Guide to Q1: Global Growth, Jobs, and the Fed January 7, 2014

LPL Financial Research forecasts U.S. economic growth, as measured by real gross domestic product (GDP), to accelerate to 3% in 2014 from the 2% pace of recent years. This marks our first above-consensus annual forecast for GDP in many years. As of mid-December 2013, the Bloomberg-tracked consensus estimate by economists for 2014 was 2.6%. If achieved, the 3% pace of GDP growth in 2014 would be the best performance for the U.S. economy since 2005, when the economy posted 3.4% growth. While a strong growth rate in comparison to the past 10 years, the 3% growth rate would simply equal the average pace of real GDP growth since the end of WWII.

Global GDP growth is also likely to accelerate in 2014. The economists’ consensus forecast expects a pickup from around 3% in 2013 to 3.5% in 2014. Beyond the United States, the major contributors to this growth rate amay also enjoy a better pace of growth in 2014:

• Europe will likely eke out a modest gain in GDP after emerging from a double-dip recession in 2013;
• China’s growth should stabilize in the coming year after slowing during the last few years; and
• Japan could record its third consecutive year of GDP growth for the first time since the mid-2000s.

Below, we take a month-by-month look at what could be some of the key milestones for the economic outlook in the first quarter of 2014.

January:

• 19th: China’s GDP report for 2013 – As of mid-December 2013, the consensus of economists polled by Bloomberg News expected that China’s GDP growth in 2013 would be between 7.5% and 8.0%, close to the 7.7% gain in 2012, but far below the 10 – 12% pace set by the Chinese economy between 2000 and 2007. In our view, markets have yet to become comfortable with the notion that China may never again see 10% GDP growth on a sustained basis, as it continues its transition from an export-led economy to a more stable, consumer-led economy. 
• 29th: First of eight Federal Open Market Committee (FOMC) meetings for 2014 – The Federal Reserve (Fed) is expected to maintain the current pace of tapering ($10 billion less in purchases) of quantitative easing at this meeting. The pace of the economy in 2014 will determine how quickly the Fed trims its purchases.

This is Janet Yellen’s first meeting as Chairwoman of the Fed and FOMC, the policymaking arm of the Fed. We continue to expect that Yellen will aim for more transparency at the Fed in 2014, and that could mean a press conference after each of the eight FOMC meetings this year. Currently, Yellen is scheduled to hold only four press conferences—after the March, June, September, and December 2014 FOMC meetings.

• 30th: The first estimate of GDP for Q4 2013 will be released – The government shutdown in the first half of October 2013 likely weighed on growth and based on the daily, weekly, and monthly data already in hand for the fourth quarter of 2013, fourth quarter 2013 GDP is currently tracking to around 2.0%. If GDP does come in at around 2.0% in the fourth quarter, GDP growth for all of 2013 would be just 1.9%.

February:

• 7th: Employment report for January 2014 will be released – The pace of job growth is one of the keys to the pace of Fed tapering in 2014. The December 2013 jobs report (due out this Friday, January 10, 2014) will likely show that the economy again created a net new 200,000 jobs in December 2013, close to the pace of job creation seen over the past three, six, and 12 months. If job creation increases markedly from this pace, the market will expect the Fed to quicken its pace of tapering. Similarly, a sustained slowdown in job creation from the current 200,000 per-month pace might cause the Fed to slow its tapering plan.

• 14th: Eurozone will report GDP for Q4 2013 and all of 2013 – The Eurozone is expected to have eked out a modest (0.4%) increase in GDP in the fourth quarter of 2013, which would leave GDP for all of 2013 0.4% below its 2012 level. Looking ahead to 2014, the Bloomberg consensus estimate for Eurozone GDP (as of mid-December 2013) stands at just 1.0%, still among the slowest growth in the developed world. While the European economy stopped getting worse in 2013, it is not likely to improve dramatically until it can effectively address its broken financial transmission mechanism. The latest data show that while money supply growth in the Eurozone is slightly positive, bank lending to small and medium-sized businesses in the Eurozone is still contracting — and at a faster rate than it was at the start of 2013 [Figure 1]. We view this as a key impediment to faster economic growth in the Eurozone in 2014.

• Late February: Retailers will report their sales and earnings for their fiscal fourth quarters, the three months ending in January 2014. – These results will serve as the final say on the 2013 holiday shopping season. The improvement in the labor and housing markets throughout 2013, as well as the increases in household net worth, driven in part by the 25 – 30% gain in equity prices in 2013 to new all-time highs, will act as support for holiday spending. Most retailers will report their December 2013 sales and provide guidance for January 2014 and beyond later this week (Thursday, January 9, 2014).

March

• 4th: Q4 2013 Flow of Funds report will be released by the Fed – The quarterly flow of funds report is often ignored by markets and the media, as it is difficult to interpret and is released with a long lag. However, the report is full of crucial data, including household balance sheets (assets and liabilities). The latest data available (Q3 2013) revealed that household net worth (assets minus liabilities) hit another new all-time high in the third quarter [Figure 2], aided by solid gains in the labor market, home prices, and sizable increases in financial assets, like equities. All of those categories continued to move higher in the fourth quarter of 2013, suggesting that household net worth will likely hit another all-time high in the fourth quarter of 2013. The rise in household net worth provides solid support for consumer spending, which represents two-thirds of GDP.

• 19th: FOMC meeting – If the Fed sticks to its current communications plan, March 19, 2014 will be Janet Yellen’s first press conference as Fed Chairwoman. As noted above, we expect Yellen to continue to enhance the Fed’s transparency over the course of 2014.

• 31st: Start of the 58th month of the economic expansion that began in July 2009 – As noted in our Outlook 2014 publication, since the end of WWII, the average economic expansion has lasted 58 months [Figure 3]. Looking back over the past 50 years, the average expansion has been 71 months. On that basis, the current recovery has another two years to go (2014 and 2015) just to get to “average.” The best comparison, however, may be the three economic expansions since the end of the inflationary 1970s, a period that has seen the transformation of the U.S. economy from a domestically focused, manufacturing economy to a more exportheavy, service-based economy. In general, this economic structure is less prone to inventory swings that drove the shorter boom-bust cycles of the past. On average, the last three expansions — the ones that began in 1982, 1991, and 2001 — lasted 95 months, or roughly eight years. Using those three expansions as the standard, the current economic expansion would merely be at its midpoint at the end of March 2014. The rather tepid pace of this expansion relative to prior expansions that lasted this long also supports the idea that we are close to the middle of the expansion, rather than the end.

_____________________________________________________________________________________________________________________________

IMPORTANT DISCLOSURES

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

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

Stock investing involves risk including loss of principal.

The 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 U.S. Treasury securities).

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.

Tapering refers to the Federal Reserve (Fed) slowing the pace of bond purchases in their Quantitative Easing (QE) program. To execute QE, the Fed purchases a set amount of Treasury and Mortgage-Backed bonds each month from banks. This inserts more money in the economy (known as easing), which is intended to encourage economic growth. Lowering the amount of purchases (tapering) would indicate less easing of monetary policy.

_____________________________________________________________________________________________________________________________

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

2014 Fixed Income Outlook December 3, 2013

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

Yielding to Growth

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

On the Horizon

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

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

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

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

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

Stay in the Middle

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

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

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

Harvesting Yield

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

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

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

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

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

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

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

International Debt

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

Opportunities in a Less Liquid Market

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

______________________________________________________________________________________________________________________________

IMPORTANT DISCLOSURES

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

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

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

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

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

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

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

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

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

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

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

 ______________________________________________________________________________________________________________________________

INDEX DESCRIPTIONS

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

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

______________________________________________________________________________________________________________________________

This research material has been prepared by LPL Financial.

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

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

Member FINRA/SIPC

Navigating the Markets November 26, 2013

Compass Changes

• No Changes

Investment Takeaways

• We expect the S&P 500 Index to grind higher through year-end, supported by durable U.S. economic growth, accommodative Federal Reserve (Fed) policy, and earnings gains.

• Our positive small cap view reflects our U.S. focus and potential to capture further stock market gains.

• We continue to favor the more U.S.-focused, consumer-oriented sectors over the global, export-focused sectors.

• We find bond valuations roughly fair and expect yields to remain largely range-bound through year-end.

• Higher-yielding, fundamentally sound segments of the bond market such as high-yield bonds, bank loans, and preferred securities remain among the more attractive fixed income options.

• Among high-quality bonds, we favor investment-grade corporate bonds due to the potential for higher yields and good fundamentals.

• We find high-yield municipal bonds attractive, but high-quality municipal bonds possess more attractive valuations and compelling taxable-equivalent yields.

• From a technical perspective, the S&P 500 Index price continues to make new all-time highs, establishing a new bullish price objective at 1845.

Broad Asset Class Views

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

Equity & Alternative Asset Classes

Favor Small Caps for U.S. Focus Potential for Further Stock Market Gains

• We expect the S&P 500 Index to continue to grind higher over the balance of the year, supported by durable U.S. economic growth, accommodative Fed policy, and earnings gains.

• We favor small caps for their potential to capture further stock market gains.

• We favor U.S. stocks relative to emerging markets (EM) and developed foreign, as Europe struggles to grow, and the growth trajectory in several key EM countries has been uneven. The recent pickup in China’s growth is encouraging.

• We maintain a preference for growth over value due to growth’s tendency to outperform in slow-growth environments and our positive consumer discretionary view.

• We believe further downside to crude oil (WTI) may be limited in the near term from a technical perspective, though the latest inventory data and relative calm in the Middle East are bearish.

• The potential for the Fed not to taper its bond purchases until after the New Year may provide near-term support for gold.

Equity Sectors

Maintain Preference for U.S. and Consumer-Focused Cyclical Sectors

• We continue to favor the more U.S.- focused, consumer-oriented sectors over the global, export-focused sectors.

• Our consumer discretionary view remains positive as spending continues to increase, albeit modestly, and the housing recovery continues despite higher mortgage rates.

• Our financials view is neutral. We see the U.S. focus, earnings gains, and valuations as positives, although mortgage activity, fixed income trading, and regulation remain concerns.

• Our modestly positive health care view reflects our U.S. focus, robust pace of product innovation, and demand uptick from the Affordable Care Act (ACA).

• The materials sector is one to watch for a potentially more positive view due to positive technicals and evidence of a pickup in growth in China.

• We expect a potential pickup in business spending and improving growth in China to help industrials sector performance.

• We remain cautious on telecom and utilities due to their interest rate sensitivity, though telecom valuations have become more reasonable in recent months.

• Our recent downgrade in our consumer staples view was driven by above-average valuations and weakening technicals, but lower oil prices help the outlook.

Fixed Income

A New Yield Range

• We find bond valuations roughly fair and expect bond prices and yields to continue to be largely range-bound between now and year-end 2013.

• We believe intermediate maturity bonds provide a better risk/return trade-off compared to short-term bonds.

• We find high-yield municipal bonds attractive, but high-quality municipal bonds possess more attractive valuations and compelling taxable-equivalent yields.

• A modest rise in yields to start November shows the bond market remains sensitive to tapering fears, but clarity from economic data, Washington, and the Fed may take months to become evident.

• Higher-yielding, fundamentally sound segments of the bond market such as high-yield bonds, bank loans, and preferred securities remain among the more attractive fixed income options.

• Among high-quality bonds, we favor investment-grade corporate bonds due to the potential for higher yields and good fundamentals.

All performance referenced herein is as of November 19, 2013, unless otherwise noted.

Global macro strategies risk include but are not limited to imperfect knowledge of macro events, divergent movement from macro events, loss of principal, and related geopolitical risks.

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

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

For the purposes of this publication, intermediate-term bonds have maturities between three and 10 years, and short-term bonds are those with maturities of less than three years.

All bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and are subject to availably and change in price. High-yield/junk bonds are not investment-grade securities, involve substantial risks, and generally should be part of the diversified portfolio of sophisticated investors. Municipal 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.

______________________________________________________________________________________________________________________________

DEFINITIONS:

EQUITY AND ALTERNATIVES ASSET CLASSES

Large Growth: Stocks in the top 70% of the capitalization of the U.S. equity market are defined as Large Cap. Growth is defined based on fast growth (high growth rates for earnings,

sales, book value, and cash flow) and high valuations (high price ratios and low dividend yields).

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

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

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

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

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

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

Large Foreign: Large-cap foreign stocks have market capitalizations greater than $5 billion. The majority of the holdings in the large foreign category are in the MSCI EAFE Index.

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

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

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

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

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

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

America, Europe, the UK, and Latin America.

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

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

______________________________________________________________________________________________________________________________

EQUITY SECTORS

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

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

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

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

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

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

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

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

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

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

______________________________________________________________________________________________________________________________

FIXED INCOME

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

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

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

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

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

Munis – High-yield: Bonds issued by various state and local governments to fund public projects. The income from these bonds is generally free from federal taxes. These bonds generally offer higher yields than other types of bonds, but they are also more vulnerable to economic and credit risk. These bonds are rated BB+ and below.

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

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

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

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

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

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

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

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

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

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

______________________________________________________________________________________________________________________________

IMPORTANT DISCLOSURES

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

Past performance is no guarantee of future results.

Stock investing involves risk including loss of principal.

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

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

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

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.

______________________________________________________________________________________________________________________________

This research material has been prepared by LPL Financial.

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

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

Member FINRA/SIPC

Another Step Forward November 5, 2013

The past weekend marked the end of daylight savings time, and time to set your clocks back, but for the bond market there was no step back in October. The bond market took another step forward during October 2013, with broad-based gains as the recent rebound continued. Future gains may be more limited as investors await further clarity on the economy and the path of the Federal Reserve (Fed) — a process that may take some time and sets up a range-bound environment through year-end.

Bond market returns were led by more credit-sensitive sectors in October such as high-yield bonds, corporate bonds, and preferred securities [Figure 1]. The limited economic data released in October showed an economy with little impact, so far, from the 16-day government shutdown during the month. Relief that a more adverse impact had been avoided for now supported corporate bonds as did good news from earnings reporting season. With just over half of S&P 500 companies having reported, third quarter 2013 S&P 500 earnings are on pace to grow 5% over the prior year, while revenues are 3% higher.

A further reduction in Fed tapering fears was a key catalyst in October bond performance. Market expectations that the Fed may wait longer before reducing the pace of bond purchases increased during October due to the government shutdown. The economic impact of the government shutdown, although negligible so far, may not become fully apparent before the Fed’s December meeting. Furthermore, the continuing resolution that ended the recent government shutdown will expire in mid-January 2014, setting up another potential shutdown that may motivate the Fed to hold off on reducing bond purchases even longer and perhaps until March 2014. Emerging market debt (EMD) is a potential beneficiary of a delayed start to Fed tapering, as Fed bond purchases help foster market liquidity and therefore reduce risks for less liquid market segments such as EMD.

Mixed economic data, in addition to government shutdown implications, also supported October bond strength. The uneven economic data, including a subpar September employment report released on October 22, 2013, led market participants to question whether economic improvement had stalled and if it warranted the Fed to taper bond purchases as soon as this December. Together, the government shutdown and mixed economic data suggested the Fed would maintain the current pace of bond purchases for longer.

Range-Trade

Will the bond market witness a third straight month of gains in November? Gains, if any, are likely to be more limited as we see a range-bound trading environment develop. The rise in bond prices and subsequent decline in yields from September 5, 2013 through the end of October has factored in much of the uncertainty over when the Fed will begin to reduce bond purchases as well as fiscal uncertainty from Washington. More importantly, the bond market has priced in what we believe is a more realistic view of when the Fed may begin to raise interest rates. In our view, the timing of the Fed’s first interest rate hike is much more important to the direction of bond prices and yields than the start of tapering.

According to fed fund futures, the first interest rate hike is expected by September 2015 — three months beyond the Fed’s current guidance of approximately June 2015. Futures pricing shows the bond market believes the Fed will wait longer to ultimately raise rates. The overly aggressive rate hike fears that led to bond weakness in the spring and summer have been largely reversed, leaving more balanced expectations [Figure 2]. At the same time, a further delay in the timing of a first rate hike, which may push bond yields lower still, seems unlikely absent an additional catalyst.

Furthermore, the decline in yields has reached a key resistance barrier represented by a 2.5% yield on the 10-year Treasury. In the midst of the sell-off in late June and mid-July of this year, the yield on the 10-year Treasury dropped to 2.5% three times but was unable to fall below that level. In late October, the 10-year Treasury yield once again reached this barrier and bounced modestly higher, temporarily at least halting the bond rally [Figure 3].

Higher valuations may limit demand from investors and provide another reason that returns are likely to slow. In the high-yield bond market, valuations have improved and are approaching early May levels [Figure 4]. Earnings season has so far confirmed the good fundamentals underlying corporate bond issuers, and defaults are likely to remain isolated, but higher valuations will still restrain additional investment, leaving interest income the primary driver of return.

We believe another catalyst may be needed to take bond prices higher and yields still lower. The modest decline in bond prices and rise in yields to start November shows the bond market does maintain some sensitivity to tapering fears as top-tier economic reports are being released. Signs of weaker economic data, the prospect of a more protracted government shutdown, or more concrete signs the Fed will take even longer to start tapering and/or raise interest rates are likely needed to promote another run higher in bond prices. The government shutdown has delayed the release of multiple economic reports and clouded the interpretation of many others. The Fed’s next meeting is not until mid-December, and the threat of another government shutdown will not be known until early 2014. All three factors will take weeks or perhaps months to assess, and a range-bound trading environment may result.

______________________________________________________________________________________________________________________________

IMPORTANT DISCLOSURES

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

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

Yield is the income return on an investment. This refers to the interest or dividends received from a security and is usually expressed annually as a percentage based on the investment’s cost, its current market value or its face value.

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.

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.

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.

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

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.

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

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

______________________________________________________________________________________________________________________________

INDEX DESCRIPTIONS

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

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

The Barclays Treasury Index is an unmanaged index of public debt obligations of the U.S. Treasury with a remaining maturity of one year or more. The index does not include T-bills (due to the maturity constraint), zero coupon bonds (Strips), or Treasury Inflation Protected Securities (TIPS).

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 Barclays U.S. Corporate High Yield Index covers the USD-denominated, non-investment grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below. The index excludes emerging markets debt. The index was created in 1986, with index history backfilled to January 1, 1983. The U.S. Corporate High Yield Index is part of the U.S. Universal and Global High Yield Indices.

J.P. Morgan Emerging Markets Bond Index Global (EMBI Global) tracks total returns for U.S. dollar denominated debt instruments issued by emerging market sovereign and quasi-sovereign entities: Brady bonds, loans, Eurobonds. Currently, the EMBI Global covers 188 instruments across 33 countries.

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 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 Citigroup Non-U.S World Government Bond Index (Un-hedged) is calculated on a market-weighted basis and includes all fixed-rate bonds with a remaining maturity of one year or longer and with amounts outstanding of at least the equivalent of U.S. $25 million. The Index excludes floating or variable rate bonds, securities aimed principally at non-institutional investors and private placement-type securities.

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 Barclays U.S. Treasury TIPS Index is a rules-based, market value-weighted index that tracks inflation protected securities issued by the U.S. Treasury. The U.S. TIPS Index is a subset of the Global Inflation- Linked Index, with a 36.0% market value weight in the index (as of December 2007), but is not eligible for other nominal treasury or aggregate indices. In order to prevent the erosion of purchasing power, TIPS are indexed to the non-seasonally adjusted Consumer Price Index for All Urban Consumers, or the CPI-U (CPI).

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 Merrill Lynch Preferred Stock Hybrid Securities Index is an unmanaged index consisting of a set of investment-grade, exchange-traded preferred stocks with outstanding market values of at least $50 million that are covered by Merrill Lynch Fixed Income Research. The Index includes certain publicly issued, $25- and $100-par securities with at least one year to maturity.

______________________________________________________________________________________________________________________________

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

 

Fall FOMC FAQ October 29, 2013

Will the Fed announce tapering at this week’s FOMC meeting?

The Fed is unlikely to announce that it is ready to begin scaling back/tapering its bond-purchase program, known as quantitative easing (QE), at this week’s meeting. The Federal Reserve (Fed) will hold its seventh (of eight) Federal Open Market Committee (FOMC) meetings this year on Tuesday and Wednesday, October 29 and 30, 2013.

Why is the Fed not likely to taper at this week’s FOMC meeting?

The main reason is the lack of visibility on the economy for Fed policymakers, due largely to the 16-day government shutdown that ended in mid-October 2013. The shutdown delayed a large number of crucial economic reports that Fed policymakers would like to have seen prior to this week’s meeting. In addition, the data that have been released since the September 17 – 18 FOMC meeting have generally been disappointing relative to expectations.

How has the economy evolved since the last FOMC meeting in mid-September 2013?

Figure 1 shows the Citigroup Economic Surprise Index for the United States over the past 12 months. The index measures data surprises relative to market expectations. A rising line means that data releases have been stronger than expected, and a falling line means that data releases have been worse than expected. The recent peak in the index came in early September 2013, just prior to the mid-September FOMC meeting. The reports released since mid-September that have fallen short of expectations include:

• Housing starts (August)
• Richmond Fed Index (September)
• Consumer Confidence (September)
• Durable goods orders and shipments (September)
• Pending home sales (August)
• Markit PMI – Manufacturing (September)
• Vehicle sales (September)
• ISM – Non-Manufacturing (September)
• Small Business Sentiment Index (September)
• Empire State Manufacturing Index (October)
• Existing home sales (September)
• Payroll employment (September)
• Markit PMI – Manufacturing (October)
• Durable goods orders and shipments (October)

How have financial conditions changed since the last FOMC meeting?

The Fed cited tightening financial conditions as one of the reasons it chose not to begin tapering at the September 17 – 18, 2013 FOMC meeting.  Figure 2 shows financial conditions – as measured by the Federal Reserve Bank of Chicago’s Financial Conditions Index — have eased since the September FOMC meeting, after tightening over the spring and summer of 2013. Note that despite tightening financial conditions between May and September 2013, they never even got close to where they were during the 2007 – 2009 financial crisis.

Will the FOMC specifically mention the government shutdown in its statement?

There is a strong likelihood that the FOMC statement will mention the recent government shutdown, and the minutes of this week’s FOMC meeting — due out in mid-November 2013 — will almost certainly mention it. The statements released during and just after the 21-day government shutdown in December 1995 and January 1996 did not specifically mention the shutdown, but in those days, FOMC statements were not as verbose as they are today. However, a quick look at the minutes from the December 19, 1995 and January 30 – 31, 1996 meetings finds that both sets of minutes did mention the shutdown and its impact on the economy. The minutes of the January 31, 1996 meeting mentioned the shutdown’s impact on the availability of economic data.

Excerpt from the minutes of the December 19, 1995 FOMC meeting:

The decline in federal purchases in part represented the transitory effects of government shutdowns and the restraining effects of spending cuts imposed by continuing resolutions and by curtailed appropriations in bills that already had been enacted into law.

Excerpts from the minutes of the January 30 – 31, 1996 FOMC meeting:

Only a limited amount of new information was available for this meeting because of delays in government releases…

…these buildups, together with the disruptions from government shutdowns…

The weakness in business activity this winter was to some extent the result of the partial shutdown of the federal government…

What else will we hear from the FOMC this week?

The only communication from the Fed at the conclusion of the meeting will be the FOMC statement, which will be released at 2 PM ET on Wednesday, October 30, 2013. There will be no new economic and interest rate forecast from members of the FOMC, nor will Fed Chairman Ben Bernanke hold a press conference. Market participants will have to wait until the conclusion of the December 17 – 18, 2013 FOMC meeting for the next economic and interest rate forecasts from the FOMC. The press conference following that meeting will be Ben Bernanke’s last as Fed Chairman. We expect that in the near future, the FOMC will strongly consider holding a press conference at each of its eight meetings per year. Many other major central banks across the globe hold press conferences and release forecasts at the conclusion of all of their meetings. In addition, most global central banks hold meetings once a month.

It’s nearly two months away, but what about the next FOMC meeting (December 17 – 18)?

As we noted in last week’s (October 21, 2013) Weekly Economic Commentary: The Lowdown on the Shutdown — The Impact on the Economy and the Fed, the 16-day government shutdown caused delays in the government’s data collection and reporting process for economic data. Since the government’s economic data calendar will not be back to normal until early December, it is unlikely Fed policymakers will announce tapering at the December 17 – 18 FOMC meeting.

An additional hurdle to tapering is the timing of the next government shutdown and debt ceiling debate. Under the terms of the bill passed by Congress in mid-October 2013 to end the shutdown and lift the debt ceiling, the government could shut down again in mid-January 2014, and the Treasury could hit its borrowing limit by early February 2014. While we see this as unlikely, as has been the case in the past few years,these deadlines create uncertainty for the public, market participants, and policymakers and could weigh on economic activity.

In addition, a special bipartisan House-Senate conference committee charged with breaking the impasse on the budget is scheduled to issue a report on December 13, 2013, just days before the December 17 – 18, 2013 FOMC meeting. While a “grand bargain” on the budget might pave the way for the Fed to taper in December 2013, the more likely outcome is that the rancor surrounding this report will only add to the fiscal uncertainty, which argues for a Fed taper in early 2014 and not at the December 17 – 18, 2013 meeting. Of course, if Congress can agree in the next few weeks (for example, by Thanksgiving) on a deal that would eliminate the possibility of another shutdown and bruising debate about the debt ceiling in early 2014, a December taper becomes more likely.

______________________________________________________________________________________________________________________________

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.

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 U.S. Treasury securities).

______________________________________________________________________________________________________________________________

INDEX DESCRIPTIONS

Citigroup Economic Surprise Index (CESI) measures the variation in the gap between the expectations and the real economic data.

The National Financial Conditions Index (NFCI) measures risk, liquidity and leverage in money markets and debt and equity markets as well as in the traditional and “shadow” banking systems. Positive values of the NFCI indicate financial conditions that are tighter than average, while negative values indicate financial conditions that are looser than average.

___________________________________________________________________________________________________________________

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

 

Liquidity: You Don’t Miss It Until It’s Gone October 15, 2013

“That’s the trouble with liquidity. It’s never there when you really need it,” remarked John Meriwether, founder of hedge fund firm Long-Term Capital Management (LTCM) back in 1998, who was forced to liquidate and close his fund in response to the market turmoil. LTCM was unable to exit certain positions and forced to sell other holdings at much lower-than-anticipated prices due to poor liquidity. The vast majority of investors do not own the esoteric securities or complex trades owned by LTCM that rely on good liquidity in various sectors of the market, but this does highlight an extreme case of an illiquid market.

Liquidity is the oil that lubricates financial markets and is particularly important in the bond market where trading is not done on a major exchange. The over-the-counter nature of the bond market requires two parties to agree on price for a certain transaction. A lack of willing participants to make markets in a specific security or segment of the market leads to illiquid trading, which can exacerbate price weakness even if the intrinsic fundamental value of a security may not have changed. If a buyer views an investment as possibly difficult to sell, a lower price may be demanded up-front to compensate for the potential future difficulty. This is particularly evident during periods of volatile markets, when many investors may try to avoid risk of any kind and shift focus to the highest quality, most liquid securities within a particular sector or market.

A Growing but Manageable Risk

Liquidity has become a growing risk in the bond market as banks, traditional large-scale players in the bond market, have gradually reduced their market participation. Due to new financial regulations over the past few years, financial institutions have less incentive to maintain an inventory of fixed income securities and warehouse certain types of bonds. Declining liquidity is an unintended consequence of Dodd-Frank financial regulation. The inventory of corporate bonds held by bond dealers remains near the lowest
levels since the end of the financial crisis [Figure 1].

Bond dealers’ reluctance to participate in broader bond markets, compared  to prior years, highlights two potential risks:

• More volatile interest rate movements. In our view, bond dealers not stepping up to support the bond market last spring was a contributor to the recent bond market sell-off. Federal Reserve (Fed) data highlighted in last week’s commentary showed that bond dealers unloaded bond  holdings in May and June, which played a role in bond market weakness. In the absence of bond dealer participation, bond prices may have fallen more than warranted by fundamental data alone before yields reached a point to entice other buyers. As we highlighted last week, liquidity, or lack of it, may play a key role in how the bond market reacts to the gradual withdrawal of Fed bond purchases. 

• Greater swings in lower-rated or more economically sensitive bonds. Lower-rated bonds, such as high-yield bonds, are among the bonds most influenced by the availability of liquidity. Due to their default risk, high-yield bond prices and yields usually incorporate some consideration of liquidity as they may be difficult to sell during times of market stress. During weak and volatile markets, rising default risk can cause investors to shy away from lower-rated bonds. This past spring high-yield bond spreads initially spiked, and high-yield bond prices weakened, on Fed tapering fears before investors began to buy and take advantage of cheaper valuations [Figure 2].

Of course, illiquid markets can also provide opportunity. The lack of liquidity led to cheaper valuations and high-yield spreads widening to almost 6%, a seven-month high. Investors who purchased on weakness, recognizing the sector was still backed by good fundamentals and the prospect for continued low defaults, were rewarded as valuations improved and the sector outperformed Treasuries from late June through the end of September 2013. Similarly, smaller markets such as emerging market debt and municipal bonds bounced back in September as new investors stepped in to take advantage of more attractive valuations brought about by illiquid markets that exacerbated weakness.

The prospect of Fed tapering, and potential bond market impacts, along with bond dealers’ reduced participation in the bond market means that liquidity may still pose a challenge for bond investors in coming months and years. In July, the Treasury Borrowing Advisory Committee, a group of bond dealers that consults with the Treasury on bond market conditions and issuance recommendations for the Treasury, highlighted declining bond market liquidity. We remain vigilant to liquidity challenges, but with bond valuations broadly much more balanced now, we view near-term liquidity risks as manageable and remain focused on more credit-sensitive sectors such as bank loans and high-yield bonds. Both sectors remain supported by good credit quality metrics, and third quarter earnings season and the resumption of economic data releases (when the government shutdown ends) are likely to be bigger drivers of performance over coming weeks rather than liquidity.

____________________________________________________________________________________________________________________________

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 yoconsult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of
any investment. Past performance is no guarantee of future results.

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

Yield is the income return on an investment. This refers to the interest or dividends received from a security and is usually expressed annually as a percentage based on the investment’s cost, its current market value or its face value.

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.

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.

High-yield/junk bonds are not investment-grade securities, involve substantial risks, and generally should be part of the diversified portfolio of sophisticated investors.

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.

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

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

Bank loans are loans issued by below investment-grade companies for short-term funding purposes with higher yield than short-term debt and involve risk.

__________________________________________________________________________________________________________________________

INDEX DESCRIPTIONS
The Barclays U.S. Corporate High Yield Index covers the USD-denominated, non-investment grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below. The index excludes Emerging Markets debt. The index was created in 1986, with index history back filled to January 1, 1983. The U.S. Corporate High Yield Index is part of the U.S. Universal and Global High Yield Indices.

The Barclays Treasury index is an unmanaged index of public debt obligations of the U.S. Treasury with a remaining maturity of one year or more. The index does not include t-bills (due to the maturity constraint), zero coupon bonds (Strips) , or Treasury Inflation Protected Securities (TIPS).

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.

J.P. Morgan Emerging Markets Bond Index Global (EMBI Global) tracks total returns for U.S. dollar denominated debt instruments issued by emerging market sovereign and quasi-sovereign entities: Brady bonds, loans, Eurobonds. Currently, the EMBI Global covers 188 instruments across 33 countries.