2010 Year-End Tax Planning Basics

For 2010, year-end tax planning is particularly challenging. That's because a great deal of uncertainty remains for both 2010 and 2011. Despite this, the window of opportunity for many tax-saving moves closes on December 31. So set aside time to evaluate your tax situation now, while there's still time to affect your bottom line for the 2010 tax year,  and stay up to-date on any late-breaking  legislative changes.

Timing is everything

Year-end tax planning is as much about the 2011 tax year as it is about the 2010 tax year. There's an opportunity for tax savings when you can predict that your income tax rate will be lower in one year than in the other. If that's the case, some simple year-end moves can really pay off.  If you think your income tax rate will be lower next year, look for opportunities to defer income to 2011. For example, you may be able to defer a year-end bonus, or delay the collection of business debts, rents, and payments for services. Similarly, you may be able to accelerate deductions into 2010 by paying some deductible expenses such as medical expenses, interest, and state and local taxes before year-end.  If you think you'll be paying tax at a higher rate next year, consider taking the opposite tack--possibly accelerating income into 2010 and postponing deductible expenses until 2011.

AMT uncertainty complicates planning

If you're subject to the alternative minimum tax (AMT), traditional year-end maneuvers, like deferring income and accelerating deductions, can actually hurt you. The AMT—essentially a separate federal income tax system with its own rates and rules--effectively disallows a number of itemized deductions, making it a significant consideration when it comes to year-end  moves. For example,  if you're subject to the AMT in 2010,  prepaying 2011 state and local taxes won't help your 2010 tax situation, but could hurt your 2011 bottom line. Since 2001, a series of temporary AMT "fixes" bumped up AMT exemption amounts, forestalling a dramatic increase in the number of individuals ensnared by the tax. But the last such fix expired at the end of 2009. While it's likely that  additional  legislation will extend the fix to 2010 (and possibly 2011 as well), right now AMT exemption amounts for  2010 are at pre-2001 levels. Bottom  line? If you think you might be subject to AMT in either 2010 or 2011, talk to a tax professional and pay close attention to what Congress does between now and the end of the year.

IRA and retirement plan contributions

Traditional IRAs (assuming that you qualify to make deductible contributions) and employer-sponsored retirement plans such as 401(k) plans allow you to contribute funds pretax,  reducing your 2010 income. Contributions you make to a Roth IRA (assuming that you meet the income requirements) or a Roth 401(k) plan aren't deductible, so there's no tax benefit for 2010, but qualified Roth distributions are completely free from federal income tax--making these retirement savings vehicles very appealing. For 2010, the maximum amount that you can contribute to a 401(k) plan is $16,500, and you can contribute up to $5,000 to an  IRA. If you're age 50 or older, you can contribute up to $22,000 to a 401(k) and up to $6,000 to an IRA. The window to make 2010 contributions to your employer plan closes at the end of the year, but you can generally make 2010 contributions to your IRA until April 15, 2011.

Still time for 2010 Roth conversions

There's still time to take advantage of the special rule that applies to Roth conversions in 2010: if you convert funds in a traditional IRA or an employer plan--like a 401(k)—to a Roth in 2010,  half the income that results from the conversion can be reported on your 2011 federal income tax return and half on your 2012 return (you can instead report all of the resulting income on your 2010 return, if you choose). Whether a Roth conversion makes sense for you depends on a number of factors, including your marginal tax rate for 2010,  2011, and 2012. However, the ability to postpone tax on the resulting income to 2011 and 2012, combined with the flexibility of being able to wait until you file your 2010 federal income tax return to decide whether you want to do so, makes a Roth conversion a strategy worth considering before year-end.

"Bonus" depreciation and expensing

Good news if you're self-employed or a small-business owner: recent legislation extended special depreciation rules that were scheduled to expire at the end of last year, allowing an additional  50% first-year depreciation deduction for qualifying property purchased in 2010 for use in your business. Again, there's a short window of opportunity to take advantage of this, since, to qualify, property has to be acquired and placed in service on or before December 31, 2010.  In  lieu of depreciation, IRC Section 179 deduction rules allow for the deduction, or "expensing," of the cost of qualifying property placed in service during the year. The maximum amount that can be expensed in 2010 and 2011 under Section 179 has been increased to $500,000 (double the maximum that applied in 2009). The $500,000 limit is reduced when the total cost of qualifying property placed in service during the year exceeds $2 million.

Also worth noting

• For 2010, itemized deductions and personal and dependency exemptions are not reduced for higher-income individuals, but (at least for now) that's going to change in 2011: these deductions will once again be subject to a phase-out based on adjusted gross income. This should be taken into account if you're considering timing income and deductions as part of your year-end planning.

• A 30% tax credit for energy-efficient improvements you make to your principal residence, or the cost of certain energy-efficient equipment you install (including furnaces, water heaters, and central air conditioning units) expires at the end of 2010. There's an aggregate credit cap of $1,500 for 2009 and 2010, so if you claimed the full $1,500 in 2009, you're out of  luck for 2010. But if you haven't reached the maximum credit amount yet, consider timing qualifying expenditures to take advantage of the credit.

• When you reach age 70½, you're generally required to start taking required minimum distributions (RMDs) from any traditional IRAs or employer-sponsored retirement plans you own. RMD requirements, however, were suspended for 2009, so you may not have taken a withdrawal  last year. RMD requirements are back for 2010, though, and the penalty is steep (50%) for failing to take an RMD by the date required--the end of the year for most individuals.

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Disclosure Information -- Important -- Please Review

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 referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

The tax information provided is not intended to be a substitute for specific individualized tax planning advice. We suggest that you consult with a qualified tax advisor.

Securities offered through LPL Financial, Member FINRA/SIPC

Prepared by Forefield Inc, Copyright 2010

November 03, 2010

Conversion Confusion (Roth IRAs in 2010 and beyond…)

Where we were, and where we are

For background, it is important to understand that until 2010, if an individual or couple wanted to convert all or a portion of their traditional IRA balance(s) to a Roth IRA (basically a choice between current taxation and future taxation), they had to have a Modified Adjusted Gross Income (MAGI) of under $100,000.  As part of the Tax Increase Prevention and Reconciliation Act of 2006, congress made a modification to this rule eliminating the income ceiling for conversions after 2009. This means that anyone who wants to can convert to a Roth IRA, no matter their income, age or size of the account being converted. Basically, if you want to convert in 2010, and are willing to pay the taxes now, you can.  Additionally, for conversions made in 2010, you have more than one option for paying the resulting tax liability. You can pay it all in 2010 (by the tax filing deadline) or defer and pay ½ in 2011 and ½ in 2012.

Why is congress making this change?

It would be nice to think that the members of congress have decided out of the goodness of their collective hearts to help us average working folks out a bit.  However, as with most things in life that seem too good to be true, there is a catch.  As previously noted, if you convert from a traditional IRA to a Roth IRA, you are required report 100% of the conversion amount as current ordinary income.  In other words, the government gets their much needed tax revenue now as opposed to waiting until you turn 59 ½ (or older) and begin drawing down your IRA account.   Clearly Uncle Sam is a firm believer in the old adage “A bird in the hand is worth two in the bush” (note that we refrained from inserting a George Bush joke here). What we are left to ponder (knowing full well that congress is unlikely to leave huge tax receipts on the table despite their eagerness to get their hands on this money quickly) is: Is this really a good deal for us? The answer to this question is a resounding ‘Maybe’.  To clarify, we need to take a look at the arguments for conversion.

Why would I convert?

Of course the big question is, why convert?  Why pay taxes now for the right not to pay taxes later?  If you do some research you will see there is no shortage of possible answers. The two most common reasons being thrown about are, first, that tax rates will likely be much higher in the future than they are now, and second, that you may not need to spend these funds in your lifetime so converting to a Roth IRA now could well save your heirs a substantial amount in taxes down the line. While these are both valid points, we would argue that, regarding first point, predicting future tax rates is a tricky business and it is not at all a foregone conclusion that rates will be substantially higher in the future. As to the second point, while some who are still a ways off from retirement are already

primarily concerned with effective generational asset transfer, most people we talk to consider asset transfer a secondary concern after knowing they have carefully planned and saved for their own retirement.

While we may take issue with some of the more trendy reasoning for conversion as outlined above, we believe there may be a more compelling argument for converting at least a portion of your traditional IRAs to Roth IRAs, which boils down to one thing; Flexibility.

Our recommendation

For those of you who have worked with us for any length of time, you are familiar with our mantra about the importance of diversification.   We firmly believe diversification and flexibility are the cornerstones to a healthy financial profile. Essentially, what the Roth conversion allows for is flexibility or ‘tax diversification’ as a hedge against future legislative maneuvers and tax law changes.

If you could tell us today what the tax code will look like and what tax rates will be when you start taking money from your IRAs in 5, 10, 20, or even 30+ years, this conversion question would be as easy to answer as so many have made it out to be.  The truth is, particularly in today’s political climate, it is impossible to determine what legislative changes will be made and what tax rates will be in effect in 3 months, let alone many years down the line.  That is why flexibility is so vital.

It is always our recommendation to have a good mix of non-qualified and qualified assets available at retirement so clients have more options available for their portfolio withdrawals.  By having some money available at capital gains rates (non-qualified), some available at ordinary income tax rates (qualified), and some available tax-free (Roth IRAs¹, etc.), clients are better able to manage their total tax obligation regardless of the tax-structure in effect at the time of their distributions. It may be necessary to give up a few dollars along the way to hedge your bets (in the form of taxes upon conversion), so that regardless of what the political or tax-rate structure is in the future, you will be able to take advantage.  Basically, this is another strategy for the unknown and unforeseeable future, something we think everyone should consider.

As nice as it would be, there is no one-size-fits-all solution to the issue of Roth IRA conversions. The correct answer depends on many factors and should be carefully considered from all angles prior to any action. Remember, if you want the option of deferring taxes on a 2010 Roth IRA conversion until 2011 and 2012, you will need to talk to your financial professional(s) and act soon.

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¹The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions apply. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.

Weekly Market Commentary

December Data Deluge

This week (November 29-December 3) is full of key economic reports in the United States, as financial market participants return from the Thanksgiving weekend. The reports will cover the status of the labor market, manufacturing, the consumer, and will help to set the tone for financial markets as the remainder of 2010 unfolds. In addition to the data deluge in the United States, financial market participants are likely to continue to fret about the ongoing sovereign debt issue in Europe, the flare-up of tensions on the Korean peninsula, and China’s actions to cool economic growth and lending. Six global central banks meet to set monetary policy this week: India, Indonesia, Thailand, Hungary, Bulgaria and the European Central Bank (ECB). None of the six banks are expected to raise rates, although both India and Thailand have already begun raising rates in this cycle. A key report on the manufacturing sector in China, the November PMI, is due out early this week, and may reignite talk of more policy shifts in China aimed at slowing growth and, more importantly, cooling inflation.

One of the key questions financial market participants will be asking themselves as they interpret this week’s data is whether or not the U.S. economy has definitively emerged from the summer soft spot that commenced in late spring 2010 and began to firm as the weather began to turn cooler. In general, most of the economic data released in the United States since early to mid-September supports the notion that the summer soft spot has ended and that the economy is reaccelerating. The pace of that reacceleration will be at the center of the debate this week.

The release of the Federal Reserve’s (Fed) Beige Book, a qualitative assessment of economic conditions in each of the 12 Federal Reserve districts will provide the broadest (and most timely) look at economic and business conditions in the U.S. economy in November. We will be looking for color on bank lending, business demand for bank loans, hiring, an early read on holiday shopping, and any change in tone following the results of the mid-term Congressional elections. This will be the first Beige Book since the onset of the Fed’s second round of quantitative easing (QE2), and we will also be combing through the report looking for early signs of the impact QE2 is having on the economy. The Beige Book is due on Wednesday, December 1.

The November Jobs Report Likely to Highlight an Improving Labor Market

Employment will be a major theme of the week’s data and, as any good holiday gift should, it comes in several varieties this week. The employment component of the November Chicago Area Purchasing Managers Index (Tuesday, November 30), the November Institute for Supply Management (ISM) report on manufacturing (Wednesday, December 1), and the Dallas Fed Index (Monday, November 29) will be the first employment related reports of the week. The results of these two surveys will be compared against the employment data already available for November—weekly initial claims, the employment readings from the Philly Fed, Richmond Fed, Kansas City Fed and Empire State manufacturing indices—all of which suggest some acceleration in hiring in the private sector between October and November.

By midweek, the focus will shift to the ADP employment report and the Challenger layoff report for November. Both reports are due out on Wednesday, December 1. The ADP employment report tracks hiring trends in the private sector based on data from the nation’s largest payroll processing firm. Over the past six months, the ADP jobs report has underestimated actual private payrolls by between 50,000 and 100,000 per month. The market is looking for a 65,000 gain in ADP employment in November, which is consistent with a private sector payroll gain of around 140,000 in November. The Challenger layoff data has been a useful indicator in recent months as market participants debated whether or not the summer soft spot would turn into a double-dip recession. Layoff announcements from U.S. corporations are at their lowest level in more than 10 years, suggesting that while companies may not be hiring as quickly as we would like them to be, they are not laying off very many workers either. The signal emanating from the Challenger layoff data is that a double-dip recession is not in the cards.

Finally, the key employment-related report of the week is due out on Friday, December 3. For the first time since early 2010, there will not be much distortion in the jobs report from the hiring of temporary government workers to conduct the 2010 Census. Thus, for the first time since the first few months of 2010, the market’s focus will be on total nonfarm payroll employment, and not just private sector employment. While it is helpful that the November jobs data is likely to be free of the Census-related distortions that have plagued the data since early 2010, the market may shift its focus from the private sector (where more than 1.1 million jobs have been created in the past 12 months) to the government sector, and especially the state and local government sector.

Typically, a reliable engine of jobs growth in good times and in bad, the state and local government sector has shed jobs in nine of the first ten months of 2010, and in 20 of the 26 months since September 2008. State and local governments have shed more than 400,000 jobs since September 2008, as the woes of the national economy and housing market hit state and local government budgets. Since most states are required by law to balance their budgets, (and labor costs account for a huge chunk of public sector costs) job cuts and funding cuts to cities, towns and municipalities are always part of the equation for legislators looking to cut costs. We continue to expect more pain on the state and local job front in the year ahead.

Over on the private sector side, the consensus is looking for a 155,000 gain in employment in November, following the surprisingly large 159,000 gain in October. If achieved (and absent any revision to prior months), the back-to-back gains in jobs in October and November would be the most robust since March and April 2010 (prior to the onset of the summer growth slowdown and double-dip fears). A gain in private sector employment close to the consensus would also mark the first time since late 2005/early 2006 that the private sector economy has generated more than 100,000 jobs in five consecutive months.

The Manufacturing and Consumer Sectors Also In Focus This Week

The manufacturing sector will also be in focus this week, highlighted by the release of the Chicago Area Purchasing Managers Index for November on November 30, and the broader, national ISM report on manufacturing on December 1. Based on the regional ISMs and regional Fed manufacturing surveys already released for November, there is a strong likelihood that the overall ISM for November will remain above 56.0 (where a reading above 50 indicates that the manufacturing sector is expanding) for the second consecutive month, after dipping to 54.4 in September. If the ISM does indeed stay above 56.0 in November, it would mark the longest stretch of time since early 2004 that the ISM has consistently been at or above 55.0. We would interpret this as yet another sign that the recovery in U.S. economy that began in June 2009 is beginning to gain some traction.

Already in focus as the 2010 holiday shopping season kicks into higher gear over the Thanksgiving weekend, the health of the U.S. consumer will again be tested as the November vehicle sales (Wednesday, December 1) and November chain store sales (Thursday, December 2) are released.

As we have been outlining in these pages throughout 2010, expectations for the consumer heading into 2010 were low. A year ago, the questions around the consumer were not about how much the consumer could spend in 2010, but how much debt they could pay down or how much money they could save. As it turns out (and as we have been pointing out all year) the consumer has been able to do all three of these things—spend a little, pay down debt, increase saving—as 2010 progressed.

Many market observers also missed the idea that “consumers” were not a single entity. The high-end consumer has seen somewhat of a resurgence, while the low- and middle-end consumers have struggled a bit more.

This week’s reports on vehicle sales and chain store sales in November are likely to continue the themes we have seen throughout 2010. Aided by a better labor market, low interest rates, and an improved financing backdrop, vehicle sales are likely to come in above the 12.0 million annualized sales pace in November for the second consecutive month. Although vehicle sales surged to a 14.2 million annualized sales pace in August 2009, as the government-sponsored “cash for clunkers” program boosted sales, vehicle sales have not been consistently above 12 million units since before the collapse of Lehman Brothers in September 2008. Vehicle sales spent most of the mid-2000s in the 16 to 17 million range, peaking at 21 million in July 2007. A return to sales consistently above the 12.5 million range would be yet another sign that the consumer is beginning to find its footing after more than two years of unsteadiness.

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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.

Purchasing Managers Index (PMI) is an indicator of the economic health of the manufacturing sector. The PMI index is based on five major indicators: new orders, inventory levels, production, supplier deliveries, and the employment environment.

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 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 Federal Reserve is the central bank of the United States. Its unique structure includes a federal government agency, the Board of Governors, in Washington, D.C., and 12 regional Reserve Banks (Atlanta, Boston, Chicago, Cleveland, Dallas, Kansas city, Minneapolis, New York, Philadelphia, Richmond, San Francisco, and St. Louis).

The NY Empire State Index is a seasonally-adjusted index that tracks the results of the Empire State Manufac­turing Survey. The survey is distributed to roughly 175 manufacturing executives and asks questions intended to gauge both the current sentiment of the executives and their six-month outlook on the sector.

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.

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Weekly Market Commentary

Bernanke Battles Back

In the days leading up to “Black Friday”, the traditional kick-off to the holiday shopping season, markets will digest news on inflation, manufacturing and home sales for October, as well as the minutes of the Fed’s November 3 FOMC meeting. Overseas, Europe’s rescue of Ireland’s finances is likely to dominate the headlines, although the refrain “who’s next” is already being heard in and around Europe. Around the globe, it is a quiet week for economic data in China, and the central bank meetings scheduled this week are limited to Israel, Poland, Georgia, Mexico, and India. Of that group, only Israel and India have been tightening policy recently, and many global central banks may begin to slow their policy tightening altogether in the coming months to offset the Fed’s actions to lower the value of the dollar.

A quick look at the reports due out this week in the United States finds that housing and manufacturing will be in focus. The October data on new and existing home sales is likely to be quite sluggish, and this week’s data is likely to lend support to the need for the full course of quantitative easing (QE2) ($600 billion by June 2011). On the manufacturing side, a weaker dollar (the dollar is down by more than 10% since mid-June 2010) has already begun to work its magic in the manufacturing sector, suggesting that durable goods shipments and orders for October should be solid. The November Richmond Fed Index will help financial markets further refine estimates for the November ISM report, due on December 1. The first two readings on the manufacturing sector in November were polar opposites: the Philly Fed Index was strong but the Empire State Manufacturing Index was weak.

The release of the October data on core inflation (known as the personal consumption expenditure (PCE) deflator excluding food and energy) will likely underscore the need for the full run of QE2 from the Fed in order to turn around the direction of prices. This measure of core inflation is preferred by the Fed and is likely to show that core inflation was running at just 1.3% year-over-year in October, one of the lowest readings in 45 years, and below the Fed’s unofficial comfort zone of 1.5 to 2.0% on core inflation.

Finally, the minutes of the November 3 FOMC meeting will be published on Tuesday, November 23. In addition to providing some additional “color” as to why the FOMC decided to embark on another round of QE, the minutes will also shed more light on the well-publicized internal dissention within the FOMC around the need for more QE and how to execute it. The FOMC will also publish its quarterly economic forecast alongside the minutes. The forecast will likely show a significant downgrade of the economic and employment outlook (versus the prior forecast made in June 2010) and reveal a downshifting of inflation forecasts as well. In our view, the FOMC will press on with QE 2 (despite the criticism) until its forecasts show inflation moving higher and the unemployment rate moving noticeably lower. There are two more forecasts (late January 2011 and April 2011) prior to the scheduled end of QE2.

The Battle Over QE2

As we wrote in last week’s Weekly Economic Commentary, “Answering the Critics”, the week after November 3 the Fed announced that it was planning to embark on QE2, the Fed, Fed Chairman Ben Bernanke, and QE2 itself came under withering criticism from politicians, pundits, central bankers, and lawmakers both at home and abroad. It did not get much easier for the Fed or Bernanke in week two (last week). The latest critics include a group of U.S. Senators (essentially Bernanke’s bosses) and a member of the U.S. House of Representatives who called for the end of the full employment portion of the Fed’s dual mandate (promoting price stability and full employment). In addition, a group of prominent economists, policymakers, and academics who wrote an open letter to Bernanke in the Wall Street Journal that was quite critical of QE2.

Last week, Bernanke pushed back with help from Warren Buffett and several members of the FOMC, as well as the head of the United States Chamber of Commerce. Late in the week, Bernanke himself delivered a passionate defense of QE2 at a conference in Europe, saying:

“…on its current economic trajectory the United States runs the risk of seeing millions of workers unemployed or underemployed for many years. As a society, we should find that outcome unacceptable. Monetary policy is working in support of both economic recovery and price stability, but there are limits to what can be achieved by the central bank alone. The Federal Reserve is nonpartisan and does not make recommendations regarding specific tax and spending programs. However, in general terms, a fiscal program that combines near-term measures to enhance growth with strong, confidence-inducing steps to reduce longer-term structural deficits would be an important complement to the policies of the Federal Reserve.”

Most of the criticism of QE2 and the Fed’s policies focuses on the impact of QE2 on inflation and inflation expectations. The critics believe that the Fed is throwing fuel on the inflationary fire by doing another round of QE. The Fed sees it differently, and believes that the current and near-term outlook for inflation is muted and that it can rein in QE2 before inflation and inflation expectations begin to accelerate. Some criticize the Fed for engendering another “asset bubble,” citing the abnormally low Fed funds rate in the early 2000s that was followed by the residential real estate boom (2002-2007) and subsequent bust (2007-present).

Of the two arguments against QE2, we find a bit more credence in the “asset bubble” argument than the “runaway inflation” argument against QE2. Given the huge overhang of unsold homes, strict lending standards, and regulators’ hyper-vigilance around the banking system, the risk of another residential real estate bubble is low. However, bubbles are always forming somewhere in the world and the Fed embarking on another round of quantitative easing may indeed be creating a bubble somewhere. However, the Fed has judged that the rewards of trying to revive economic growth in the United States in the near-term outweigh the longer-term risk of engendering another asset bubble.

Our long-held view is that while there are a few similarities between the economic and policy backdrop today and the run up to the 1970s/80s era inflation, the backdrop is much less inflationary today. This leads us to conclude that when inflation does return, it will not be anything close to the sharp increase in prices seen in the 1970s and early 1980s, when headline inflation was in the 10% to 14% per year range and core inflation was between 8% and 12% per year.

Inflation remained low throughout most of the early to mid-1960s, but began to creep up in the mid-to-late-1960s before exploding higher in the mid-1970s through the early 1980s. Some attribute the rise in inflation to the heavy spending on the Vietnam War and President Lyndon Johnson’s Great Society programs. We certainly can draw parallels to today, where government spending as a share of GDP has risen from 18.5% at the end of the 1990s to nearly 25% by 2009, the highest since World War II.

However, some of the other factors that likely contributed to the surge in inflation in the 1970s and early 1980s are not present today. Some of those include:

·         Union membership had a potent impact on wage growth during the 1960s and 1970s. As a percent of the workforce, membership has fallen from close to 25% in the late-1960s to under 10% today.

·         In the 1960s and early 1970s, wages were often tied to inflation rates via cost of living adjustments (COLAs), which created a “wage price spiral”. COLAs are far less prevalent in today’s labor market.

·         The United States left the gold standard in 1971, and allowed the US dollar to float, which boosted inflation expectations in the early 1970s

·         Today, the Fed has built up 30 years of inflation fighting credibility. It had virtually no inflation fighting credentials in the 1960s and 1970s.

·         Explicit inflation targets exist today in some countries, and are being seriously discussed by the Fed. Explicit inflation targets were nonexistent in the United States and very rare elsewhere in the late 1960s and early 1970s.

·         Long-term inflation expectations in the United States are low and have been relatively stable over the past 15 to 20 years; in the late 1960s, inflation expectations were higher than today, and rising.

·         High inflation often leads to even higher inflation as it reinforces expectations. Over the past five years, core inflation has averaged 1.9% and has been decelerating for more than 25 years; in the late 1906s, core inflation averaged close to 4.0% and was already accelerating.

·         Productivity has been quite strong in the past 15 years. In contrast, productivity was much weaker through the inflationary period from the mid-1960s through the early-1980s.

A key reason why we do not think a severe bout of 1970s-style inflation is in the cards for the U.S. economy in the years to come is excess capacity of both labor and capital in the global economy. The emergence of China as an economic power has been a big factor in the creation of excess capacity. In addition, the dynamics and composition of the U.S. and global economies today are vastly different, and far less inflation friendly, than they were in the late 1960s and early 1970s. In short, the starting point for inflation matters, and in that regard, we are at a much better starting point today than in the late 1960s.

Some examples include:

·         Capacity utilization (which measures the percentage of U.S. factories’ production capabilities being utilized) hit a new all-time low in June 2009 at 65%, and has only recovered to 72.7% today. The global recession has dampened utilization, but even over the past five years, capacity utilization averaged about 75%. By comparison, during the late 1960s, capacity utilization averaged 88% resulting increasingly in being met by higher prices rather than additional output.

·         The economy is much more global today than it was in the late 1960s. Capital and labor flow much more freely over international borders than they did in the late 1960s and early 1970s, which helps to eliminate the bottlenecks that can lead to inflation pressures. For example, before the global recession hit in mid- 2008, trade (exports plus imports) accounted for about one-third of U.S. GDP, more than three times as high as it was in the late 1960s.

·         Wages account for about 70% of business costs. In the latest 12 months, wage growth is running at a 2.0% pace. In the late 1960s, wage growth was running at over 6%, and was accelerating.

Evidence That Economy is Reaccelerating is Mounting, but is it Sustainable?

We have been on “reacceleration” watch for more than a month now, and last week’s serving of data was supportive of the premise that the U.S. economy’s summer soft spot has faded, and supports our long-held view that a double-dip recession in the United States was not likely. The data however, does not suggest that the economy is growing fast enough to push the unemployment rate lower or the inflation rate higher (the Fed’s goals for QE2) and, therefore, it is unlikely right now that the FOMC would end its QE2 program early.

The following reports all pointed to an economy that had shifted into a higher gear as the fourth quarter began:

·         Retail sales for October

·         Manufacturing industrial production for October

·         Business shipments and inventories for October

·         Leading indicators for October

·         Philadelphia Fed manufacturing index for November

·         Weekly initial claims for unemployment insurance for the week ending November 13

·         Banks loans to businesses for the week ending November 13

Some data, including the very weak Empire State Manufacturing Index for November, the near-disastrous readings on housing starts and building permits in October, along with week-over-week declines in the readings on mortgage applications and weekly retail sales, continue to suggest an economy that is still near stall speed, and in need of more aid from the Fed.

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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.

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.

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 zero it indicates factory-sector growth, and when below zero indicates contraction.

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 is considered an indicator of economic conditions in one of the most populated states in the U.S.

The Richmond Fed Index is a survey of manufacturing conditions in the fifth federal reserve district. It covers the Mid-Atlantic States of Maryland, North and South Carolina, Virginia and West Virginia.

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

Answering the Critics

This week is a busy week for economic data as the market may begin to judge the effectiveness and wisdom of quantitative easing (QE). The latest flare-up in the European fiscal saga will compete for attention this week with a cornucopia of U.S. economic data for October and November. The data, which includes reports on retail sales, industrial production, consumer and producer price inflation, housing starts and leading indicators for October, as well as the Empire State and Philadelphia Fed manufacturing surveys for November, may help answer several questions market participants, policymakers and pundits have been asking in recent weeks:

·         Is the economic soft spot really over?

·         Is QE working yet to push inflation higher and the unemployment rate lower?

·         Was QE necessary in the first place?

The Federal Reserve’s (Fed) second round of quantitative easing (QE2), large-scale purchases by the Fed of Treasury notes, begins this week. QE2 is aimed at keeping interest rates lower for a longer time to allow both consumers and businesses to refinance and pay down debt thereby, in theory, boosting economic activity, lowering the unemployment rate and pushing up the inflation rate. Last week, the Fed, Fed Chairman Bernanke, and QE2 itself came under withering criticism from politicians, pundits, central bankers, and lawmakers both at home and abroad, leaving the market wondering how much more pressure the Fed can take.

Our view is that the Fed can manage the criticism in the short and medium term, but longer term, the severity of the QE2 “backlash” may prompt an early retreat from QE2, perhaps earlier than is necessary to foster an environment supporting sustainable economic growth. Congress has the ultimate authority over the Fed’s dual mandate of full employment and price stability. Thus, Chairman Ben Bernanke’s regular visits to Capitol Hill, especially when the new Congress is seated in January, will take on increased significance for markets. Although Bernanke is not scheduled to speak, a confirmation hearing this week in the Senate of one of President Obama’s appointees to the Federal Reserve Board of Governors (Peter Diamond) may provide some members of Congress with the platform to criticize QE2.

Some of the impact of the anticipation of QE2 will likely be on display in this week’s data. A weaker dollar is an indirect consequence of QE2. The dollar has declined by more than 7% since Bernanke first hinted that QE2 was a realistic possibility at a late-August speech in Jackson Hole, Wyoming (according to the Federal Reserve Major Currencies Index). More dollars in the system means that each dollar is worth less. In turn, a cheaper US dollar makes U.S. exports less expensive to foreigners. The October Industrial Production report, due out on Tuesday, November 16 is one gauge of how exporters have benefitted from QE2.

Similarly, housing is a direct beneficiary of QE2. The October housing starts report and the National Association of Homebuilders sentiment survey for November are due out this week. The Fed’s goal is to keep rates lower for a longer time, encouraging property owners (residential or commercial) to refinance at lower rates, and use the money saved on more spending, hiring or debt pay down. Housing affordability is at an all-time high and lending standards are easing, but it is probably too soon to tell if QE2 has affected the housing market yet.

Finally, retail sales for October will be scrutinized for clues about the upcoming holiday shopping season, but the effect of QE2 can be seen in this data set as well. At +1.2% month-over-months, October retail sales were stronger than expectations (+0.7% month-over-month) and stronger than September's +0.6% month-over-month reading. In addition, the September reading was revised upward. Some of the October strength in the consumer was overstated, given that building material store sales surged in October and those sales feed into gross domestic product (GDP) as business capital spending, and not consumer spending.

On balance, the October retail sales report supports the idea that the U.S. economy continued to reaccelerate in October, but that consumers remain cautious ahead of the crucial holiday shopping season. The October retail sales data is consistent with recent data points for October and November, which suggests the economy was reaccelerating out of the soft spot that began this spring. QE2 affects consumer spending via higher equity prices (boosting wealth), lower interest rates (more affordable to finance purchases), and more bank lending to both businesses (fostering job creation) and consumers (enabling more consumer loans).

Budget Battle Begins, but it is not Likely to End for a While

Last week, the National Commission on Fiscal Responsibility and Reform laid out a path to fiscal responsibility. The co-chairs of the President's bi-partisan National Commission on Fiscal Responsibility and Reform, Democrat Erskine Bowles and Republican Alan Simpson, announced their recommendations to reduce the deficit and debt. The report of the full commission will release its findings on December 1, but keep in mind that Congress chose to make these recommendations of the Commission non-binding. Thus, the plan put forth last week — as well as the one due out in a few weeks — should be viewed as the starting point for Congress to address this very important issue over the coming years.

As we discussed in last week’s Weekly Economic Commentary, it is not sustainable over the long run to have Federal spending running nearly twice as fast as tax receipts. As a result, over the longer term, our view is that both sides of the issue (revenues and spending) will need to be addressed. In addition, indeed, that is what the deficit commission report did. The report essentially put everything on the table, and provided a bi-partisan and fair assessment of the work that needs to be done to put the nation’s fiscal house in order:

·         Tax increases

·         Spending cuts

·         Gasoline tax increases

·         Cutting government waste and “pork barrel” spending

·         Culling through farm subsidies

·         Modifications to both social security and Medicare

·         Curbing defense spending

Our best guess is that, despite the momentum this document provides, serious actions to address reducing the deficit and debt will not occur until after the 2012 Presidential elections.

Economy Appears to Be Reaccelerating, But at What Speed?

Although limited in scope and volume, last week’s batch of economic data in the United States continued to paint a picture of an economy that was reaccelerating out of the summer soft spot. Ironically, the soft spot began when Greek’s fiscal woes made headlines during the European fiscal flare-up up in March and April of 2010. Last week the issue flared again, but this time Ireland, not Greece, was the epicenter. Our view continues to be that deficit and debt issues in peripheral Europe will flare up from time to time (as they did last week in Ireland). However, because the market expects little or no growth out of Europe in 2011, (the consensus is calling for 1.3% growth in real GDP in the Eurozone in 2011) the main issue for markets will be the so-called “contagion effect” (i.e. will the sovereign debt issues in peripheral Europe spread to the banking sector in other parts of Europe and the United States). Thus far, the issue in Ireland has had little impact on the banking sector in the United States or the more fiscally sound European nations like Germany and France.

Turning back to the data in the United States last week, the following reports all pointed to an economy that had shifted into a higher gear as the weather turned cooler:

·         Weekly retail sales for the week ending November 6

·         Consumer sentiment for the first half of November

·         Initial claims for unemployment insurance for the week ending November 6

·         Banks loans for the week ending November 3

·         Wholesale trade for September

·         The National Federation of Small Business sentiment for October

·         The Fed’s Senior Loan Officer Survey for Q4 2010

However, while the financial media’s favorite summertime refrain — double-dip — has faded along with the fall colors as we approach winter, the economy is by no means booming. Growth, as measured by real GDP, may have accelerated a bit early in the fourth quarter, but probably only pulled the economy out of stall speed and into a slightly more rapid trajectory.

The most notable of these reports was probably the weekly report on new claims for unemployment insurance for the week ending November 6. Initial filings for unemployment insurance fell sharply (24,000) in the latest week and have declined in eight of the past 12 weeks. Aside from a single week this past summer, claims have not been this low (446,500 per week) since the summer of 2008. Claims probably need to drop into the 350,000 per week range to convince markets that the labor market is capable of generating enough jobs (roughly 150,000 to 250,000 per month) in order to push the unemployment rate lower. In embarking on QE2, the Fed specifically noted that the unemployment rate (at 9.6%) was unacceptably high, so it is clear that the Fed is also watching the weekly initial claims data very 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.

Investing in international and emerging markets may entail additional risks such as currency fluctuation and political instability.

Stock investing involves risk including loss of principal Past performance is not a guarantee of future results.

The Federal Reserve Major Currencies Index is a weighted average of the foreign exchange values of the US dollar against a subset of currencies in the broad index that circulate widely outside the country of issue. The weights are derived from those in the broad index. Countries whose currencies are included in the MAJOR CUR­RENCIES INDEX are the Euro Area, Canada, Japan, United Kingdom, Switzerland, Australia, and Sweden. The Euro Area includes Germany, France, Italy, Netherlands, Belgium/Luxembourg, Ireland, Spain, Austria, Finland, Portugal, and Greece.

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

The Philadelphia Fed Survey is a business outlook survey used to construct an index that tracks manufacturing conditions in the Philadelphia Federal Reserve district. The Philadelphia Fed survey is an indicator of trends in the manufacturing sector, and is correlated with the Institute for Supply Management (ISM) manufacturing index, as well as the industrial production index.

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

Weekly Market Commentary

The Calm After the Storm

The midterm elections, the decision by the Federal Reserve to embark on another round of quantitative easing (QE 2), and a better-than-expected jobs report for October made last week one for the history books. Market historians may not remember the upcoming week as clearly, however, given the lack of economic and policy events due out.

The U.S. economic calendar is typically quiet the week after the monthly jobs report is released. This week’s docket is even more muted due to the Veteran’s Day holiday on Thursday, November 11, when the bond market, as well as the federal government’s data mill is closed.

Aside from the regular weekly data on weekly chain store sales, mortgage applications, and initial claims for unemployment insurance, there is only a handful of data reports due out in the United States this week. The reports include the merchandise trade report for September, consumer sentiment for the first half of November, and the federal budget data for the first month of fiscal year (FY) 2011 (October 2010).

Market participants will still have plenty to mull over this week as they continue to digest last week’s monumental events. This week, Chinese authorities will release the full slate of October economic data in China, which will refocus attention on the ever-widening trade gap between the United States and China, even as markets brace for the upcoming Group of 20 (G-20) meeting in Korea on November 11–13. There are no major central banks meetings this week, although the central banks in India, Turkey, and Malaysia are set to meet. No rate increases are expected, but both Malaysia and India have been tightening policy by raising domestic interest rates to cool domestic inflation since late 2009/early 2010. On balance, with a lack of any key U.S. economic data, fiscal, monetary and currency policy will be in focus ahead of the G-20.

Budget Battle?

The budget data for October 2010 — the first month of fiscal 2011 — is due out on Wednesday, November 10. The market is looking for a $148 billion budget deficit in October 2010.

Financial markets almost never react to the monthly budget data, and have not reacted much to the reality that the United States has now racked up two consecutive years of trillion-dollar plus budget deficits, and is well on its way to a third in FY 2011. This is generally because the dollar is the world’s “reserve” currency (i.e. much of world trade is conducted in dollars) interestcosts on the debt are low and falling, and the United States has never defaulted on its debt.

As a reminder, the U. S. government ended FY 2010 with $1.29 trillion deficit, equal to 8.9%of gross domestic product (GDP), a modest improvement over the $1.42 trillion gap that made up 10% of GDP in fiscal year 2009. Looking ahead, the non-partisan Congressional Budget Office (CBO) projects that under current law (assuming, among other things, that all the Bush era tax cuts expire at the end of calendar year 2010), the annual budget deficit will “improve” to $1.066 trillion in FY 2011, which ends on September 30, 2011.

However, the CBO forecasts that if the Bush tax cuts are extended, and more realistic economic assumptions are used, the deficit in the current fiscal year (FY 2011) will approach $1.4 trillion. Longer term, the United States needs to spend less, take in more revenue and save more.

The “debt ceiling” (the nation’s credit card spending limit) is likely to come up for a vote in early 2011. This may prompt some talk about the deficit, but despite the change in control of the House of Representatives in last week’s midterm elections, the best guess is that policy makers will not sit down to make the difficult choices about what to cut and by how much until there is a true crisis.

Is the Economy Reaccelerating?

The better-than-expected October jobs report raises the odds of a reacceleration in the economy, but it is still too soon to tell. The October jobs report corroborates the data we saw last week, for October (ISM, Service Sector ISM, vehicle sales, factory orders), all of which beat expectations, were better than the prior month, and saw upward revision to prior month's data.

The October employment report was an upside surprise, but suggests that there is more work to do on the labor market. The private sector economy added 159,000 jobs in October, well ahead of expectations of a gain of 80,000, and even well above the upper end of the range of economists' estimates (+20,000 to +135,000) for the report. The October data was relatively free of distortions and, on balance, the data suggest that the "soft spot" the economy endured during the late spring and summer months may have dissipated as fall began. The October jobs report did have its weak spots however, as 14.8 million people remain unemployed, another

7,000 state and local government workers lost their jobs in October, and the overall unemployment rate remained stubbornly high at 9.6%.

While the private sector economy has now added more than 100,000 jobs in each of the past four months, Congress, the Obama administration, and most importantly, the Fed, would like to see job growth in the 200,000 to 300,000 per month range. Why? With the labor force increasing by around 150,000 per month, it will take at least that many jobs (about 150,000 per month) just to keep the unemployment rate steady. Although the private sector has added back 1.1 million jobs (in the 12 months ending in October 2010), nearly 8.5 million jobs were lost during the Great Recession and its immediate aftermath. At the level of monthly job growth seen over the course of the past 12 months, it would take another six and a half years to get back to pre-recession levels on the job front.

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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 Group of Twenty (G-20) Finance Ministers and Central Bank Governors is the premier forum for our interna­tional economic development that promotes open and constructive discussion between industrial and emerging-market countries on key issues related to global economic stability. By contributing to the strengthening of the international financial architecture and providing opportunities for dialogue on national policies, international co-operation, and international financial institutions, the G-20 helps to support growth and development across the globe.

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