Annuities Get An Image Makeover

In January, 2010, the Obama administration’s Middle Class Task Force, headed by vice-president Joe Biden, released its preliminary ‘Fact Sheet’ which contained the following excerpt :

“The Administration is…Promoting the availability of annuities and other forms of guaranteed lifetime income, which transform savings into guaranteed future income, reducing the risks that retirees will outlive their savings or that their retirees’ living standards will be eroded by investment losses or inflation.”

With that one sentence, the annuity industry received an image makeover the likes of which could hardly have been dreamed of beforehand. So often derided in the media and among consumer advocates as being an instrument of evil, annuities (and particularly variable annuities) have long-suffered an image as expensive, complex and unnecessary products whose main purpose was to put money in the pockets of the unscrupulous agents who sold them.

So how is it that the newly elected Obama administration, seemingly the most progressive administration in decades, came to extol the virtues of the annuity contract and the potential income guarantees available in them? The key to understanding this paradigm shift is in the ripple effects of the so-called ‘Great Recession’ on the retirement savings of millions of American workers.

For many years now, employers large and small have been moving away from the large scale defined benefit pension plans of old and towards the defined contribution plans we have now become so accustomed to. Chances are that if you are under the age of 50 and work for anyone other than a government agency or possibly a large publicly-traded company that has been in existence for more than 50 years, you have never even considered the concept of a defined benefit pension as part of your retirement savings. The difference between a defined benefit plan and a defined contribution plan essentially boils down to who assumes the risk of the assets running out before the retiree has finished spending them (passed away). An employer who provides a defined benefit pension agrees to pay a set amount of income (usually based on some combination of years of service, life expectancy, average compensation or assets contributed to the plan) to the retiree for life. Thus, they are taking on the risk that the assets set aside for this purpose will last long enough to cover those payments. In most cases, the pension plan will need to invest the assets in the plan in order to at least keep up with inflation or grow over time. Obviously this can expose the plan and the employer to a substantial risk in the event of a major downturn in the markets in which the assets are invested.

The defined contribution plan on the other hand exposes only the retiree (or pre-retiree) to the risk of market downturns which is why the corporate world has moved to this model over the years. It also illustrates why so many workers now find themselves in a precarious position following the events of the past few years. As their plan accounts have fallen, workers are faced with the difficult responsibility of turning those plans into an income stream to replace their salaries in retirement which these days can last upwards of 30-40 years. Trying to determine what percentage of your pre-retirement income will be sufficient to get you through retirement is hard enough, but actually managing the investments and distributions in retirement can be daunting. Those who can afford to pay a financial planner to assist them in these tasks are at a significant advantage but even the most seasoned professional cannot completely shield workers who need growth over the long-term from the sometimes devastating effects of major market downturns in the short-term. So, if the question workers are faced with is: “how do I achieve long-term growth, while taking on minimum investment risk and eventually create an income stream that I cannot outlive in retirement?” one product with the potential for all of that is the variable annuity¹.

^[1] Annuities are long-term, tax-deferred retirement vehicles intended for retirement purposes. Guarantees for all types of annuities are based on the claims paying ability of the issuing insurance company. Annuities are not FDIC insured. Withdrawals prior to age 59 ½ are subject to 10% IRS penalty, and surrender charges may apply. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal, unless the contract is held inside a Roth IRA. Policies of any annuity type should be reviewed carefully before purchasing.

Variable annuities contain both investment and insurance components. They are sold by prospectus. The investment returns and principal value of the available sub-account portfolios will fluctuate so that the value of an investor’s unit, when redeemed, may be worth more or less than its original value.

With a variable annuity, funds are invested in underlying sub-accounts with the value of the annuity fluctuating in connection to the performance of those sub-accounts over time. Most variable annuities have optional riders² for purchase which will provide minimum income and death benefit guarantees among others. Once it is time to turn the funds into an income stream, you can annuitize the annuity, at which point you give up the ability to access the funds and the insurance company agrees to pay you a specific amount regularly (monthly, quarterly, annually) for the rest of your life, or for some other pre-determined amount of time. Through income guarantees and annuitization, clients can effectively transfer the risk of the income base going down from themselves to the insurance company. Alternatively, there are now many companies who offer withdrawal benefit riders that will guarantee that a certain percentage (such as 5 or 6%) of the value of the annuity can be taken out each year for life, while still having access to the balance of funds if needed.

² Riders are guaranteed options that are available to an annuity or life insurance contract holder. While some riders are included in a base contract, others may carry additional fees, charges, limitations and restrictions.  Please consider them carefully.

Over the years, annuities and their supporters have often been vilified and painted as the bottom-feeders of the industry. These characterizations are not totally unfounded and we have seen plenty of clients come to us after having been sold an annuity that they did not understand or may not have needed. As with most financial products, there is nothing inherently bad about the product itself, but with the way it has been sold. Too often annuities have been the wrong product at the wrong time for the wrong client, but sold nevertheless by unscrupulous brokers trying to make some fast money. However, for the right client with the right needs, they serve their purpose dutifully.

The main issues detractors tend to have with variable annuities are cost and lack of liquidity. The cost of an annuity and associated riders can run upwards of 3-4% annually which is considerably higher than the 1-2% total annual cost of investing in a typical managed ETF portfolio for example. This is something to be considered carefully for sure, but may not be as onerous as it seems at first glance.

First, many clients find the premium a worthwhile price to pay for the accompanying guarantees and transfer of risk. Second, if the confidence those guarantees inspire allow the client to stay invested for the long term where he or she might otherwise make knee-jerk or emotional decisions during volatile markets, the additional costs may well be substantially less than the damage caused by those decisions. Finally, for clients with a long-term accumulation horizon, the benefit guarantees encourage them to invest more aggressively in the underlying sub-accounts than they would be comfortable with in a regular investment account. Thus, over the long-term, the potentially higher returns which may be achieved by investing more aggressively have a good chance of balancing out the additional fees associated with the variable annuity and accompanying riders.

Many variable annuities come with surrender charges (a penalty assessed if funds are withdrawn before the end of an annuity’s multi-year surrender period), making the product fairly illiquid. Also, once a contract is annuitized (turned into an income stream), the client no longer has access to the underlying funds. For these reasons, it is always recommended that clients who are considering a variable annuity have both a long-term (10 years or more) time horizon and other more liquid assets that can be accessed if necessary. As usual, diversification is the key, and as such, a variable annuity should always be considered as just one part of a client’s overall retirement savings portfolio and never the sole vehicle.

As of the writing of this article, the S&P 500 is up almost100% from the March 2009 lows. As head cheerleader when the market was at its lows 2 years ago, and in our attempt to be the voice of reason now that it has doubled since, we would be remiss if we did not caution that, as we all know, the market cannot go up indefinitely. For some, it may make sense to take a small amount of those gains, and lock them in, using a vehicle such as a variable annuity while still allowing for potential upside going forward. This is a strategy we have seen used effectively and feel has merit for the right clients.

There has been a significant shot in the arm for the annuity industry recently, beginning with the market meltdown of late 2008 and the resulting recession, and culminating with the Obama administration’s promotion of annuities and other forms of guaranteed lifetime income products to help workers prepare for retirement. For our part, we neither viewed annuities as instruments of evil before the recession nor as the savior of worker’s retirements now that the president has endorsed them. Rather, variable annuities, like most other financial instruments, are but one tool which, when used properly and in concert with other financial tools, can help to build the foundation of a long and fulfilling retirement.

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.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio.  Diversification does not ensure against market risk.

Weekly Economic Commentary

Fed in Focus

This week’s relatively quiet economic calendar in the United States (new and existing home sales along with durable goods orders and shipments for May) will allow markets to focus on the Federal Reserve (Fed), Greece, and the fiscal debate in the United States. In many ways, what the Fed does after the second round of quantitative easing, known as QE2, ends next week will depend on the outcome of the situation in Greece (and elsewhere in peripheral Europe) and on the outcome of the fiscal debate in the United States.

The Fed’s policymaking arm, the Federal Open Market Committee (FOMC), meets to set policy this week amid a soft spot in the global economy, the end of QE2, concern over the ability of Greece to meet its upcoming debt obligations and the debate over U.S. fiscal policy. How these events unfold over the coming weeks and months may help to guide Fed policy, but unfortunately for the Fed and market participants, none of these issues are likely to be resolved anytime soon.

The Fed is expected to leave its policy rate at near zero percent, and signal that it will maintain the current size of its balance sheet for the foreseeable future, but that it will not make any new purchases of Treasury securities that could be called QE3. Fed policymakers are likely to acknowledge the recent “soft spot” in the economy, but view it as transitory in nature. While the Fed will be pleased with the recent drop in consumer energy prices (since the FOMC last met on April 27, retail gasoline prices have moved from well over $4.00 per gallon to under $3.75 per gallon as crude oil prices dropped from $113 per barrel to near $91 per barrel), the increase in bank lending to businesses, and the stability in inflation expectations. We continue to expect the Fed to take a wait-and-see attitude on monetary policy, given the weak run of economic data over the past few months. Our view this year has been that the hurdle for the Fed to end QE2 early was high, but that the hurdle for the Fed to begin another round of quantitative easing (QE3) was even higher.

At his press conference on April 27, when asked about the possibility of QE3, Bernanke said that the risks (i.e. higher inflation and unhinged inflation expectations) of doing another round of quantitative easing were not worth the rewards (a lower unemployment rate and a better labor market). In addition, several voting and non-voting members of the FOMC have publicly stated that they would not support another round of quantitative easing. Meanwhile, many members of Congress have been openly hostile to the idea of more stimulus from the Fed, and since Congress is ultimately the Fed’s “boss”, the Fed has to take that into consideration as it formulates monetary policy.

Still, several events that may trigger the Fed to consider QE3 are on the front burner as the Fed meets this week.

·         Should the soft spot in the economy spiral into something more severe or long lasting (which is not our, nor the Fed’s forecast), the Fed might consider another dose of monetary policy (in the form of more purchases of Treasuries), but the threat of a double-dip and deflation, a period of falling wages and prices, would have to be substantial. The FOMC will release its latest economic forecast this week, and while we expect the Fed to lower its growth outlook for 2011 and raise its unemployment rate forecast, we do not expect a significant enough shift to warrant action from the Fed.

·         A worsening and widening of the European fiscal crisis that leads to widespread defaults by nations in Europe that could be accompanied by a freeze-up of global credit markets would likely lead the Fed to consider another round of monetary stimulus. We expect Fed Chairman Bernanke to field a number of questions on the situation in Europe and its potential impact on the U.S. economy at this week’s press conference.

·         A sharp contraction in fiscal policy (beyond what is already expected as state and local governments shed workers and as 2009’s $787 billion fiscal stimulus package fades further) over the near term, might prompt the Fed to do another round of quantitative easing, or at least stay on hold for longer. At his press conference following the April 27, 2011 FOMC meeting, Fed Chairman Bernanke noted that if any changes to fiscal policy are focused entirely on the short-run, and then these changes might have some negative consequences for growth. In that case, he noted, the Fed would take those into account appropriately. Our view here is that the hurdle for the Fed to act based on a deal to cut the deficit over the long term is quite high.

In addition to the potential catalysts for QE3 listed above, there are a number of other events — for example a series of severe natural disasters in the United States or a terrorist attack that does widespread damages to the nation’s economic infrastructure — which may cause the Fed to consider adding more monetary policy stimulus to the economy. Our view remains that, while we expect monetary policy to remain on hold for the foreseeable future, the hurdle for the Fed to begin QE3 remains high.

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

Stock investing involves risk including loss of principal.

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

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 #739563 (Exp. 06/12)

Weekly Economic Commentary

Lowered Expectations

Fresh data on manufacturing and housing for June highlight this week’s busy economic data calendar in the United States as markets try to assess the duration and severity of the economic soft spot. Fiscal and monetary policy intersect this week as Federal Reserve (Fed) Chairman Bernanke delivers a speech on fiscal sustainability, as both chambers of Congress return to work on the debt ceiling issue. We examine households’ balance sheets two years into the equity market rebound.

In a speech to bankers last week in Atlanta, Fed Chairman Bernanke said he viewed the recent weakness in the economy as temporary. Bernanke described the economic recovery as uneven and frustrating, but disappointed those market participants looking for the Fed to embark on another round of quantitative easing to jolt the recovery to life. Bernanke's speech also suggests, however, that the Fed is in no mood to tighten policy either. The Fed’s Beige Book, a qualitative assessment of economic conditions in each of the 12 Federal Reserve districts, released last week, confirmed that view. This week’s full docket of economic data reports for May and June will test that view.

This week is a very busy week for economic data in the United States, as market participants try to assess the duration and severity of the current soft spot in the economic recovery, which turns two years old this month. While last week’s quiet economic calendar saw about half of the reports beat expectations, over the past four weeks, only 25% of economic reports in the United States beat expectations. About the same percentage of reports released over the past four weeks saw an improvement versus the prior period (i.e. the May report represented an improvement from the April reading), and only 40% of the reports saw upward revisions to the prior period’s data. Taken together, the economic data over the past four weeks has been the weakest in two years. As we head into this week, expectations are low. But are they low enough?

June data on manufacturing conditions in New York and Philadelphia highlight this week's economic data calendar, which also includes reports on May inflation (producer price index and consumer price index), retail sales, housing starts, leading indicators and industrial production. On balance, the data are likely to show that growth continued to decelerate in May versus April as a result of the earthquake in Japan, the late Easter and unusually severe weather. The consensus forecasts for the June data all suggest that the market is expecting a reacceleration in activity in June. We would agree, but that reacceleration may not become evident in the data until July.

Bernanke Joins the Budget Battle

This week, the Fed is in its unofficial “quiet period” ahead of next week’s (June 22) Federal Open Market Committee (FOMC) meeting. The FOMC, the Fed’s policymaking arm, will release a new economic forecast next week, and Fed Chairman Bernanke will hold another press conference at the conclusion of the June 22 meeting. In our view, the Fed will not materially change its stance on monetary policy at the June 22 FOMC meeting, and that the latest round of quantitative easing (QE2) will end on time at the end of June. The Fed is likely to leave the stimulus provided by QE2 in place until at least autumn of 2011, if not longer, to allow the economy to regain some of the steam it has lost over the past few months.

Bernanke is slated to speak this week on fiscal policy, a topic he addressed in-depth on June 7, and has addressed nearly every time he appears before Congress. Bernanke this week is likely to continue to prod Congress to put the United States on sounder fiscal footing. In his June 7 address, Bernanke cautioned that “a sharp fiscal consolidation focused on the very near term could be self-defeating if it were to undercut the still-fragile recovery.” Bernanke seems to be suggesting to Congress to enact a long-term deficit reduction plan without cutting spending (or raising taxes) too much in the next few years.

Both houses of Congress are in session this week, and legislative time is running low as we approach the August 2 deadline on the debt ceiling. The good news is that the conversation in Washington has moved from whether or not to cut the deficit to how much to cut, but the bad news is that the two sides (the White House/Senate Democrats and House Republicans) remain far apart on the “hows”: How much to cut - the latest word is that a plan to cut the deficit by $2 trillion dollars over the next 10 years is in the works - and how to cut (spending cuts, tax increases, or both) remain up in the air. President Obama’s much publicized golf outing with House Speaker John Boehner this weekend (June 18 – 19) may provide the impetus for the next round of the negotiations. Our view is that Congress will act to raise the debt ceiling, but that the path toward that outcome may be a rocky one for financial markets.

Household Net Worth Up, As Rising Bond and Stock Markets Offset Housing

One of the underappreciated stories in the economy over the past several years has been the recovery in consumer net worth since the depths of the Great Recession in late 2008 and early 2009. Consumer net worth — defined as household assets (cars, houses, financial assets including stocks, bonds, mutual funds, pension assets, money market accounts, etc.) less household liabilities (mortgage debt, credit card debt, consumer loan debt) — posted another quarter-over-quarter gain in the first quarter of 2011 — the latest data available — and has now posted quarterly gains in seven of the past eight quarters dating back to early 2009.

Since hitting a five-year low at just over $49 trillion in Q1 2009, consumer net worth has increased by $9 trillion, and stands at just over $58 trillion. Despite the gain in recent years, household net worth remains nearly $8 trillion below its all-time peak, set in early 2007 before the onset of the Great Recession and the accompanying collapse in housing prices. The slow recovery in household net worth helps to explain the below-average consumer spending during the first two years of the economic recovery, a period that typically sees robust consumer spending growth.

The $9 trillion increase in consumer net worth over the past two years is a result of a 13% gain in asset prices, and a 2% drop in liabilities of households.

The gain in asset prices was driven by:

·         Equity prices, as measured by the Russell 3000 Index, rising 100%+ from their early 2009 lows.

·         Bond prices, as measured by the Barclays Capital Aggregate Bond Index, increasing 18% from their early 2009 lows.

The large gain in equity and bond prices more than offset the 2% drop in real-estate values since early 2009.

While some of the 2% drop in liabilities over the past two years was certainly involuntary (consumers walking away from mortgages, consumer loans and credit card debt), part of the big drop in household liabilities since mid-2008 ($688 billion) reflects a healthy, voluntary paring down of debt by consumers.

While the consumer net worth data is somewhat stale — the latest data available is for the first quarter of 2011 — the monthly report on consumer credit outstanding (released on June 3) can provide a fresher look at the state of consumer finances. Although consumer credit outstanding has increased in each of the past seven months (through April 2011), the ratio of consumer credit outstanding to disposable income fell again and at 20.7% in April 2011 is 60 basis points (bps) below year-ago levels (21.3%) and 370 bps below the peak of 24.4% hit in 2005.

As we note regularly in the Weekly Economic Commentary, consumer spending accounts for more than 70% of U.S. gross domestic product (GDP). Consumer finances have been vigorously debated by market participants since the onset of the financial crisis and the Great Recession. Starting in the early 1990s, consumers had been on a spending spree — accelerating spending, reducing savings, and piling up debt. However, there has been a noticeable reversal of that trend the last few years as strapped consumers have been forced to address soaring debts by reducing discretionary spending. This is best illustrated by the Financial Obligations Ratio (FOR), which the Fed uses to track how much of a household’s disposable income goes toward paying debt, including mortgage (or rent), credit card, lease, homeowners’ insurance, and property tax payments.

As of the fourth quarter of 2010 (the latest data available), the FOR was the lowest in 15 years and is below the long-term average of 17.2%. Based on the big drop in the monthly debt-to-income ratio in early 2011, the FOR likely improved further in the first quarter of 2011. Some of the reduced debt burden is the result of consumer defaults, but the drop in the FOR in recent quarters suggests that the combination of low interest rates, attractively refinanced mortgages, rising incomes (personal income in April 2011 was up 4.4% from a year ago and is at an all-time high), and less debt to service is hastening the improvement in consumers’ ability to spend. Consumers have been paying down debt, increasing their spending (at a modest rate for this point in a recovery), and saving more since late 2008.

We would expect this pattern to continue over the remainder of 2011, and into 2012, which means slower-than-normal consumer spending dampening economic growth, but not causing outright declines that would portend a double-dip recession.

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IMPORTANT DISCLOSURES The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

Quantitative Easing is a government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity.

Stock investing involves risk including loss of principal.

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

The 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.

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 #737632 (Exp. 06/12)

Weekly Economic Commentary

Waiting for the Turn

Market participants will have to look elsewhere for direction this week amid a quiet week for economic reports in the United States. Policy events at home and abroad could help fill the void. The May jobs report was a disappointment any way you look at it, but we will examine whether it was the start of a new trend. Japan’s economy is still transitioning from recovery to rebuilding in the wake of the March 11 earthquake.

Policy, Not Data, Likely to Move Markets this Week

The week after the release of the monthly jobs report (released Friday, June 3) is typically a quiet one for economic data, and this week fits that pattern. Other than the usual weekly readings on retail sales, initial claims for unemployment insurance and mortgage applications, there are no market-moving economic reports due out in the United States this week. The data that is due out — trade deficit and wholesale sales and inventories — is both “old” (for April) and considered second-tier by market participants.

The lack of a robust calendar of U.S. economic data this week will force markets to focus on policy and overseas events. The Federal Reserve (Fed) will release its Beige Book (a qualitative assessment of economic and business conditions in each of the 12 regional Federal Reserve districts), and a plethora of Fed speakers are on tap. Speeches by hawks (those favoring a tighter monetary policy) outweigh appearances by monetary policy doves (those who generally favor easier monetary policy). As we have noted in the past, while the hawks and doves on the Fed seem to garner the most attention from the financial media, it is the center of gravity at the Fed-Chairman Ben Bernanke, Vice Chairwoman Janet Yellen and New York Fed President Bill Dudley, that will likely dictate Fed policy in the coming months. All three are slated to speak this week. Any shift in tone (which has been toward easier policy for longer) from this group would be notable. The next Fed policy meeting is June 22. Fed Chairman Bernanke will hold a press conference that day and the Fed will also release its latest economic forecast as well.

Overseas this week, markets remain vigilant for another rate hike in China as Chinese authorities are expected to release some of China’s economic indicators for May. Although China’s economy has decelerated over the past year (from 12% to near 10%), economic growth has not slowed enough to cool domestic inflation. The desire to cool the pace of inflation in China is driving China’s central bank, the Peoples Bank of China, to raise interest rates. We, and the market, expect a few more rate hikes in China over the coming months.

Outside of China, monetary and fiscal policy is in focus overseas this week, as central banks in Europe, the United Kingdom, Australia, New Zealand, South Korea, Brazil, India, Peru and Indonesia are set to meet. Of these central banks, South Korea, Peru, Brazil and India are expected to raise interest rates this week. More than 25 central banks around the globe are already raising rates to combat domestic inflation brought on by soaring economic growth, and all the banks expected to raise rates this week are in that group. Central banks in Australia, Indonesia, and New Zealand have also raised rates in the past few years, but have paused recently.

Meanwhile, most developed economies’ central banks have continued to maintain accommodative monetary policy as these economies struggle with slow growth and more restrictive fiscal policy. Although the ECB did raise rates earlier this spring, the latest flare-up in the fiscal woes in peripheral Europe (Greece, Portugal, and Ireland) has put the ECB back on hold. The Bank of England (BOE) is on hold as well, as the large cut in public spending enacted by the UK government in 2010 begins to take hold.

May Jobs Report a Disappointment, But Not Likely to be the Start of a New Trend

The weak May employment report confirmed the recent lull in economic activity, but in our view does not represent the start of a new trend for the economy or the job market. The private sector economy created just 83,000 jobs in May 2011, far short of lowered expectations, which fell dramatically in the days leading up to the jobs release. Despite the disappointment, the private sector economy has created jobs for 15 straight months, totaling 2.1 million jobs, but there is still a long way to go to recoup the 8.8 million jobs lost in the Great Recession. There was some evidence in the May jobs report of downward pressure on jobs from the Japanese earthquake, the late Easter, poor weather, and higher oil prices, although even excluding these factors, the report would have represented a deceleration in job creation relative to recent trend.

The 5,000 drop in manufacturing jobs between April and May reflected both unusually severe weather in the Midwestern and Southern United States in May, as well as supply chain disruptions associated with the earthquake, tsunami and nuclear disaster in Japan. The late Easter (Easter fell on April 24, 2011, which is the latest that Easter has occurred in nearly 70 years) most likely contributed to the seasonally-adjusted 9,000 drop in retail employment in May (after a huge 64,000 gain in April) and to the 6,000 drop in employment in the leisure and hospitality industry in May, following average monthly job gains of 45,000 in this category in February, March and April. Higher oil prices may also have impacted both retail and leisure employment as more money spent by consumers on gasoline means less money available to spend on clothing and travel.

Looking ahead to June, the late Easter impact will fade and if the weather cooperates, we should see a return to an average of about 200,000 job growth per month. However thus far in June we have seen tornados in Massachusetts and areas in the Midwest and West are bracing for historic flooding following near record snowfall this past winter. On the supply chain front, there are some signs (see section below) that Japan has finally moved from the cleanup phase to the recovery and rebuilding phase nearly three months after the devastating earthquake and tsunami hit on March 11. This should help manufacturing employment bounce back in June and the months ahead.

Fundamentally, the backdrop for hiring in the United States remains solid, but not spectacular. Corporate profits are at a new all-time high, companies have plenty of cash, financing costs are low, banks are more willing to lend to businesses today than at any time in the past five years and credit markets are functioning better now than at any time in four years. In addition, the economy has been in recovery for two years, jobs have been added in each of the past 15 months, and growth in emerging market economies (where we send 50% of our exports) remains robust. Finally, layoff announcements over the past 12 months (476,000) were the fewest in any 12 month period since 1998, when the unemployment rate was 4.5%.

While the low level of layoff announcements suggests that businesses are confident that the recession is over, obstacles remain to hiring. In the financial sector, the Dodd- Frank regulatory burden is still being absorbed by banks and other financial institutions, making planning and hiring difficult. Uncertainty over monetary and especially fiscal policy at home and abroad is being met with caution among business owners, especially among small businesses who account for two-thirds of job creation. Finally, while credit to businesses from the banking system is flowing as freely as it has in several years, the terms of the credit are not quite a generous as they were in the mid-2000s.

On balance, the backdrop for hiring remains supportive for modest (200,000 to 250,000 net new jobs per month) job creation in the coming months, but it is still likely to take the economy several more years before it recoups all of the jobs lost during the Great Recession.

An Update on Japan

On balance, market participants probably underestimated the impact of the March 11 earthquake in Japan (the world’s third largest economy) and its aftermath on the global economy. The market expected some supply chain disruptions as a result of the quake, tsunami and nuclear disaster, but the market probably underestimated both the severity and duration of the disruption. Looking ahead, while there is not as much high frequency (daily, weekly) economic data in Japan as there is in the United States, the data released over the past week or so in both Japan and outside of Japan, suggests that a turn in the Japanese data is at hand, although evidence of the impact of the quake is likely to persist for a while longer.

Signs that the Japanese earthquake would have a more pronounced impact on the global economy were evident in the 15% month-over-month drop in Japanese industrial production in March versus April. Other signs included:

·         A 37% year-over-year plunge in vehicle sales in March 2011 versus March 2010.

·         The 20 point drop in a the key “economy watchers” diffusion index from 48.4 in February 2011 to 27.7 in March 2011, indicating only about one-quarter of respondents thought conditions were improving in March down from one half of respondents in February.

·         The 15% year-over-year drop in department store sales in March.

As the April data was being reported in early May, the situation looked even worse. After plunging 37% year-over-year in March, vehicle sales fell 51% year-over-year in April. Even the economic data in the United States felt the impact, most notably the big drop in the Institute of Supply Management’s (ISM) non-manufacturing index for April report released in early May.

By mid-May, there were signs of a bounce back in Japan, although a more muted one than expected by the market. In short, the incoming data in Japan had stopped getting worse, a key precondition for data getting better.

·         The Economy Watchers survey improved to 28.3 in April from 27.7 in March, but remained well below the pre-quake peak.

·         Machine tool orders, which plunged 8.0% year-over-year in March, rose 6.8% in April, but remained well below pre-quake levels.

·         Department store sales, which plunged 15% year-over-year in March, fell by only 1.5% year-over-year in April

·         Overall retail sales, which fell 8% month-over-month in March, posted a 4% month-over-month gain in April.

·         Industrial production, which fell 15.0% month-over-month between February and March rose 1.0% between March and April, and private sector surveys suggest that Japanese industrial production will accelerate sharply in both May and June

Over the past week or so, some of the incoming Japanese data for May suggests that the rebuild effort picked up steam in May. Even some of the U.S. economic data most impacted by the quake looked better. For example, the ISM’s non-manufacturing index moved from 53.8 in April up to 54.6 in May, reversing some of the post-quake losses seen in the April report. In addition, Japan’s ISM index for May moved higher after falling in March and April, and Japan’s non-manufacturing ISM rose to 43.8 in May from 35 in March and near 34 in April. The pre-quake reading here was 50.

There are several key reports on the Japanese economy for May due out this week (Economy Watchers, consumer sentiment and machine orders) that are expected to show that the pace of recovery in Japan hastened in May.

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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.

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.

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.

Stock investing involves risk including loss of principal.

This research material has been prepared by LPL Financial.

The LPL Financial family of affiliated companies includes LPL Financial and UVEST Financial Services Group, Inc., each of which is a member of FINRA/SIPC.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and makes no representation with respect to such entity.

Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by any Government Agency | Not a Bank/Credit Union Deposit

Weekly Economic Commentary

Housing Woes Continue

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

Housing and Manufacturing Dominate the Week Ahead

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

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

Housing Market Still Struggling Two Years Into the Economic Recovery

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

There are many positives for the housing market including:

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

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

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

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

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

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

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

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

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

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

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

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IMPORTANT DISCLOSURES The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

Stock investing involves risk including loss of principal.

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

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

The ISM index is based on surveys of more than 300 manufacturing firms by the Institute of Supply Management. The ISM Manufacturing Index monitors employment, production inventories, new orders, and supplier deliveries. A composite diffusion index is created that monitors conditions in national manufacturing based on the data from these surveys.

This research material has been prepared by LPL Financial.

The LPL Financial family of affiliated companies includes LPL Financial and UVEST Financial Services Group, Inc., each of which is a member of FINRA/SIPC.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and makes no representation with respect to such entity.

Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by any Government Agency | Not a Bank/Credit Union Deposit

Weekly Economic Commentary

Inflation Is Key This Week

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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IMPORTANT DISCLOSURES The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

Stock investing involves risk including loss of principal.

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

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

This research material has been prepared by LPL Financial.

The LPL Financial family of affiliated companies includes LPL Financial and UVEST Financial Services Group, Inc., each of which is a member of FINRA/SIPC.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and makes no representation with respect to such entity.

Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by any Government Agency | Not a Bank/Credit Union Deposit