Trust September 13, 2013

Trust

The latest Beige Book (released Wednesday, September 4, 2013) and the August employment report (released Friday, September 6, 2013) likely provided Fed policymakers enough “cover” to begin scaling back QE. Figure 1 compares the latest readings on the LPL Financial Beige Book Barometer, as well as key metrics from the employment report, to the readings from September 2012, when the Federal Open Market Committee (FOMC) voted to commence the latest round of QE, dubbed QE3.

Data shows that the economy is not booming, the labor market is still struggling, and the Fed’s preferred measure of inflation has decelerated in recent months. All this suggests that although there is not a clear cut economic case for the Fed to begin slowing QE at the September 17 – 18 FOMC meeting, the overall economy (according to the Beige Book) and the labor market have improved modestly in the 12 months since the FOMC voted to embark on QE3.

Instead, comments over the past few months on the unintended consequences of QE from many Fed officials, including Fed Chairman Ben Bernanke, suggest that the FOMC may be questioning the efficacy of continuing to pursue QE. Therefore, they are ready to begin to taper sooner rather than later. In particular, Fed officials have expressed concerns that additional QE could potentially disrupt the smooth functioning of securities markets, cause investors to take on excessive risk and “reach for yield” in certain segments of the fixed income markets, and add to financial instability in the global economy.

Perhaps more importantly, in our view, since Fed Chairman Bernanke’s testimony before the Joint Economic Committee of Congress in May of this year, financial market participants have come to expect that the Fed would begin to taper this month, absent a major downshift in the economy. If the Fed does not follow through on tapering, it risks losing the market’s hard-earned trust; and any trust the markets have in the Fed today will likely come in handy when the Fed has to begin removing stimulus and raising rates in the years ahead.

In our view, the “trust” argument for the Fed to begin tapering QE next week is stronger than either the economic argument, or the “risks” argument; and as a result, the Fed is likely to announce modest tapering of QE next week. The latest consensus of market participants is that the Fed will trim QE by $10 – 15 billion, from $85 billion per month, to $70 – 75 billion per month. At the same time, the Fed is likely to place more emphasis on its promise to keep its key policy rate, the Fed funds rates, lower for longer; and, to rely more on this strengthened rate guidance than on QE as a policy tool in the period ahead.

Beige Book: Window on Main Street

The latest edition of the Federal Reserve’s (Fed) Beige Book, released on September 4, 2013, once again described the economy as increasing at a modest-to-moderate pace, with little wage or inflation pressures. Autos and housing, despite the recent rise in interest rates, were mentioned as key drivers of growth. As noted above, the tone of the latest Beige Book report suggests that the Fed is still on track to begin scaling back QE, but that it remains a long way from tightening monetary policy by raising its fed funds rate target.

In order to provide one snapshot of the entire Beige Book collage of data, we created our proprietary Beige Book Barometer (BBB) [Figure 2]. The barometer ticked down to +70 in September 2013 from +79 in July 2013, and +82 in June 2013. Despite the downtick since April 2013, the BBB remains well above its Superstorm Sandy-related dip to +30 in November 2012. Note that the April 2013 reading (+112) was both a post-Great Recession high and also the highest reading since 2005, suggesting a broadening and deepening of the economic expansion. The move down to +70 from +112 between the April and July 2013 editions of the Beige Books came as the number of positive words dropped and the number of negative words hit a fresh seven-year low in September 2013. The drop in the number of negative words in the Beige Book to a seven-year low can be viewed as reflecting the diminishing pace of headwinds (e.g., fiscal policy, Europe, China, housing, and general economic uncertainty ) that have hampered the U.S. economic
recovery over the past four years.

Our BBB, a diffusion index that measures the number of times the word “strong” or its variants (stronger, strength, strengthen, etc.) appear in the Beige Book less the number of times the word “weak” or its variants (weaken, weaker, etc.) appear, is displayed in Figure 2. The barometer is an easy-to-use, quantitative way to measure small shifts in the outlook and capture shades between strong and weak in the predominately qualitative Beige Book report.

Beige Book: How It Works

The Beige Book compiles qualitative observations made by community bankers and business owners about economic (labor market, prices, wages, housing, nonresidential construction, tourism, manufacturing) and banking (loan demand, loan quality, lending conditions) conditions in each of the 12 Fed districts (Boston, New York, Philadelphia, Kansas City, etc.). This local color that makes up each Beige Book is compiled by one of the 12 regional Federal Reserve districts on a rotating basis—the report is much more “Main Street” than “Wall Street” focused. It provides a window into economic activity around the nation using plain, everyday language. The report is prepared eight times a year ahead of each of the eight Federal Open Market Committee (FOMC) meetings. The next FOMC meeting is September 17 – 18, 2013.

The previous word clouds or text clouds, which are a visual format useful for quickly perceiving the most important words in a speech, text, report, or other transcript, are culled from the Fed’s Beige Books published last week (September 4, 2013), the prior report (July 17, 2013) and in August 2012. In general, the more often a word appears in a speech, text, report or other transcript, the larger that word appears in the word cloud. The word clouds show the top 50 words for each of the two Beige Books mentioned above. Similar words are grouped together and common words like “the,” “and,” “a,” and “is” are excluded, as are words that appear frequently in all Beige Books (federal, district, loan, level, activity, sales, conditions, firms, etc.).

How the Barometer Works

The Beige Book Barometer is a diffusion index that measures the number of times the word “strong” or its variations appear in the Beige Book less the number of times the word “weak“ or its variations appear. When the Beige Book Barometer is declining, it suggests that the economy is deteriorating. When the Beige Book Barometer is rising, it suggests that the economy is improving.

Word Clouds Show Growing Concern About Impact of Health Care Reform and Rising Rates

The word clouds in Figure 4 are dominated by words describing the tone of the economy when the Beige Books were published. Although not picked up in the nearby word cloud, the most notable trend in the latest Beige Book was the large uptick in the number of mentions of “health care,” “health insurance,” and the “Affordable Care Act” (ACA). There were 26 mentions of these words in the September Beige Book, up from just 15 in July. Clearly, heath care remains a major issue for Main Street as the ACA begins to be implemented. Health care, health insurance, and the Affordable Care Act were mentioned 28 times in June 2013, 26 times in April 2013, and 18 times in the March 2013 Beige Book. The topic warranted just eight mentions in the January 2013 Beige Book. In contrast, those words were found just a handful of times in the Beige Book released a year ago (July and August 2012). We will continue to monitor these health care words closely in the upcoming Beige Books, as the economy continues to adjust to the impact of the ACA. We expect this set of words to grow in importance in the coming months.

There were nine mentions of “mortgage rates”/”rising rates” in the September 4, 2013 Beige Book, up from just five in July 2013. There were no mentions of rising rates in the June 2013 Beige Book nor in the Beige Books in July or August 2013. Despite the rise in rates, the Beige Book noted that “attractive financing conditions and pent-up demand supported a robust pace of automobile sales in most Districts” and that “rising home prices and mortgage interest rates may have spurred a pickup in recent market activity, as many ‘fence sitters’ were prompted to commit to purchases.” Rising rates and their impact across all sectors of the economy will be important to monitor in the coming quarters as the Fed begins to scale back quantitative easing.

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IMPORTANT DISCLOSURES

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

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

Stock investing involves risk including loss of principal.

Quantitative easing (QE) 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 United States Treasure securities).

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

Beige Book: Window on Main Street July 23, 2013

Unseasonable Weather Still Weighing on the Economy

The latest edition of the Federal Reserve’s (Fed) Beige Book, released on July 17, 2013, described the economy as increasing at a modest-to- moderate pace, with little wage or inflation pressures. Housing and commercial real estate were mentioned as key drivers of growth. The report, along with comments made by Fed Chairman Ben Bernanke at his semi-annual Monetary Policy Testimony to Congress last week (July 15 – 19), suggest that the Fed is still on track to begin scaling back its quantitative easing (QE) program this fall, but that it remains a long way from tightening monetary policy by raising its fed funds rate target.

In order to provide one snapshot of the entire Beige Book collage of data, we created our proprietary Beige Book Barometer (BBB) [Figure 1]. The barometer ticked down to +79 in July 2013, from +82 last  month. The April 2013 reading was +112. Despite the downtick since April, the BBB remains well above its Superstorm Sandy-related dip to +30 in November 2012. Note that the April 2013 reading (+112) was  both a post-Great Recession high and also the highest reading since 2005, suggesting a broadening and deepening of the economic expansion. The move down to +79 from +112 between the April and July 2013 editions of the Beige Books came as the number of positive words dropped and the number of negative words hit a fresh seven year low in July 2013. The drop in the number of negative words in the Beige Book to a seven-year low can be viewed as reflecting the diminishing pace of headwinds (e.g., fiscal policy, Europe, China, housing) that have hampered the U.S. economic recovery over the past four years.

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

Headwinds From Fiscal Policy Diminish

The word “fiscal” appeared just four times in the latest Beige Book, down from five in June 2013, and 12 in April. There were 17 mentions in the March 2013 Beige Book, and a whopping 38 in the January 2013 edition. Because of the timing of the collection of comments for the January 2013 Beige Book (comments from contacts in the business and banking community were collected throughout December 2012 and during the first few days of January 2013), we noted that with 38 mentions of the word “fiscal,” the January 2013 Beige Book likely overstated the impact of the fiscal cliff on economic activity in early 2013.

At the start of 2013, as Congress passed legislation to avoid the worst case scenario of the fiscal cliff, but allowed the sequester (i.e., government spending cuts prescribed in the debt ceiling agreement reached in 2011) to proceed, we expected that the word “sequester” would start to appear more often in the Beige Book. Thus far, however, that has not been the case. The word sequester was not used at all in the latest two Beige Books (July and June 2013) and appeared just once in the April 2013 Beige Book. Mentions of budget or budget cuts have been almost non-existent in the recent Beige Books as well. Looking ahead, we still expect the word sequester (or related words) to show up in the next several Beige Books, but with the debt ceiling debate and possible government shutdown now pushed back until late 2013, fiscal uncertainty outside of the impact of the sequester will likely continue to fade in upcoming Beige Books. The peak of the impact of the sequester will likely be felt in the recently completed second quarter and third (current) quarter of 2013.

Word Clouds Show Unseasonably Cool Weather and Growing Concern About Impact of Health Care Reform Still Acting as Headwinds

The word clouds in Figure 3 are dominated by words describing the tone of the economy when the Beige Books were published. Below are some observations on the current Beige Book (released on July 17, 2013) relative to other recent editions of the Beige Book.

• In the last two Beige Books (June and July 2013), the word “weather” appeared a total of 43 times, 27 times in the June 2013 edition of the Beige Book, and 16 times in the July 2013 version. The 43 mentions were nearly double the 24 mentions of weather in the same two Beige Books in June and July 2012. All but a few of the mentions of weather in the last two (June and July 2013) were in a negative context. The words rain, wet, cool, and cold appeared a total of 22 times in the June and July 2013 Beige Books. These words did not appear at all in the June and July 2012 Beige Books. This helps to explain, in part, the poor U.S. economic data reports — both on an absolute basis and relative to expectations — for much of the spring (March, April, May, and early June), especially in housing. In corporate earnings reports for the second quarter (April, May, and June 2013), managements in the housing construction, lodging, and leisure and hospitality industries have also mentioned unseasonably cold and wet weather as having a negative impact on results. The key takeaway here is that a return to “normal” weather could provide a significant lift to weather-sensitive portions of the economy and to upcoming readings on our BBB. Indeed, the first three weeks of July 2013 have generally seen warmer-than-usual temperatures and less-than-usual amounts of rainfall across the nation.

• In the Beige Books released in late November 2012 and early January 2013, economic uncertainty surrounding the fiscal cliff and the rebound from the economic disruption wrought by Superstorm Sandy dominated. Sandy and the fiscal cliff have since faded as concerns, and uncertainty has faded a bit as well. There were just seven mentions of the word “uncertain” in the July 2013 Beige Book, down from 13 in the June Beige Book. It was used 26 times in March 2013, and 43 in January 2013. The seven mentions of uncertain in the June 2013 Beige Book were the fewest since June 2011.

• The word “confidence” appeared just nine times in the latest Beige Book, 10 times in the June 2013 Beige Book, seven times in the April 2013 Beige Book, and 11 times in the March 2013 Beige Book. However, unlike in 2011 and most of 2012, when the word was used in a negative context (i.e., lack of confidence, weak confidence), most of the mentions of the word confidence in the Beige Book have been in a positive context. Eight of the nine mentions in July, nine of the 10 mentions in June, five of the seven mentions in April, and nine of the 11 mentions in the March 2013 Beige Book were in a positive context. Thus, over the past few Beige Books since Superstorm Sandy, business and banking contacts have generally become more confident in the recovery, especially in housing. This suggests that a sustained, multi-year recovery in the housing market is likely underway.

• Although the number of mentions of “health care,” “health insurance,” and the “Affordable Care Act” (ACA) totaled just 15 in the latest Beige Book, heath care remains a major issue for Main Street as the ACA begins to be implemented. Health care, health insurance, and the Affordable Care Act were mentioned 28 times in June 2013, 26 times in April, and 18 times in the March 2013 Beige Book. The topic warranted just eight mentions in the January 2013 Beige Book. In contrast, those words were found just a handful of times in the Beige Book released a year ago (June and July 2012). We will continue to monitor these health care words closely in the upcoming Beige Books, as the economy continues to adjust to the impact of the ACA. We expect this set of words to grow in importance in the coming months.

• There were just three mentions of Europe in the latest Beige Book, down from eight mentions in the June 2013 Beige Book. Europe was mentioned nine times in the April 2013 edition of the Beige Book. The three mentions of Europe in July 2013 were the fewest since October 2012, and well below the 15 – 20 mentions seen in the summer and fall of 2012, as Europe struggled through elections in Greece and increased fears of a break-up. Not surprisingly, nearly all of the mentions of Europe in the latest Beige Book were in a negative context. Perhaps business and banking contacts on Main Street are not as exposed to Europe as some of the larger businesses and financial institutions on Wall Street are that dominate media coverage. But it is also worth noting that the European debt crisis is well into its fourth year, and Main Street may be getting used to it now. The relatively few mentions of Europe are consistent with our view that the European economy has probably stopped getting worse, even though it may not accelerate anytime soon.

• Despite the well-publicized slowdown in China’s economy in the second quarter of 2013, the concerns around an overheated Chinese property market, and a sudden rise in overnight borrowing costs in China, China warranted just two mentions in the latest Beige Book, down from three mentions each in the April and June 2013 Beige Books. The Beige Book suggests that while China has not entirely disappeared from Main Street’s radar, it is far less of a concern than the media makes it out to be. Indeed, the last time China warranted as many as six mentions in the Beige Book was in January 2012, as fears of a “hard landing” in China began to gather steam. The Chinese economy appeared to have bottomed out in late 2012, avoiding a “hard landing,” but recent data in China suggest that it has not re-accelerated as quickly as some market participants hoped.

___________________________________________________________________________________________________________________________________

IMPORTANT DISCLOSURES

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

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

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

Quantitative easing (QE) 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 United States Treasure securities).
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INDEX DESCRIPTIONS

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

The 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

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Beige Book Bounce-Back March 13, 2013

Positive Tone; More Modest Expansion 

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

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

Still Bouncing Back From the Fiscal Cliff and Sandy

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

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

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

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

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

Word Clouds Show Modest Expansion

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

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

_______________________________________________________________________________________IMPORTANT DISCLOSURES

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

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

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

Stock investing involves risk including loss of principal.

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

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

_______________________________________________________________________________________INDEX DESCRIPTIONS

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

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

_______________________________________________________________________________________ This research material has been prepared by LPL Financial.

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

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

_______________________________________________________________________________________

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Beige Book Rebounds January 24, 2013

Weekly Market Commentary from Garrett and Robinson

Modest Expansion

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

Bouncing Back From the Fiscal Cliff and Sandy

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

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

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

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

Word Clouds Show Modest Expansion

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

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

_____________________________________________________________________________________________________________

IMPORTANT DISCLOSURES

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

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

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

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

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

The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.  Stock investing involves risk including loss of principal.  International investing involves special risks, such as currency fluctuation and political instability,  nd may not be suitable for all investors.

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

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

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

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

_____________________________________________________________________________________________________________

INDEX DESCRIPTIONS

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

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

This research material has been prepared by LPL Financial.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is

not an affiliate of and makes no representation with respect to such entity.

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

Member FINRA/SIPC