Midsummer Madness July 30, 2013

Eight times a year, the outcome of the Federal Reserve’s (Fed’s) Federal Open Market Committee (FOMC) meeting becomes the focal point for market participants. Four times each year, the first look at the health of the economy in the prior quarter (via the Bureau of Economic Analysis’s (BEA) report on gross domestic product [GDP]), dominates the headlines. Similarly, at the start of each month, the Report on Business from the Institute for Supply Management (ISM) and the monthly labor market report from the U.S. Department of Labor are the centerpieces of any trading week. This week (July 29 – August 2, 2013), all four of these key events are on the docket. How rare is this? In the 708 weeks between January 1, 2000 and today (13 years and seven months), all four of these often market-moving events have all occurred in the same week just seven times, most recently in the last week of January of this year. Historically, these weeks have exhibited 20% more volatility than an average week over this time span.* Add in the 135 S&P 500 companies expected to report their earnings results for the second quarter of 2013 this week, and this week is unlikely to be just another boring mid-summer week for financial market participants.

In addition to those four key events, markets will digest vehicle sales for July, pending home sales for June, home prices for May, as well as key data in China (Purchasing Managers’ Index [PMI] for July) and Japan (industrial production and vehicle sales for June 2013) along with the Bank of England (BOE) and the European Central Bank’s (ECB) monthly policy meetings.

FOMC in Focus:
Tuesday, July 30 & Wednesday July 31, 2013

• This is the fifth of eight FOMC meetings this year.
• ƒƒThis meeting will not include a press conference from Fed Chairman Ben Bernanke, and the FOMC will not be releasing a new economic forecast at the conclusion of this meeting. In recent years, markets have been conditioned not to expect many changes to Fed policy at FOMC meetings that do not include press conferences and new forecasts from the FOMC.
• ƒƒThe GDP report for the second quarter of 2013 will be released at the start of the second day of the two-day meeting, and the report will likely show that the economy barely expanded in the quarter. The FOMC will likely acknowledge this in the statement.
• A lack of communication between the Fed and the markets — especially the bond market — in May and June 2013 led to an uptick in market volatility. The FOMC will likely want to use the statement that follows this week’s meeting to further clarify its position on tapering quantitative easing (QE), but at the same time strengthen its commitment to keep the fed funds rate near zero, even as it is winding down its QE program.
• As noted in our Mid-Year Outlook 2013, we expect that the Fed will begin to slow its QE program this fall, dependent on the economy meeting the Fed’s above-consensus forecasts. We expect that the Fed will maintain the fed funds rate near zero the rest of this year and all of next year.

Q2 GDP in Focus:
Wednesday, July 31

• The consensus of economists (as measured by Bloomberg News) is looking for a very modest 1.0% annualized increase in real GDP for the second quarter of 2013. Estimates have moved sharply lower over the past four weeks, as several of the high-profile reports on the economy for May and June that feed into GDP (inventories, exports and imports, retail sales, durable goods shipments) fell short of expectations.
• The impact of higher taxes, the sequester, cooler-than-usual weather in most of the nation for most of the spring, as well as weak economies in Europe and China all acted as impediments to growth in the second quarter.
• ƒThe second quarter GDP report may be more difficult than usual for markets to interpret. Every July, the government agency (BEA) that compiles the GDP data releases revised data on GDP and its components going back three years. The revised data are based on new information from individuals, corporations, and businesses across the economy that was not available to the BEA initially.
• ƒThis year, the GDP accounts are undergoing what the BEA calls a “comprehensive revision.” Every five years or so, the BEA incorporates both new data and new methodology into its revisions of GDP. Overall GDP and its components are subject to revision all the way back to 1929!
• This year, the most significant changes to the way the BEA calculates GDP come from the treatment of intellectual property (IP). Currently, items like corporate spending on research and development (R&D) or television and film rights are not counted as final GDP. The comprehensive revision will count IP as final GDP, and that will provide a one-time boost to the level of GDP. The market — and the Fed — are well aware of these changes, and although the financial media will likely make a big deal of these changes, the market is not likely to react much.
• Overall, while the quarter-to-quarter wiggles of GDP growth may change — and perhaps show a deeper Great Recession and a slightly stronger recovery — the pattern of GDP is likely to stay the same.
• As noted, in our Mid-Year Outlook 2013, we expect that the U.S. economy will continue to grow at about 2% in 2013, supported by housing, as well as consumer and business spending, offsetting the drag from government spending.

July ISM in Focus:
Thursday, August 1, 2013

• ƒƒThe consensus of economists (as measured by Bloomberg News) is looking for a 52.0 reading on the ISM for July, after the 50.9 reading in June.
• A reading above 50 on the ISM indicates that the manufacturing sector is expanding.
• A reading below 50 on the ISM indicates that the manufacturing sector is contracting, and an ISM reading at 42 indicates that the overall economy is in recession.
• The ISM has been in a narrow range between 49 and 54 for the past 12 months.
• The Markit PMI — released several weeks ahead of the ISM report — has been gaining acceptance among market participants as a good proxy for the ISM report, and may, over time, diminish the importance to the markets of the ISM report. The Markit PMI reading for July 2013 was strong. At 53.2, it was above consensus expectations of 52.6 and also above the June 2013 reading of 51.9.
• Over the second half of 2013, we continue to expect the manufacturing sector is likely to be boosted by “onshoring” of jobs, relatively cheap and plentiful supplies of energy, and decent pace of capital spending.  Weakness in Europe and China and a stronger dollar continue to be drags on the manufacturing sector.

July Employment Report in Focus:
Friday, August 2

• The consensus of economists (as measured by Bloomberg News) is that that the economy created a net new 185,000 jobs in July 2013. The economy has created around 200,000 jobs per month over the past three, six, and 12 months. This figure is derived from a survey of business establishments.
• The consensus is looking for the unemployment rate (measured from a survey of households) to tick down to 7.5% in July from 7.6% in June. Generally speaking, the economy needs to create around 150,000 jobs per month to keep the unemployment rate steady.
• The shift in weather from a cool, damp June to a more normal July should lead to a rebound in weather-sensitive areas of employment like leisure and hospitality, food services and recreation.
• Teachers and other education workers employed by state and local governments are always a wild card this time of year, as most local governments end their fiscal years on June 30. State and local governments have shed teaching jobs in each of the past three months (April, May, and June), and a bounce back could occur in July.
• Our view is that the health of the labor market as measured by the monthly job count (around 200,000 per month) has met the Fed’s expectations of a “real and sustainable” improvement in the labor market. But other measures of the health of the labor market — hiring rates, the quit rate, and the unemployment rate — still show that the labor market is not yet back to normal See the Weekly Economic Commentary: Real and Sustainable: Revisited from July 8, 2013 for more details.

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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.

* Between January 2000 and December 2012, the median percent difference between the high price and low price of the week for the S&P 500 was 2.9%. In the weeks where there were all four of these events in the same week, the median percentage difference between the high price and low price of the week for the S&P 500 was 3.5%.

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 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).

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.

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 S&P/Case-Shiller U.S. National Home Price Index measures the change in value of the U.S. residential housing market. The S&P/Chase-Shiller U.S. National Home Price Index tracks the growth in value of real estate by following the purchase price and resale value of homes that have undergone a minimum of two arm’s-length transactions. The index is named for its creators, Karl Chase and Robert Shiller.

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

Markit is a leading, global financial information services company that provides independent data, valuations and trade processing across all asset classes in order to enhance transparency, reduce risk and improve operational efficiency. The Markit Purchasing Managers’ IndexT (PMIT) is a composite index based on five of the individual indexes with the following weights: New Orders – 0.3, Output – 0.25, Employment – 0.2, Suppliers’ Delivery Times – 0.15, Stocks of Items Purchased – 0.1, with the Delivery Times Index inverted so that it moves in a comparable direction.

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

Business Capital Spending April 3, 2013

On March 28, 2013, the Bureau of Economic Analysis (BEA) of the U.S. Department of Commerce reported that corporate profits of all U.S.-based corporate entities — as measured in the National Income and Product Accounts (NIPA) — hit an all-time high in the fourth quarter of 2012. The bulk of companies in the S&P 500, a subset of the companies in the NIPA profits data, will report their earnings for the first quarter of 2013 in the coming weeks.

Strong overseas economies (especially in emerging markets), restrained hiring, modest wage gains, low interest rates, solid worker productivity, and an economic cycle that is just three months shy of its fourth birthday have all contributed to the record level of profits.

Economy-wide, corporate cash levels remain at all-time highs, as firm managements remain reluctant to commit to more hiring, spending, and expansion, given the severity of the Great Recession, the sluggish pace of economic growth in the current recovery, and the uncertainty surrounding the legislative and regulatory outlook in Washington.

Putting Profits and Cash to Work

Companies can choose many paths in putting their profits and cash to use. Choices include, but are not limited to:

• Starting or increasing dividend payments to shareholders;
• Buying back shares;
• Buying other companies;
• Increasing hiring;
• Ramping up research and development; and Investing in new plant and equipment or, as it is commonly known, business capital spending.

The official name for business capital spending in the government’s gross domestic product (GDP) accounts is gross private nonresidential investment. In plain English, business capital spending is what businesses spend on:

• Structures: Factories, office buildings, office parks, utilities, shopping malls, amusement parks, hotels, restaurants, mines, and oil wells.
• Equipment and software: Computers, computer software, communication equipment, medical equipment, industrial equipment, engines and turbines, transportation equipment, furniture, construction machinery, etc.

Most Business Capital Spending Has Been on New Equipment and Software

To put business capital spending into perspective, in recent quarters, 75% of business capital spending has been on equipment and software, with only 25% of business spending on structures, according to NIPA. Overall business capital spending (on both equipment and software and structures) accounts for around 11% of GDP. The all-time peak, hit in the mid-2000s, was 12%. Although real GDP is back to an all-time high, overall business capital spending has not yet recovered its pre-Great Recession peak. Of the other major components of GDP (consumer spending, business spending, housing, exports, imports, and government spending), business capital spending joins housing and government spending as components that have not yet recovered their pre-Great Recession highs.

Overall business capital spending has not yet hit new all-time highs. However, the equipment and software portion of business capital spending hit a new all-time high in early 2012, driven primarily by spending on upgrading computers and software, to help make existing employees more productive. Spending on industrial equipment and transportation equipment — used by businesses to make and transport goods — has yet to recover its pre-Great Recession peak. Businesses remain reluctant to spend on these big ticket items, and for those firms without big cash stockpiles, banks remain reluctant to lend to small and medium-sized businesses to make these big ticket purchases.

Mining and Power Generation Lead Spending on Structures

Over on the structures side of business capital spending (malls, office parks, warehouses, factories, utilities, hotels, mining, and oil exploration, etc.), the only areas where business capital spending is back to pre-Great Recession peaks are in mining and power generation. These areas are of course benefitting from the nascent energy renaissance in the United States, which has led to increased production of natural gas and oil supplies. Spending on traditional business structures — largely dependent on rising employment — like offices, manufacturing facilities, and warehouses, remains moribund. Business spending on new malls, restaurants, hotels and recreational facilities like amusement parks also remains quite depressed in some cases at just 50 – 60% of pre-Great Recession peaks, as the economy continues to work down the excesses of the decade-and-a-half long housing boom that ended in the mid-2000s.

Caution Ahead?

Looking ahead, profit growth — a key driver of future business capital spending — is poised to slow, after surging in the past four years from the depths of the Great Recession. Increases in the equity market are also one of the key drivers of future business capital spending. Just last week, the S&P 500 — a broad measure of equity prices in the United States, hit a new all-time high. The S&P 500 is up more than 10% over the past year and is up nearly 130% since March 2009. Low interest rates, and willingness of banks (and markets) to lend to businesses are also key drivers of business spending. Thanks to the Federal Reserve (Fed), interest rates remain low, providing low borrowing costs for corporations looking to borrow via bank loans or the bond market to fund business capital spending. Although borrowing costs are low, demand by businesses — especially small businesses — for bank loans remains muted. In addition, banks’ lending standards for small businesses for loans to finance capital spending remain tighter than they were during the mid-2000s economic recovery.

Pent-up demand and lack of business capital spending in recent years — especially in structures, where spending has lagged — should lead to stronger spending in the coming years. For example, the average age of business structures is nearly 22 years, the highest since the mid-1960s. The recent ramp-up in energy production also suggests more spending in this area in the coming years to update and improve the nation’s energy infrastructure (pipelines, terminals, etc.).

While most of the indicators point to an ongoing improvement in capital spending in the coming quarters and years, the looming uncertainty in Washington, along with the sluggish pace of hiring, suggests that businesses are likely to remain cautious in deploying their profits and cash. The mechanics of business capital spending, including the long lead times for many business spending projects, are also at play. Since the end of World War II, the average economic expansion has lasted about five years, although the expansions since 1982, on average, lasted for almost eight years. Still, this June will mark the fourth anniversary of the current economic recovery. Although, in our view, there are few signs that the recovery is in any danger, firms may not want to commit to multi-year projects if managements believe another recession is right around the corner.

____________________________________________________________________________________________

IMPORTANT DISCLOSURES

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

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

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

The National Income and Product Accounts (NIPA) is the official government system of collecting, processing, and reporting assorted production and income measures used to track aggregate activity in the macroeconomy. This system of accounts, maintained by the Bureau of Economic Analysis in the Department of Commerce, is the source of official estimates of gross domestic product, net domestic product, national income, personal income, disposable income, gross national product, and related measures that are published quarterly and annually.

INDEX DESCRIPTIONS

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

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 This research material has been prepared by LPL Financial.

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