Tuesday, February 15, 2011

Weekly Market Commentary

A Blockbuster Week for Policy and Data
After a quiet week for data and policy last week (February 7 – 11), this week is shaping up to be a blockbuster. On the policy front, President Obama releases his 2012 budget early in the week and the Federal Reserve will publish the minutes of its latest Federal Reserve Open Market Committee meeting along with its most recent economic forecast in the middle of the week. Data on manufacturing for January (industrial production) and February (Philly Fed and Empire State) is likely to continue to show strength, aside from weather impacts. Housing data this week (homebuilder sentiment and housing starts) is likely to be heavily influenced by weather, as the housing market continues to bounce along the bottom. January data on consumer and producer inflation is likely to draw a great deal of attention given the recent flare-up in inflation concerns. The January retail sales data is also likely to show solid consumer demand, although it too is likely to be heavily influenced by the brutal winter weather in January. The full slate of Chinese economic data for January this week will serve to remind markets that more policy tightening in China is likely in the coming weeks and months.

At Least 25 Central Banks Have Already Raised Interest Rates in this Cycle, with More Likely to Come
Monetary policy overseas will also be in focus this week, as central banks in Japan, Sweden, India, Hong Kong and Chile meet to set rates. India and Chile are expected to raise interest rates this week; both have been raising rates for at least a year now. In addition to Chile and India, at least 23 other central banks around the globe have raised rates since late 2009. In the developed world, seven nations (Canada, Sweden, Norway, Australia, New Zealand, South Korea and Israel) have raised rates and are poised to raise rates further to combat growing domestic inflation and above-trend domestic economic growth.
At least 18 emerging market nations have already raised rates. Notable emerging market nations that have raised interest rates this cycle include China, Brazil, India, Taiwan, Malaysia, Indonesia, Chile and Peru. Developing nations have raised rates for some of the same reasons developed nations have raised rates — rising domestic inflation, above-trend economic growth and, in some cases, soaring domestic property markets. The three rate increases in China since October 2010 have captured the market’s attention, and more rate hikes are likely in the weeks and months ahead. Our sense is that until markets can get comfortable with the timing and extent of the rate increases in China (and in other large emerging market nations), investors are likely to remain cautious when investing in emerging markets.

Domestic Inflation in Focus this Week
The release of the January data on producer prices (Wednesday, February 16) and consumer prices (Thursday, February 17) will likely renew market chatter about domestic inflation in the United States. To be sure, domestic inflation remains tame, by almost any measure, although inflation (and fears of inflation) seems to be everywhere. The expected 0.3% month-over-month gain in the consumer price index (CPI) in January 2011 would leave consumer prices just 1.6% above their January 2010 level. The 1.6% year-over-year reading on the CPI expected in January 2011 would be smaller than all but 83 of the 600 monthly (year-over-year) inflation readings (less than 14%) recorded in the past 50 years. Inflation has averaged 4.0% since 1960.
In addition to benign inflation readings, expectations for headline inflation remain low from investors, consumers, and professional forecasters. As measured by the difference between the yield on the 10-year Treasury note and the yield on a 10-year Treasury inflation protected security (TIPS), the market is pricing in just 2.3% inflation over the next 10 years. Consumers’ inflation expectations are measured each month in the University of Michigan’s Survey of Consumers. Heavily influenced by the recent rise in food and gasoline prices, consumers are expecting 3.4% inflation over the next 12 months according to the most recent survey. Looking out over the next five years, which tends to mitigate the impact of a near-term rise in gasoline prices, consumers expect just 2.9% inflation. Consumers’ expectations for long-term inflation have held steady around 3.0% for almost 20 years. Similarly, professional forecasters’ long-term inflation forecasts (as measured by the Survey of Professional Forecasters conducted quarterly by the Philadelphia Fed) have remained relatively constant near 2.5% for the past 15 to 20 years. The FOMC forecast is for inflation to remain in the 1.5 to 2.0% range over the “long term”, and the non-partisan Congressional Budget Office (CBO) expects inflation to average around 1.8% over the next 10 years.
Given that observed and forecasted inflation remains quite low, why is the market (and the news media) so focused on inflation? Here in the United States, while overall food inflation is running at just under 2%, prices of certain foods are booming. For example, prices of meats and poultry are up nearly 6% from a year ago. Dairy prices are up nearly 4%. Within the CPI, the weights of the goods and services that make up the index are determined by what portion the item represents within our overall spending. Overall, food represents about 14% of our annual spending, and is therefore a 14% weight in the CPI. However, meats and dairy represent just fewer than 30% of our annual expenditures, and have only a 3% weight in the CPI. Price gains in most food categories outside of meats and dairy (cereals, fruits, beverages, etc.) are running at around 1% over the past year.


Selected Components of CPI
Category
Weight
(As of December 2010)
Year-Over-Year Change
(December 2009 to December 2010)

Total CPI
100%
+1.6%
Food
13.7%
+1.5%
Meats and Poultry
1.8%
+5.5%
Dairy
0.8%
+3.7%
Energy
9%
+7.9%
Gasoline
4.9%
+13.9%
Heating Oil
0.2%
+16.5%
Apparel
3.6%
-1.1%
Audio and Video Equipment
1.8%
-2.6%
Home Furnishings and Operations

4.4%
-2.5%
Source: Bureau of Labor Statistics


Another area of concern among consumers is the price of gasoline, heating oil, electricity and natural gas. Together, energy prices are up about 8% over the past year, and represent about 9% of our annual budgets. The culprits here are gasoline prices (+14% year-over-year) and home heating oil (+17% year-over-year). Electricity (uses for both heating and cooling homes) and natural gas prices (heating and hot water) are flat to down from a year ago.
Thus, most of the rise in food and energy prices can be traced to gasoline, heating oil, meats and dairy. While these are items that most Americans price and pay for on an almost daily basis, spending on these items represents less than 10% of overall spending (and therefore has about a 10% weight in the CPI). Nevertheless, price changes in these items can heavily influence perceptions about inflation.
Although we do not think about them or buy them as often, items like apparel, televisions, and household furnishings and operations also make up about 10% of what we spend, and therefore represent 10% of the CPI. Over the past year, apparel prices are down 1.1%, prices of audio and video equipment are down about 3%, and prices of household operation and furnishings are down 2.5%.

Budget Battle Just Beginning
As this report was being prepared for publication, President Obama released his budget proposal for fiscal year 2012, which begins on October 1, 2011. The proposed budget aims to cut the deficit (from the current baseline) by $1.1 trillion over the next 10 years, with two-thirds of the cuts coming from the spending side. The spending cuts will be viewed as too small by many members of the Republican majority in the House, and be viewed as too large by the Democratic majority in the Senate. For the current fiscal year (fiscal year 2011, which ends on September 30, 2011), the President’s budget has penciled in a $1.6 trillion deficit, with $3.8 trillion in spending falling far short of covering the expected $2.2 trillion in revenues. In fiscal year 2012, spending of $3.7 trillion will exceed expected revenues by $1.1 trillion.
On balance, very few of the policy related budget items in the President’s 2012 budget have a chance to be enacted. Indeed, even in years when the President’s party has control of both houses of Congress, the President’s budget proposal is merely a series of guideposts, policy initiatives and campaign slogans wrapped in the guise of precise numbers. In the current environment, his proposals have almost no chance of being passed into law.
House Republicans have proposed up to $100 billion in cuts in this fiscal year, but with over $3.8 trillion in spending expected in fiscal year 2011, even as much as $100 billion in cuts, while a good start, is literally just a rounding error. The debate over the budget will persist over the remainder of this year and will hopefully become a key theme in the Congressional and Presidential election year of 2012. Near term, the wrangling over the ceiling on the nation’s debt limit (which is expected to be reached in early spring 2011) and the release of the House Republicans’ budget in April will be key.

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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.
Treasury inflation-protected securities (TIPS) help eliminate inflation risk to your portfolio as the principal is adjusted semiannually for inflation based on the Consumer Price Index - while providing a real rate of return guaranteed by the U.S. Government.
Investing in international and emerging markets may entail additional risks such as currency fluctuation and political instability. Investing in small-cap stocks includes specific risks such as greater volatility and potentially less liquidity.
Stock investing involves risk including loss of principal Past performance is not a guarantee of future results.
This research material has been prepared by LPL Financial.
The LPL Financial family of affiliated companies includes LPL Financial and UVEST Financial Services Group, Inc., each of which is a member of FINRA/SIPC.
To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and makes no representation with respect to such entity.
Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by any Government Agency | Not a Bank/Credit Union Deposit

Tuesday, February 8, 2011

Weekly Market Commentary

Fighting the FED
Facing a limited domestic economic calendar this week, market participants in the United States are likely to focus on the still unfolding political crisis in Egypt, another round of corporate earnings reports in the United States, several key overseas central bank meetings, Chinese economic data for January, and a full slate of public appearances from Federal Reserve (Fed) officials. Amid an upside breakout in yields on U.S. Treasury notes, this week’s $72 billion Treasury auction of 3-, 10- and 30-year notes will draw close attention. In the absence of fresh data on the U.S. economy, markets will pay even closer attention to the weekly economic data on retail sales, mortgage applications and jobless claims, and continue to reflect on last week’s heavy slate of data which included the monthly jobs report for January.

A Survey of Small Businesses Highlights a Quiet Economic Calendar
The week after the release of the monthly employment report is usually a quiet one for economic data in the United States, and this week is no exception. Although the market will digest reports on consumer credit outstanding, wholesale inventories, and imports and exports for December, none of the reports is likely to be market-moving, as the fourth quarter of 2010 is now a distant memory. Instead, markets may place more focus on the regular slate of weekly data on retail sales, mortgage applications and initial claims for unemployment insurance. Although this data is likely to again be impacted by severe winter weather, it will shed some light on how the economy was performing as January turned to February.
The National Federation of Small Business (NFIB) report on small business optimism for February is due this week, providing a more timely, though limited, view on small business in the middle of the first quarter of 2011. Heavily dominated by construction firms (roughly 20% of the respondents are construction-oriented while only 5% of the overall economy is construction-related), this index has moved steadily higher from its mid-2009 lows. The index is expected to tick up again in February but, on balance, small business optimism remains well below levels seen in the mid-2000s. Poor sales, difficulty obtaining credit, too much government regulation and taxes continue to weigh on small business optimism. Small businesses accounted for nearly two-thirds of all hiring over the past 20 years, and have only recently (and tentatively) begun adding to payrolls, according to the ADP survey of small business hiring.
Overseas, the end of the Lunar New Year celebration in China brings economic reports on Chinese imports and exports for January, and opens the door for more interest rate increases and other policy actions designed to slow inflation in China. Elsewhere, central banks in the United Kingdom, The Philippines, and South Korea meet this week to decide policy. The Bank of England (BOE) is in easing mode, but the consensus is looking for higher rates out of the BOE by year-end. The South Korean central bank has been raising rates since mid-2010 and surprised markets with a rate hike in mid- January. Another rate hike is expected this week. No rate hike is expected in the Philippines. Despite 7.0% GDP growth, the inflation rate remains in check at around 3.0%. GDP growth in the Philippines, an emerging market nation, is expected to decelerate to around 5.0% in 2011, while overall GDP growth in the emerging markets is expected to be in the 6.0% to 7.0% range in 2011, despite a modest deceleration in growth in China from close to 10.0% in 2010 to 9.5% in 2011.

Ben Bernanke in the Hot Seat This Week
The Fed will remain in the headlines this week, as several key Fed officials are slated to make public appearances. Markets will likely focus on a speech by Dallas Fed President Richard Fisher on Tuesday, February 8, and Fed Chairman Ben Bernanke’s testimony before noted Fed critic Congressman Ron Paul’s House Budget Committee on Wednesday, February 9. Last week, Fisher, a well-known inflation “hawk” (a policy maker more likely to be worried about too much inflation than not enough growth), stated that he would not support another round of quantitative easing when the current round of quantitative easing ends in June.
Quantitative easing is also likely to be a key topic of discussion when Fed Chairman Bernanke is questioned by Congressman Paul. Paul is a well-known Fed critic, is not in favor of QE2, and is author of a book called “End the Fed.” Paul will likely push Bernanke on the Fed’s transparency and also call for a full audit of the Fed, which Bernanke has strongly opposed in the past. It should make for an interesting Wednesday morning in Washington.

The January Employment Report Was Stronger Than the Headline Suggested
The January employments report (released on Friday, February 4) was beset with the same weather-related problems that impacted most of the other data we have in hand for January 2011. Our basic view on the labor market— the economy is growing quickly enough to generate some job growth, but not quickly enough to generate enough job growth to satisfy the Fed—was unchanged by the report. Much of the weakness in the January employment report, including the meager 36,000 gain in employment between December and January, can be explained away by foul weather. Expectations were for the economy to create more than 140,000 jobs in the month. It marked the eighth consecutive January in which the job count fell short of expectations.
There were signs behind the headlines of the report that the underlying health of the labor market continued to improve. Bucking a strong three-decade trend, the December job count was revised higher. In 23 of the last 31 years (dating back to 1980), the December jobs count was revised down along with the release of the January data. In addition, three “weather-sensitive” areas of employment (construction, transportation and leisure) saw a combined 75,000 drop in employment in January relative to December. Over much of 2010, these three sectors combined added around 25,000 jobs per month. The 100,000 swing between the “normal” gain of 25,000 per month for most of 2010 and the 75,000 drop in January (largely due to weather) accounted for all of the disappointment (relative to expectations) in January.
Digging a little deeper, there was also some good news about the underlying health of the labor market in the “household survey.” The household survey revealed that the unemployment rate dropped by 0.4 percentage points in January 2011 to 9.0%. The 0.8 percentage point drop in the unemployment rate over the past two months (December 2010 and January 2011) was the steepest two-month drop in the unemployment rate since 1958. The only other time in the last 50+ years that came close to matching the 0.8% drop over a two-month period was in mid-1983, as the unemployment rate dropped 0.7 percentage points in what turned out to be the start of a very robust recovery in the labor market.
There are certainly reasons to cast some suspicion on the big drop in the unemployment rate since nearly one million people were unable to work in January due to bad weather, according to the household survey, nearly five times the normal amount in a typical January. The Fed and the markets will be watching to see if the unemployment rate continues to drift lower from here in the next several months amid more “normal” weather. If so, the view held by us, the Fed and, to some extent, the consensus of a tepid labor market may be challenged and suggest the labor market is improving more rapidly than is now thought.


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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.
Investing in international and emerging markets may entail additional risks such as currency fluctuation and political instability. Investing in small-cap stocks includes specific risks such as greater volatility and potentially less liquidity.
Stock investing involves risk including loss of principal Past performance is not a guarantee of future results.
This research material has been prepared by LPL Financial.
The LPL Financial family of affiliated companies includes LPL Financial and UVEST Financial Services Group, Inc., each of which is a member of FINRA/SIPC.
To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and makes no representation with respect to such entity.
Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by any Government Agency | Not a Bank/Credit Union Deposit

Tuesday, February 1, 2011

Weekly Market Commentary

Snowed Under
Financial market participants will be pulled in several directions this week as January turns into February. Political developments in North Africa and the Middle East are likely to be top of mind this week and serve as a reminder that geopolitics are never too far removed from the headlines. Policy — a key theme in markets last week (January 24 – 28) — lingers as a potential market-mover this week, as does Federal Reserve Chairman Ben Bernanke who will hold a press conference, a very unusual event for a Chairman of the Federal Reserve. Additionally, central banks in Australia, Iceland, India, the Czech Republic, Indonesia, as well as the European Central Bank (ECB) meet to set policy this week. Other than India, none of these central banks are expected to raise rates, although rising inflation in much of the developing world has put renewed focus on the actions of emerging market central banks in response to higher food and fuel prices.
Back home in the United States, fiscal policy will continue to be at or near the top of the headlines, as the battle over the debt limit ceiling looms. In addition to the geopolitics and policy, a full slate of crucial economic data for December and January in the United States is due out this week. Data on consumer spending, inflation, manufacturing, construction and the labor market are all due out this week. The key report of the week is the employment report for January, on Friday, February 4. In China, a key report on manufacturing activity in January is set to be released late Monday night. Markets remained concerned about the pace of economic growth and, more importantly, inflation in China, and we continue to expect more policy tightening in China in the coming weeks and months.

Will The Rise in Energy Prices Short Circuit the Recovery?
As this publication was being prepared, December data on consumer spending, personal income, and the Fed’s preferred measure of inflation, the personal consumption expenditure (PCE) deflator, excluding food and energy, along with reports on manufacturing activity in Chicago, Milwaukee and Dallas in January were being released. Later in the week, the employment picture in early 2011 will come into focus, as first the Challenger layoff data for January, then the ADP employment report and finally the nonfarm payroll jobs report for January will be released. Unusually severe winter weather across large swaths of the United States in much of January is likely to have an impact on the employment data and indeed all the economic data for January.
The income, spending and price data for December largely reinforced the Fed’s case for continuing its program of quantitative easing. Income growth (at just 3.8% year-over-year) suggests that employment is growing too slowly, while the 0.7% year-over-year gain in the core PCE deflator in December remains well below the low end of the Fed’s unofficial comfort zone for this metric, +1.5 to 2.0%. The Fed’s decision to embark on a second round of quantitative easing was based on the idea that the Fed was not fulfilling either part of its dual mandate of low and stable inflation and full employment. The latest data on spending and inflation continues to show that while the economy is growing, and a recovery is underway, it remains tenuous. Our view remains that despite political pressure, the Fed will continue to pursue quantitative easing until it is slated to end in June 2011, but that the hurdle is high for the Fed to initiate yet another round of quantitative easing later this year.
One concern many market participants (and consumers) have had in recent weeks and months as oil and gasoline prices have moved higher is what impact these rising energy prices will have on the economy as a whole, and on consumer spending in particular. The data embedded in the monthly personal income and spending report released as this report was being prepared will likely shed some light on this. In December 2010, consumers spent $646 billion (on an annualized basis) on gasoline, electricity, home heating oil, natural gas, etc. That figure represented just over 6.0% of total consumer spending. Since hitting a low of 4.8% of spending in late 2008/ early 2009, energy spending by consumers as a percent of total spending has moved steadily higher, although it remains well below the peak hit in mid-2008 of 7.0%. In dollar terms, U.S. consumers were spending $710 billion (annualized) in mid-2008 (versus the aforementioned $646 billion today) as oil prices hovered near $150 per barrel, gasoline prices were above $4 per gallon and natural gas was close to $14 per BTU.
Today, oil prices are just below $90 per barrel, gasoline prices are about $3 per gallon and natural gas is running between $4 and $5 per BTU. A “shock” in the form of a cut in oil production and resulting sharp rise in consumer energy prices was one of the preconditions for the double-dip recession in 1980 – 82, and played a big part in the economic slowdown in late 2007 and early 2008 ahead of the worst of the financial crisis in late 2008/early 2009 that was precipitated by the collapse of Lehman Brothers in September 2008. On balance, while we are watching the rise of consumer energy prices closely, our view is they have not risen far enough or fast enough to suggest that the economy is headed for a double dip. In 2008 (and 1981, when the second leg of the double-dip recession ensued), the labor market was deteriorating, real incomes were stagnating, inflation, interest rates and, most importantly, consumer debt levels were high and rising. Today, the labor market is improving, real incomes are accelerating, and inflation, consumer interest rates and, most importantly, consumer debt levels, are falling.

January Jobs Report Likely To Be Impacted By Weather, Revisions
In the second half of the week, markets’ attention will turn to the labor market. Reports on layoffs (as measured by the outplacement firm Challenger, Gray and Christmas) and private sector employment (as measured by ADP, the nation’s largest payroll processing firm) for January will set the stage for the monthly employment report from the U.S. Department of Labor on Friday, February 4.
Unfortunately, the most closely watched data is likely to be beset with distortions this time around, making it even more difficult to interpret. The weather is the key wildcard for the report and could have a significant impact on the headline job count. Much colder and wetter wintery weather in most of the country in January will most likely hold down the job count in weather-sensitive industries like retail, construction and leisure.
In the month of January, the weekly data on initial filings for unemployment insurance was heavily influenced by the weather. The employment indices in the various regional manufacturing indices during January (Chicago, Philadelphia, Empire State, Dallas, Richmond, etc.) were mixed at best, and many of these surveys cited poor weather as an influence on economic activity in the month. Markets will try to look past the weather impact and hope that February brings more “normal” winter weather, which would allow markets to simply average January and February’s employment readings to get a better gauge of the underlying health of the labor market.
The January jobs report will also incorporate some methodological changes to the report, as well as the annual benchmark revision to the jobs data done each year to synch up tax records and payroll counts over the past several years. Both the establishment survey (which tallies the number of employees at businesses) and the household survey (which queries some 300,000 households about the employment status of the members of the household) are subject to revision. The revisions to the payroll survey are likely to show that 366,000 fewer jobs were created between March 2010 and December 2010 than was previously thought. Revisions and methodological changes may also impact the household survey, which is used to derive the nation’s unemployment rate.

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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. Investing in international and emerging markets may entail additional risks such as currency fluctuation and political instability. Investing in small-cap stocks includes specific risks such as greater volatility and potentially less liquidity. Stock investing involves risk including loss of principal Past performance is not a guarantee of future results. Investing in alternative investment may not be suitable for all investors and involve special risks such as risk associated with leveraging the investment, potential adverse market forces, regulatory changes, potential liquidity. There is no assurance that the investment objective will be attained.
This research material has been prepared by LPL Financial. The LPL Financial family of affiliated companies includes LPL Financial and UVEST Financial Services Group, Inc., each of which is a member of FINRA/SIPC. To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and makes no representation with respect to such entity.
Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by any Government Agency | Not a Bank/Credit Union Deposit.