has accelerated to a still muted 2.0% year-over-year, up from the 1.4% year-over-year reading in September 2012, according to BLS.
• Declining union membership. At the start of the decade-and a-half surge in inflation in the mid-1960s, nearly 25% of the nation’s workforce was unionized. This led to a high portion of the overall wage structure in the United States being tied to cost of living adjustments (COLAs). COLAs tied wage increases to increases in the overall price level of goods and services in the economy. Thus, when inflation accelerated in the 1960s and 1970s, that acceleration was automatically factored back into wages, and the wage price spiral was on. Today, less than 10% of the workforce is unionized, and COLAs are few and far between. In short, the link between rising inflation that caused a lot of inflationary damage in the 1970s is broken. Today, less than 6% of private sector workers are unionized, while 36% of public sector employees are unionized, according to BLS.
• Economy growing below long-term potential. For the past five years, the U.S. economy has been growing more slowly than the long-term potential growth rate of the economy, pushing the “output gap” wider [Figure 4]. The more negative the output gap, the less upward pressure on capacity constraints in the economy and, in turn, the less upward pressure on wages and prices. In sharp contrast, note that in the 11-year span between 1963 and 1974, the output gap was positive in all but a handful of quarters, meaning that the economy was growing above its long-term potential for more than a decade. During this time, the Fed made things worse by keeping monetary policy relatively loose, adding fuel to the already inflationary environment.

Many factors have the potential to push inflation higher. Those include, but are not limited to:

• Cash on banks’ balance sheets. As a result of the successive rounds of QE from the Fed over the past five years, nearly $1.8 trillion is sitting on banks’ balance sheets waiting to be lent out to consumers and businesses. This is an enormous amount of money, and if the transmission mechanism between the Fed’s monetary policy and the overall economy was functioning properly, this would be a huge concern. However, the transmission mechanism is still not functioning properly and the velocity of money, or how quickly the cash on banks’ balance sheets moves through the economy, has dropped dramatically over the past five years [Figure 5]. If velocity does reaccelerate, inflation could move from banks’ balance sheets to the real economy as well. We continue to monitor this closely, but since we last wrote about inflation in September 2012, there has been no increase in the velocity of money in the economy.
• Recent run-up in food and energy prices. The U.S. drought in the summer of 2012 and the rise in geopolitical tensions have pushed up wholesale prices of food and energy products. Those price increases should begin to show up in headline consumer inflation in the coming months, pushing the CPI higher. However, economy-wide, commodity prices account for only 10% of business’ input costs, and with near-record high profit margins, firms have the ability to absorb some of these higher input costs. The key, however, is that the COLA/wage price spiral paradigm that ruled in the 1960s and 1970s is basically nonexistent in today’s economy, suggesting that higher input costs are unlikely to be passed through to higher inflation in any significant way. In addition, a rise in the prices of some goods and services tends to lead to less demand and a shift to less expensive substitutes. This effect, along with sluggish income growth, may further mute any pass through of higher food and energy prices to other parts of the economy.
• Demographics. As the population ages, the mix of goods and services purchased by the overall economy shifts as well. In general, prices for goods consumed by younger population cohorts are stable or falling. Of course, tuition for college is rising rapidly, but prices for big screen televisions, computers, hand-held mobile devices, software, etc. are not surging, and in some cases are falling when adjusted for quality. On the other hand, the cost of health care, a major component of older consumers’ budgets is rising rapidly, and those price increases are pressuring insurance rates at the individual level, and putting tremendous strain on the Federal budget outlook as well. The pace of healthcare cost increases will continue to have a major impact on both the inflation outlook, and the outlook for the Federal budget deficit in the coming years due to the impact of the Affordable Care Act.

On balance, while there are several factors poised to push inflation higher, there are far more factors working today that are pushing inflation lower. In addition, virtually none of the main causes of the inflationary 1970s — an economy running above its long-term potential growth rate, rising inflation expectations, high union membership and COLA induced wage price spiral, and a “closed” U.S. economy — are in place today, making the inflation situation today far different than at the start of the last inflation surge in the early 1970s.

_____________________________________________________________________________________________

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.

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).

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.

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

Deflation is a general decline in prices, often caused by a reduction in the supply of money or credit. Deflation can also be caused by a decrease in government, personal or investment spending.

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

_____________________________________________________________________________________________

Member FINRA/SIPC

Page 7 of 7

RES 4110 0313

Tracking #1-151324 (Exp. 03/14

_____________________________________________________________________________________________

 Stay Connected with Us!

    

www.garrettandrobinson.com

Marching Toward the Pre-Recession Peak March 5, 2013

Marching Toward the Pre-Recession Peak

On Friday, March 8, 2013, the U.S. Bureau of Labor Statistics (BLS) will release its Employment Situation Report for February 2013. The report, which always generates plenty of conversation among politicians, pundits, and market participants, is actually two reports in one. Please see the nearby text box for a breakdown of the two surveys within the monthly Employment Situation Report.

Labor Market Stress Measures Are Dropping Across the Board

We would be more skeptical of the drop in the unemployment rate and the gains in the payroll job count if other measures of labor market stress (layoff announcements, initial claims for unemployment insurance, job openings, hours worked, etc.) had not moved in the same direction.

• Layoff announcements — collected by a private sector outplacement firm, Challenger, Grey & Christmas — in the 12 months ending in January 2013 totaled 510,000, very close to a 12-year low of 476,000 hit in early 2011. In mid-2009, the 12-month total of announced layoffs was over 1.6 million.
• Initial claims for unemployment insurance, tallied at the state level, averaged just 355,000 per week in the four weeks ending February 23, 2012, the lowest reading in five years (2008). Claims peaked at nearly 650,000 per week in mid-2009. In late February 2013, just fewer than 7 million people were receiving some type of unemployment benefit, down from close to 15 million in early 2010.
• The number of job openings, as measured by the U.S. BLS Job Opening and Labor Turnover report, found that in December 2012, there were more than 3.6 million open jobs, up from just fewer than 2.2 million in mid-2009.
• Virtually every measure of consumer sentiment, all of which are collected by the private sector, is at, or close to, five-year highs. The improved sentiment is a function of a stronger equity market, less volatility in financial markets, improved labor markets, the vastly improved housing market, and, until recently lower prices for gasoline.
• Gallup employment data — The private sector Gallup polling firm asks 18,000 Americans on a regular basis about their employment status, and the unemployment rate derived from that survey has moved down significantly since
  the beginning of 2010, tracking the official unemployment rate calculated by the U.S. Department of Labor.
• Gallup underemployment data — However, the Gallup data also suggest that “underemployment” remains quite high at around 18%, consistent with the government’s measure of “underemployment” (see box). The U-6 unemployment rate (which takes into account part-time workers and discouraged workers) in January 2013 stood at 14.4%, down from a peak of over 17% in 2009 [Figure 1].

The private sector economy in the United States lost 8.8 million jobs between the peak in t employment in January 2008 and the trough in employment in February 2010. Since the end of the recession in June of 2009, the private sector of the economy has created 5 million jobs. Since the labor market trails the overall economy, the labor market itself didn’t bottom out until February 2010, eight months after the end of the recession. Since that point, the private sector economy has created just over 6 million new jobs {Figure 2} Still the economy needs to add another 2.7 million net new jobs to get back to the all time high set in early 2008 during the early months of the recession. How quickly the economy can create those 2.7 million jobs will in large part determine if, when and how the Federal Reserve (FED) begins to scale back its quantitative easing (QE) program and eventually begin to lift rates from their exceptionally low level.

The Next 2.7 Million Jobs

• If the 2.7 million jobs are added over the rest of 2013, for an average monthly gain of just fewer than 250,000 per month, the Fed is likely to begin to scale back its QE program this year. Job gains at that pace would also likely put downward pressure on the unemployment rate, pushing toward the 6.5% “threshold” at which the Fed would consider raising rates.
• If the next 2.7 million jobs are created over the next over 15 months (by early 2014), net new job creation would be around 175,000 per month, the pace at which the economy has created jobs over the past 12 months. At this pace, the unemployment rate would likely decline only gradually, and likely not threaten the 6.5% threshold until mid-2015. This pace of job growth would be most consistent with our view of the pace of economic growth in 2013 — around 2.0%.
• If it takes the economy longer than 15 months to create the next 2.7 million jobs, it likely would mean that the economic recovery has stalled — perhaps due to the ongoing fiscal debate in the United States or a deepening recession in Europe. In this scenario, the Fed would likely continue to purchase $85 billion of Treasury and agency mortgage-backed bonds (MBS) per month beyond the end of 2013, and may even consider additional QE to help foster job growth.

In the economic recoveries in the early 1980s, early 1990s, and early 2000s, it took the economy 25 months, 38 months, and 54 months, respectively, for the economy to get back to peak employment. If the economy continues to create jobs at the same pace it has over the past 12 months (around 175,000) per month, total private sector employment won’t recoup all of the 8.8 million jobs lost during the Great Recession until April 2014. April 2014 is four years and two months from the trough in private sector employment (February 2010) and 63 months since the prior peak in employment hit in January 2008. The pace of job creation in this recovery has been “frustratingly slow,” a phrase used by Fed Chairman Ben Bernanke in recent years. The unique nature (bursting of the housing and credit bubble of the mid-2000s) of the Great Recession and its aftermath, along with the stops and starts in U.S. fiscal policy, and the ongoing fiscal crisis in Europe have all contributed to the sluggish recovery in the U.S. economy. The sluggish economy, in turn, has led to the tepid pace of job creation since the recession ended in 2009.

_______________________________________________________________________________________

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.

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.

Mortgage Backed Securities are subject to credit, default, 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, market and interest rate risk.

_______________________________________________________________________________________

INDEX DESCRIPTIONS

The Chicago Purchasing Managers’ Index is read on a monthly basis to gauge how manufacturing activity is performing. This index is a true snapshot of how manufacturing and corresponding businesses are performing for a given month. A reading of 50 or above is considered a positive reading. Anything below 50 is considered to indicate a decline in activity. Readings of the index have the ability to shift the day’s trading session one way or another based on the results.

Producer Price Index is an inflationary indicator published by the U.S. Bureau of Labor Statistics to evaluate wholesale price levels in the economy.

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

Member FINRA/SIPC

 ______________________________________________________________________________________

Stay Connected with Us!

    

www.garrettandrobinson.com

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

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

Dog Days for the Dow August 16, 2012

Garrett & Robinson Weekly Market Commentary

The “dogs of the Dow” have best handled the heat of the dog days of summer.

The so-called “dogs of the Dow” strategy entails owning the highest dividend-yielding stocks in the Dow Jones Industrial Average (DJIA). Yield has been a rewarding theme in the markets this summer. In general, it has been the highest-yielding stocks and bonds that have outperformed their peers. For example, since the beginning of June in the bond market High-Yield Bonds have trounced the returns on High-Grade Corporate or Government Bonds, according to Barclays Index data. And in the stock market, the highest-yielding sectors have outperformed. Over the past three months, the high dividend-yielding Telecommunications Services, Consumer Staples, and Utilities sectors of the S&P 500 have been outperformers. Specifically, the 10 dogs of the Dow stocks this year, led by strong performance among the Telecom carriers that are the highest-yielding stocks, have outperformed the DJIA during the summer months by over three percentage points.

But as the dog days of summer draw to a close during the coming weeks, yield may no longer be the overriding market theme. The Fed’s conference in Jackson Hole, Wyo., is coming up on August 30-September 1. The Fed may use this opportunity to communicate its intention to pursue a third round of quantitative easing (so-called QE3), likely involving the purchase of Treasuries, Agencies, and Mortgage-Backed Bonds.

Counter-intuitively, a look back at prior rounds of Fed bond purchases shows that Treasury yields actually increased following the start of bond purchases. In each of the three prior bond purchase programs—QE1, QE2, and Operation Twist—the yield on the 10-year Treasury increased almost immediately, as you can see in Figure 1. This is because markets are forward-looking, and investors quickly anticipated the beneficial impacts of the Fed’s bond buying on the economy. As yields rise, investors shed more defensive, yield-oriented investments in favor of those with more potential for price appreciation.

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.

During the summer months so far, the most likely beneficiaries of another round of quantitative easing by the Fed have not reflected an increasing likelihood of Fed action. This can be seen in yield-oriented stocks leading rather than lagging the market, bond yields not rising, the dollar not falling, and gold not posting gains typically seen when the market expects a new bond buying program from the Fed.

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.

Names of securities mentioned herein are for informational purposes only and should not be considered investment advice or guidance, offer or solicitation, offer to buy or sell securities, nor a recommendation or endorsement by LPL Financial of the security or investment strategy. LPL Financial does not endorse or evaluate individual equities.

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.

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.

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.

Operation Twist is the name given to a Federal Reserve monetary policy operation that involves the purchase and sale of bonds. “Operation Twist” describes a monetary process where the Fed buys and sells short-term and long-term bonds depending on their objective.

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.

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.

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.

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.

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.

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

LPL Financial, Member FINRA/SIPC

What to Watch During the Most Important Week of the Year June 21, 2012

This week features the most market-moving events of the year, so far. Not only do they hold the potential to affect the markets this week, the decisions made this week may shape the market environment for years to come.

These events include:

• The Greek election on Sunday and the formation of a new government,
• The G20 meeting on Monday and Tuesday,
• The Iran nuclear program meeting on Tuesday and Wednesday,
• The last Federal Reserve (Fed) meeting before the end of Operation Twist on Thursday,
• The Supreme Court ruling on the health care law is likely this week.

The coverage of these events in the news will be hard to miss. Here we will detail what we will be watching for at each event.

Greek Election

The pro-bailout and austerity parties appear to have won enough votes in the election held on Sunday to form a government (unlike in the May 6, 2012 election). With the election unlikely to result in setting a precedent for countries leaving the Eurozone at the behest of Germany, a potential financial crisis stemming from runs on Southern European banks may be averted. This outcome was largely anticipated by the markets, based on polling data, with a 5% gain in the S&P 500 since June 1.

However, how quickly a new government emerges and what is said about renegotiating the terms of Greece’s second bailout is important to whether the gain is sustained. Greece is in desperate need of funds—not only to service its debts but also to provide for drugs, food, and energy (which are mostly imported) for the Greek people. Greece will run out of money in a few weeks if an agreement is not reached to deliver the next tranche of the bailout money. So far, Germany has indicated that while the bailout targets should not be changed, the timeframe in which to reach them may be extended. However, a New Democracy/PASOK coalition government will likely seek more significant changes. Tough talk on renegotiation—from either side—could undermine the markets.

Most importantly, if a path for Greece to remain in the Eurozone becomes clear, the contagion and bank run beginning to affect Spain and Italy may recede along with their bond yields. Progress towards a long-term solution for a combined Europe can continue while Greece, a very small part of the Eurozone economy, will remain in a depression but be able to afford basic necessities for its people.

In a related action, with the vote out of the way, the European Central Bank may take action to provide economic stimulus and liquidity to banks.

G20 Meeting

There are low expectations for this meeting, so any outcome would be an upside surprise for markets. We are watching for any new efforts at stabilizing the Eurozone.

• An endorsement of a framework for a Eurozone-wide deposit insurance program, essentially linking all of the individual countries’ FDIC-like programs into one program for all of the Eurozone, could be seen as progress on a banking union and would likely be welcomed by the markets and European bank stocks.

• The audit of Spanish banks’ capital needs—a precursor to the 100 billion euro Spanish bailout—may be unveiled at the G20. Once assessment of the recapitalization is complete, the amount to help shore up Spain’s banks can begin to be dispersed and may stem the rise in Spanish bond yields to unsustainable levels.

• Finally, the G20 could announce an increase to the $430 billion in IMF funds to combat the pressures in Europe.

Iran Nuclear Talks

The deadline for Iran to make concessions on its nuclear program or face U.S. oil-related sanctions against Iran’s central bank is scheduled to take effect on June 28, and European Union restrictions on oil imports from Iran begin on July 1. Iran has already seen oil orders fall sharply. Iran’s oil exports are estimated by the International Energy Agency to have fallen by an estimated 40% since the start of the year, falling to 1.5 million barrels per day in April-May 2012 from 2.5 million at end 2011.

Yet Iran remains steadfastly against the ban on all uranium enrichment, and the market expects the talks in Moscow are unlikely to yield any more ground than the prior two talks this year. Without progress the risk rises of a military move by Israel or by an increasingly embattled Iranian president, who has seen his political power erode in the Iranian parliament.

We are watching for a potential compromise involving a freeze on highly enriched uranium while allowing Iran to produce power plant grade fuel. A modest breakthrough along these lines could be an upside surprise—though unlikely to materially further lower oil prices, it may relieve some geopolitical risk overhanging the markets.

Federal Reserve

Given the weakness in recent U.S. economic data, the risks posed by the European problems, and the potential for tight fiscal policy next year including major tax hikes and spending cuts, the Fed is likely to announce a new stimulus program, such as QE3. Or the Fed may extend the current one, known as Operation Twist. If not, the markets will be disappointed. Stocks fell by 16-19%, as measured by the S&P 500 Index, after the end of each of the past two stimulus programs.

The Fed has many options, but it is the size and duration of the program that is most important. The Fed may choose a moderate-sized plan around half the size of the $400 billion Operation Twist to suggest they are keeping firepower in reserve against a further deterioration in the situation in Europe. However, a program too small—or merely opting to extend the short-rate guidance to beyond late-2014—risks disappointing the markets.

Supreme Court

A decision on the constitutionality of the Affordable Care Act will come this week—or next week at the latest—before the Supreme Court adjourns for the summer. What to watch for is not subtle: if the law is upheld, struck down, or if parts of the law are struck down.

The consensus expects the Supreme Court to strike down just the mandate requiring individuals to buy insurance with limits on pricing. This has been weighing on the stocks of HMOs and providers due to the adverse impact on profitability. However, if the court surprises investors and strikes down the entire law, HMOs would benefit while generic drug makers, hospitals, and diagnostic companies in the Health Care sector may suffer.

In addition, this decision has political implications. Striking down any of the law would be a blow to President Obama’s reelection campaign. Industries tied to the outcome of the election may fare differently. In any case, expect Republicans to make it a priority to seek to dismantle the law next year.

It is important to not get caught up in the volatility that each event this week may bring and instead stay focused on what emerges to form the bigger picture. The stock market may be near an attractive point to reinvest cash—especially as clarity emerges from the events this week and the earnings season nears.

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 may involve 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.

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 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.

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.

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.

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.

Manufacturing Sector: Companies engaged in chemical, mechanical, or physical transformation of materials, substances, or components into consumer or industrial goods.

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.

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

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

LPL Financial, Member FINRA/SIPC

The Spring Slide May 24, 2012

It has been 410 years since the first initial public offering (IPO). The Dutch East India Company helped people add spice to their daily lives, connect to those in faraway places, and became the richest company the world had ever seen. High hopes for similar success surrounded the Facebook IPO on Friday. However, the long-awaited IPO was unable to spur enthusiasm among stock market investors. Stocks posted the worst week in six months as the S&P 500 fell 4.3%, making three straight weeks of declines culminating in an 8.7% decline from this year’s peak in April.

In each of the past two years, the stock market began a slide in the spring, a phenomenon often referred to by the old adage “sell in May and go away,” which lasted well into the summer months. In both 2010 and 2011, an early run-up in the stock market, similar to this year, pushed stocks up about 10% for the year by mid-April. On April 23, 2010 and April 29, 2011, the S&P 500 made peaks that were followed by 16–19% losses that were not recouped for more than five months. On March 26, we published the 10 indicators that warned of another Spring Slide this year but noted that this year’s decline may not be as steep as in the prior years. Now that the Spring Slide is in full swing, we have to watch out for the big event with the potential to make it as severe as the past two years.

A combination of factors contributed to the reversal in direction for the stock market, including an extended and exhausted rally, a slowdown in the economy, and weakening earnings outlooks. But what added fuel to the decline in 2010 was the negative environment that included the end of the Fed’s QE1 stimulus program, the uncertainty around the impact of the Dodd-Frank legislation, the passage of the Affordable Care Act, the Eurozone debt problems and bailouts, central bank rate hikes, and the end of the homebuyer tax credit. In 2011, the negatives that helped drive the slide further included the end of the Fed’s QE2 stimulus program, the Japan earthquake and nuclear disaster that disrupted global supply chains and pulled Japan into a recession, the Arab Spring erupted pushing up oil prices, rising inflation, central bank rate hikes, the Eurozone debt problems coming to a head, and, most importantly, the budget debacle and related downgrade of U.S. Treasuries.

Looking ahead, the negatives we face in 2012 already include the end of the Fed’s Operation Twist stimulus program, China’s slowdown, the European recession, geopolitical risks, the election uncertainty, and anticipation of the 2013 budget bombshell of tax hikes and spending cuts. However, some positives this year may help offset some of the negatives, making for a potential decline that may be less steep than those of the past two years.

• First, central banks are now cutting rather than hiking rates, which should help to temper global recession fears evident during the past two years’ Spring Slides. For example, China has cut reserve requirements three times in the past six months.

• Second, housing is showing signs of improvement, as both new and existing home sales are rising at a 5–7% pace, and home prices are now on the rise.

• Third, gasoline and food prices are decelerating, which helps to explain why consumer sentiment has been rising along with retail sales in May despite the market decline.

• Finally, auto production schedules are robust for the next quarter and likely to support manufacturing activity, which had fallen in May through July of the past two years and contributed to the market decline.

We will be on the lookout for signs that the Spring Slide may be as steep as the past couple of years. However, we will also be preparing our shopping list to take advantage of this broad pullback in the markets as it runs its course.

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 may involve risk including loss of principal.

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.

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 mention of individual companies noted herein is not for a recommendation to buy or sell the company nor the products and services they provide. We do offer any opinions or analysis on individual securities.

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.

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

LPL Financial, Member FINRA/SIPC

Spring Slide Indicators Update May 2, 2012

One month ago we provided our list of the 10 indicators to watch that seemed to precede the stock market declines in 2010 and 2011 and may warn of another spring slide. In both 2010 and 2011 an early run-up in the stock market, similar to this year, pushed stocks up about 10% for the year by mid-April. On April 23, 2010 and April 29, 2011, the S&P 500 made peaks that were followed by 16-19% losses that were not recouped for more than five months, a phenomenon often referred to by the old adage “sell in May and go away.” Now that the time the prior slides have begun has arrived it is time to revisit the status of the indicators.

So far, about half of the 10 indicators are waving a red flag, while four are yellow for caution, and only one is green. On balance the indicators point to a significant risk of a repeat of the spring slide this year. We will continue to monitor these closely in the coming weeks.

1.    Fed stimulus – In each of the past two years, Federal Reserve (Fed) stimulus programs known as QE1 & QE2 came to an end in the spring or summer, and stocks began to slide until the next program was announced. The current program known as Operation Twist was announced on September 12, 2011 and is coming to an end. It is scheduled to conclude at the end of June 2012. The Fed’s communications in April appeared no closer to announcing QE3, raising the risk of a repeat of the spring slide.

2.    Economic surprises – The Citigroup Economic Surprise index measures how economic data fares compared with economists’ expectations. The currently falling line suggests expectations have become too high; this typically coincides with a falling stock market relative to the safe haven of 10-year Treasuries.

*The Citigroup Economic Surprise Index is an unmanaged index, which cannot be invested into directly. Past performance is no guarantee of future results.

3.    Consumer confidence – In 2010 and 2011, early in the year the daily tracking of consumer confidence measured by Rasmussen rose to highs just before the stock market collapse as the financial crisis erupted. The peak in optimism gave way to a sell-off as buying faded. Investor net purchases of domestic equity mutual funds began to plunge and turned sharply negative in the following months. This measure of confidence is once again beginning to fall from the highs.

*The Rasmussen Daily Consumer Confidence Index is an unmanaged index, which cannot be invested into directly. Past performance is no guarantee of future results.

4.    Earnings revisions – Last week was about earnings and the news was good. S&P 500 profits were up 7% (4.7% ex-Apple) from a year ago with 72% of companies beating expectations, relative to 68% in the past four quarters. However, strong first quarter earnings reported in April of 2010 and 2011 were not enough to avoid the spring slide. The first couple of weeks of the first quarter earnings season in April 2010 and April 2011 drove earnings estimates for the next 12 months higher, but as the second half of the earnings season got underway in May 2010 and May 2011, guidance disappointed analysts and investors as the pace of upward revisions began to decline. This year the earning revisions have followed a similar pattern, so far. It is too early to say whether this indicator is flashing a warning sign. We will be watching to see if estimates begin to taper off now that earnings expectations have risen on the initial reports.

5.    Yield curve – In general, the greater the difference between the yield on the 2-year and the 10-year U.S. Treasury notes, the more growth the market is pricing into the economy. This yield spread, sometimes called the yield curve because of how steep or flat it looks when the yield for each maturity is plotted on a chart, peaked in February of 2010 and 2011 at 2.9%. Then the curve started to flatten, suggesting a gradually increasing concern about the economy, as the yield on the 10-year moved down to around 2%. This year the market is pricing a more modest outlook for growth, but we will be watching to see if the recent flattening in the yield curve continues with the yield on the 10-year having moved back to 2% during April 2012.

6.    Oil prices – In 2010 and 2011, oil prices rose about $15-20 from around the start of February, two months before the stock market began to decline. This year oil prices have climbed back to the levels around $105 that they reached in April of last year. However, they have risen only about $10 since around the start of February 2012 and seem to have stabilized. A further surge in oil prices would make this indicator more worrisome.

7.    The LPL Financial Current Conditions Index (CCI) – In 2010 and 2011, our index of 10 real-time economic and market conditions peaked around the 240-250 level in April and began to fall by over 50 points. This year, the CCI recently reached 249 and has started to weaken and currently stands at 224.

8.    The VIX – In each of the past two years the VIX, an options-based measure of the forecast for volatility in the stock market, fell to a low around 15 in April before ultimately spiking up over 40 over the summer. Last week, the VIX declined once again to 16. This suggests investors have again become complacent and risk being surprised by a negative event or data.

9.    Initial jobless claims – It was evident that initial filings for unemployment benefits had halted their improvement by early April 2010, and beginning in early April 2011, they deteriorated sharply. In 2012, April has again led to deterioration in initial jobless claims as they have jumped by about 30,000 to nearly 390,000. A continued climb this week would echo last year’s spike.

10.    Inflation expectations – The University of Michigan consumer survey reflected a rise in inflation expectations in March and April of the past two years. In fact, in 2011, the one-year inflation outlook rose to 4.6% in both March and April. This year, inflation expectations also jumped higher in March, but receded a bit from the March jump that echoed what we saw in 2010 and 2011.

Finally, one issue not addressed specifically in the indicators, but important in the markets, is the rising European stresses – evident in the spring of 2010 and 2011. European policymakers including those at the European Central Bank, who meet later this week (May 3, 2012), have been facing a lot of pressure to act and do something about the renewed fears evident in the yields on Spanish and Italian debt and European stocks. European leaders have once again refocused away from unpopular austerity to talk of stimulating growth, at the expense of rising bond yields. If leaders continue to do little to address the market’s concerns it could again accelerate the bond market sell-off and begin to affect stocks here in the U.S. similar to the spring slides in 2010 and 2011.

This week most of the attention will be directed towards the Institute for Supply Management (ISM) and employment reports for April 2012. But as we pointed out a month ago, these measures did not deteriorate ahead of the market decline, but along with it. It is not that they are not important; it is just that they did not serve as useful warnings of the slide to come, while the above 10 indicators did.

The return of daily volatility in April 2012 and the fact that April 2012 ended up as a flat month for stocks after six months of strong gains may suggest we are near a turning point. Given this year’s double-digit gains and the possibility of another spring slide for the stock market, investors may want to watch these indicators closely for signs of a pullback.

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 may involve risk including loss of principal.

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

The ISM index is based on surveys of more than 300 manufacturing firms by the Institute of Supply Management. The ISM 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 VIX is a measure of the volatility implied in the prices of options contracts for the S&P 500. It is a market-based estimate of future volatility. When sentiment reaches one extreme or the other, the market typically reverses course. While this is not necessarily predictive it does measure the current degree of fear present in the stock market.

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

LPL Financial, Member FINRA/SIPC

 

Are the markets suffering from a case of spring allergies? April 25, 2012

In April, the markets seem to be suffering from a case of spring allergies. One day they are feeling better and climbing higher, the next they weaken and drop. Like pollen-induced sneezes, the almost involuntary market spasms at each of the data points have resulted in a noticeable uptick in volatility after a very quiet first quarter. In fact, so far during April nearly half of the trading days have seen more than a 1% swing in the S&P 500.

The symptoms are not likely to clear up this week. The allergens floating around the U.S. this week that markets may react to include: the Fed meeting, first quarter earnings reports, and key economic data.

• The Fed may not offer enough insight on a potential QE3-a third round of quantitative easing-that investors seem to be looking for after recent economic data.
• First quarter earnings reports thus far generally exceeded analyst estimates by a wide margin without material downward revisions to upcoming quarters’ estimates. Yet the stock market, as measured by the S&P 500, was up only about 0.6% last week and investors’ bar of expectations may now be even higher as the earnings reporting season nears the halfway point later this week.
• Among the economic data released this week, initial jobless claims will be closely watched to see if they make a third consecutive week of deterioration and qualify as red flag number five out of our 10 leading indicators of another spring slide in the stock market and other “risk assets.”

The real test for the markets this week may come from overseas as markets react to: the French elections and accompanying policy uncertainty, the recession worsening in Europe, and finally Spanish banks will report their earnings.

• We will have to see what Socialist Party candidate Francois Hollande’s victory in the first round French presidential election on Sunday, April 22 means to European politics and the French-German relationship in leading the unified anti-crisis programs. Hollande’s socialist political ideology may make for a difficult relationship with Germany’s right-leaning Chancellor Angela Merkel. In addition, French domestic politics could change with higher spending proposals likely under Hollande-he has stated an intention to renegotiate European treaties on deficit limits-and could push French bond yields higher.
• As the European recession deepens-evidenced this week by a disappointing European manufacturing report for April-for the first time since before Japan entered its multi-decade slump, German 2-year bond yields have dipped lower than those of Japan, at around 0.1%. This decline in 2-year yields to near zero reflects both a flight to quality within Europe, as money leaves Spanish and Italian bonds, and a deteriorating outlook for growth. The specter of a lost decade is overhanging Europe as it echoes the post-bubble Japanese economy in the 1990s defined by troubled banks, a deepening recession, a volatile stock market, and very low yields.
• Many Spanish banks will report first quarter earnings this week, including heavyweights Banco Popular, Santander, and BBVA. Spain’s problems lie largely with its banks. Markets have been pricing in an increasing probability of a bank default in recent weeks, suggesting injections of capital may be necessary. Investors will be looking for the scope of the damage to balance sheets resulting from the ongoing real estate declines and recession along with the accompanying need for government capital. The scrutiny will be intense, with Spanish 10-year bond yields back up to around 6% from as low at 4.8% in February, despite the International Monetary Fund (IMF) getting pledges for an even bigger financial crisis backstop.

Investors’ immune systems may be hypersensitive after the past five years. But the market’s symptoms may also be signs of an oncoming illness. With volatility now returning and the market advance becoming led by fewer stocks (the average S&P 500 stock is stuck at the level reached in early February), further signs are emerging in market behavior that it may be vulnerable to a pullback.

 

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.

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

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.

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.

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

LPL Financial, Member FINRA/SIPC