Weekly Economic Commentary

Bucking the Trend

Housing, the consumer, and the manufacturing sectors will likely dominate the economic landscape this week in the United States, as the U.S. government’s economic data mills make one final push ahead of the traditional lull in the economic calendar the week between Christmas and New Year’s Day. Of course, the U.S. economic data has taken a back seat to other events in recent weeks, and this week is not likely to be an exception. The debt dilemma in Europe, the final wrangling in Congress over the extension of the payroll tax cut and unemployment benefits, along with the fallout from the death of North Korean leader Kim Jong Il might once again force financial market participants’ focus elsewhere.

The state and local government sector is likely to continue exerting downward pressure on U.S. economic growth in 2012, even after restraining growth in gross domestic product (GDP) in all but three of the 15 quarters since the beginning of 2008.

The Week’s Economic Reports Likely to Take a Back Seat to Washington, Europe and Korea

Even as consumers rush to make their final purchases of the 2011 holiday shopping season — Hanukkah begins on December 20 and ends on December 28, and of course Christmas is December 25 — the government’s data mills are making one last push to get all of the economic data out the door. This week’s dataset in the United States is dominated by housing, manufacturing and the consumer. The housing data due this week includes a mix of reports on sales, prices, starts, permits and sentiment for both November and December 2011. In general, the housing reports due this week are likely to show that the modest recovery in the housing market that began nationally in early 2009 continued through the end of 2011.

Manufacturing is another focus of this week’s data in the United States. In recent months, domestic manufacturing activity has bucked the global trend of deceleration, and has reaccelerated a bit. Part of the reacceleration has come as the global supply chain returned to normal after the Japanese earthquake and tsunami. For example, auto and light truck production in the United States in the latest week (ending December 16) was the strongest since early 2008. Auto and light truck production has not been sustained at these levels since late 2007, prior to the onset of the Great Recession.

This week, data on durable goods orders and shipments in November are likely to provide further evidence that the U.S. manufacturing sector continues to move in the right direction as 2011 draws to a close. Will the likely recession in Europe along with slower growth in China and other emerging markets impact manufacturing in the United States in 2012? It almost certainly will, but it probably already has had an impact. But, despite the slowing, the underlying strength in the manufacturing sector has been stronger than the consensus thought just a few months ago.

Finally, the consumer will be in the spotlight this week as well with the regular weekly reading on retail sales due out on Tuesday, December 20, the University of Michigan’s consumer sentiment index for December on Thursday, December 22, and the November personal income and spending data on Friday, December 23. Consumer spending, which accounts for two-thirds of the overall economy, has been buoyed in recent weeks by a sharp drop in gasoline and other consumer energy prices, better news on the labor market and more stability in the housing market. Last week (December 12 – 16), the National Retail Federation (NRF) — a trade group of the nation’s retailers — raised its 2011 holiday sales forecast by a full percentage point. The group, which forecast a modest 2.8% year-over-year gain in holiday shopping in 2011 back in early October 2011, now says holiday shopping is likely to rise by 3.8% — above the long-term average gain in holiday sales of 2.6%, but below the robust 5.2% sales gain seen during the 2010 holiday shopping season.

In the past, the National Retail Federation has been very conservative in its holiday sales forecasts. Thus, the guidance provided by the NRF last week, along with the return of cold weather to much of the nation in mid-December, and the solid gain in the equity market since September, all suggest that sales are likely to come in at around 4 to 5% when all the receipts are counted. Retailers will report their December sales on Thursday, January 5.

State and Local Governments Likely to Continue to Be a Drag on Economic Growth in 2012

Since the onset of the Great Recession in the first quarter of 2008, the state and local government sector — traditionally a reliable, though modest source of strength for the U.S. economy over the past 30 years — has exerted downward pressure on economic growth amid a major disconnect between revenues and spending. Over that time (15 quarters), the state and local government sector has been a drag on overall GDP in 12 quarters, or 80% of the time. Between the end of World War II and the end of 2007, the state and local government sector made a positive contribution to growth 85% of the time.

As the Great Recession took hold, state and local governments struggled to match declining revenues — as property taxes, corporate taxes, sales taxes, income taxes and fees all were negatively impacted by the downturn — with rising costs. The most visible realignment of costs to lower revenues came in state and local government employment. Since peaking in August 2008, state and local governments have shed nearly 4% of their workers, or more than 610,000 jobs. If anything, that figure probably understates the impact to the overall economy, because it does not take into account that many older state and local government employees are retiring early, and being replaced by lower paid workers, who often are not receiving the same level of benefits.

Looking ahead, the decline in state and local government workers is likely to persist into 2012, though at a more modest pace than over the past three and a half years. As the economy has stabilized in 2010 and 2011, so too have state and local government revenues. However, the Great Recession did little to relieve state and local governments of their obligations to meet mounting post-retirement benefits like healthcare and pension costs for current and former employees. When continued pressure on federal aid to state and local governments is factored in it leaves state and local governments with very little wiggle room to hire any additional workers or make any major commitments to spend on social programs, education or infrastructure projects. Thus, one of the few avenues left for state and local governments to continue to align short and long term costs with revenues is to continue to pare workers and cut back on expansion of existing programs. The net result is likely to be another year in which the state and local government sector provides little support for the overall economy.

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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.

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 #1-031423 (Exp. 12/12)

The Investment Tax Landscape: Countdown to 2013

In December 2010, Congress extended the so-called Bush-era tax cuts by passing the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. However, for investors, the legislation may represent not a pardon but a stay of execution. While it's true that federal tax rates on income, qualifying dividends, and capital gains have been extended through the end of the 2012 tax year, many of the issues that influenced the debate over tax rate extensions will continue to be the subject of heated discussion. As a result, investors have been granted a reprieve while Congress wrestles with those issues. That's time you can use to think about how best to position your portfolio.

The can won't stay kicked down the road forever

Why should you look at the time between now and 2013 as an opportunity? Because the U.S. budget deficit is at levels that both political parties recognize can't be sustained long-term. Even if Congress canagree on budget cuts, the possibility of higher taxes in the future can't be ruled out.

There are several categories of investors who should be paying particular attention to the planning process in the coming years. They include people with investments that have appreciated substantially in value; people who rely on dividends and bonds to provide them with ordinary living expenses; and people who are considering investing in the newly issued stock of a small business.

Capital gains and dividends

The tax cut extensions gave investors who have large unrealized capital gains some breathing room. Rather than a top tax rate of 20%, long-term capital gains will generally continue to be subject to a maximum rate of 15%, and the rate for investors in the lowest two tax brackets will remain at zero. If you own investments that have appreciated substantially in value and that now represent a bigger portion of your portfolio than you'd like, you have another chance to examine whether it makes sense to unwind those investments before the end of 2012. Taxes obviously are only one factor in making such a decision, of course. However, if you've been considering selling an asset anyway, you've got some time to plan and gradually implement a strategy for doing so.

Two points worth remembering: first, unless further action is taken, the top long-term capital gains rate will increase to 20% after 2012 (a top rate of 10% will apply to investors in the 15% tax bracket); and second, even at the increased level, the rates on those gains would still be relatively low. As recently as 1986, under President Ronald Reagan, the Tax Reform Act of 1986 provided for capital gains to be taxed at the same rates as ordinary income, with a top rate of 28%. To paraphrase Mark Twain, no one is safe when Congress is in session, and there's no guarantee that the top capital gains rate after 2012 might not be increased beyond the scheduled 20% maximum.

Qualified dividends will continue to be taxed through 2012 at the long-term capital gains rates rather than as ordinary income, as they were before 2003 and are scheduled to be again beginning in 2013. The higher your tax bracket and the more reliant you are on dividends for your income, the more you should be aware of the potential impact if that income were subject to higher taxes. Again, many factors will affect your decision about the role of dividends in your portfolio, including the potential for higher interest rates in the future. However, doing some "what-if" analysis might be useful.

Taxable vs. tax-free bonds

Taxable bonds typically pay higher interest rates than municipal bonds. However, if you're in a relatively high tax bracket or expect to be in one in the future, munis can potentially offer a better after-tax return. They may be worth a second look between now and 2013, when--separate from any potential increase in federal income tax rates--the unearned income of people making $200,000 a year ($250,000 for couples filing a joint return) is scheduled to be subject to a new 3.8% Medicare contribution tax. Absent further legislative changes, that could make munis even more attractive for affluent investors.

However, as with any investment decision, there are many factors to consider. Local and state governments have come under severe financial constraints in recent years, and though the default rate on muni bonds has historically been low, default by individual governmental bodies is always possible. Also, the legislation that extended the tax cuts did not authorize continued issuance of Build America Bonds (BABs) beyond 2010. During the almost two years BABs were authorized, many local and state governments used them to tap the taxable bond market; that temporarily reduced the issuance of new tax-free munis. However, since BABs can no longer be issued without further authorization from Congress, the supply of new munis may increase, which could affect prices. Finally, interest rates have been at historic lows since the end of 2008; since bond prices move in the opposite direction from their yields, rising interest rates would not be good news for bond prices.

2013 and beyond

The nation's financial pressures will almost certainly mean continued adjustments to the tax code as 2013 approaches. Though there are no guarantees about what will happen when the new provisions expire, investors generally have another chance to fine-tune their planning efforts while taxes remain historically low. If a bird in the hand is worth two in the bush, why not get expert help in taking advantage of the opportunities available now?

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2011

College Costs Keep On Climbing

As federal and state budgets continue to shrink due to falling revenues and lawmakers attempts to reign in deficits and spending, the fallout is being increasingly absorbed by current and future college students and their families as they try to deal with the skyrocketing costs of post-secondary education around the country.

Two recent reports from the College Board Advocacy & Policy Center, Trends in College Pricing 2011 and Trends in Student Aid 2011 detail the rapid rise in tuition costs for the nation’s two- and four-year public, private and for-profit colleges and universities. The headline of the report is an 8.3% increase nationally in tuition and fees at public four-year colleges and universities (a 4.5% increase at private four-year colleges) between 2010-2011 and 2011-2012. The report also breaks out the increase state-by-state, however, and to no one’s surprise, California lead the way in tuition and fee increases during the same period.

“California, which enrolls about 10 percent of the nation’s full-time public four-year college students, had the highest percentage increase in published in-state tuition and fees (21 percent) for that sector in 2011-12.”

Those numbers are causing sticker shock to the millions of families trying to cope with current costs or plan for the future, and causing them and their financial advisors to completely re-evaluate their projections. And while the costs continue to rise, it has not become a deterrent for enrollment. Total post-secondary enrollment increased by about 22 percent between 2005-06 and 2010-11 according to the reports as young people clearly realize the importance of a college degree as it relates to future earnings power.

“While the importance of a college degree has never been greater, its rapidly rising price is an overwhelming obstacle to many students and families,” said College Board President Gaston Caperton. “Making matters worse is the variability of price from state to state.”

In California, already one of the nation’s most expensive states to attend college, a recent budget proposal by University of California officials is calling for steep rate increases of up to 16% per year over the next four years if the state doesn’t increase funding to the U.C system. According to a recent Associated Press report,  “In July, UC officials approved a 9.8 percent tuition increase for the current school year -- on top of a previously approved 8 percent -- after the state reduced UC funding by $650 million, or about 20 percent. The system could lose another $100 million if the state generates less revenue than anticipated.”(Chea)¹. While the regents have not yet taken action on the newest proposed increases, unless greater funding can be obtained from the state, which seems unlikely, it is hard to imagine that further large-scale increases will not be implemented.

It is important to understand that while the percentage increases in tuition and fees are eye-popping, the published charges are not always an accurate indicator of the actual total costs of attending various universities. The price variability of additional costs such as room and board, is often magnified due to the difference in cost of living from region to region. According to a recent article in the Daily Californian, “Although UC Berkeley’s in-state tuition and fees — which were $8,353 in 2009-10 — are the lowest of all the UC campuses with the exception of UCLA, the high cost of living in the Bay Area makes the total cost for students much higher. According to estimates from the report, the total cost of attending UC Berkeley in 2009-10 was $28,312.” (Bickham)².

Students are increasingly forced to make tough budgetary decisions in the face of these additional costs in an effort to control their total debt obligations once they have finished school. One of our interns from U.C Berkeley recently explained the measures she and some of her classmates have made to this end: “…on-campus student housing has gotten so expensive, that for this year, 5 of us got together and found a one bedroom apartment to share which costs less than half of what we would be paying for student housing”.

Students are making these kinds of decisions because they are keenly aware that there is no guarantee of a good-paying job waiting for them once they graduate with their degree in-hand. “In the current economic climate, recent college graduates who borrowed for their education face particular challenges in paying back their student loans. The unemployment rate for young college graduates rose from 8.7 percent in 2009 to 9.1 percent in 2010, the highest annual rate on record.”(Reed)³. These numbers closely mirror the current national averages for unemployment which is surprising given that unemployment among college graduates has traditionally been considerably lower than the national average.

The rapidly rising prices of college tuition coupled with the deterioration of the labor market following the recent deep recession have contributed to soaring American student debt, which, by some estimates, now exceeds a trillion dollars and is larger than total US credit card debt. It is no wonder that among current students who are absorbing these higher costs, and recent graduates facing the realities of a stagnant job market, frustration is mounting. The huge debt burdens and the inability to service them are among the main undercurrents of the ‘Occupy’ movements around the country, and the recent clashes on college campuses highlight the growing concerns surrounding them.

Despite the fact that the state and federal governments have slashed funding for public higher education and all indications are that trend will continue for the foreseeable future, they have at least tried to provide some small amount of relief by way of tax credits and continued favorable tax treatment of certain college savings vehicles such as 529 plans. These measures are small consolation however for the growing numbers of over-leveraged, under-employed young people entering the workforce each year fresh out of America’s colleges and universities.

So what does all of this mean for the millions of families that are trying to save for future college costs? Certainly, the importance of a college degree is as great as ever, even if it doesn’t grant the holder an automatic path to financial freedom. Increasingly, we are seeing parents using these current conditions as a teaching moment for their children on the importance of financial literacy and the value of saving. Providing guidance and incentives for children to learn to budget and save for their own educations can have a lasting effect in preparing them for their post-education lives. As always, careful planning and saving are the keys to success, and the earlier the better.

¹ Chea, Terence. "UC Tuition Could Nearly Double Under Budget Plan." Huff Post Los Angeles 09 Sept 2011. n. pag. Web. 16 Sept. 2011

² Bickham, Travis. "UC Berkeley student loan debt less than nation’s average." Daily Californian 07 Nov 2011. n. pag. Web. 9 Nov. 2011

³ Reed, Matthew, Lauren Asher, Pauline Abernathy, Diane Cheng, Debbie Frankle Cochrane, and Laura Szabo-Kubitz. "Student Debt and the Class of 2010." Project on Student Debt. The Institute for College Access and Success, Nov 2011. Web. 9 Nov 2011.

Weekly Economic Commentary

The Labor Market Continues Its Long Climb Back

Market participants with the loudest voices and financial media were virtually convinced during the summer and fall of 2011 that the U.S. economy was in, or about to enter, a recession. Our view was, and remains, that the U.S. economy would avoid recession in 2011 and 2012, and the recent run of better-than-expected economic data in the United States has reinforced our view. We expect the U.S. economy to grow about 2% in 2012, which is below the long-term average and the consensus forecast, while emerging market countries post stronger growth and Europe experiences a mild recession.

Our forecast for a economic growth in 2012 is supported by solid business spending and modest, but stable, consumer spending. While inflation may recede early in the year, by year-end it may begin to re-emerge as the impact of a falling dollar, rising commodity prices and the record-breaking monetary stimulus by the Federal Reserve (Fed) begin to be reflected in prices. We expect global growth in 2012 to be supported by solid emerging market growth including the consensus of 8 – 9% growth in China, the world’s second largest economy, while Europe experiences a mild recession.

The Fed’s economic projections, released at the conclusion of the November 2011 Fed policy meeting, call for 2.5 – 2.9% GDP growth in 2012, well above our forecast and the consensus forecast, and an even more robust 3.0 – 3.5% pace of growth in 2013. The Fed’s forecast for the economy represents the upper bound of the range of forecasts for the economy and the labor market for 2012 and beyond, and lies in stark contrast to the financial market and financial media’s dour outlook for the economy next year as noted above.

The Fed surprised investors twice in 2011. First, in August, by announcing its commitment to keep rates at their current low level until at least mid- 2013; and secondly, in September, by announcing a bolder-than-expected Operation Twist, a program to sell short-term Treasuries and buy long-term Treasuries to pressure long-term interest rates lower. In late October 2011, several Fed officials discussed so-called Quantitative Easing 3 (QE3), or another round of large-scale securities purchases, perhaps this time taking place in the mortgage-backed securities market. While we think another program of stimulus from the Fed faces high hurdles, it is clearly leaning towards keeping rates low, which is generally a positive for the bond market.

However, the Fed may find itself increasingly between a rock and a hard place as 2012 matures. Too little growth and the fear of deflation is the “rock” that the Fed has been aggressively focused on avoiding. The Fed is much less concerned about the “hard place,” or the entire stimulus it has provided leading to too much inflation. Now, the distance between the two risks is far apart. However, the Fed may find itself in an increasingly narrow gap between a rock and a hard place as 2012 matures leading to higher yields in the bond market by year-end. While the Fed may have to scramble in 2013 to begin to take up some of the extraordinary amount of monetary stimulus now in the system, in the meantime it is likely that the economy will fail to live up to the Fed’s relatively lofty expectations for growth.

The Labor Market Continued Its Long, Slow Climb Back in November

The solid, but not spectacular November employment report (released on Friday, December 2) points to modest economic growth, not recession, in the fourth quarter. On balance, the details of the November jobs report were mixed, but the report was generally consistent with other data released in recent weeks that suggested a modest improvement in the labor market in November. The survey of businesses within the November employment report revealed that the private sector economy added 140,000 jobs in November, and that the job count in prior months was higher than previously thought. While the result was below both the published consensus (+150,000) and the "whisper number" (175,000 or more), the report generally confirmed further modest improvement in the labor market. The economy shed 8.9 million private sector jobs between late 2007 and early 2010, and has added back just 2.6 million jobs since then. At the current pace of private sector job creation — our forecast is for a gain of around 150,000 jobs per month — it would take another three and a half years to recoup all the jobs lost during the Great Recession.

The survey of households within the monthly employment report revealed that the unemployment rate dropped to 8.6% in November from 9.0% in October. The 8.6% unemployment rate was the lowest since March 2009, when the rate was on the way up to its peak of 10.1%. The media’s focus on Friday was on the stunning 0.4% point drop in the unemployment rate in November. The drop was partly due to an improving labor market, and probably partly the result of some statistical quirks.

The unemployment rate is calculated by dividing the number of unemployed (13.3 million) by the number of persons in the labor force (154 million). In November, the labor force fell by 315,000 while the number of unemployed fell by 594,000. Both readings are relatively large by historical standards. However, in the past 65 years, in 60% of the months in which the unemployment rate drops by at least 0.3% in a month, the labor force also posts a monthly decline. The household survey has its own tally of employment, and that measure increased by 278,000 in November, and has increased by 1.3 million in the past four months. This pace of job growth is consistent with job growth during the economic recoveries in the mid-90s and mid-2000s. It needs to be sustained in the coming months in order for the labor market to continue to heal.

Our view remains that the U.S. economy is likely to grow between 2.5% and 3.0% in the fourth quarter of 2011 and post growth of around 2.0% in 2012. A further, dramatic deterioration of the fiscal and market situation in Europe, a policy mistake here in the United States or abroad, or an exogenous event (terror attack, natural disaster, etc.), among other events, may cause us to change our 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.

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.

The Federal Open Market Committee action known as Operation Twist began in 1961. The intent was to flatten the yield curve in order to promote capital inflows and strengthen the dollar. The Fed utilized open market operations to shorten the maturity of public debt in the open market. The action has subsequently been reexamined in isolation and found to have been more effective than originally thought. As a result of this reappraisal, similar action has been suggested as an alternative to quantitative easing by central banks.

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 #1-027809 (Exp. 12/12)