Weekly Economic Commentary

Housing Woes Continue

Housing and manufacturing data for April and May will provide the economic data backdrop in the United States this week, as investors react to the latest fiscal flare-up in peripheral Europe. Nearly two years into the economic recovery, the housing market remains in turmoil. We examine the positive and negative aspects of the housing market, and its impact on the health of the recovery.

Housing and Manufacturing Dominate the Week Ahead

As the market debates commodity prices and the fate of Greek debt, investors will absorb data for April and May on housing, manufacturing, and leading indicators this week. As always, markets will also digest the weekly readings on chain store sales, mortgage applications and initial filings for unemployment insurance. The Federal Reserve (Fed) will release the minutes of the April 26 – 27 Federal Open Market Committee (FOMC) meeting and several voting members of the FOMC are scheduled to make public comments this week. Overseas, it looks like a quiet week for central bank activity, as the only notable central bank meeting to set policy this week is the Bank of Japan, although another rate hike from the Peoples Bank of China (PBOC), which does not have a set schedule for its meetings, could come at any time.

The manufacturing sector will be represented this week by the Empire State Manufacturing Index for May (the first look at manufacturing in May), the Philadelphia Fed Manufacturing Index for May, along with the industrial production and capacity utilization data for April. The Empire State data was released as this report was being prepared and revealed that manufacturing activity continued to expand in New York State in May, but at a slower pace than in April. The 11.88 reading in May (a reading above zero in this Index indicates an expanding manufacturing sector in the New York region while a reading below zero indicates contraction in the sector) was the sixth consecutive reading above zero, and the twenty-second reading above zero in the past 23 months dating back to the beginning of the economic recovery in June 2009. We expect the rest of the month’s manufacturing data, including the Institute for Supply Management’s (ISM) report on Manufacturing, to show a similar pattern — continued growth in the manufacturing sector in May, but at a slower rate than in April. This pattern is consistent with the behavior of the manufacturing sector at a similar point (i.e., two years in) in virtually every other economic recovery since World War II.

Housing Market Still Struggling Two Years Into the Economic Recovery

Housing data for April and May will dominate this week, as we reach the peak weeks of the important spring selling season in the housing market. At the beginning of the week, the National Association of Homebuilders (NAHB) survey for May will provide a crucial update on the health of the new home market. At the end of the week, the existing home sales data for April will provide some color in the market that is still suffering the after-effects of the bursting of the mortgage debt bubble. In between, data on housing starts and building permits for April will be released.

There are many positives for the housing market including:

·         Homebuyer affordability (the ability of a household with the median income to afford the payments on a median priced home) is at an all-time high

·         The ratio of home prices to median income is at an all-time low (indicating that the housing bubble that peaked in 2005 has now fully deflated, and then some)

·         Banks’ lending standards for making home loans have been loosening since mid-2008

·         The financial obligations ratio (the ratio of financial obligations — including automobile lease payments, rental payments on tenant-occupied property, homeowners' insurance and property tax payments — to disposable personal income) for renters is at a 16-year low

·         The inventory of unsold new homes is at an all-time low. As noted below however, it’s the inventory of unsold existing homes that is the concern

·         A rapidly improving foreclosure pipeline (mortgage delinquencies, defaults, bank-owned houses)

Nationwide, the housing market (sales, prices, construction) has been stagnant, at best, since bottoming out in early 2009, with the recent slide in home prices nationwide receiving most of the financial media’s attention. But the housing market is “local” and while the national stats on housing have stabilized, pockets of severe weakness remain in places like California, Nevada, Florida, Michigan and Arizona.

The main issue remains the huge inventory of unsold existing homes (3.5 million as of March 2011) plus the so called “shadow inventory” of bank-owned and foreclosed homes (roughly 3 to 4 million) that will enter the market. In addition, the slowdown in the later stages of the aforementioned foreclosure pipeline may largely be the result of the delays in processing documents rather than a fundamental improvement in the housing market. In addition, “distressed” sales continue to account for a large portion (one-quarter to one-third) of all existing home sales, putting further downward pressure on prices.

The housing market impacts the overall economy via several avenues. The most direct impact is on home construction. In 2010, construction of new homes accounted for around 2% of gross domestic product (GDP), down from 6% at the peak of the housing boom in 2005-2006. Not much was expected out of housing in 2011, and thus far, the sector is meeting those lowered expectations. Housing also impacts GDP indirectly via construction employment, commissions of real estate and mortgage brokers, and most importantly, via the wealth effect.

In April 2011, 564,000 people were employed in building houses and condos, representing less than one half of one percent of total private sector employment. At the peak of the housing bubble in 2005-2006, 1.1 million people were employed in the construction of new houses and condos, representing close to 1% of private sector employment. It is quite unlikely that the nearly 500,000 construction jobs lost over the past five years are coming back anytime soon. At the peak, nearly 2.2 million people were employed in the real estate industry as brokers and lenders. Today, that figure is closer to 1.9 million workers, and the 200,000 or so jobs lost here are unlikely to come back soon either.

The wealth effect associated with housing probably has the largest indirect impact on the economy. At the peak in 2005 – 2006, the value of residential real-estate (less the debt associated with residential real estate) stood at nearly $16 trillion. At the worst of the housing bust in early 2009, the value of real estate net of home mortgages was under $8 trillion. Today, more than two years later, the value of residential real estate (less real estate debt) remains close to $8 trillion. The good news is that despite the lackluster performance of real estate, overall household net worth (household assets less household liabilities) has increased by nearly $8 trillion since the early 2009 low, thanks to the surge in the stock market — and despite the flat performance of residential real estate. Still, in order for the consumer to fully recover the spending power it had prior to the real estate downturn, the housing market has to start to perform better. The economic recovery has occurred without the help of housing, and can continue without the help of housing, but the recovery is not likely to feel like a real recovery — nor achieve a more robust pace of growth — for most American’s until housing can regain some of its former glory.

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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.

The NY Empire State Index is a regional economic indicator published by the Federal Reserve Bank of New York and released around the middle of the month. It's considered to be an indicator of economic conditions in one of the most populated states in the U.S.

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 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 Economic Commentary

Inflation Is Key This Week

Reports on April inflation dominate this week’s economic calendar, but China’s economic calendar and a possible rate hike in China are also on the market’s radar. The April jobs report was solid (not spectacular), but it is still a long climb back for the labor market.

As we noted in last week’s Weekly Economic Commentary, the first week of every month is chock full of timely economic data. The busy first week of the month usually gives way to a quiet “week after,” but that is not the case this week (May 9 – 13, 2011). Market participants have plenty of data to digest as they mull over last week’s data, which included the April jobs report, and market action, headlined by the plunge in commodity prices.

The key reports this week in the U.S. are on inflation and inflation expectations, but data on the March trade balance and April retail sales will garner plenty of attention as well. In addition, this week is when Chinese authorities release most of their economic data for April. The full slate of economic data in China coincides with the 2011 United States-China Strategic and Economic Dialogue in Washington, D.C. China’s currency and interest rate policies, as well as the U.S. fiscal policy, are likely to be among the key topics of conversation at the summit. Markets are still anticipating another few interest rate hikes from the Chinese central bank, the Peoples Bank of China (PBOC), and the next move could come at any time. Accelerating inflation in China (5.2% year-over-year CPI inflation expected in China in April) is pushing the PBOC to act and inflation data for April due out in the U.S. this week could put similar pressure on the Federal Reserve (Fed).

April readings on the Consumer Price Index (CPI) and producer price index (PPI) are due out this week in the U.S., along with the early May reading on consumers’ inflation expectations from the University of Michigan’s Survey of Consumers. The year-over-year readings on the PPI and CPI are going to grab plenty of attention, with the PPI likely to post a 6.5% year-over-year gain and the CPI a 3.1% year-over-year increase. Both indices are being driven higher by surging energy and commodity prices, although the gap between the PPI (6.5% year-over-year) and CPI (+3.1% year-over-year) underscores the “firewall” between higher commodity costs and the consumer. We’ll discuss this firewall effect later in this report.

Beyond what are likely to be startlingly large increases in the headline PPI and CPI, the core (excluding food and energy) readings on both are expected to be muted, which should give the Fed comfort. Still, in our view, Fed policymakers face a communications (and potentially a credibility) problem as headline inflation surges but core inflation — which is what the Fed focuses on when making monetary policy decisions — remains tame. Although our view is that Fed Chairman Bernanke did a solid job in his first-ever post Federal Open Market Committee (FOMC) press conference on April 27, his response to the questions around headline versus core inflation was not convincing. Bernanke has another chance to answer these types of questions following the June 22 FOMC meeting.

At the aforementioned April 27 press conference, Bernanke did mention that Fed policymakers were closely monitoring inflation expectations. One very timely measure of inflation expectations can be found in the University of Michigan’s Survey of Consumer Sentiment. That survey asks consumers what their expectations are for inflation over the next year and five years. The Fed typically focuses on the five-year number. Consumer’s five year ahead inflation expectations have been stable for the past ten to 15 years, after falling sharply between the late 70s and early 80s through the late 90s. The latest reading, at 2.9%, is right at the average reading over the last ten years or so. The Fed has made it clear that any upward move in inflation expectations would be met with tighter monetary policy, which makes this data point from the University of Michigan one of the most important indicators for market participants to monitor as the Fed prepares to remove the monetary stimulus from the system.

Solid April Jobs Report, but it is Still a Long Climb Back for the Labor Market

The private sector economy created 268,000 jobs in April, the 14th consecutive monthly gain. The result was better-than-expected and represented acceleration in job creation versus the prior month. A portion of the gain in jobs in April may have been related to the late Easter (April 24) in 2011 versus 2010 (April 4), which pushed some retail and lodging and leisure hiring into April this year, but the impact of the Japanese earthquake on the global supply chain may have held down hours worked and some hiring in the United States. State and local government hiring remains the weak spot in the employment market, as another 22,000 were lost here, bringing the total number of jobs shed in the state and local government sector since the end of the recession to nearly 430,000.

While not a booming report on the health of the labor market, the April jobs report (released Friday, May 6) suggests that the United States labor market weathered higher oil prices and the supply chain disruptions in Japan quite well thus far. In addition, the report serves as a reminder that while unemployment claims — which have moved higher in recent weeks raising concerns about a “double dip” recession — are a great, timely indicator of the health of the labor market, they say more about the unemployment rate than they do about the pace of hiring. Adding to the positive backdrop for the global economy was the April labor market report for Canada, which was also released on Friday, May 6. The Canadian economy added 58,000 jobs in April, which given the size of the respective economies, is the equivalent of 450,000 new jobs in the United States. The result far exceeded expectations and serves as further confirmation of continued growth in the global economy in the months and quarters ahead.

The monthly jobs report from the United States Department of Labor is actually two reports in one, which is why the unemployment rate can rise even as the number of jobs increases. The unemployment rate (the number of unemployed persons divided by number of persons in the labor force) is calculated using the "household survey," which tallies responses from 60,000 households each month (a huge number for a nationwide sample, where political polls typically survey around 1,000 people to garner data for national political races) asking them about their employment status. This month, the number of unemployed persons increased by 205,000 while the labor force increased by 15,000, leading to the higher unemployment rate. At 9.0%, the unemployment rate is below its recent peak of 10.1% (hit in the fall of 2009), but remains above the Fed’s 8.5% target for the unemployment rate for the fourth quarter of 2011.

The job count data (discussed below) is collected via the "establishment survey," which surveys 140,000 businesses and asks them about the composition of their payrolls. Over time, these two surveys (“household” and “establishment”) tend to converge and tell the same story about the labor market, but over shorter periods (a month or a quarter) they can send conflicting signals.

The April gain in private sector jobs was the most in any single month since February 2006. Over the past three months, the private sector economy has added an average of 253,000 jobs per month, also the best reading since early 2006. Encouragingly, the diffusion index (the number of industries adding workers less the number of industries shedding workers) ticked up to 64.6 in April from 64.4 in March. Over the past three months, the diffusion index has averaged 66.6, the highest reading since 1998, when the United States economy was booming. This solid reading is further confirmation that the United States labor market recovery is well underway and firmly entrenched even in the face of rising input costs and the global supply chain disruptions as a result of the earthquake and tsunami in Japan. However, the labor market still has a long way to go.

The private sector has added 2.1 million jobs in last 14 months (March 2010 through April 2011) after the private sector economy lost 8.8 million between December 2007 and February 2010. This is the best 14-month run for job creation since September 2005 through October 2006, but there is still a long, long way to go (6.7 million) to get back all the 8.8 million private sector jobs lost.

At current pace (253,000 per month over last 3 months) it will take another two years and two months to get those 6.7 million jobs back. That’s June 2013, or five and a half years after the peak in employment in December 2007.

By comparison, it took the economy four and a half years to get back to peak employment after the mild 2001 recession, and around three years after the mild 1990 – 91 recession, and less than three years to recover all the jobs lost in the severe 1981 – 82 recession.

The sluggish pace of job creation (relative to prior recoveries) is one of the reasons why this does not feel like a recovery yet to many people. This same phenomenon is also helping to keep wages muted, which acts as a firewall against soaring input prices being passed along to the end consumer. Finally, the tepid pace of job growth (and the still historically high percentage of people who have been out of work for more than six months) will resonate with the policymakers at the Fed, who are likely to be cautious about removing the stimulus too soon.

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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.

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.

Producer Price Index (PPI) is an inflationary indicator published by the U.S. Bureau of Labor Statistics to evaluate wholesale price levels in the economy.

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 Economic Commentary

Busy Week for Data and Policy

The week’s economic calendar is bookended by the April ISM report on Monday and the April jobs report on Friday. In between, both fiscal and monetary policy (at home and abroad) will take center stage.

Traditionally, the first week of every month is chock full of timely economic data. This first week of May is no different, as economic data, geopolitics and the debate over the United States’ debt ceiling is likely to replace first quarter earnings reports and guidance as the key drivers of market activity this week. From beginning to end, this week is full of crucial economic reports for April and March that will help guide actions of Federal Reserve policymakers and market participants. This ranges from the April report on business from the Institute of Supply Management (ISM) on Monday to the April employment report on Friday. In addition to the data, Congress returns to work this week after a two-week break, with the debate over the debt ceiling likely to take center stage. Market participants will also be debating the short- and long-term impact on markets and economies after U.S. forces killed Osama bin Laden, the mastermind of the September 11 terrorist attacks and leader of the al-Qaeda terrorist network.

In between the April ISM report on Monday and the April employment report on Friday, markets will digest data on the consumer (April vehicle sales, April chain store sales, March consumer credit), labor costs (productivity and unit labor costs in the first quarter of 2011), and factory orders. In addition, the regular weekly reports on retail sales, mortgage applications and initial filings for unemployment insurance are sure to draw some attention this week.

As this publication was being prepared, the ISM report on business for April was released. The report revealed that while the U.S. manufacturing sector has cooled in recent months, conditions in the manufacturing portion of the economy remain robust, and that the economic recovery that began nearly two years ago remains firmly in place. In addition, the forward-looking elements of the ISM (new orders, backlog of orders, new export orders) all suggest that the recovery will remain in place for the foreseeable future. In every economic recovery, the ISM typically gets to around 60 (it got as high as 61.4 in February 2011) and then begins to fade back to 50. A reading above 50 on the ISM suggests that the manufacturing sector is expanding. A reading above 44 on the ISM suggests that the overall economy is expanding.

Thus, while the ISM may have peaked for this cycle, we do not think this means that the economy is headed back into recession. In fact, a dip in the ISM in this point in the cycle is normal, and some easing of price pressures in the manufacturing area may allow the Fed to remain on hold a little longer.

Although all the economic reports due out this week will be closely scrutinized by markets (and the Fed), the key report is likely to be the April employment report, which is due out on Friday, May 6. The recovery in the labor market is still in its early stages (the private sector has added just over 1.8 million jobs in the last 13 months after shedding more than 8.8 million in the Great Recession and its aftermath), but it has picked up steam in recent months, having added close to 200,000 jobs per month over the last four months.

Markets are looking for a similar gain (around 200,000) in private sector employment in April and for the unemployment rate to remain at 8.8%. If the consensus is correct, the April jobs data will be another step toward recovery for the labor markets, but at its current pace, the labor market recovery is probably too slow to convince the Fed that tighter monetary policy is warranted.

Policy Parade

On the policy side, there are a scattering of Fed officials slated to speak this week, and markets will want to pay especially close attention to comments this week from Fed’s “Big Three”: Chairman Ben Bernanke, Vice Chairwoman Janet Yellen and New York Fed President Bill Dudley. Bernanke, Yellen and Dudley represent the “center of gravity” at the Fed, and their comments on the economy and interest rates should, in our view, carry more weight than comments from other Fed officials, especially vocal critics of quantitative easing (QE2) like Dallas Fed President Richard Fisher and Philadelphia Fed President Charles Plosser.

With Congress back from a two-week vacation, the nation’s fiscal situation is likely to return to the top of the headlines. Officially, the U.S. Treasury’s ability to borrow runs out on May 16, but in reality, Treasury has enough wiggle room to borrow until July 8, 2011. Between now and then, the debate over whether or not to raise the debt ceiling, how much to raise it by (a trillion would likely get us through the next year or so, while a $50 billion increase would only get us a week or two) and whether or not to tie an increase in the debt ceiling to a longer-term agreement on the scope of Federal spending and taxes will be an almost constant companion to the ups and downs of the market.

As we wrote in the April 11, 2011 Weekly Economic Commentary, in exchange for raising the debt ceiling, Congressional Republicans are most likely going to want deep cuts in spending for both fiscal year 2012 and beyond. The Senate Democrats and the White House want smaller cuts, and for spending cuts to be accompanied by tax increases. The game of “political chicken” over the debt ceiling limit in the next few months has to potential to move markets, especially the debt markets. As previously noted, a series of small ($50 billion or so) short-term increases in the debt ceiling are possible over the next few months, which would lead to a number of “drop dead” dates on the budget that may increase volatility in the financial markets.

Central bank policy will be a key theme overseas as well this week, as several major central banks, including the Reserve Bank of Australia (RBA), the Bank of England (BOE) and the European Central Bank (ECB) meet to set policy this week. Although both the RBA and the ECB have raised rates already in this economic cycle to combat domestic inflation concerns, neither central bank is expected to hike rates this week. The BOE remains on hold, perhaps in deference to the ongoing fiscal austerity in the United Kingdom, a path the Fed could choose to take should any budget deal between President Obama and the House Republicans contain sizeable spending cuts. Elsewhere, central banks in the Philippines, Romania, Malaysia, the Czech Republic and India all meet this week to set rates. Of those, both the Philippines and Malaysia could raise rates this week. Both have already hiked rates in response to booming domestic economic growth and in an effort to combat rising domestic inflation.

Although China’s central bank, the Peoples Bank of China (PBOC), does not have a set schedule for its policy actions, another move to tighten monetary policy (via interest rates or by an increase in banks reserve ratio requirements) could happen at any time, as authorities in China grapple with a booming economy and rising domestic inflation. The PBOC has raised its benchmark lending rate four times since October 2010, most recently on April 5, 2011, and has increased its reserve ratio requirement nine times since January, 2010, most recently on March 18, 2011. Over the weekend of April 30-May 1, the Chinese Purchasing Managers Index for April was released revealing that China’s manufacturing economy continued to cool in April. The report is the first information markets get on the health of the Chinese manufacturing sector each month. At the margin, the continued cooling in the Chinese manufacturing sector may mean fewer rate hikes by the PBOC in the weeks and months ahead, but the PBOC will almost certainly raise rates one or two more times, and that could happen as soon as this week.

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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.

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.

Stock investing involves risk including loss of principal.

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.

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.

Chinese Purchasing Managers Index: The PMI includes a package of indices to measure manufacturing sector performance. A reading above 50 percent indicates economic expansion, while that below 50 percent indicates contraction.

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