Janet Yellen’s Employment Report March 5, 2014

This Friday, March 7, 2014, the U.S. Department of Labor will release the Employment Situation report for February 2014. The Employment Situation report is two reports in one; the household survey generates the headline unemployment rate, while the establishment survey generates the nonfarm payroll job count. The unusually harsh winter weather across a large swath of the nation in February 2014 will likely have a major impact on the employment data in February. As of early Monday, March 3, 2014, the consensus of economists as polled by Bloomberg News is looking for a net increase of 154,000 private sector jobs in February 2014, after the 142,000 gain in January 2014. Prior to the 75,000 weather-impacted gain in jobs in December 2013, the private sector economy was consistently creating between 175,000 and 200,000 net new jobs per month. We continue to look for a return to that pace of job creation once the weather returns to normal.

The consensus is looking for a 6.6% reading on the unemployment rate (see “A Closer Look: Labor Market Surveys,” page 5) in February 2014, the same reading as in January 2014. The market will be especially interested in the unemployment rate this month because just a 0.1% drop to 6.5% pushes the rate to the Federal Reserve’s (Fed) threshold of 6.5%.

This threshold was a common theme in the second leg of Fed Chair Janet Yellen’s testimony before the Senate Banking Committee late last week (Thursday, February 27, 2014). Although the focus in the media this week ahead of the release of the Employment Situation report is likely to be on the nonfarm payroll job count and the unemployment rate, in this week’s Weekly Economic Commentary, we will focus on Janet Yellen’s employment report on various employment statistics that Yellen said the Fed will be watching closely.

Last week, senators on the Senate Banking Committee asked Yellen several times about the state of the labor market. A sampling of her answers is below, and we’ve bolded some of the labor market metrics she mentioned:

The unemployment rate is not a sufficient statistic to measure the health of the labor market. An additional 5 percent, an unusually high fraction of our labor force is working part time for economic reasons which means they’re unable to get full-time work but want it. That’s an additional 7 million plus Americans who are involuntarily employed part time. And we have [an] unusually high fraction of Americans who are unemployed and have been for substantial amounts of time. So, you know, as we go — go to a fuller consideration of how is the labor market performing, we need to take all of those things into account.

There is no hard and fast rule about what unemployment rate constitutes full employment, and we need to consider a broad range of indicators. Many members of the committee have emphasized this point and it’s one I agree with.

Well, Senator, we are very focused on and concerned about the high level of long-term unemployment. It’s really unprecedented to see something like 37 percent of unemployed in long spells. I mean, what can we do? We can try to foster a stronger labor market generally. We don’t have tools that are targeted at long-term unemployment. But in taking account of how much slack there is in the labor market…

Look, if the unemployment rate is above that (6.5%), we see absolutely no need to consider any possibility of raising rates. Below that we begin to look more carefully.

The unemployment rate, if I had to choose one metric, the unemployment rate is probably best. And members of our committee aren’t certain exactly what constitutes full employment, but generally see a range of 5 percent to 6 percent or a little bit in that area to be a state of full unemployment in the economy. But also looking at part time employment, job flows, what’s happening with wages and a broader set of metrics I think is necessary.

The fact that we’ve seen very slow growth in wages, for example, I take as one of many pieces of information suggesting the labor market has not — has not returned to normal and has quite a ways to go.

Fed Monitoring Labor Market Indicators

In general, Yellen made it clear that the Fed is in no hurry to raise rates when the unemployment rate crosses the 6.5% threshold. This metric was first cited by the Federal Open Market Committee (FOMC) in December 2012, when it noted that it “currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.”

Instead, Yellen pointed out, the Fed would broaden the labor market indicators it is monitoring, and “look more carefully” at other relevant metrics. The tone of Yellen’s remarks indicated that while she didn’t speak for the FOMC, she was not ready to say that the labor market was back to normal, or anywhere close to it, even though the unemployment rate was poised to cross the 6.5% threshold.

The risk in this view for financial markets — and especially the bond market — is that there is less slack in the labor market than Yellen and most other members of the FOMC think there is. While there are still many more factors pushing down on inflation than pushing inflation higher, wages account for two-thirds of businesses’ costs, and therefore, play a big role in the overall pace of inflation. We have already seen evidence that wages are rising and labor market conditions are tightening in a few scattered industries. For example, energy, construction, information technology, and logistics were cited in the most recent Beige Book as professions that were seeing above-average wage increases and higher starting pay for skilled workers. We are likely to hear more about this in the next Beige Book, which is due out this week. If market participants sense that wage pressures are gaining momentum, and that the Fed is “behind the curve” on inflation, bond yields could rise rapidly over a short period of time and counteract the monetary stimulus the Fed is supplying to the economy.

The infographic on page 4 details the performance of nine key labor market metrics mentioned by Yellen in her recent public appearances. Although most have partially recovered from their Great Recession nadirs, only a few have returned to “normal.” Until they do — or at least until they make significant progress toward normal — markets should expect that the Fed will be content with keeping its fed funds rate target near zero. In our view, late 2015 or even early 2016 is when the Fed is likely to begin raising rates.

A Closer Look:  Labor Market Surveys

• A survey of 60,000 households nationwide — an incredibly large sample size for a national survey — generates the data set used to calculate the unemployment rate, the size of the labor force, part-time and full-time employment, the reasons for and duration of unemployment, and employment status by age, educational attainment, and race. The “household survey” has been conducted essentially the same way since 1940, and although it has been “modified” over the years, the basic framework of the data set has stayed the same. The last major modification to the data set (and to how the data is collected) came in 1994. To put a sample size of 60,000 households into perspective, nationwide polling firms typically poll around 1,000 people for their opinion on presidential races.
• The headline unemployment rate (6.6% in January 2014) is calculated by dividing the number of unemployed (10.2 million in January 2014) by the number of people in the labor force (155.5 million). The civilian population over the age of 16 stood at 246.9 million in January 2014. A person is identified as being part of the labor force if they are over 16, have a job (employed), or do not have a job (unemployed) but are actively looking for work. A person is not in the labor force if they are neither employed nor unemployed. This category includes retired persons, students, those taking care of children or other family members, and others who are neither working nor seeking work.
• In January 2014, the labor force was 155.5 million, which consisted of 145.2 million employed people and 10.2 million unemployed people. Another 91.4 million people over the age of 16 were classified as not in the labor force. The 155.5 million people in the labor force plus the 91.4 million people not in the labor force is equal to the over 16 civilian population, 246.9 million.
• The payroll job count data are culled from a survey of 440,000 business establishments across the country. The sample includes about 141,000 businesses and government agencies, which covers approximately 486,000 individual worksites drawn from a sampling frame of Unemployment Insurance (UI) tax accounts covering roughly 9 million establishments. The sample includes approximately one-third of all nonfarm payroll employees. From these data, a large number of employment, hours, and earnings series in considerable industry and geographic detail are prepared and published each month.

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IMPORTANT DISCLOSURES

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

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

Stock investing involves risk including loss of principal.

The Bureau of Labor Statistics is a government agency that produces economic data that reflects the state of the U.S. economy. This data includes the Consumer Price Index, the unemployment rate and the Producer Price Index.

______________________________________________________________________________________________________________________________

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

The Employment Situation: Slow Climb Back February 4, 2014

This Friday, February 7, 2014, the U.S. Department of Labor will release its monthly Employment Situation report. Though a lagging indicator of the economy, the report will likely garner plenty of attention from market participants, policymakers, politicians, pundits, the news media, and the public.

In December 2007 and January 2008, U.S. private sector jobs peaked at 115.7 million. The Great Recession and its aftermath saw the private sector economy shed 8.9 million jobs, and by February 2010, the private sector economy was down to 106.8 million jobs. Since then, the private sector economy has created 8.2 million jobs, and as 2013 ended, needed just under 700,000 net new jobs to get back to the pre-recession peak. We expect that to occur sometime in the first six months of 2014 [Figure 1].

Prior to the disappointing December 2013 employment report (released in early January 2014), which revealed that the private sector economy had created only 87,000 net new jobs in the weather-impacted month of December 2013, the economy had consistently been creating between 175,000 and 200,000 net new jobs per month [Figure 2]. We expect this pace of job creation to continue in 2014, with some variation around the trend due to fundamentals and weather. (See below for a discussion of weather’s impact on the January 2014 report.)

Weather and Revisions:  Sources of Uncertainty

The consensus of economists as surveyed by Bloomberg News is looking for a 190,000 gain in private sector payrolls in January 2014, after the 87,000 gain in December 2013. The range of estimates — the difference between the high and low estimate — is unusually wide for the January report. In recent years, the range of estimates has been around 120,000; for January’s report it is 200,000. The unusually wide range reflects the uncertainty around the impact of the weather on both the December 2013 and January 2014 reports, and also the revisions to the employment data made each year at this time.

While not all of the weakness in the December 2013 employment report was due to an unusually cold and snowy December, a sizable portion was. In January 2014, the population-adjusted average temperature was two degrees above normal. In December 2013, the same metric was two degrees colder than usual. The anomaly was even worse during the survey week (the week containing the 12th of the month) for the December 2013 employment report. It was six degrees colder than usual during the survey week in December 2013, and two degrees warmer than usual during the survey week in January 2014. In addition, the Department of Labor said that 273,000 people were “unable to work because of bad weather” in December 2013, the most for any December since 1977. This metric will be very closely watched again in January.

Another source of uncertainty surrounding the January 2014 employment report is revisions. In February of each year, the Labor Department releases revised data on the number of employees on payrolls. The revisions are based on new information gathered from businesses records and tax returns. Because of these revisions, the monthly changes in the payroll job count over the past year will be adjusted, but the pattern of employment is unlikely to change very much.

As noted in our Outlook 2014: The Investor’s Almanac, our view for this year is that U.S. economic growth will accelerate to 3.0% from the 2.0% pace seen in 2013. We expect both the federal government’s lifting of fiscal drags and increased state and local government spending to boost economic growth this year. In all of 2013, state and local government spending subtracted a small amount (0.02 percentage points) from gross domestic product (GDP) growth, but all of that drag occurred in the first quarter of 2013. By contrast, state and local governments added 54,000 jobs in 2013, marking the first year since 2008 that the sector added jobs. This sector added jobs in eight of the final 11 months of 2013, and we expect that trend to persist well into 2014 and beyond.

Fedlines and Labor Market Health Points

Of course, financial markets pay so much attention to this report because policymakers at the Federal Reserve (Fed) have tied the pace of quantitative easing (QE), and indeed the Fed’s guidance on rates, to the health of the labor market. “Maximum employment” in the context of price stability is the Fed’s goal, and the new Fed chairwoman, Janet Yellen, has cited several labor market metrics in public appearances over the past several years. Next week, Tuesday, February 11, 2014, Yellen will deliver the Fed’s semiannual Monetary Policy testimony (also known as the Humphrey-Hawkins testimony) to Congress, providing the market with her views on policy, the economy, and the labor market for the first time as Fed chairwoman.

In its most recent (January 29, 2014) statement, the Federal Open Market Committee (FOMC), the Fed’s policy making arm, reaffirmed that:

The current exceptionally low target range for the federal funds rate of 0 to 1/4 percent will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.

In addition, in his final press conference as chairman in December 2013, Ben Bernanke discussed the unemployment rate, saying:

And so we were comfortable setting a 6.5 percent unemployment rate as the point at which we would begin to look at a more broad set of labor market indicators. However, precisely because we don’t want to look just at the unemployment rate, we want to — once we get to 6½ — we want to look at hiring, quits, vacancies, participation, long-term unemployment, et cetera, wages. We couldn’t put it in terms of another unemployment rate level, specifically. So, I expect there will be some time past the 6½ percent before all of the other variables that we’ll be looking at will line up in a way that will give us confidence that the labor market is strong enough to withstand the beginning of increases in rates.

The metrics Bernanke noted, including hiring, quits, vacancies, and participation, have been cited by Yellen in the past as indicators she was watching to gauge the health of the labor market. This week’s employment report for January 2014 will provide updates of several of these metrics (the participation rate, long-term unemployment, wages, hiring), and market participants will closely watch these as they gauge the pace of tapering and the Fed’s guidance on rates.

On the other hand, the data on “quits” and “vacancies” are found in the monthly Job Openings and Labor Turnover Survey (JOLTS). The JOLTS report (for December 2013) is due out on the same day (and at the same time) that Janet Yellen delivers her first Humphrey-Hawkins testimony to Congress, next Tuesday, February 11, 2014. Figure 3 shows that the “quit rate” — the percentage of job leavers who leave their jobs voluntarily (presumably because they have better prospects elsewhere) — climbed to near-record highs in late 2013. However, some of the other labor market metrics noted recently by Bernanke and Yellen are still at depressed levels.

On balance, the January 2014 employment report will garner plenty of attention from market participants, the media, and the public as the labor market continues its slow climb back to its pre-recession peak.

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

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

Stock investing involves risk including loss of principal.

The 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.

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

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.

____________________________________________________________________________________________________________________________

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

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

Ben’s Top 10 December 23, 2013

The Federal Reserve’s (Fed) policymaking arm, the Federal Open Market Committee (FOMC), announced that it will begin tapering, or scaling back, its bond-buying program known as quantitative easing (QE) at its final meeting of the year last week. The Fed will now purchase $75 billion per month in QE — $10 billion less than the current monthly $85 billion, citing less fiscal drag and the “cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions.”

We believe the Fed made somewhat of a “trade” with the bond market. On one side, the Fed reduced QE by $10 billion per month. Conversely, the Fed delivered a bullish and confident view on the U.S. economy — signaling that it would keep interest rates lower for longer. The stock market was more than willing to forego $10 billion in purchases now (via the taper) in exchange for a bullishly confident Fed that will likely keep rates lower for longer and saw this as a good trade. After all, it is the Fed’s zero interest rate policy, not its soonto- be tapered bond purchases, that has the biggest impact on maintaining lower rates and boosting economic growth.

Fedlines: Ben’s Top 10

Unless the Fed decides to hold a press conference at its next policy meeting in late January 2014, last week’s press conference was outgoing Fed Chairman Ben Bernanke’s last. During that final press conference, Bernanke was asked about — and weighed in on — several key topics that will likely impact financial markets and the economy throughout 2014. Below, we examine Bernanke’s top 10 answers in his own words at his final press conference as Fed Chairman.

1. Is tapering tightening?

“And so I do want to reiterate that this is not intended to be a tightening.”

2. What advice do you have for Janet Yellen? (If confirmed by the Senate, Yellen will replace Bernanke as Fed Chairman in early 2014.)

“Well, I think the first thing to agree to is that Congress is our boss. The Federal Reserve is a(n) independent agency within the government. It’s important that we maintain our policy independence in order to be able to make decisions without short-term political interference.”

3. At what pace will the Fed taper?

“Sure, on the first issue of 10 billion (dollars), again, we say we are going to take further modest steps subsequently, so that would be the general range.”

4. Would the Fed do more if the economy falters? Would you increase purchases?

“But there are things that we can do. We can strengthen the guidance in various ways. And while the view of the committee was that the best way forward today was in this more qualitative approach, which incorporates elements both of the unemployment threshold and the inflation floor, that further strengthening would be possible and it’s something that is certainly not been ruled out.

And of course, asset purchases are still there to be used. We do have tools to manage a large balance sheet. We’ve made a lot of progress on that. So while — again, while we think that we can provide a high level of accommodation with a somewhat slower place, but still very high pace of asset purchases and our interest rate policy, we do have other things we can do if we need to ramp up again. That being said, we’re hopeful that the economy will continue to make progress and that we’ll begin to see the whites of the eyes of the end of the recovery and the beginning of the more normal period of economic growth.”

“Under some circumstances, yes, … we could stop purchases if the economy disappoints, we could pick them up somewhat if the economy is stronger.”

5. Why Has Recovery Been So Slow?

“It’s — of course that’s something for econometricians and historians to grapple with, but there have been a number of factors which have contributed to slower growth. They  include, for example, the observation of financial crises tend to disrupt the economy, may affect innovation, new products, new firms.

We had a big housing bust, and so the construction sector of course has been quite depressed for a while. We’ve had continuing financial disturbances in Europe and elsewhere. We’ve had very tight — on the whole, except for in 2009, we’ve had very tight fiscal policy.

People don’t appreciate how tight fiscal policy has been. At this stage in the last recession, which was a much milder recession, state, local and federal governments had hired 400,000 additional workers from the trough of the — of the recession. At the same point in this recovery, the change in state, local and federal government workers is minus 600,000.

So there’s about a million workers’ difference in how many people are — been employed at all levels of government. So fiscal policy has been tight, contractionary. So there have been a lot of headwinds. All that being said, we have been disappointed in the pace of growth, and we don’t fully understand why. Some of it may just be a slower pace of underlying potential, at least temporarily. Productivity has been disappointing. It may be that there’s been some bad luck, for example, the effects of the European crisis and the like. But compared to other advanced industrial countries, Europe, U.K., Japan — compared to other countries — advanced industrial countries recovering from financial crises, the U.S. recovery has actually been better than most.

It’s not been good. It’s not been satisfactory. Obviously, we still have a labor market where it’s not easy for people to find work. A lot of young people can’t get the experience and entree into the labor market. But I think given all of the things that we’ve faced, it’s perhaps, at least in retrospect, not shocking that the recovery has been somewhat tepid.”

6. What impact has QE had on the economy? Has QE worked?

”Well, it’s very hard to know — in terms of the study it’s very hard to know — it’s an imprecise science to try to measure these effects. You have to obviously ask yourself, you know, what would have happened in the absence of the policy. I think that study — I think it was a very interesting study, but it was on the upper end of the estimates that people have
gotten in a variety of studies looking at the effects of asset purchases.

That being said, I’m pretty comfortable with the idea that this program did, in fact, create jobs. I cited some figures. To repeat one of them, the Blue Chip forecast for unemployment in this current quarter made before we began our program was on the order of 7.8 percent, and that was before the fiscal cliff deal, which even — created even more fiscal head
winds for the economy. And of course, we’re now at 7 percent. I’m not saying that asset purchases made all that difference, but it made some of the difference. And I think it has helped to create jobs.

And you can see how it works. I mean, the asset purchases brought down long-term interest rates, brought down mortgage rates, brought down corporate bond yields, brought down car loan interest rates. And we’ve seen response in those areas as the economy has done better. Moreover, again, this has been done in the face of very tight, unusually tight fiscal policy for a recovery period. So I do think it’s been effective, but the precise size of the impact is something I think that we can very reasonably disagree about and the work will continue on. As I said before, the uncertainty about the impact and the uncertainty about the effects of ending programs and so on is one of the reasons why we have treated
this as a supplementary tool rather than as our primary tool.”

7. Are you concerned about deflation?

“Now, it is true that while we have passed the — or made significant progress on the labor market and growth hurdles, there is still this question about inflation, which is a bit of a concern, more than a bit of concern, as we indicated in our statement. Our outlook is still for inflation to go back to 2 percent. I gave you some reasons why I think that will happen. But we take that very seriously. And if inflation does not show signs of returning to target, we will take appropriate action.”

8. What impact has fiscal policy had on the recovery?

“We’ve had very tight — on the whole, except for in 2009, we’ve had very tight fiscal policy. People don’t appreciate how tight fiscal policy has been. At this stage in the last recession, which was a much milder recession, state, local and federal governments had hired 400,000 additional workers from the trough of the — of the recession. At the same point in this recovery, the change in state, local and federal government workers is minus 600,000. So there’s about a million workers’ difference in how many people are being employed at all levels of government. So fiscal policy has been tight, contractionary.”

9. What is your view on the recent budget deal?
“I will say a couple of things about this deal. One is that, relative to where we were in September and October, it certainly is nice that there has been a bipartisan deal and that it looks like it’s going to pass both houses of Congress. It’s also, at least directionally, what I have recommended in testimony, which is that it eases a bit the fiscal restraint in the next couple
of years, a period where the economy needs help to finish the recovery. And in place of that it achieves savings further out in the — in the 10-year window. So those things are positive things. Of course there’s a lot more work to be done. I have no doubt about that. But it’s certainly a better situation than we had in September and October, or in January during the fiscal cliff, for that matter. And I think it will be good for confidence if fiscal policy and congressional leaders work together to — even if — even if the outcomes are small, as this one was, it’s a good thing that they are working cooperatively and making some progress.

10. Has the large budget deficit weighed on the recovery?

“I mean, investment is driven by sales, by the need for capacity. And, you know, with a slow-growing GDP, slow-growing economy, most firms yet — do not yet feel that much pressure on their capacity to do major new projects. There’s also a variety of uncertainties out there — fiscal, regulatory tax and so on — that no doubt affects some of these calculations…I think there are a lot of factors. Usually you think that the way that a deficit or a long-term debt would affect investment would be through what’s called
crowding out, that it’s raising interest rates. But high interest rates — we may have many problems, but high interest rates is not our problem right now. There’s plenty of — particularly for larger firms, there’s plenty of credit available at low interest rates.”

Fed Watch: Employment Metrics
Outside of “Ben’s Top 10,” we learned that the Fed is indeed watching the employment metrics that we have written about several times this year:

• The quit rate;
• The hiring rate;
• Job openings;
• Wages;
• Long-term unemployment; and
• The participation rate.

Fed Watch: Inflation Factors
On the inflation front, Bernanke opined that some special factors are holding inflation back now and that inflation may pick up in the coming months. He said the FOMC is watching:

• Health care costs;
• Inflation expectations (as measured by markets and surveys of individuals and professionals);
• Wage inflation;
• U.S. and international GDP growth.

The Fed delivered a holiday surprise for the market — a bullish forecast via a signal that it will remain “highly accommodative” with low interest rates for longer . As we have discussed, we view the Fed’s decision as reaffirming our outlook for accelerating economic and profit growth in 2014. We continue to believe 2014 marks a return to a focus on the fundamentals of investing.

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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.

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

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.

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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. 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.

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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

 

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.

_________________________________________________________________________________________________________________________________________________________________________________

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

Trading Partners September 3, 2013

The upward revision to second quarter gross domestic product (GDP) garnered a great deal of market attention last week (August 26 – 30, 2013). The report, released on Thursday, August 29, revealed that second quarter GDP — initially reported in late July 2013 as a 1.7% gain — was revised higher to a 2.5% gain. All of the upward revision to second quarter GDP can be explained by a narrower trade deficit. Initially, the trade deficit in the second quarter was reported as $451 billion, a 0.8% drag on overall GDP growth. Now, the revised data show that the trade gap stood at “only” 422 billion in the second quarter — the same as in the first quarter of 2013 — and as a result, the economic drag from trade for the quarter was eliminated. Looking ahead to the third quarter of 2013 and beyond, market participants and policymakers are asking: Can trade make a significant positive contribution to GDP growth in the quarters ahead, given the outlook for growth in Europe, China, Japan, and emerging markets?

Tracking the Pace of U.S. GDP Growth

While second quarter GDP was revised higher, the first quarter was not subject to revision and remained at 1.1%, leaving GDP growth in the first half of 2013 at a tepid 1.8%. The Federal Reserve (Fed) is still forecasting a 2.45% gain in GDP this year. With 1.8% growth in real GDP in the first half of the year, real GDP would have to grow by more than 3.0% in the third and fourth quarters of 2013 to match the Fed’s consensus forecast for the year. The Fed will release a revised forecast for the economy, labor markets, and inflation for 2013, 2014, and 2015 on September 18, 2013 at the conclusion of the next Federal Open Market Committee (FOMC) meeting. The FOMC is likely to revise downward its 2013 GDP growth forecast. The new forecast, along with the release of the FOMC’s initial public forecast for the economy, inflation, and the labor market in 2016 (also due on September 18), may help to soothe market fears about the pace of tapering and tightening.

The data in hand for the first two months of the third quarter of 2013 suggest that third quarter GDP is tracking to well under 2%, and may be closer to 1%. The data released thus far for the third quarter of 2013 include:

• Personal consumption expenditures for July;
• Industrial production for July;
• Retail sales for July and August;
• Durable goods shipments and orders for July;
• Vehicle sales for July;
• Weekly initial claims for unemployment insurance through the week ending August 24;
• ISM and regional Federal Reserve Manufacturing Indexes for July and August; and
• New and existing home sales for July.

Data due out this week (September 2 – 6, 2013) on vehicle sales, the Institute for Supply Management (ISM) Purchasing Managers’ Index (PMI), merchandise trade, construction spending, factory shipments and inventories for July and August 2013, and, of course, the August employment report (due out on Friday, September 6) will help to further clarify the pace of GDP growth in the current quarter, the rest of 2013, and into 2014.

GDP Overseas

Data released over the past several months suggest that the economies in Europe and China have stabilized. Meanwhile, market participants have increased their GDP growth forecasts for Japan over the past nine months, as Japanese policymakers have ramped up monetary and fiscal policy and embarked on a series of structural reforms aimed at jarring Japan’s economy out of a multi-decade slumber. Our view remains that while the economies in China and Europe have stopped getting worse, it may take several more quarters before they can meaningfully re-accelerate. While growth has picked up in Japan — second quarter GDP growth in Japan was 2.6% — it remains disappointing relative to elevated expectations. In addition, many emerging market nations (about 50% of U.S. exports head to emerging markets), including India, Brazil, and Indonesia are now experiencing growth and inflation scares, and some (Brazil and Indonesia) are raising interest rates to head off inflation. Many of the market participants and Fed policymakers who expect U.S. GDP to accelerate in the second half of 2013 and in 2014 are likely counting on accelerating growth in Europe, China, Japan, and emerging markets to drive U.S. exports higher. But is that enough to boost U.S. GDP growth?

As noted in our Weekly Economic Commentary: Exporting Good Old American Know-How, from August 19, 2013, the United States has run a trade deficit (importing more goods and services from other countries than it exports) since the mid-1970s, and our large deficit on the goods side (around $759 billion in 2012) more than offsets the trade surplus we have on the service side of the ledger (around $213 billion in 2012). Combined, our goods and services trade deficit was $547 billion in 2012, slightly smaller than the $569 billion deficit in 2011. As a result of the slight narrowing of the deficit between 2011 and 2012, net exports contributed 0.1% to the 2.8% gain in GDP in 2012.

Net Exports Typically Do Not Boost U.S. GDP Growth

The infographic on page 2, “Profile of U.S. Exports” (Profile) reveals that over the past 40 years — aside from recessions (when imports fall faster than exports, narrowing the trade deficit) — net exports have never added more than 1.0% to overall GDP growth. Thus, even if the economies of Europe, China, Japan, and emerging markets accelerate sharply in the next few quarters, it is unlikely that net exports will provide a large boost to GDP growth this year.

In theory, an unexpected uptick in economic activity among our largest  export destinations should be a plus for our exports to that region, but in practice, the impact to our trade balance and economy may not immediately reflect the better growth prospects overseas. In addition, exchange rate movements also can influence cross-border trade, but movements often work with a long lag. Since many of our exports do not compete on price, the value of the dollar is not always the best way to gauge the relative strength of our exports to many markets. Generally speaking, U.S. exports compete globally on quality, rather than price.

Export Destinations: Economic Prospects in Canada and Mexico

The Profile details the destinations (trading partners) and mix (goods versus services) of our exports. Fourteen percent of our exports (both goods and services) are bound for the Eurozone, while just 6% head to China. Remarkably, only 5% of our exports go to Japan. Combined, our exports to the Eurozone, Japan, and China account for 25% of our total exports. Closer to home, 16% of our exports head north of the border to Canada, and another 11% head south of the border to Mexico. Thus, our exports to our two closest neighbors (27% of all exports) are larger than our exports to the Eurozone, Japan, and China combined (25%). Accordingly, market participants should probably pay more attention to the economic prospects of Canada and Mexico and a bit less to the prospects of China, the Eurozone, and Japan.

Mix of Goods/Services: Goods Are 70% of All Exports

The Profile also details the goods/services mix of our exports. Currently, goods account for around 70% of all exports, but that varies widely by trading partner. The export mix to Canada and Mexico is skewed toward goods rather than services, which is partially explained by auto production, since auto parts factories and final assembly plants account for such a large portion of trade. Our export mix to the Eurozone, China, and Japan is…well… more mixed. Services, at around 40%, account for more of our trade to the Eurozone and Japan than in our overall trade mix. In China, however, an above-average 78% of our exports are goods. All else being equal, an unexpected and permanent shift higher in economic growth for trading partners like China, the Eurozone, and Japan should boost our exports to those nations over time and, in turn, our GDP. But it is important to note that outside of recessions, net exports rarely add more than 0.5% to GDP growth. So while we spend a great deal of time discussing the health of the economy in China, the Eurozone, Japan, and emerging markets, the economic prospects of our nearest neighbors (Canada and Mexico) have a bigger influence on our overall exports.
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IMPORTANT DISCLOSURES

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

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

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

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

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.

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’ Index (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.

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.

Challenger, Gray & Christmas is the oldest executive outplacement firm in the United States. The firm conducts regular surveys and issues reports on the state of the economy, employment, job-seeking, layoffs, and executive compensation.

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

Deficit Distraction August 27, 2013

Deficit Distraction

In the 12 months ending July 2013, the federal government spent $3.4 trillion and took in $2.7 trillion in revenues, making the federal deficit (revenues less spending) about $725 billion, the smallest deficit recorded since late 2008. At just 3.5%, the deficit as a percent of nominal gross domestic product (GDP) over the past 12 months was also the smallest since late 2008, and stands in sharp contrast to the 10% deficit-to-GDP ratio posted in fiscal year (FY) 2009 ending September 2009 [Figure 1].

The story is much the same fiscal year to date in FY 2013, which ends on September 30, 2013. In the first 10 months of FY 2013, the budget deficit was $607 billion, or roughly 3.6% of GDP. Outlays have totaled $2.9 trillion and revenues have totaled $2.3 trillion. The first 10 months of FY 2013 saw the smallest deficit and deficit to GDP of any comparable period back to the first 10 months of FY 2008. An improved economy, a stronger labor market, spending cuts from sequestration, and recent changes to tax rates account for most of the improvement, although a few “one-time items” have also played a role. The non-partisan Congressional Budget Office (CBO), which produces an excellent update on the progress of the federal budget every month called “Monthly Budget Review” (see http://www.cbo.gov), continues to project that the budget deficit in FY 2013 will total $642 billion, or around 4.0% of GDP.

What’s Driving the Improvement in the Deficit?

Fiscal year to date in 2013, federal revenues are up 14%, while spending is down nearly 4%. Combined individual income tax receipts — which account for around 85% of federal revenues — are up 15% in the first 10 months of FY 2013 versus the same period in FY 2012. Personal income taxes account for roughly 50% of Federal revenues while taxes withheld for Social Security and Medicare account for 35% of federal revenues. A better labor market (2.3 million net new jobs were created over the past 12 months) and rising wages (wage and salary income, as measured by the monthly report on personal income and spending, is up 4% year over year), account for some of the gain. The fiscal cliff — the expiration of the Social Security payroll tax cut in January 2013 and the increase in tax rates for incomes above certain thresholds — have also boosted revenues. The rising equity market has also accounted for some of the gain in individual tax revenues: equity markets hit new all-time highs in the first half of 2013 and investors may set aside tax payments after exercising stock options or selling stocks. Corporate profits are at record levels, and corporate tax receipts are up 17% in the first 10 months of FY 2013 versus the similar period in FY 2012. Corporate tax receipts account for 10 – 15% of federal tax revenues [Figure 2].

At $2.9 trillion, federal budget outlays in the first 10 months of FY 2013 were $90 billion (or 4%) lower than in the same period in 2012. Not surprisingly, given the solid performance of the labor market noted above, federal spending on unemployment benefits was down a whopping 24% in the first 10 months of FY 2013, while defense spending (impacted in part by the sequester) fell 7%. Federal spending activities outside of defense and entitlement programs like Social Security, Medicare, and Medicaid fell 3% in the first 10 months of FY 2013 versus the first 10 months of FY 2012, but that figure is skewed lower by payments received by the federal government from the Troubled Asset Relief Program (TARP) and big payments from the large, quasi-government mortgage giants Fannie Mae and Freddie Mac that were at the center of the financial crisis. Despite the distortions, the sequester is having a modest impact in controlling non-defense discretionary spending. Interest payments on the public debt totaled $216 billion in the first 10 months of FY 2013, down 2% from the $222 billion in the similar period of FY 2012 [Figure 3].

Warning Signs

Some warning signs exist in the otherwise positive budget picture thus far in FY 2013 however, and if these warning signs continue to be ignored by policymakers, the near-term improvement in the budget picture is not likely to last. FY 2013 to date, federal spending on mandatory programs (payments set by formula written into the law) like Social Security, Medicare, and Medicaid is running above the pace of nominal GDP growth. Federal spending on Social Security benefits is up 5.4%, nearly twice the rate of nominal GDP growth over the past year (2.9%). Similarly, spending on Medicare is up 3.0% in the first 10 months of FY 2013, while Medicaid spending is up 5.7%, also about twice the rate of nominal GDP growth. The non-partisan CBO expects the improvement in the federal budget deficit to continue over the rest of this fiscal year, and for the next several fiscal years as well, through FY 2015. By then, the CBO expects the deficit as a percent of GDP to fall to 2.0%, the smallest since the 1.2% deficitto- GDP-ratio recorded in FY 2007, the last fiscal year prior to the Great Recession. From a 2.0% deficit-to-GDP ratio in FY 2015, the CBO projects that under current law, the deficit will increase to 3.2% in FY 2020 and to 3.5% by FY 2023, the last year the CBO makes a projection.

Most of the deficit deterioration in the latter half of this decade and the first half of the next occurs as a result of deterioration in the structural deficit, i.e., spending on mandatory programs like Social Security, Medicare, and Medicaid far outstripping the pace of GDP growth, mainly due to an aging population. The CBO projects that tax receipts targeted for use by those programs will only grow at the same pace as the overall economy over the next 10 years or so. Thus, the risk is that Congress and the general public will be distracted by the rapidly improving near-term budget outlook, and will not address the longer-term structural budget problem quickly enough to head off a worsening, long-term budget deficit.

____________________________________________________________________________________________________________

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.

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

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.

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’ Index (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.

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.

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This research material has been prepared by LPL Financial.

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

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

Member FINRA/SIPC

Real and Sustainable: An Update July 10, 2013

Real and Sustainable: An Update

Just prior to the release of the May 2013 employment, report, we wrote in our June 3, 2013, Weekly Economic Commentary: Real and Sustainable, that in the coming months:

“Federal Reserve (Fed) policymakers must decide if the recent pace of job creation-on average, the economy added 175,000 per month over the past year-and/or the drop in the unemployment rate (from 10.0% at the peak in 2010 and from 8.2% in May 2012) was ‘real and sustainable’ to warrant a tapering of QE.”

“Real and sustainable” was also a phrase used by Fed Chairman Ben Bernanke at his now (in)famous testimony before the Joint Economic Committee (JEC) of Congress on May 22, 2013. Answering a question about when the Fed would begin unwinding QE, Bernanke said:

“As the economic outlook and particularly the outlook for the labor market improves in a real and sustainable way, the committee will gradually reduce the flow of purchases.”

Bernanke used similar words answering questions at the press conference following the June 18 – 19 Federal Open Market Committee (FOMC) meeting.

Now, with both the May and June 2013 jobs reports, as well as the June FOMC Meeting and Fed Chairman Bernanke’s press conference in the rearview mirror, financial markets have largely embraced the notion that the Fed will begin tapering QE sometime this fall. Payroll employment in the private sector in both May and June 2013 exceeded expectations, and the job gains reported for April 2013 and May 2013 were revised markedly higher with the release of the June 2013 data. As a result, the private sector economy has added about 200,000 net new jobs per month over the past three, six, and 12 months [Figure 1]. It is pretty clear that the market, especially the bond market, thinks that adding 200,000 jobs per month is “real and sustainable.”

Of course, Fed policymakers are not only looking at the number of private sector jobs being created each month. In early March 2013, FOMC Vice Chair Janet Yellen — who is a leading candidate to replace Bernanke as Fed Chairman in 2014 — said that she was looking at a number of indicators on the labor market and economy. These included:

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

Tracking the Labor Market: Not Quite There Yet

Figures 2 – 5 show the labor market indicators mentioned by Bernanke last week and Yellen in early March 2013. A quick review of the figures suggests that while job growth has been “real and sustainable,” several of the other key measures the Fed is monitoring are not yet sending the same signal. Yellen and Bernanke — two of the three FOMC members of the “center of gravity” at the Fed — are probably not yet ready to begin scaling back QE.

• While down from the peaks seen during the Great Recession of 2008 – 2009, the unemployment rate, at 7.6% in June 2013, remains well above the 6.5% threshold for raising rates, and also well above the 5.50 – 5.75% rate the FOMC forecasts as the new “normal” unemployment rate. In his prepared comments to the press just prior to his FOMC press conference on June 19, 2013, Bernanke said that QE would likely end in mid-2014, when the unemployment rate hits 7.0%.

• The economy is now consistently creating 200,000 jobs per month, and has been over the past 12 months.

• At 3.6% in April 2013, the latest data available, the hiring rate — the level of new hiring as a percent of total employment measured from the Job Openings and Labor Turnover Survey (JOLTS) data remains depressed, and well below the 4.5 – 5.0% hire rate seen prior to the onset of the Great Recession in 2007. In her March 4, 2013 speech, Yellen noted, “the hiring rate remains depressed. Therefore, going forward, I would look for an increase in the rate of hiring.” The May JOLTS report is due out this Tuesday, July 9, 2013.

• In that same speech, Yellen noted “layoffs and discharges as a share of total employment have already returned to their pre-recession level”. Indeed, Figure 4 shows that the discharge rate, at 1.2% in April 2013, is very close to an all-time low. A good proxy for this metric is the weekly readings on initial claims for unemployment insurance and the monthly Challenger layoff data, both of which continue to show that companies are reluctant to shed more workers at this point in the business cycle.

• The quit rate measures the percentage of people who leave their jobs voluntarily, presumably because they are confident enough in their own skills — or in the health of the economy — to find another job. In the three months ending in April 2013 (the latest data available), 53% of the people who were separated from their jobs (laid off, fired, retired, or left voluntarily) were job quitters. This reading was just below the 54% readings in February and March 2013, which were the highest readings on this metric since mid- 2008. Even at 54%, this metric remains well below its pre-Great Recession norm of 56 – 60%. Commenting on this metric in her March 4, 2013 speech,  Yellen noted “a pickup in the quit rate, which also remains at a low level, would signal that workers perceive that their chances to be rehired are good — in other words, that labor demand has strengthened.”

• The final metrics mentioned by Yellen — consumer spending and overall economic growth — both remain well below average, and indeed still point to an economy that is still running at around two-thirds speed.

GDP and Jobs: Why the Disconnect?

Since the end of the 1981-82 recession, the economy has seen four periods when it has consistently created 200,000 or more private sector jobs per month:

• Mid-1980s
• Late 1980s
• ƒƒ Mid-1990s through the end of the decade
• ƒƒ Early 2006

On average, when the economy has consistently produced 200,000 jobs over a 12-month period, economic growth — as measured by growth in real gross domestic product (GDP) — has averaged between 4.5% and 5.0%. Today, the economy is struggling to grow at 2.0%, and our forecast is that growth is likely to be near 2.0% over the rest of 2013. What has caused the disconnect between job and GDP growth, and does better job growth mean better economic growth in the period ahead?

In general, the economy leads job growth, not the other way around. The timing of the economic recoveries and labor market recoveries over the past 20 years is helpful in illustrating this point. Coming out of the 2007 – 2009 Great Recession, the economy bottomed out in June 2009, while the labor market did not begin creating jobs regularly until spring 2010. The same pattern played out coming out of the mild recession in 2001. The recession ended in November 2001, but the economy did not begin to consistently create jobs until the summer of 2003. The 1990 – 91 recession ended in March 1991. The private sector economy did not begin creating jobs regularly until a year later, in the spring of 1992.

The recent disconnect between private sector job growth and the performance of the economy can be partially traced to several factors. First, the severity and composition of the Great Recession was unique in its scope, and recent financial-led recessions in other countries suggest that economies recover more slowly from recessions caused by severe financial crisis. Restrictive fiscal policy at both the federal and state and local levels is also a culprit of the disconnect between 200,000 per month job growth and an economy growing at only around 2.0%. In the first half of 2013, the economic drag from fiscal policy (less spending and higher taxes) likely shaved around 2.0% from GDP. In addition, the recession in Europe and the sharp slowdown in emerging markets have sharply curtailed our export growth, which in turn, puts downward pressure on GDP growth.

The bottom line is that job creation tends to lag the overall economy, and that the recent job gains likely do not portend stronger economic growth in the coming months. Any uptick in economic growth over the next few quarters would likely be the result of an easing of fiscal pressures or improvement in the economies in Europe and emerging market countries.

Closer Look: Labor Market Surveys

• A survey of 60,000 households nationwide — an incredibly large sample size for a national survey — generates the data set used to calculate the unemployment rate, the size of the labor force, part-time and full-time employment, the reasons for and duration of unemployment, employment status by age, educational attainment, and race. The “household survey” has been conducted essentially same way since 1940, and although it has been “modified” over the years, the basic framework of the data set has stayed the same. The last major modification to the data set (and to how the data is collected) came in 1994. To put a sample size of 60,000 households into perspective, nationwide polling firms typically poll around 1,000 people for their opinion on presidential races.

• ƒƒThe headline unemployment rate (7.6% in June 2013) is calculated by dividing the number of unemployed (11.8 million in June 2013) by the number of people in the labor force (155.8 million). The civilian population over the age of 16 stood at 245.5 million in June 2013. A person is identified as being part of the labor force if they are over 16, have a job (employed), or do not have a job (unemployed) but are actively looking for work. A person is not in the labor force if they are neither employed nor unemployed. This category includes retired persons, students, those taking care of children or other family members, and others who are neither working nor seeking work.

• ƒƒ In June 2013, the labor force was 155.8 million, which consists of 144 million  employed people and 11.8 million unemployed people. Another 89.7 million people over the age of 16 were classified as not in the labor force. The 155.8 million people in the labor force plus the 89.7 million people not in the labor force is equal to the civilian population over 16, 245.5 million.

• The payroll job count data is culled from a survey of 440,000 business establishments across the country. The sample includes about 141,000 businesses and government agencies, which cover approximately 486,000 individual worksites drawn from a sampling frame of Unemployment Insurance (UI) tax accounts covering roughly 9 million establishments. The sample includes approximately one-third of all nonfarm payroll employees. From these data, a large number of employment, hours, and earnings series in considerable industry and geographic detail are prepared and published each month.

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

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

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 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.

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This research material has been prepared by LPL Financial.

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

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

Member FINRA/SIPC

Sizzling Summer Fed FAQ June 18, 2013

What Is the Schedule of Events for the Fed This Week?

The Federal Reserve (Fed) holds its fourth (of eight this year) Federal Open Market Committee (FOMC) meeting this Tuesday and Wednesday, June 18 – 19. The meeting will be followed by an FOMC statement, and the FOMC’s latest economic and Fed funds projections at 2 PM ET. Fed Chairman Ben Bernanke’s second (of four) press conference of 2013 begins at 2:30 PM ET.

Will the Fed Raise Rates at This Meeting?

Since mid-May 2013, the market has moved up the date of the first Fed rate hike from late 2015/early 2016 to early 2015. In our view, the Fed is likely to keep rates lower for longer than the market now anticipates. This should help keep a lid on longer-term interest rates, such as the 10-year Treasury, and on instruments like mortgage rates, which are closely tied to the yield on Treasuries.

If the Fed Is Tapering Quantitative Easing (QE), Is It Tightening Monetary Policy?

No. As long as the Fed’s balance sheet is expanding, the Fed is easing monetary policy. In late 2010, President of the New York Fed William Dudley suggested in a speech that: “…$500 billion of purchases would provide about as much stimulus as a reduction in the federal funds rate of between half a point and three quarters of a point (50 to 75 basis points). “So, at $85 billion a month, the Fed is doing the equivalent of cutting the Fed funds rate (which has been near zero since late 2008) by 10 basis points per month. Even if the FOMC were to decide to taper purchases to $40 – $45 billion per month, it would still be “cutting” the Fed funds rate by around 5 basis points per month.

Will the Fed Act to Calm Financial Markets, Especially the Bond Market?

Since Ben Bernanke’s testimony to the Joint Economic Committee(JEC) of Congress on May 22, 2013, volatility has moved higher in financial markets. Bernanke’s appearance at the JEC, and especially the question and answer portion of the testimony suggested to the market that the FOMC was preparing to begin scaling back its purchases of Treasuries and mortgage backed securities (MBS). Prior to the testimony, markets generally thought that the FOMC would purchase $85 billion per month of Treasuries and MBS through at least the end of 2013. Since the JEC testimony, markets have begun to question that timing and are now expecting the Fed to begin tapering its purchases in September 2013. In our view, the decision for the Fed to continue with the current pace of QE is data dependent. Based on our forecast for the labor market, inflation, and the economy, the Fed is likely to continue its bond purchases through at least September 2013. At that time, the Fed may “test” run a temporary tapering with markets….

When Will the Fed Stop QE?

Even if the Fed does signal that it is prepared to begin tapering its purchases of Treasuries and MBS, it will, in our view, likely continue to pursue QE for some time, and perhaps until the end of 2014. While the Fed has provided “thresholds” for when it would consider raising its Fed funds rate: “… (low rates) will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.” it has stopped short of providing specific thresholds for ending QE. Instead, the Fed has said: “The Committee will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability.”

Can Congress Make the Fed Stop Quantitative Easing?

Yes. Congress, can, at any time, vote to take away or restrict the Fed’s dual mandate to: “…maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.” There are many voices in Congress — especially in the House — that are unhappy with the Fed’s pursuit of QE, and legislation has been introduced in both houses of Congress over the past several years that would limit the Fed’s mandate. It is highly unlikely that such legislation would pass the Senate in the current session of Congress.

What Is the Fed’s Number on the Labor Market?

The QE debate among market participants — and likely among Fed policymakers as well — centers around the labor market and whether or not it has seen “real and sustainable” improvement. Over the past year, the U.S. economy has consistently created around 175,000 net new jobs per month. Some Fed policymakers have hinted that 150,000 jobs per month is the best the economy can do, and any job growth stronger than that could trigger inflation. Other Fed policymakers have suggested that 200,000 jobs per month is the right number to target, and that the Fed still has some work to do to get there. For some, 175,000 net new jobs per month could be the right number. Markets have their own view of what the “right number” is too. However, market participants looking for the FOMC to provide a specific target on job creation may be disappointed this week.

How Has the Labor Market Performed Since the Last FOMC Meeting in May 2013?

The FOMC has seen two jobs reports since the last FOMC meeting on May 1, 2013. The May 1, 2013 FOMC meeting was held a few days before the release of the April 2013 employment report. The May 2013 employment report was released on June 7, 2013. The April 2013 employment report showed that the economy created 165,000 jobs in April — far more than the 140,000 expected. The May 2013 employment report revealed that the economy added 175,000 jobs in May, in line with expectations and that the job counts over the prior two months were revised downward by a total of 12,000. The unemployment rate was 7.5% in April 2013 and 7.6% in May 2013. Several other labor market metrics the Fed is known to be watching (see our Weekly Economic Commentary: Watch What the Fed Watches, March 25, 2013, for more details)have been mixed at best since the last FOMC meeting. In our view, the labor market is improving, but the recent pace of job creation (around 175,000 per month) seems likely to persist until the economy can grow more robustly than 2.0% to 2.5%.

Isn’t the FOMC Worried About Inflation Anymore?

As has been the case since Congress amended the Federal Reserve Act to grant the Fed’s dual mandate (see above), the FOMC’s job has been to promote full employment and stable prices. In recent years, the FOMC has been much more concerned with deflation — a prolonged period of falling wages and prices — than it has been about inflation. Recent readings on the Fed’s preferred measure of inflation, the personal consumption deflator excluding food and energy (core PCE deflator), have been decelerating. In March 2012, the year-over-year reading on the Fed’s preferred measure of inflation was 2.0%. The latest reading (April 2013) shows that core inflation is now at 1.0%, which matches the lowest reading ever in the 53+ year history of the data series. In our view, there are still more factors pushing down on inflation than pushing up on inflation (see the Weekly Economic Commentary from March 18, 2013 for more details) and the Fed’s primary focus right now is on the other side of its dual mandate.

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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 t0 investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

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

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

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

Mortgage-Backed Securities are subject to credit, default risk, prepayment risk that acts much like call risk when you get your principal back sooner than the stated maturity, extension risk, the opposite of prepayment risk, and interest rate risk.

Stock investing involves risk including loss of principal.

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.

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 (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.

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INDEX DESCRIPTIONS

The “core” PCE price index is defined as personal consumption expenditures (PCE) prices excluding food and energy prices. The core PCE price index measures the prices paid by consumers for goods and services without the volatility caused by movements in food and energy prices to reveal underlying inflation trends.

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.

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

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