Weekly Economic Commentary

What’s The Consensus?

This week (July 25 – 29), the global economic and policy calendar really heats up after a relatively quiet week last week. Of course, until a resolution on raising the debt ceiling in the United States is reached (the deadline is August 2), market participants will be focused on Washington rather than on the economic data. In addition, another 175 S&P 500 companies will report their second quarter results this week, and these earnings reports may also divert attention away from Washington, at least temporarily.

In the United States, the Federal Reserve's (Fed) Beige Book (a qualitative assessment of economic and business conditions in each of the 12 Fed districts) and the second quarter report on gross domestic product (GDP) will get the most attention from the financial media, but regional manufacturing reports for July, the June durable goods report, and, of course, jobless claims could also be market movers. Overseas, India's central bank meets to set policy, as does the Reserve Bank of New Zealand. Many emerging market central banks, as well as central banks of developed economies with heavy exposure to commodities, are still raising rates to combat booming growth and accelerating inflation. Although China may hike rates again at any time, and Brazil raised rates for the fifth time since early 2010 last week, many overseas central banks are likely much closer to the end of their tightening cycles than they were in the early part of 2011.

It is expected to be a quiet week on the economic data front in China, with the next key data point being the release of the July purchasing managers index on July 31. However, a number of key reports on Japan's economy (industrial production, retail sales, construction) covering June will be released this week that should help markets gauge the pace of the recovery from the earthquake and tsunami. As noted in the section below, the Japanese earthquake and tsunami temporarily dampened economic activity in the United States in the second quarter of 2011, and the market expects that the reversal of these temporary factors will lift growth in the third quarter of 2011. Company specific data from Japan’s automakers (released over the weekend of July 23 – 24) suggest that there was rapid improvement in the auto supply chain in June, which bodes well for a strong reading on June industrial production in Japan, which is due out on Friday, July 29.

At the start of 2011, the consensus (as measured by a survey of 65 economists by Bloomberg news) forecast for real GDP growth in the United States in 2011 was for growth of 3.1%. Today, that consensus forecast stands at just 2.5%. Our view today, as it was at the beginning of the year, is that the United States economy will grow between 2.5 and 3.0% in 2011. Note that real GDP growth has averaged 2.8% since 1980. Thus, at the start of the year, we had a below consensus view of GDP growth in 2011, and today, our view is roughly in line with consensus. Interestingly, while we stuck to our view over the first six months of 2011, the consensus forecast rose (to as high as 3.2% by February 2011), and fell (to the aforementioned 2.5%) this year.

The consensus forecast for growth in 2012 in the United States stands at 3.0%, versus 3.2% in January 2011. By comparison, the Fed is expecting GDP growth to average 2.8% in 2011 and 3.5% in 2012. It is notable that both Fed forecasts are above the consensus. In our view, the Fed is more likely to lower than raise its forecast for economic growth in the coming months. The next Fed forecast is set to be released in November 2011.

Turning now to the outlook for global growth, we find that the consensus is looking for 4.0% GDP growth in 2011, only slightly below the 4.2% growth the consensus was expecting in January 2011. The key driver here remains growth in emerging market economies, which are expected to experience 6.6% growth in 2011 and 6.4% in 2012, roughly triple the forecast for the developed world (2.2% in 2011 and 2.6% in 2012). Strong GDP growth in emerging market economies — despite the many rate hikes implemented by most emerging market central banks over the past 18 months — continues to drive not only global GDP growth, but also U.S. exports and U.S. corporate profits. Merchandise trade data compiled by the United States Department of Commerce shows that around 50% of U.S. exports go to emerging market economies.

Taking a shorter-term view, the consensus estimate for U.S. economic growth in the second quarter of 2011 is for a 1.8% quarter-over-quarter gain in real GDP after a 1.9% quarter-over-quarter gain in the first quarter of 2011. The second quarter GDP data is due out on Friday, July 29, 2011. As is typically the case this time of year, the government agency that compiles the GDP data, the Bureau of Economic Analysis (BEA), will also release revised data on GDP and its components (consumer spending, exports, government spending, etc.) back to 2008. Some components will be revised back to early 2003. While the revisions to prior data won’t change the investing landscape- after all, markets are forward looking, the data will be pored over by pundits, the media and politicians looking for ways to assign blame (or take credit) for the Great Recession and the recovery over the past two years.

Several temporary factors (severe weather, floods, and Japanese earthquake-related supply chain disruptions, high consumer energy prices) likely curtailed growth in the second quarter. While we expect these weights on growth to lift in the second half of the year and foster more rapid growth, several factors that weighed on growth in the first half of 2011 will continue to weigh upon growth in the second half of 2011 and beyond. Among these longer term issues are:

·         Ongoing layoffs in state and local governments

·         A moribund residential and commercial real estate market

·         A tepid labor market

·         Sagging business and consumer confidence

Until these longer term weights on growth are resolved, the prospects for economic growth in the United States are muted. In short, while the U.S. economy has experienced a relatively modest recovery — roughly in line with the recoveries from the mild recessions in the early 1990s and early 2000s — when compared to the severity of the Great Recession, the recovery does not “feel” like a real recovery. It is not likely, unfortunately, that the second quarter GDP report will change that view.

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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 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.

An emerging market is a nation that is progressing toward becoming advanced, as shown by some liquidity in local debt and equity markets and the existence of some form of market exchange and regulatory body.

Developed economies are typically described as a country with a relatively high level of economic growth and security. Some of the most common criteria for evaluating a country's degree of development are per capita income or gross domestic product (GDP), level of industrialization, general standard of living and the amount of widespread infrastructure. Increasingly other non-economic factors are included in evaluating an economy or country's degree of development, such as the Human Development Index (HDI) which reflects relative degrees of education, literacy and health.

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

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

Tracking #748665 (Exp. 07/12)

Weekly Economic Commentary

What’s Missing?

Economics and central bank policy will most likely play second fiddle to the ongoing debt ceiling debate in the United States, the fiscal woes in Europe, and the heart of the second quarter earnings reporting season for S&P 500 companies. Housing data (homebuilder sentiment, housing starts, building permits, existing and pending home sales) will dominate the week, but the key report of the week may very well be the July reading of the Philadelphia Fed manufacturing index. Overseas, data on June consumer spending in Japan and July manufacturing in China will draw the most attention from market participants. It is a relatively quiet week for the Federal Reserve, with only a few speakers on the docket. Meanwhile the central banks in Brazil, Canada, India and South Africa meet this week, with only Brazil poised to raise rates. Indeed, many overseas central banks may now be much closer to the end of their tightening cycles than they were in the early part of 2011.

The Great Recession ended over two years ago and yet, economic growth remains sluggish, the labor market is still moribund, and consumer confidence has barely budged since June of 2009. So what’s missing? The answer of course, is in the question: The recovery is missing growth, and jobs and confidence, but why? The section below briefly examines how we got here (i.e. two years into the recovery) and what makes this recovery “different” from prior economic recoveries. Our answers may surprise you.

In testimony to Congress last week (July 11 – 15), Federal Reserve Chairman Ben Bernanke noted that although the economy was growing, and expected to continue to grow in the coming quarters, headwinds to growth were prevalent. The headwinds noted by Bernanke included the following:

·         Slow growth in consumer spending, even after accounting for the effects of higher food and energy prices

·         The continuing depressed condition of the housing sector

·         Still-limited access to credit for some households and small businesses

·         Fiscal tightening at all levels of government.

In prior public appearances over the past few months, Bernanke, in addition to mentioning temporary factors—the earthquake and Tsunami in Japan and its impact on the global supply chains, severe weather and higher energy prices—has cited “weakness in the financial sector” and “balance sheet and deleveraging issues” as longer-term issues that may be impacting the recovery.

While consumers have “hung in there” as we expected at the beginning of 2011 (see 2011 Outlook publication), the slow labor market and ongoing repair of consumer balance sheets (i.e. consumers are paying down debt and saving, along with doing a little spending) has clearly limited the consumers’ influence on the recovery. Through the first seven quarters of the recovery (the second quarter of 2009 through the first quarter of 2011), consumer spending’s contribution to overall real domestic product (GDP) growth has been 11 percentage points, which sounds great considering that consumer spending accounts for two-thirds of GDP. But the consumer’s contribution to GDP growth in this recovery pales when compared to the recoveries following the mild 1990 – 91 and 2001 recessions, and is not even in the same league with the performance of the consumer following the severe 1973 – 75 and 1981 – 82 recessions.

Contribution to GDP Growth Over the First Seven Quarters of Recovery

(In Percentage Points of GDP Growth)

                             Recovery             Recovery            Recovery              Recovery             Recovery

                             From Great           From 2001           From 1990-91       From 1981-82       From 1973-75

                             Recession            Recession           Recession            Recession            Recession

Consumer              11.0                        13.3                        15.4                        24.7                        18.9

Spending

Housing                 -0.3                         3.0                          3.0                          7.3                          6.2

State & Local        -1.5                          0.8                          1.4                          2.2                          0.2

Government

Spending

Source: Haver 07/18/11

On average, during the first seven quarters of the economic recovery following the two mild recessions (1990 – 91 and 2001), consumer spending contributed around 14 percentage points to growth. In the similar period following the severe recessions (1973 – 75 and 1981 – 82), consumer spending contributed around 22 percentage points to growth. Tepid real income growth which, in turn, is a result of tepid job growth, takes most of the blame here during the current recovery, along with the aforementioned balance sheet repair. Looking ahead, the consumer-related headwinds are likely to persist, keeping a lid on spending and consumer confidence. Our forecast remains that the consumer will continue to “hang in there” but will not be the driver of economic growth it was during similar stages of prior recoveries.

Turning now to housing, over the first seven quarters of the current recovery, housing has been a net drag on overall GDP growth, marking the first time in the post-WWII era that housing has not made a contribution to overall economic growth this far into a recovery. On average, during the economic recoveries following mild recessions, housing contributed three percentage points to GDP growth, and that figure is closer to seven percentage points in recoveries from severe recessions. As one might expect, the weakness in housing in this recovery has had a major impact on employment in the construction industry.

Construction employment has declined at a 3.7% annualized pace since June 2009, while in the recoveries from the severe recessions in the 70s and 80s, construction employment at this point in the cycle had increased by 4.0%. Looking ahead, housing is likely to continue to bounce along the bottom, not getting any worse, but not getting any better either.

A large overhang of unsold existing homes—officially around four million, but there are another two million or so existing homes in the so-called “shadow inventory” (bank-owned houses mired in the foreclosure pipeline) —continues to be the largest impediment to an improved housing market, although tighter lending standards (relative to the 2002 – 2006 boom years) and a tepid labor market are also helping to restrain housing. On the plus side, housing affordability (the ability of a family with the median income to afford the payment on the median priced house) is at an all-time high, and banks are becoming more willing to lend in this sector. There is a ton of housing-related data due out this week for June and July that the market will continue to monitor to assess the health of this small, but important segment of the economy.

Since WWII, state and local government spending and employment has been a reliable source of economic growth at virtually all points in the business cycle. But as noted last week by Fed Chairman Bernanke (and often by LPL Financial Research in recent months) state and local governments have been an unprecedented impediment to growth and employment in this recovery.

For the first time since WWII, state and local government spending has not added to growth over the first seven quarters of an economic recovery. In fact, state and local government spending has subtracted one and a half percentage points from growth over the past two years, and state and local government employment has contracted at a 1.5% annualized rate over that time. In contrast, state and local government spending has added around one full percentage point to growth over the first seven quarters of the prior four economic recoveries, while adding jobs at a 1.5% annualized rate. Looking ahead, the best case would be that state and local government’s contribution to GDP growth stabilizes, and that the job losses seen in the sector continue at the current pace (around 15,000 to 20,000 per month) for the foreseeable future, as states and municipalities of all sizes continue to struggle with too much spending and not enough revenue.

Of course, the lack of contribution from state and local government and housing, along with the historically low contribution from the consumer at this stage of the recovery, has left the heaving lifting to the export sector, inventory accumulation, business spending and, of course, federal government spending. Three of the four of the drivers of growth thus far in the recovery—business capital spending, exports, and inventory accumulation—appear likely to continue, while federal government spending will likely fade as budget cuts at the federal level loom on the horizon.

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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 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.

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

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 notan 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

Tracking #746685 (Exp. 07/12)

Weekly Economic Commentary

A Confidence Game

Data on inflation, the consumer, and the manufacturing sector in the United States all will compete for attention this week with the latest round of debt ceiling talks in Washington, the Chinese economic data for June, and the start of the Q2 2011 earnings reporting season for most S&P 500 companies. The Federal Reserve (Fed) will also join the mix this week, as they release the minutes of the June 21 – 22 Federal Open Market Committee (FOMC) meeting and Fed Chairman Ben Bernanke will deliver his semiannual Monetary Policy testimony to Congress. More concerns over the fiscal health of Europe (the latest flare-up involves Italy) will also be on the market’s radar this week, as will central bank meetings in Japan, Indonesia, South Korea, Thailand and Chile. Finally, last week’s disappointingly weak June jobs report is likely to continue to reverberate through the market, as participants continue to wait for the long awaited “bounce” in economic data, after an economically difficult second quarter, impacted by weather, natural disasters at home, and, of course, the Japanese earthquake.

Bernanke on the Hot Seat in Congress This Week

In years past, a Fed chairman appearance before the House Financial Services Committee to deliver the Congressionally-mandated semiannual monetary policy testimony (formerly known as the Humphrey Hawkins testimony) would be met with a great deal of anticipation and hype from the market, and especially the financial media. This year, however, the approach of current Fed Chairman Ben Bernanke’s testimony has not generated as much buzz. The reason may be that while in years past the Humphrey Hawkins testimony was one of the only opportunities anyone outside the Fed had a chance to ask the Fed Chairman a question, or to allow the Fed Chairman to elaborate on various issues. These days, the Fed is more transparent than ever. In just the past two and a half years, Bernanke has appeared on the CBS news magazine 60 Minutes twice, held several “town hall” meetings, held a limited access press conference (where questions were submitted in advance) and, more recently, has conducted two full-scale press conferences, where reporters can ask Bernanke whatever they want.

Still, in the wake of the weak June jobs report, and in the midst of the debt ceiling debate, Bernanke’s comments will be closely watched by market participants. It is quite likely that Fed Chairman Bernanke will be grilled by Congress on the economy, and especially the labor market, and what, if anything, the Fed can do to create more jobs. Bernanke’s response is likely to be similar to the responses given in his recent press conferences (April 27 and June 22), in which he described the economy as frustratingly slow and uneven. In addition, members of Congress are likely to question Bernanke about the ongoing debt ceiling debate. In response, Bernanke is likely to gently remind the members of the House Financial Services committee (who are essentially his boss) that it is Congress’ jobs to balance the budget, while it is the Fed’s job to run monetary policy.

In recent public appearances, Bernanke has suggested that the budget negotiations focus on the long term, and that it would be very desirable to take “strong action” to lower the budget deficit over the long term. However, Bernanke has also made it clear that “it would be best not to have sudden and sharp fiscal consolidation in the very near term” as it does not do much for the long-run budget situation and is "just a negative for growth”. Finally, Bernanke is likely to be asked under what conditions the Fed would consider doing more to help the economy, i.e. more quantitative easing (QE3).

When asked about the possibility of QE3 at his last press conference on June 22, Bernanke downplayed the idea, noting that the risk of deflation had waned and that economic activity had picked up since the summer of 2010 when the Fed first hinted at QE2. He did leave the door open slightly saying that the Fed would “continue to monitor’ economic activity and “act as needed.” Our view here remains that the hurdle for the Fed to embark on QE3 remains very high.

June Jobs Report Jolts Markets

The June jobs report was a major disappointment to markets, and to those market participants (including ourselves) that had been saying that the economic “soft spot” had ended and that the economy would reaccelerate back to a slightly more robust growth path in the second half of the year. Even after seeing the report, we maintain the view that the private sector economy can create between 200,000 and 250,000 jobs per month in the next few years, which would be enough to push the unemployment rate down slightly, and keep the consumer “hanging in there” as a support to modest growth in the economy. Our forecast for the United States economy and the labor market in particular, continues to be below the consensus, although the consensus has moved down considerably since the beginning of 2011.

The June nonfarm payroll jobs report (which is actually two reports in one) revealed that the private sector economy created just 57,000 jobs in June, the fewest in any month since June 2010. Making matters worse, the job count in the prior two months was revised downward by 44,000. Over the past two months (May and June 2011) the economy added an average of just 65,000 jobs per month, after adding close to 225,000 per month in the early part of 2011. The data that generates the monthly job count is based on a survey of 140,000 businesses across the United States.

The unemployment rate, which is calculated using data culled by surveying 60,000 households about their employment status, rose 0.1% to 9.2% in June, the highest reading since December 2010. The sample sizes of both the establishment survey (140,000 businesses) and household survey (60,000 households) are extraordinarily large sample sizes for a national survey. For perspective, national polling on presidential elections only uses around 1,000 respondents.

Other than sizeable gains in retail, transportation and leisure, and hospitality employment in June, there were few bright spots in the June employment report. State and local government payrolls fell by another 25,000 and have now dropped in ten of the last eleven months. Since August 2008, state and local government employment (which at just over 19 million, accounts for around 15% of all employment in the United States) has decreased by 577,000, as states, counties, cities and towns across the country struggle in the aftermath of the Great Recession.

Despite the disappointment in June, conditions are favorable for job creation in the months ahead, although significant obstacles to hiring remain, especially in the small business community. Banks are lending again, and terms of these loans are getting more favorable, although they are not yet back to pre-2007 levels. Business capital spending is booming, corporate profits are approaching all-time record levels, and companies have plenty of cash. Near record-low market interest rates have allowed many larger corporations to reduce costs even more by refinancing existing debt. In addition, overseas growth (50% of U.S. exports go to fast-growing emerging markets) is still running at more than three times growth in the United States, even as China continues to slow its economy.

In our view, the biggest impediment to hiring may be confidence. Businesses must have confidence that the now two-year old recovery is firmly in place before committing to expanding their workforce. In addition, businesses need to be confident that our leaders in Washington and at the state and local level will tackle the debt and deficit problems, while fostering a hiring- friendly regulatory environment. On the flip side, in order to lend to businesses confidently, banks need to have certainty around their regulatory backdrop, while at the same time having confidence that the economy is strong enough to support lending.

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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.

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

Tracking #744964 (Exp. 07/12)