Weekly Market Commentary

The Path to a More Transparent Fed

Last week's batch of economic data had a weaker tinge to it, but financial markets largely dismissed the data, focusing instead on events overseas. If history is a guide, the market may not be able to ignore this week's data, which includes key reports on manufacturing (Institute for Supply Management (ISM) and Chicago Area Purchasing Managers), consumer spending (personal income and spending for February and vehicle sales for March), and employment (Challenger layoff announcement, ADP employment and the government's employment report) in March. China's ISM report for March is also due out this week, as market participants continue to debate the timing and extent of the next interest rate hike in China. On the policy front, Congress returns from recess just in time to address the looming government shutdown (April 8). As emerging market nations continue to grapple with robust growth and rising domestic inflation, Taiwan's central bank is expected to raise rates this week. In addition, there are several notable Fed speakers on the docket this week, as market participants continue to debate when the Fed will begin to rein in some of the unprecedented monetary policy now in the system.

While the employment data and ISM for March (due out on Friday, April 1) will draw the most attention from policymakers and market participants, the February data on personal income, personal spending, and inflation that was released as this report was being prepared revealed accelerating incomes, slower spending, and another tick higher for core inflation. In addition, the February data on personal income and spending showed that spending by consumers on energy and energy-related goods and services accounted for 6% of total spending and 5% of total personal incomes in February. This is a metric we are watching closely as we gauge the impact of rising energy prices on the economy.

At the peak of energy prices in July 2008, consumer spending on energy goods and services represented 7% of total personal spending and 5.7% of personal incomes. In the early 1980s, consumer energy spending accounted for nearly 10% of spending and 8% of incomes.

Another Step Towards a More Transparent Fed

Last week, the Federal Reserve (Fed) announced that Fed Chairman Bernanke will hold a press conference after four of the eight meetings of the Fed’s policymaking arm, the Federal Open Market Committee (FOMC). The press conferences will coincide with the release of the FOMC’s quarterly economic forecasts, which are made at the FOMC meetings held in January, April/May, June, and October/November each year. Thus, on April 27, June 22 and November 2, 2011, the FOMC statement, along with the FOMC’s forecast, will be released at 12:30 PM ET, and Bernanke will take questions at 2:15 PM ET. At the other FOMC meetings, the FOMC statement will be released, as usual, at 2:15 PM ET. Operationally, this suggests that any major shift in Fed policy is much more likely to come at one of the four press conference FOMC meetings, rather than at one of the four non-press conference meetings. These press conferences may also downgrade the importance of the release of the FOMC minutes (three weeks after the FOMC meeting) for market participants. Finally, the press conferences may make the weekly parade of Fed speakers less relevant to financial markets.

Press conferences are only the latest in a series of moves toward greater transparency by the Fed over the past two decades. Beginning in the early 2000s, the FOMC began contemplating ways to better communicate its policies to the public. It set aside time at several FOMC meetings a year to discuss communication issues, ranging from full transparency (i.e. broadcast the FOMC meetings live) to a more nuanced approach (making more frequent economic forecasts, setting and communicating explicit targets for inflation and the economy) and speeding up the release of policy related documents like the FOMC minutes and economic forecasts.

Since the onset of the financial crisis in 2007, the FOMC (as a proxy for the Fed) has taken a more active role in the economy, and that has raised the ire of some politicians and raised suspicion among the public that is largely unaware of what the Fed does or how it operates. This pressure from Congress (and the public) has probably hastened the FOMC’s move toward more transparency, and as the FOMC begins to unwind the massive monetary stimulus currently in the system over the next few years, clarity from the Fed on its goals for monetary policy and the economy is more crucial than ever. In addition, rising food and energy prices in recent months

also presents the FOMC with a communication issue with the public, given the policymakers’ focus on consumer prices excluding food and energy.

Until the early-90s, a shift in Fed policy had to be gleaned by “Fed watchers” and market participants from analyzing trading in the relatively obscure market for the federal funds rate, the interest rate that banks charge each other to borrow overnight. Then, in 1994, the FOMC began issuing a statement the same day a change in monetary policy was made. In 1995, this change was made permanent, but it was not until 2000 that the FOMC began issuing a statement following all of its meetings, regardless of whether or not a change in policy occurred. This policy will continue.

The release of the minutes of each of the FOMC meetings has taken a similar path toward greater transparency. Today, the minutes of each of the eight FOMC meetings are released to the public three weeks after the meeting occurs. Between 1993 and 2004, the minutes were released three days after the subsequent FOMC meeting, or about seven weeks after the meeting was held. In the 1960s, FOMC minutes were released with a three-month lag, and prior to that time, the FOMC minutes were published only annually.

Prior to 2007, the FOMC issued two economic forecasts a year, which were presented by the Fed Chairman at Congressional testimony in February and July each year. Beginning in 2007, the FOMC started publishing four economic forecasts per year (of economic growth, inflation, and the unemployment rate). The forecasts are published three weeks after the FOMC meeting. Under the new regime, the FOMC’s quarterly forecasts will be released the same day as the FOMC meeting.

From 1960 through most of the 1990s, the Chairman of the Fed rarely, if ever, made any public appearances, and took questions from the media even less frequently. Over the past several years, under increasing public and political pressure, Fed Chairman Bernanke has appeared on the television show 60 Minutes, held a town hall meeting, held a press conference, authored an op-ed in the Washington Post, and held several events where he took questions from students at universities around the country. The move announced last week to hold a press conference after four of the eight FOMC meetings a year continues that trend, and more closely aligns the Fed’s communication policy with that of other major foreign central banks like the European Central Bank and the Bank of England.

Where Are We in the Economic Recovery?

The current economic recovery commenced in June 2009, after the economy experienced the longest (18 months) and most severe (real gross domestic product declined by 4.1%) recession since the 1930s. Thus, the current economic recovery will be 21 months old at the end of March 2011. How does that compare to other recoveries?

Since 1945 (the end of WWII), there have been 12 recessions and 11 economic recoveries. On average, the 11 recoveries have lasted 58 months (around five years), and the median recovery (five were longer and five were shorter) was 45 months long. The shortest post-WWII recovery was in 1980 – 81 (12 months), the longest was the 120-month expansion in the 1990s and early 2000s. The last three recoveries (1980s, 1990s, and 2000s) were 92, 120, and 73 months long, respectively, putting the average recovery during that time at around eight years.

As the 2007 – 2009 Great Recession was the longest and most severe recession since the Great Depression in the 1930s, we think it makes sense to look at the length of recoveries following the three most severe economic downturns in the last 110 years — the Great Depression in the 1930s, the 1973 – 75 recession, and the 1981 – 82 recession. We find that the recovery following the Great Depression of the 1930s lasted 80 months, the recovery following the 1973 – 73 recession lasted 58 months and the recovery following the 1981 – 82 recession lasted, as noted above, 92 months. The average here is around six years.

During the height of the double-dip recession fears in the middle of 2010, we wrote extensively about what usually causes a recession to occur. Although the source of each recession is different, generally speaking, some of the conditions that lead to the end of an economic recovery include:

·         Widespread imbalances in the economy

·         Too much debt in the personal sector

·         A sudden and sharp tightening in Fed monetary policy

·         An inverted yield curve (when short-term interest rates are above long-term interest rates)

·         A soaring dollar

·         Sharply tighter fiscal policy

·         High nominal interest rates (think the late 70s/early 80s)

·         Pronounced weakness in global trading partners

·         A sudden and sharp spike in consumer energy prices

While some of these conditions (rising consumer energy prices, slower growth in some global trading partners) are in place today (and a few are often in place regardless of where we are in the economic recovery), many are not and, at just 21 months, the economic recovery that began in June 2009 is most likely only in its early stages. If the current recovery is the same length as the average recovery since the end of WWII, we are only about one-third of the way through. If this recovery follows the path of the recoveries following the three most severe recessions in the past 110 years, we are only about one-fourth of the way into the recovery. If the last 30 years is any guide, the current expansion will last eight years, and we are still in the “early innings” of the recovery.

Economic and market conditions can and will change, and we will continue to monitor the economic data and policy events in the United States and overseas as we assess the health of the economy and its impact on financial markets.

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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.

The 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.

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

Weekly Market Commentary

Gauging The Fed

The attention of financial market participants will be split between the relatively light economic calendar in the United States and continuing to assess the implications of the earthquake in Japan and its aftermath along with the escalation of the conflict in Libya. In addition, U.S. monetary policy could move to the forefront this week, as Federal Reserve Board (Fed) Chairman Bernanke and two noted inflation "hawks" on the Federal Open Market Committee (FOMC), Charles Plosser from Philadelphia and Richard Fisher from Dallas, are scheduled to make public appearances. Although Congress is out of session this week, the release of the United Kingdom’s budget at midweek may refocus attention on the U.S. budget situation. Elsewhere overseas, it is a quiet week for Chinese economic data, as market participants continue to gauge how much longer China’s central bank will be moving interest rates higher to slow growth and rein in domestic inflation. Several overseas central banks are set to meet this week, including the Philippines, South Africa, and the Czech Republic. Of that group, only the Philippines is likely to raise rates.

This week's data in the United States includes new and existing home sales and durable goods orders for February, as well as the weekly data on initial claims, retail sales and mortgage applications for mid March. All of the data will be scoured by markets looking for impact from the earthquake in Japan and rising consumer energy prices. There have already been several company specific announcements (mainly in the automotive and technology sectors) related to supply-chain disruptions caused by the earthquake, tsunami and nuclear crisis in Japan. With the corporate earnings reporting season for the first quarter of 2011 right around the corner, we would not be surprised to see an increasing number of firms announce some type of disruption to their operations due to the situation in Japan. The economic data in the United States (and elsewhere) could also potentially be impacted by these temporary supply chain disruptions as well. As we wrote last week, markets did not expect much in the way of growth in the world’s third largest economy prior to the catastrophe (and have not for many years) and now, in the short term, growth prospects in Japan have been diminished further. Over the medium term, however, as the affected infrastructure (roads, ports, electrical grid, railways, homes and buildings) are rebuilt, the economy in Japan (and globally) is likely to get a lift, but the longer-term prospects in Japan remain muted. The financial costs of rebuilding are only likely to further negatively impact growth and financial flexibility in the years to come.

A Closer Look at Fed Policy in 2011 and 2012

Turning to the Fed, the noticeable improvement in the economic data so far this year, along with a measurable uptick in readings on core inflation (inflation excluding food and energy), already has some market participants debating the timing of the Fed’s first policy tightening. Unlike in past Fed tightening episodes, where the Fed only had one policy lever at its disposal (typically the fed funds rate or earlier, the discount rate) this time around the Fed has several levers to tighten policy, including the size of its balance sheet and the Fed funds rate. The market puts the Fed’s first rate hike in March 2012, we think it could come closer to the middle of 2012. We expect the Fed to maintain the size of its balance sheet over the second half of 2011, but the Fed is likely to begin to shrink its balance sheet in late 2011 or early 2012, by not reinvesting coupons of the Treasuries and mortgage-backed securities it owns or the proceeds of maturing holdings back into the marketplace. The signal of a shift toward allowing its balance sheet to shrink could come as soon as the June FOMC meeting. Any such move will be data dependant, and also dependant on the progression of the FOMC’s economic forecasts.

Supporters of action by the Fed to tighten policy sooner rather than later are likely to be emboldened this week when Charles Plosser and Richard Fisher (policymakers more concerned about rising inflation than they are about rising unemployment and slower growth) take the stage this week. Both men are voting members on the FOMC, and both have been critics of QE2. However, at the two FOMC meetings held so far this year, neither Plosser nor Fisher has voted against continuing QE2. Both, however, have made it clear that they would very likely vote against starting another round of QE in June, when QE2 expires. As we have been saying for many months now, the hurdle to end QE2 is high but the hurdle to begin QE3 in June 2011 is even higher, although the odds have moved up slightly with the quake in Japan and higher oil prices acting to crimp growth.

Fed Chairman Bernanke is also on the docket this week, and may provide insight into how the earthquake (and its aftermath) in Japan is likely to impact the global economy, and in particular the United States economy in the coming weeks and months. Bernanke is also likely to continue to make the case that the recent rise in energy and commodity prices is transitory and that the pass through into higher core inflation is unlikely. In the past there has been little pass through of rising commodity prices into overall CPI inflation and even less pass through into the Fed’s preferred measure of inflation, the personal consumption expenditure deflator excluding food and energy.

Looking ahead, the market will digest the minutes of the March 15 FOMC meeting on April 5. Those minutes are also likely to contain a discussion of the FOMC’s initial assessment of the Japanese earthquake and aftermath on the global economy. The next Beige Book is due out on April 13, and the next FOMC meeting is set for April 27. The FOMC will produce another quarterly forecast of the economy, inflation and the unemployment rate at the April 27 FOMC meeting. That forecast (which may set the stage for the first steps toward policy tightening) will be released in mid May 2011.

Economic Growth in the First Quarter of 2011 Still Looks Solid

U.S. economic data and policy events took a back seat to global events (Japan quake and aftermath, escalation of the conflict in Libya, and ongoing turmoil in the Middle East) last week (March 14 – 18). The data on manufacturing released in the United States last week (Empire State Manufacturing and Philly Fed Manufacturing Indices for March and industrial production for February) suggested that the manufacturing sector remains strong and prospects for more robust growth in the coming quarters are solid as well. The price data for February (PPI and CPI) showed that rising raw materials' prices continue to push input costs higher, but that there has been little pass-through to the end consumer, especially on core inflation. The index of leading indicators for February also suggested more solid economic growth over the next nine to twelve months, and the weekly readings on unemployment insurance, mortgage applications and retail sales continued to show little impact from rising energy prices on the job market or consumer spending. The economy is on track to post a 3.0 to 3.5% gain in Q1 2011.

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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.

Empire State Manufacturing Survey is a monthly survey of manufacturers in New York State conducted by the Federal Reserve Bank of New York.

The fast price swings in commodities and currencies will result in significant volatility in an investor's holdings.

The Producer Price Index (PPI) program measures the average change over time in the selling prices received by domestic producers for their output. The prices included in the PPI are from the first commercial transaction for many products and some services.

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

Philadelphia Federal Index is a regional federal-reserve-bank index measuring changes in business growth. The index is constructed from a survey of participants who voluntarily answer questions regarding the direction of change in their overall business activities. The survey is a measure of regional manufacturing growth. When the index is above 0 it indicates factory-sector growth, and when below 0 indicates contraction.

The Commodity Research Bureau (CRB) Index is an index that measures the overall direction of commodity sectors. The CRB was designed to isolate and reveal the directional movement of prices in overall commodity trades.

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

Weekly Market Commentary

Focus on Japan and the Fed

The devastating earthquake in Japan and its short- and long-term impact on the world’s third biggest economy, the Federal Reserve’s policy meeting, and a scattering of economic data for February and March in the United States will be top of mind this week for investors. The Chinese economic data is quiet this week, while central banks in Norway, Hong Kong, Switzerland, Chile, Japan, Colombia and Iceland meet to set policy. Of these, only resource-rich Chile is expected to raise rates, and Japan’s central bank has already injected a record $183 billion into the Japanese economy in response to the earthquake. Last week’s economic data and events in the United States revealed that rising gasoline prices were having a negative impact on consumer sentiment and near-term inflation expectations, but economic growth in the United States looks solid as the first quarter of 2011 draws to a close.

A Quick Look at Japan, the World’s Third Largest Economy

The earthquake, tsunami and still-unfolding nuclear crisis in Japan is likely to be a source of concern for market participants in the coming weeks. As we digest this catastrophic event (and its immeasurable human toll), we thought it would be appropriate to provide a quick overview of Japan’s economy. Japan, with a population of over 127 million people, is the world’s third largest economy, about one-third the size of the U.S. economy and just about the same size as China’s economy. Of course, China and Japan’s economies have moved in opposite directions in recent years with Japan’s economy growing at under 1% per year over the past 10 years, while China’s economy has increased by an average of over 10% per year over the past 10 years. Looking ahead, the market expects real gross domestic product (GDP) growth in Japan of just 1.5% in 2011 and only about 2.0% in 2012. Thus, the market did not expect much from Japan prior to the quake, and is likely to expect even less in its aftermath.

The area in northeastern Japan most directly impacted by the earthquake and resulting tsunami accounts for between 5% and 10% of Japan’s economic activity, and is focused mainly on agriculture, pulp and paper manufacturing, and petroleum refining. By comparison, the 1995 earthquake in Kobe, Japan hit what was then the largest and busiest port in Japan. Kobe is also Japan’s sixth largest city and a key industrial manufacturing center. In another comparison, closer to home, the region most impacted by 2005’s Hurricane Katrina (Louisiana, Alabama and Mississippi) accounts for just over 3% of GDP in the United States.

Japan has a trade surplus (it exports more goods than it imports) and its major exports to the world are vehicles, electronics, industrial equipment and computers. Japan’s biggest export customers are China, the United States, the European Union, South Korea and Taiwan. Japan’s largest exports to the United States include:

·         Cars and trucks

·         Car and truck parts

·         Industrial machinery

·         Electronics

    

Japan biggest imports are:

·         Raw materials (oil, food, lumber)

·         Machinery

·         Textiles

China accounts for 20% of Japan’s imports, about 12% come from the United States, and around 10% of Japan’s imports come from the Gulf oil states. Japan’s major imports from the United States are civilian aircrafts and parts, industrial machinery, agriculture and medical equipment.

As previously noted, the Bank of Japan has already injected a massive amount of liquidity into the Japanese economy in the wake of the disaster, and the Japanese government has pledged another $2.4 billion to hasten relief efforts, but more is likely. In short, markets did not expect much in the way of growth in the world’s third largest economy prior to the catastrophe (and have not for many years) and now, in the short term, growth prospects have been diminished further. Over the medium term, as the affected infrastructure (roads, ports, electrical grid, railways, homes and buildings) are rebuilt, the economy is likely to get a lift, but the longer-term prospects in Japan remain muted. The financial costs of rebuilding are only likely to further negatively impact growth and financial flexibility in the years to come.

What to watch For at This Week’s FOMC Meeting

The Fed’s policymaking arm, the Federal Open Market Committee (FOMC), meets this week to discuss policy. While no one expects the FOMC to raise rates at this meeting, the FOMC could acknowledge the recent gains in the labor market and economy, and further elevate the discussion over rising raw material prices and wages setting a hawkish tone. However, the FOMC is also likely to acknowledge that while economic growth has improved, the labor market is growing again and that core inflation is rising, growth is not yet strong enough to push the unemployment rate significantly lower or core inflation significantly higher to convince the FOMC that tighter monetary policy is needed. In short, while the statement from the March 15 FOMC meeting is not likely to signal an outright shift in Fed policy (which would have major implications for bond, stock and commodities markets) the statement is likely to be another incremental step toward an eventual FOMC interest rate hike.

The FOMC is also likely to maintain its Large Scale Asset Purchase Program (LSAP), which is commonly known as the second round of quantitative easing (or QE2 for short) , and view an early end to QE2 as unlikely. We also expect the FOMC statement to reduce the odds of implementing QE3 when QE2 expires in June. We have long held the view that the hurdle was high for ending QE2, but even higher to commence QE3.

Finally, there is also likely to continue to be “dissent” within the FOMC itself, but we point out that there were no votes against maintaining current FOMC policy (federal funds rate near zero, QE2, expanding balance sheet) at the last FOMC meeting in January. Since then, however, several likely FOMC dissenters (Philadelphia Fed President Charles Plosser and Dallas Fed President Richard Fisher) have hinted that while they are not happy with QE2, they are not willing to vote against it. They have said, however, that they would not take the same view toward yet another round of quantitative easing (i.e. QE3) when QE2 expires in June. This sets up a likely battle on the FOMC over the next several months, a battle likely to be decided by the path and pace of economic growth and the ability of businesses to pass on higher input costs to end consumers.

Last Week’s Economic Data Revealed That U.S. Economic Growth Remained Solid in the Face of Higher Energy Prices

Last week’s economic data, highlighted by a 1.0% surge in retail sales in February and an energy induced dip in consumer confidence, suggested that economic activity in the United States was quite strong in the first quarter even as energy prices rose, impacting consumer sentiment and inflation expectations. Reports on consumer credit for January, small business optimism for February, business inventories for January, and retail sales for February suggested that the U.S. economy probably grew faster than previously expected in the fourth quarter (closer to 3.5% than the originally reported 2.8% growth) and that economic growth in the first

quarter of 2011 (which ends on March 31) is likely to be close to 3.5%.

However, the larger-than-expected trade deficit in January (led by a surge in oil imports), an unexpected rise in initial claims for unemployment insurance in mid-March, and a drop in consumer sentiment fueled by rising gasoline prices tempered markets’ enthusiasm for the U.S. economy. In addition, the release of the February budget data for the U.S. government served to remind markets that the United States is well on its way to another record budget deficit in fiscal year 2011, which ends at the end of September.

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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. 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. Personal Consumption Expenditures is a measure of price changes in consumer goods and services. Personal consumption expenditures consist of the actual and imputed expenditures of households; the measure includes data pertaining to durables, non-durables and services. It is essentially a measure of goods and service targeted toward individuals and consumed by individuals.

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

Weekly Market Commentary

Economy Appears to be Accelerating as it Absorbs Higher Energy Prices

A relatively quiet period for economic data and events this week in the United States should allow financial market participants to focus on the troubling rise in energy prices that has accompanied the ongoing political unrest in the Middle East. Outside the United States, a full slate of economic data in China and a scattering of central bank policy meetings will compete for the market’s attention. Finally, markets will continue to mull over the February employment report (released on Friday, March 4), which revealed that the U.S. labor market may have finally turned the corner. Aside from the monthly jobs report, the other economic data released last week was equally strong, suggesting that the economy was accelerating (not decelerating as it was in 2007-2008) as it began to absorb the higher consumer energy prices.

Rising Gasoline Prices to Impact Consumer Spending in February and Beyond

Aside from the regular weekly readings on retail sales, mortgage applications and initial claims for unemployment insurance, the only potentially market-moving economic report due out in the United States this week is the U.S. government’s retail sales report (issued by the Commerce Department) for February. The nation’s retailers reported their sales last week and results again exceeded expectations despite higher energy prices. The government’s monthly retail sales report this week extends beyond chain store retailers and includes sales at auto dealers, gasoline service stations, restaurants, grocery stores, sporting goods stores, electronic, furniture and appliance stores.

The broadest measure of consumer spending is the monthly report on personal consumption expenditures. This report includes all consumer purchases captured in the retail sales report, and also consumer spending on services—haircuts, dry cleaning, healthcare, public transportation, airfares, utilities, hotels, theme parks, legal fees, insurance, childcare, entertainment, college tuition, etc.—which together accounts for 70% of consumer spending. Consumer spending, in turn, accounts for about two-thirds of gross domestic product. Spending on services is, for the most part, not captured in the retail sales report due out this week. The February personal consumption data is due out in late March.

Although most of the rise in gasoline prices occurred in the latter half of February, gasoline service station sales are likely to have a big impact on overall retail sales in February. In addition, vehicle manufacturers already reported their February sales (the strongest in three years), so the market is likely to focus on “core” retail sales (sales excluding gasoline, auto dealers and building supply stores) to get the best reading on the underlying health of the consumer in February. Core retail sales is at an all-time high (surpassing its 2007 peak in early 2010), and was up 5.1% year-over-year in January 2011. By comparison, core retail sales growth averaged about 6.0% in the mid-2000s recovery.

The solid but not spectacular gains in retail sales in recent months are being driven by:

·         Personal income is up 4.7% year-over-year in January 2011 (income growth averaged 6% during the mid-2000s recovery)

·         Ongoing repair of consumer balance sheets (monthly debt payments relative to incomes are below their long-term average)

·         Higher consumer net worth (flat housing prices and a 100% gain in equity prices over the past two years)

On the downside, rising consumer energy prices, the lack of mortgage equity withdrawal (home equity loans were a sizeable source of spending power for homeowners in the mid-2000s), and a subdued labor market recovery are restraining consumer activity. On balance, we expect modest gains in consumer spending in 2011, stronger than 2010, though below the long-term average for this point in the economic cycle.

Strong February Jobs Report Caps off a Strong Week for Economic Data

As previously noted, last week’s batch of economic data (mainly for January and February) was almost universally strong. Personal income, personal spending, vehicle sales, the Beige Book, the ISM reports on manufacturing and nonmanufacturing, weekly initial claims for unemployment insurance, and chain store sales all matched or exceeded expectations. In general, last week’s data followed the pattern observed at the start of 2011 which saw severe weather in January dampen economic activity that gave way to more normal weather in February, boosting economic activity.

The strong February jobs report capped off the week. On balance, the data suggest that the U.S. economy was gathering momentum in early February 2011, and was probably in a better position to absorb the rise in consumer energy prices than it was in 2007-2008, when oil prices rose from $50 to $150 per barrel, and gasoline prices moved from around $2.00 per gallon to over $4.00 per gallon between early 2007 and mid-2008.

The private sector added 222,000 jobs in February, a snapback from the meager 68,000 jobs added in January. Severe winter weather had a big impact on the job count in January, and market participants are likely to average the payroll job count in January and February to get a better sense of the underlying health of the labor market. At 145,000, the average job gain in the first two months of 2011 is an improvement over where we were six months ago, but is probably not yet robust enough to convince the Fed that the labor market is completely healed. There were solid job gains in manufacturing, construction, transportation, and leisure. State and local governments shed another 30,000 jobs in February and have lost 400,000 since the end of the recession.

We remind readers that the monthly jobs report is made up of two surveys, the establishment survey and the household survey. The establishment survey generates the payroll job count data previously mentioned, while the household survey produces the unemployment rate. The unemployment rate is calculated by dividing the number of unemployed persons by the total number of people in the labor force. In February, the number of unemployed persons fell by 190,000 to 13.7 million and has declined by 1.4 million in the past three months. This is consistent with the drop in initial filings for unemployment benefits over the past three months. The labor force increased by 60,000 in February to 153.2 million, so the unemployment rate (13.7 million/153.2 million) fell from 9.0% in January to 8.9% in February.

While a promising sign, the strong February jobs report by no means signals an “all clear” for the labor market. The economy shed 8.8 million private sector jobs between January 2008 and February 2010, and has added just 1.5 million jobs back since early 2010. At the pace of job creation seen in February (222,000) it would take another 33 months (nearly three years) to recoup all the jobs lost in the Great Recession.

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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. 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. The fast price swings in commodities and currencies will result in significant volatility in an investor's holdings. The 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.

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

Weekly Market Commentary

Will Rising Energy Prices Derail the Recovery?

Financial market participants face a barrage of key policy events and economic data this week as they try to assess the impact of rising consumer energy prices on the global economic recovery. On the policy side, Federal Reserve (Fed) Chairman Bernanke will deliver key testimony on the economy and monetary policy, the Fed will release its Beige Book (a qualitative assessment of economic conditions in the United States), and central banks in Canada, Brazil, Australia, India, Indonesia and the European Central Bank (ECB) all meet to set policy this week. In addition, a shutdown of the U.S. government looms later in the week (March 4) as Congress scrambles to cobble together a spending bill that both parties can agree to.

On the economic front, the week is full of potentially market-moving reports. Early in the week, reports on manufacturing sentiment in the United States (Chicago Area Purchasing Managers Index), the Institute for Supply Management’s (ISM) report on Business for February, along with a report on Chinese manufacturing sentiment in February will garner most of the market’s attention. By midweek, the market will begin to focus on the state of the labor market in February with the release of the Challenger-tracked corporate layoff announcements and ADP employment report. The consumer is in the mix this week as well, with reports on consumer spending and personal income for January, vehicle sales for February, and chain store sales for February all due out. The week concludes with the much-anticipated February employment report, which is likely to show that the economy added over 200,000 jobs after severe weather held down employment in January.

Last week’s economic data and events were dominated by the sharp rise in oil prices, which, in turn, were largely the result of further unrest in the Middle East, mainly in Libya. The drop in initial claims for unemployment insurance, the gains in consumer confidence, Richmond Fed manufacturing index and weekly retail sales (all data readings for February) were consistent with previously released data for February. This data suggests that severe weather negatively impacted economic activity in January and that more normal weather in February allowed for a sharp rebound in activity. Thus, the underlying health of the U.S. economy can best be measured by taking an average of January and February’s data. Weak reports (for January) released last week included new home sales, and durable goods orders and shipments. We expect that when this data is reported for February (in late March), it too will show a rebound in activity.

Will Rising Consumer Energy Prices Derail the Recovery?

We will shift our focus now to the issue of rising energy prices and its impact on the economic recovery and on the consumer in particular. As we previously noted, one of the biggest threats to the economic recovery is a big spike in energy prices that would sharply curtail consumer spending and, to a lesser extent, business spending and lead to a slowdown in the economy and a potential recession. The relentless rise in consumer energy prices in the mid-2000s (from 2003 through mid-2008) were a major factor in derailing the mid-2000s (2002-2007) economic recovery and we remain vigilant to those risks.

Detailed data on consumer spending in January 2011 found in the monthly report on personal income and spending help to provide a broader perspective on what consumers spend on energy related goods and services. In January 2011, consumers spent an annualized $631 billion on energy goods and services (gasoline, home heating oil, propane, electricity, natural gas, etc.). The data on spending is adjusted for seasonality, so it takes into account the fact that people spend more on heating oil and natural gas in January than they do in June, but also accounts for the fact that consumers do more driving in June than in January. Seasonally adjusting data allows us to compare month-to-month changes in dataset and also allows us to compare spending in one month to spending in a different month on an “apples-to-apples” basis.                                                           

Out of context, $631 billion appears to be a great deal of money, but when compared to total personal spending ($10.6 trillion in January 2011), personal income ($12.9 trillion) and gross domestic product ($14.9 trillion), consumer spending on energy and energy services is relatively small. On balance, 6% of consumer spending and around 5% of personal incomes were spent on energy and energy services in January 2011. While low, these readings have moved steadily higher over the past two years, as prices of energy climbed from their Great Recession lows. For example, at the peak of energy prices in July 2008, consumers spent $710 billion on energy goods and services, representing 7% of total personal spending and 5.7% of personal incomes. In the worst of the Great Recession in late 2008, spending on energy goods and services sunk to $469 billion (4.8% of spending and 3.8% of incomes).

Higher energy costs impact businesses as well, although the data on what businesses spend on energy related goods and services is not as detailed as the consumer spending data. On balance, energy costs account for between 5 and 10% of overall business costs. By comparison, labor costs are roughly 70% of business costs. We note that the most noticeable impact on businesses from higher energy prices is on shipping and transportation costs. Businesses will try to pass these higher transport and shipping costs onto the end user (typically, the consumer), and if they are unable to pass on these costs, businesses profit margins (which are near record high) could suffer, which would slow corporate profit growth.

Since December 2008, spending on energy goods and services has moved from 4.8% of total consumer spending to 6.0% of spending, but still shy of the 7.0% of spending hit in mid-2008. Even that elevated reading was dwarfed by the near 10% of spending on energy goods and services relative to total spending seen in the late 1970s and early 1980s. Still, it is how far and how fast energy spending rises that matters most, and by those metrics the recent rise in consumer spending on energy goods and services is still muted. For example, in 1973, consumer spending on energy goods and services accounted for around 6% of total spending. After two oil embargoes (1973 and 1979), consumer energy spending accounted for nearly 10% of spending by 1980. This rising share of energy spending acted as a tax on the economy during the mid-to-late 1970s, slowing consumer spending and the overall economy, contributing to three recessions (1973- 75, 1980 and 1981-82).

Energy spending as a percent of total spending troughed in the early 2000s at around 4.0%, and by mid-2008 had nearly doubled to 7%. In our view, the surge from around 5% in late 2006 to the aforementioned peak in mid- 2008 (7%) was a key factor in causing the onset of the Great Recession in late 2007. In short, the move higher in energy prices and spending in the last 24 months or so has probably not been sharp enough or rapid enough to derail the recovery by itself. However, should consumer energy prices (gasoline, heating oil, electricity) move sharply higher in the coming months, and income gains reverse course and stagnate, the recovery would be in jeopardy. We will continue to monitor this important metric closely.

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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 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.

The Richmond Fed Index is based on one of many regional surveys that measure manufacturing activity. These surveys can be of some help in forecasting the national NAPM - particularly the Philadelphia and Chicago surveys which are more closely watched due to their timeliness and the fact that these regions represent a reasonable cross section of national manufacturing activities. This report is released after the National Association Purchasing Managers (NAPM) survey and is therefore of little value.

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