Weekly Market Commentary

Gauging The Fed

The attention of financial market participants will be split between the relatively light economic calendar in the United States and continuing to assess the implications of the earthquake in Japan and its aftermath along with the escalation of the conflict in Libya. In addition, U.S. monetary policy could move to the forefront this week, as Federal Reserve Board (Fed) Chairman Bernanke and two noted inflation "hawks" on the Federal Open Market Committee (FOMC), Charles Plosser from Philadelphia and Richard Fisher from Dallas, are scheduled to make public appearances. Although Congress is out of session this week, the release of the United Kingdom’s budget at midweek may refocus attention on the U.S. budget situation. Elsewhere overseas, it is a quiet week for Chinese economic data, as market participants continue to gauge how much longer China’s central bank will be moving interest rates higher to slow growth and rein in domestic inflation. Several overseas central banks are set to meet this week, including the Philippines, South Africa, and the Czech Republic. Of that group, only the Philippines is likely to raise rates.

This week's data in the United States includes new and existing home sales and durable goods orders for February, as well as the weekly data on initial claims, retail sales and mortgage applications for mid March. All of the data will be scoured by markets looking for impact from the earthquake in Japan and rising consumer energy prices. There have already been several company specific announcements (mainly in the automotive and technology sectors) related to supply-chain disruptions caused by the earthquake, tsunami and nuclear crisis in Japan. With the corporate earnings reporting season for the first quarter of 2011 right around the corner, we would not be surprised to see an increasing number of firms announce some type of disruption to their operations due to the situation in Japan. The economic data in the United States (and elsewhere) could also potentially be impacted by these temporary supply chain disruptions as well. As we wrote last week, markets did not expect much in the way of growth in the world’s third largest economy prior to the catastrophe (and have not for many years) and now, in the short term, growth prospects in Japan have been diminished further. Over the medium term, however, as the affected infrastructure (roads, ports, electrical grid, railways, homes and buildings) are rebuilt, the economy in Japan (and globally) is likely to get a lift, but the longer-term prospects in Japan remain muted. The financial costs of rebuilding are only likely to further negatively impact growth and financial flexibility in the years to come.

A Closer Look at Fed Policy in 2011 and 2012

Turning to the Fed, the noticeable improvement in the economic data so far this year, along with a measurable uptick in readings on core inflation (inflation excluding food and energy), already has some market participants debating the timing of the Fed’s first policy tightening. Unlike in past Fed tightening episodes, where the Fed only had one policy lever at its disposal (typically the fed funds rate or earlier, the discount rate) this time around the Fed has several levers to tighten policy, including the size of its balance sheet and the Fed funds rate. The market puts the Fed’s first rate hike in March 2012, we think it could come closer to the middle of 2012. We expect the Fed to maintain the size of its balance sheet over the second half of 2011, but the Fed is likely to begin to shrink its balance sheet in late 2011 or early 2012, by not reinvesting coupons of the Treasuries and mortgage-backed securities it owns or the proceeds of maturing holdings back into the marketplace. The signal of a shift toward allowing its balance sheet to shrink could come as soon as the June FOMC meeting. Any such move will be data dependant, and also dependant on the progression of the FOMC’s economic forecasts.

Supporters of action by the Fed to tighten policy sooner rather than later are likely to be emboldened this week when Charles Plosser and Richard Fisher (policymakers more concerned about rising inflation than they are about rising unemployment and slower growth) take the stage this week. Both men are voting members on the FOMC, and both have been critics of QE2. However, at the two FOMC meetings held so far this year, neither Plosser nor Fisher has voted against continuing QE2. Both, however, have made it clear that they would very likely vote against starting another round of QE in June, when QE2 expires. As we have been saying for many months now, the hurdle to end QE2 is high but the hurdle to begin QE3 in June 2011 is even higher, although the odds have moved up slightly with the quake in Japan and higher oil prices acting to crimp growth.

Fed Chairman Bernanke is also on the docket this week, and may provide insight into how the earthquake (and its aftermath) in Japan is likely to impact the global economy, and in particular the United States economy in the coming weeks and months. Bernanke is also likely to continue to make the case that the recent rise in energy and commodity prices is transitory and that the pass through into higher core inflation is unlikely. In the past there has been little pass through of rising commodity prices into overall CPI inflation and even less pass through into the Fed’s preferred measure of inflation, the personal consumption expenditure deflator excluding food and energy.

Looking ahead, the market will digest the minutes of the March 15 FOMC meeting on April 5. Those minutes are also likely to contain a discussion of the FOMC’s initial assessment of the Japanese earthquake and aftermath on the global economy. The next Beige Book is due out on April 13, and the next FOMC meeting is set for April 27. The FOMC will produce another quarterly forecast of the economy, inflation and the unemployment rate at the April 27 FOMC meeting. That forecast (which may set the stage for the first steps toward policy tightening) will be released in mid May 2011.

Economic Growth in the First Quarter of 2011 Still Looks Solid

U.S. economic data and policy events took a back seat to global events (Japan quake and aftermath, escalation of the conflict in Libya, and ongoing turmoil in the Middle East) last week (March 14 – 18). The data on manufacturing released in the United States last week (Empire State Manufacturing and Philly Fed Manufacturing Indices for March and industrial production for February) suggested that the manufacturing sector remains strong and prospects for more robust growth in the coming quarters are solid as well. The price data for February (PPI and CPI) showed that rising raw materials' prices continue to push input costs higher, but that there has been little pass-through to the end consumer, especially on core inflation. The index of leading indicators for February also suggested more solid economic growth over the next nine to twelve months, and the weekly readings on unemployment insurance, mortgage applications and retail sales continued to show little impact from rising energy prices on the job market or consumer spending. The economy is on track to post a 3.0 to 3.5% gain in Q1 2011.

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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.

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

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

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

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 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.

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 Commodity Research Bureau (CRB) Index is an index that measures the overall direction of commodity sectors. The CRB was designed to isolate and reveal the directional movement of prices in overall commodity trades.

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

Focus on Japan and the Fed

The devastating earthquake in Japan and its short- and long-term impact on the world’s third biggest economy, the Federal Reserve’s policy meeting, and a scattering of economic data for February and March in the United States will be top of mind this week for investors. The Chinese economic data is quiet this week, while central banks in Norway, Hong Kong, Switzerland, Chile, Japan, Colombia and Iceland meet to set policy. Of these, only resource-rich Chile is expected to raise rates, and Japan’s central bank has already injected a record $183 billion into the Japanese economy in response to the earthquake. Last week’s economic data and events in the United States revealed that rising gasoline prices were having a negative impact on consumer sentiment and near-term inflation expectations, but economic growth in the United States looks solid as the first quarter of 2011 draws to a close.

A Quick Look at Japan, the World’s Third Largest Economy

The earthquake, tsunami and still-unfolding nuclear crisis in Japan is likely to be a source of concern for market participants in the coming weeks. As we digest this catastrophic event (and its immeasurable human toll), we thought it would be appropriate to provide a quick overview of Japan’s economy. Japan, with a population of over 127 million people, is the world’s third largest economy, about one-third the size of the U.S. economy and just about the same size as China’s economy. Of course, China and Japan’s economies have moved in opposite directions in recent years with Japan’s economy growing at under 1% per year over the past 10 years, while China’s economy has increased by an average of over 10% per year over the past 10 years. Looking ahead, the market expects real gross domestic product (GDP) growth in Japan of just 1.5% in 2011 and only about 2.0% in 2012. Thus, the market did not expect much from Japan prior to the quake, and is likely to expect even less in its aftermath.

The area in northeastern Japan most directly impacted by the earthquake and resulting tsunami accounts for between 5% and 10% of Japan’s economic activity, and is focused mainly on agriculture, pulp and paper manufacturing, and petroleum refining. By comparison, the 1995 earthquake in Kobe, Japan hit what was then the largest and busiest port in Japan. Kobe is also Japan’s sixth largest city and a key industrial manufacturing center. In another comparison, closer to home, the region most impacted by 2005’s Hurricane Katrina (Louisiana, Alabama and Mississippi) accounts for just over 3% of GDP in the United States.

Japan has a trade surplus (it exports more goods than it imports) and its major exports to the world are vehicles, electronics, industrial equipment and computers. Japan’s biggest export customers are China, the United States, the European Union, South Korea and Taiwan. Japan’s largest exports to the United States include:

·         Cars and trucks

·         Car and truck parts

·         Industrial machinery

·         Electronics

    

Japan biggest imports are:

·         Raw materials (oil, food, lumber)

·         Machinery

·         Textiles

China accounts for 20% of Japan’s imports, about 12% come from the United States, and around 10% of Japan’s imports come from the Gulf oil states. Japan’s major imports from the United States are civilian aircrafts and parts, industrial machinery, agriculture and medical equipment.

As previously noted, the Bank of Japan has already injected a massive amount of liquidity into the Japanese economy in the wake of the disaster, and the Japanese government has pledged another $2.4 billion to hasten relief efforts, but more is likely. In short, markets did not expect much in the way of growth in the world’s third largest economy prior to the catastrophe (and have not for many years) and now, in the short term, growth prospects have been diminished further. Over the medium term, as the affected infrastructure (roads, ports, electrical grid, railways, homes and buildings) are rebuilt, the economy is likely to get a lift, but the longer-term prospects in Japan remain muted. The financial costs of rebuilding are only likely to further negatively impact growth and financial flexibility in the years to come.

What to watch For at This Week’s FOMC Meeting

The Fed’s policymaking arm, the Federal Open Market Committee (FOMC), meets this week to discuss policy. While no one expects the FOMC to raise rates at this meeting, the FOMC could acknowledge the recent gains in the labor market and economy, and further elevate the discussion over rising raw material prices and wages setting a hawkish tone. However, the FOMC is also likely to acknowledge that while economic growth has improved, the labor market is growing again and that core inflation is rising, growth is not yet strong enough to push the unemployment rate significantly lower or core inflation significantly higher to convince the FOMC that tighter monetary policy is needed. In short, while the statement from the March 15 FOMC meeting is not likely to signal an outright shift in Fed policy (which would have major implications for bond, stock and commodities markets) the statement is likely to be another incremental step toward an eventual FOMC interest rate hike.

The FOMC is also likely to maintain its Large Scale Asset Purchase Program (LSAP), which is commonly known as the second round of quantitative easing (or QE2 for short) , and view an early end to QE2 as unlikely. We also expect the FOMC statement to reduce the odds of implementing QE3 when QE2 expires in June. We have long held the view that the hurdle was high for ending QE2, but even higher to commence QE3.

Finally, there is also likely to continue to be “dissent” within the FOMC itself, but we point out that there were no votes against maintaining current FOMC policy (federal funds rate near zero, QE2, expanding balance sheet) at the last FOMC meeting in January. Since then, however, several likely FOMC dissenters (Philadelphia Fed President Charles Plosser and Dallas Fed President Richard Fisher) have hinted that while they are not happy with QE2, they are not willing to vote against it. They have said, however, that they would not take the same view toward yet another round of quantitative easing (i.e. QE3) when QE2 expires in June. This sets up a likely battle on the FOMC over the next several months, a battle likely to be decided by the path and pace of economic growth and the ability of businesses to pass on higher input costs to end consumers.

Last Week’s Economic Data Revealed That U.S. Economic Growth Remained Solid in the Face of Higher Energy Prices

Last week’s economic data, highlighted by a 1.0% surge in retail sales in February and an energy induced dip in consumer confidence, suggested that economic activity in the United States was quite strong in the first quarter even as energy prices rose, impacting consumer sentiment and inflation expectations. Reports on consumer credit for January, small business optimism for February, business inventories for January, and retail sales for February suggested that the U.S. economy probably grew faster than previously expected in the fourth quarter (closer to 3.5% than the originally reported 2.8% growth) and that economic growth in the first

quarter of 2011 (which ends on March 31) is likely to be close to 3.5%.

However, the larger-than-expected trade deficit in January (led by a surge in oil imports), an unexpected rise in initial claims for unemployment insurance in mid-March, and a drop in consumer sentiment fueled by rising gasoline prices tempered markets’ enthusiasm for the U.S. economy. In addition, the release of the February budget data for the U.S. government served to remind markets that the United States is well on its way to another record budget deficit in fiscal year 2011, which ends at the end of September.

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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. Stock investing involves risk including loss of principal Past performance is not a guarantee of future results. 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. Personal Consumption Expenditures is a measure of price changes in consumer goods and services. Personal consumption expenditures consist of the actual and imputed expenditures of households; the measure includes data pertaining to durables, non-durables and services. It is essentially a measure of goods and service targeted toward individuals and consumed by individuals.

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

Economy Appears to be Accelerating as it Absorbs Higher Energy Prices

A relatively quiet period for economic data and events this week in the United States should allow financial market participants to focus on the troubling rise in energy prices that has accompanied the ongoing political unrest in the Middle East. Outside the United States, a full slate of economic data in China and a scattering of central bank policy meetings will compete for the market’s attention. Finally, markets will continue to mull over the February employment report (released on Friday, March 4), which revealed that the U.S. labor market may have finally turned the corner. Aside from the monthly jobs report, the other economic data released last week was equally strong, suggesting that the economy was accelerating (not decelerating as it was in 2007-2008) as it began to absorb the higher consumer energy prices.

Rising Gasoline Prices to Impact Consumer Spending in February and Beyond

Aside from the regular weekly readings on retail sales, mortgage applications and initial claims for unemployment insurance, the only potentially market-moving economic report due out in the United States this week is the U.S. government’s retail sales report (issued by the Commerce Department) for February. The nation’s retailers reported their sales last week and results again exceeded expectations despite higher energy prices. The government’s monthly retail sales report this week extends beyond chain store retailers and includes sales at auto dealers, gasoline service stations, restaurants, grocery stores, sporting goods stores, electronic, furniture and appliance stores.

The broadest measure of consumer spending is the monthly report on personal consumption expenditures. This report includes all consumer purchases captured in the retail sales report, and also consumer spending on services—haircuts, dry cleaning, healthcare, public transportation, airfares, utilities, hotels, theme parks, legal fees, insurance, childcare, entertainment, college tuition, etc.—which together accounts for 70% of consumer spending. Consumer spending, in turn, accounts for about two-thirds of gross domestic product. Spending on services is, for the most part, not captured in the retail sales report due out this week. The February personal consumption data is due out in late March.

Although most of the rise in gasoline prices occurred in the latter half of February, gasoline service station sales are likely to have a big impact on overall retail sales in February. In addition, vehicle manufacturers already reported their February sales (the strongest in three years), so the market is likely to focus on “core” retail sales (sales excluding gasoline, auto dealers and building supply stores) to get the best reading on the underlying health of the consumer in February. Core retail sales is at an all-time high (surpassing its 2007 peak in early 2010), and was up 5.1% year-over-year in January 2011. By comparison, core retail sales growth averaged about 6.0% in the mid-2000s recovery.

The solid but not spectacular gains in retail sales in recent months are being driven by:

·         Personal income is up 4.7% year-over-year in January 2011 (income growth averaged 6% during the mid-2000s recovery)

·         Ongoing repair of consumer balance sheets (monthly debt payments relative to incomes are below their long-term average)

·         Higher consumer net worth (flat housing prices and a 100% gain in equity prices over the past two years)

On the downside, rising consumer energy prices, the lack of mortgage equity withdrawal (home equity loans were a sizeable source of spending power for homeowners in the mid-2000s), and a subdued labor market recovery are restraining consumer activity. On balance, we expect modest gains in consumer spending in 2011, stronger than 2010, though below the long-term average for this point in the economic cycle.

Strong February Jobs Report Caps off a Strong Week for Economic Data

As previously noted, last week’s batch of economic data (mainly for January and February) was almost universally strong. Personal income, personal spending, vehicle sales, the Beige Book, the ISM reports on manufacturing and nonmanufacturing, weekly initial claims for unemployment insurance, and chain store sales all matched or exceeded expectations. In general, last week’s data followed the pattern observed at the start of 2011 which saw severe weather in January dampen economic activity that gave way to more normal weather in February, boosting economic activity.

The strong February jobs report capped off the week. On balance, the data suggest that the U.S. economy was gathering momentum in early February 2011, and was probably in a better position to absorb the rise in consumer energy prices than it was in 2007-2008, when oil prices rose from $50 to $150 per barrel, and gasoline prices moved from around $2.00 per gallon to over $4.00 per gallon between early 2007 and mid-2008.

The private sector added 222,000 jobs in February, a snapback from the meager 68,000 jobs added in January. Severe winter weather had a big impact on the job count in January, and market participants are likely to average the payroll job count in January and February to get a better sense of the underlying health of the labor market. At 145,000, the average job gain in the first two months of 2011 is an improvement over where we were six months ago, but is probably not yet robust enough to convince the Fed that the labor market is completely healed. There were solid job gains in manufacturing, construction, transportation, and leisure. State and local governments shed another 30,000 jobs in February and have lost 400,000 since the end of the recession.

We remind readers that the monthly jobs report is made up of two surveys, the establishment survey and the household survey. The establishment survey generates the payroll job count data previously mentioned, while the household survey produces the unemployment rate. The unemployment rate is calculated by dividing the number of unemployed persons by the total number of people in the labor force. In February, the number of unemployed persons fell by 190,000 to 13.7 million and has declined by 1.4 million in the past three months. This is consistent with the drop in initial filings for unemployment benefits over the past three months. The labor force increased by 60,000 in February to 153.2 million, so the unemployment rate (13.7 million/153.2 million) fell from 9.0% in January to 8.9% in February.

While a promising sign, the strong February jobs report by no means signals an “all clear” for the labor market. The economy shed 8.8 million private sector jobs between January 2008 and February 2010, and has added just 1.5 million jobs back since early 2010. At the pace of job creation seen in February (222,000) it would take another 33 months (nearly three years) to recoup all the jobs lost in the Great 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. Stock investing involves risk including loss of principal Past performance is not a guarantee of future results. Investing in alternative investment may not be suitable for all investors and involve special risks such as risk associated with leveraging the investment, potential adverse market forces, regulatory changes, potential liquidity. There is no assurance that the investment objective will be attained. The fast price swings in commodities and currencies will result in significant volatility in an investor's holdings. 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 Market Commentary

Will Rising Energy Prices Derail the Recovery?

Financial market participants face a barrage of key policy events and economic data this week as they try to assess the impact of rising consumer energy prices on the global economic recovery. On the policy side, Federal Reserve (Fed) Chairman Bernanke will deliver key testimony on the economy and monetary policy, the Fed will release its Beige Book (a qualitative assessment of economic conditions in the United States), and central banks in Canada, Brazil, Australia, India, Indonesia and the European Central Bank (ECB) all meet to set policy this week. In addition, a shutdown of the U.S. government looms later in the week (March 4) as Congress scrambles to cobble together a spending bill that both parties can agree to.

On the economic front, the week is full of potentially market-moving reports. Early in the week, reports on manufacturing sentiment in the United States (Chicago Area Purchasing Managers Index), the Institute for Supply Management’s (ISM) report on Business for February, along with a report on Chinese manufacturing sentiment in February will garner most of the market’s attention. By midweek, the market will begin to focus on the state of the labor market in February with the release of the Challenger-tracked corporate layoff announcements and ADP employment report. The consumer is in the mix this week as well, with reports on consumer spending and personal income for January, vehicle sales for February, and chain store sales for February all due out. The week concludes with the much-anticipated February employment report, which is likely to show that the economy added over 200,000 jobs after severe weather held down employment in January.

Last week’s economic data and events were dominated by the sharp rise in oil prices, which, in turn, were largely the result of further unrest in the Middle East, mainly in Libya. The drop in initial claims for unemployment insurance, the gains in consumer confidence, Richmond Fed manufacturing index and weekly retail sales (all data readings for February) were consistent with previously released data for February. This data suggests that severe weather negatively impacted economic activity in January and that more normal weather in February allowed for a sharp rebound in activity. Thus, the underlying health of the U.S. economy can best be measured by taking an average of January and February’s data. Weak reports (for January) released last week included new home sales, and durable goods orders and shipments. We expect that when this data is reported for February (in late March), it too will show a rebound in activity.

Will Rising Consumer Energy Prices Derail the Recovery?

We will shift our focus now to the issue of rising energy prices and its impact on the economic recovery and on the consumer in particular. As we previously noted, one of the biggest threats to the economic recovery is a big spike in energy prices that would sharply curtail consumer spending and, to a lesser extent, business spending and lead to a slowdown in the economy and a potential recession. The relentless rise in consumer energy prices in the mid-2000s (from 2003 through mid-2008) were a major factor in derailing the mid-2000s (2002-2007) economic recovery and we remain vigilant to those risks.

Detailed data on consumer spending in January 2011 found in the monthly report on personal income and spending help to provide a broader perspective on what consumers spend on energy related goods and services. In January 2011, consumers spent an annualized $631 billion on energy goods and services (gasoline, home heating oil, propane, electricity, natural gas, etc.). The data on spending is adjusted for seasonality, so it takes into account the fact that people spend more on heating oil and natural gas in January than they do in June, but also accounts for the fact that consumers do more driving in June than in January. Seasonally adjusting data allows us to compare month-to-month changes in dataset and also allows us to compare spending in one month to spending in a different month on an “apples-to-apples” basis.                                                           

Out of context, $631 billion appears to be a great deal of money, but when compared to total personal spending ($10.6 trillion in January 2011), personal income ($12.9 trillion) and gross domestic product ($14.9 trillion), consumer spending on energy and energy services is relatively small. On balance, 6% of consumer spending and around 5% of personal incomes were spent on energy and energy services in January 2011. While low, these readings have moved steadily higher over the past two years, as prices of energy climbed from their Great Recession lows. For example, at the peak of energy prices in July 2008, consumers spent $710 billion on energy goods and services, representing 7% of total personal spending and 5.7% of personal incomes. In the worst of the Great Recession in late 2008, spending on energy goods and services sunk to $469 billion (4.8% of spending and 3.8% of incomes).

Higher energy costs impact businesses as well, although the data on what businesses spend on energy related goods and services is not as detailed as the consumer spending data. On balance, energy costs account for between 5 and 10% of overall business costs. By comparison, labor costs are roughly 70% of business costs. We note that the most noticeable impact on businesses from higher energy prices is on shipping and transportation costs. Businesses will try to pass these higher transport and shipping costs onto the end user (typically, the consumer), and if they are unable to pass on these costs, businesses profit margins (which are near record high) could suffer, which would slow corporate profit growth.

Since December 2008, spending on energy goods and services has moved from 4.8% of total consumer spending to 6.0% of spending, but still shy of the 7.0% of spending hit in mid-2008. Even that elevated reading was dwarfed by the near 10% of spending on energy goods and services relative to total spending seen in the late 1970s and early 1980s. Still, it is how far and how fast energy spending rises that matters most, and by those metrics the recent rise in consumer spending on energy goods and services is still muted. For example, in 1973, consumer spending on energy goods and services accounted for around 6% of total spending. After two oil embargoes (1973 and 1979), consumer energy spending accounted for nearly 10% of spending by 1980. This rising share of energy spending acted as a tax on the economy during the mid-to-late 1970s, slowing consumer spending and the overall economy, contributing to three recessions (1973- 75, 1980 and 1981-82).

Energy spending as a percent of total spending troughed in the early 2000s at around 4.0%, and by mid-2008 had nearly doubled to 7%. In our view, the surge from around 5% in late 2006 to the aforementioned peak in mid- 2008 (7%) was a key factor in causing the onset of the Great Recession in late 2007. In short, the move higher in energy prices and spending in the last 24 months or so has probably not been sharp enough or rapid enough to derail the recovery by itself. However, should consumer energy prices (gasoline, heating oil, electricity) move sharply higher in the coming months, and income gains reverse course and stagnate, the recovery would be in jeopardy. We will continue to monitor this important metric 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.

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 Richmond Fed Index is based on one of many regional surveys that measure manufacturing activity. These surveys can be of some help in forecasting the national NAPM - particularly the Philadelphia and Chicago surveys which are more closely watched due to their timeliness and the fact that these regions represent a reasonable cross section of national manufacturing activities. This report is released after the National Association Purchasing Managers (NAPM) survey and is therefore of little value.

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

A Blockbuster Week for Policy and Data

After a quiet week for data and policy last week (February 7 – 11), this week is shaping up to be a blockbuster. On the policy front, President Obama releases his 2012 budget early in the week and the Federal Reserve will publish the minutes of its latest Federal Reserve Open Market Committee meeting along with its most recent economic forecast in the middle of the week. Data on manufacturing for January (industrial production) and February (Philly Fed and Empire State) is likely to continue to show strength, aside from weather impacts. Housing data this week (homebuilder sentiment and housing starts) is likely to be heavily influenced by weather, as the housing market continues to bounce along the bottom. January data on consumer and producer inflation is likely to draw a great deal of attention given the recent flare-up in inflation concerns. The January retail sales data is also likely to show solid consumer demand, although it too is likely to be heavily influenced by the brutal winter weather in January. The full slate of Chinese economic data for January this week will serve to remind markets that more policy tightening in China is likely in the coming weeks and months.

At Least 25 Central Banks Have Already Raised Interest Rates in this Cycle, with More Likely to Come

Monetary policy overseas will also be in focus this week, as central banks in Japan, Sweden, India, Hong Kong and Chile meet to set rates. India and Chile are expected to raise interest rates this week; both have been raising rates for at least a year now. In addition to Chile and India, at least 23 other central banks around the globe have raised rates since late 2009. In the developed world, seven nations (Canada, Sweden, Norway, Australia, New Zealand, South Korea and Israel) have raised rates and are poised to raise rates further to combat growing domestic inflation and above-trend domestic economic growth.

At least 18 emerging market nations have already raised rates. Notable emerging market nations that have raised interest rates this cycle include China, Brazil, India, Taiwan, Malaysia, Indonesia, Chile and Peru. Developing nations have raised rates for some of the same reasons developed nations have raised rates — rising domestic inflation, above-trend economic growth and, in some cases, soaring domestic property markets. The three rate increases in China since October 2010 have captured the market’s attention, and more rate hikes are likely in the weeks and months ahead. Our sense is that until markets can get comfortable with the timing and extent of the rate increases in China (and in other large emerging market nations), investors are likely to remain cautious when investing in emerging markets.

Domestic Inflation in Focus this Week

The release of the January data on producer prices (Wednesday, February 16) and consumer prices (Thursday, February 17) will likely renew market chatter about domestic inflation in the United States. To be sure, domestic inflation remains tame, by almost any measure, although inflation (and fears of inflation) seems to be everywhere. The expected 0.3% month-over-month gain in the consumer price index (CPI) in January 2011 would leave consumer prices just 1.6% above their January 2010 level. The 1.6% year-over-year reading on the CPI expected in January 2011 would be smaller than all but 83 of the 600 monthly (year-over-year) inflation readings (less than 14%) recorded in the past 50 years. Inflation has averaged 4.0% since 1960.

In addition to benign inflation readings, expectations for headline inflation remain low from investors, consumers, and professional forecasters. As measured by the difference between the yield on the 10-year Treasury note and the yield on a 10-year Treasury inflation protected security (TIPS), the market is pricing in just 2.3% inflation over the next 10 years. Consumers’ inflation expectations are measured each month in the University of Michigan’s Survey of Consumers. Heavily influenced by the recent rise in food and gasoline prices, consumers are expecting 3.4% inflation over the next 12 months according to the most recent survey. Looking out over the next five years, which tends to mitigate the impact of a near-term rise in gasoline prices, consumers expect just 2.9% inflation. Consumers’ expectations for long-term inflation have held steady around 3.0% for almost 20 years. Similarly, professional forecasters’ long-term inflation forecasts (as measured by the Survey of Professional Forecasters conducted quarterly by the Philadelphia Fed) have remained relatively constant near 2.5% for the past 15 to 20 years. The FOMC forecast is for inflation to remain in the 1.5 to 2.0% range over the “long term”, and the non-partisan Congressional Budget Office (CBO) expects inflation to average around 1.8% over the next 10 years.

Given that observed and forecasted inflation remains quite low, why is the market (and the news media) so focused on inflation? Here in the United States, while overall food inflation is running at just under 2%, prices of certain foods are booming. For example, prices of meats and poultry are up nearly 6% from a year ago. Dairy prices are up nearly 4%. Within the CPI, the weights of the goods and services that make up the index are determined by what portion the item represents within our overall spending. Overall, food represents about 14% of our annual spending, and is therefore a 14% weight in the CPI. However, meats and dairy represent just fewer than 30% of our annual expenditures, and have only a 3% weight in the CPI. Price gains in most food categories outside of meats and dairy (cereals, fruits, beverages, etc.) are running at around 1% over the past year.

Selected Components of CPI
Category	Weight (As of December 2010)	Year-Over-Year Change (December 2009 to December 2010)
Total CPI	100%	+1.6%
Food	13.7%	+1.5%
Meats and Poultry	1.8%	+5.5%
Dairy	0.8%	+3.7%
Energy	9%	+7.9%
Gasoline	4.9%	+13.9%
Heating Oil	0.2%	+16.5%
Apparel	3.6%	-1.1%
Audio and Video Equipment	1.8%	-2.6%
Home Furnishings and Operations	4.4%	-2.5%
Source: Bureau of Labor Statistics

Another area of concern among consumers is the price of gasoline, heating oil, electricity and natural gas. Together, energy prices are up about 8% over the past year, and represent about 9% of our annual budgets. The culprits here are gasoline prices (+14% year-over-year) and home heating oil (+17% year-over-year). Electricity (uses for both heating and cooling homes) and natural gas prices (heating and hot water) are flat to down from a year ago.

Thus, most of the rise in food and energy prices can be traced to gasoline, heating oil, meats and dairy. While these are items that most Americans price and pay for on an almost daily basis, spending on these items represents less than 10% of overall spending (and therefore has about a 10% weight in the CPI). Nevertheless, price changes in these items can heavily influence perceptions about inflation.

Although we do not think about them or buy them as often, items like apparel, televisions, and household furnishings and operations also make up about 10% of what we spend, and therefore represent 10% of the CPI. Over the past year, apparel prices are down 1.1%, prices of audio and video equipment are down about 3%, and prices of household operation and furnishings are down 2.5%.

Budget Battle Just Beginning

As this report was being prepared for publication, President Obama released his budget proposal for fiscal year 2012, which begins on October 1, 2011. The proposed budget aims to cut the deficit (from the current baseline) by $1.1 trillion over the next 10 years, with two-thirds of the cuts coming from the spending side. The spending cuts will be viewed as too small by many members of the Republican majority in the House, and be viewed as too large by the Democratic majority in the Senate. For the current fiscal year (fiscal year 2011, which ends on September 30, 2011), the President’s budget has penciled in a $1.6 trillion deficit, with $3.8 trillion in spending falling far short of covering the expected $2.2 trillion in revenues. In fiscal year 2012, spending of $3.7 trillion will exceed expected revenues by $1.1 trillion.

On balance, very few of the policy related budget items in the President’s 2012 budget have a chance to be enacted. Indeed, even in years when the President’s party has control of both houses of Congress, the President’s budget proposal is merely a series of guideposts, policy initiatives and campaign slogans wrapped in the guise of precise numbers. In the current environment, his proposals have almost no chance of being passed into law.

House Republicans have proposed up to $100 billion in cuts in this fiscal year, but with over $3.8 trillion in spending expected in fiscal year 2011, even as much as $100 billion in cuts, while a good start, is literally just a rounding error. The debate over the budget will persist over the remainder of this year and will hopefully become a key theme in the Congressional and Presidential election year of 2012. Near term, the wrangling over the ceiling on the nation’s debt limit (which is expected to be reached in early spring 2011) and the release of the House Republicans’ budget in April will be key.

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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.

Treasury inflation-protected securities (TIPS) help eliminate inflation risk to your portfolio as the principal is adjusted semiannually for inflation based on the Consumer Price Index - while providing a real rate of return guaranteed by the U.S. Government.

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.

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

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

Fighting the FED

Facing a limited domestic economic calendar this week, market participants in the United States are likely to focus on the still unfolding political crisis in Egypt, another round of corporate earnings reports in the United States, several key overseas central bank meetings, Chinese economic data for January, and a full slate of public appearances from Federal Reserve (Fed) officials. Amid an upside breakout in yields on U.S. Treasury notes, this week’s $72 billion Treasury auction of 3-, 10- and 30-year notes will draw close attention. In the absence of fresh data on the U.S. economy, markets will pay even closer attention to the weekly economic data on retail sales, mortgage applications and jobless claims, and continue to reflect on last week’s heavy slate of data which included the monthly jobs report for January.

A Survey of Small Businesses Highlights a Quiet Economic Calendar

The week after the release of the monthly employment report is usually a quiet one for economic data in the United States, and this week is no exception. Although the market will digest reports on consumer credit outstanding, wholesale inventories, and imports and exports for December, none of the reports is likely to be market-moving, as the fourth quarter of 2010 is now a distant memory. Instead, markets may place more focus on the regular slate of weekly data on retail sales, mortgage applications and initial claims for unemployment insurance. Although this data is likely to again be impacted by severe winter weather, it will shed some light on how the economy was performing as January turned to February.

The National Federation of Small Business (NFIB) report on small business optimism for February is due this week, providing a more timely, though limited, view on small business in the middle of the first quarter of 2011. Heavily dominated by construction firms (roughly 20% of the respondents are construction-oriented while only 5% of the overall economy is construction-related), this index has moved steadily higher from its mid-2009 lows. The index is expected to tick up again in February but, on balance, small business optimism remains well below levels seen in the mid-2000s. Poor sales, difficulty obtaining credit, too much government regulation and taxes continue to weigh on small business optimism. Small businesses accounted for nearly two-thirds of all hiring over the past 20 years, and have only recently (and tentatively) begun adding to payrolls, according to the ADP survey of small business hiring.

Overseas, the end of the Lunar New Year celebration in China brings economic reports on Chinese imports and exports for January, and opens the door for more interest rate increases and other policy actions designed to slow inflation in China. Elsewhere, central banks in the United Kingdom, The Philippines, and South Korea meet this week to decide policy. The Bank of England (BOE) is in easing mode, but the consensus is looking for higher rates out of the BOE by year-end. The South Korean central bank has been raising rates since mid-2010 and surprised markets with a rate hike in mid- January. Another rate hike is expected this week. No rate hike is expected in the Philippines. Despite 7.0% GDP growth, the inflation rate remains in check at around 3.0%. GDP growth in the Philippines, an emerging market nation, is expected to decelerate to around 5.0% in 2011, while overall GDP growth in the emerging markets is expected to be in the 6.0% to 7.0% range in 2011, despite a modest deceleration in growth in China from close to 10.0% in 2010 to 9.5% in 2011.

Ben Bernanke in the Hot Seat This Week

The Fed will remain in the headlines this week, as several key Fed officials are slated to make public appearances. Markets will likely focus on a speech by Dallas Fed President Richard Fisher on Tuesday, February 8, and Fed Chairman Ben Bernanke’s testimony before noted Fed critic Congressman Ron Paul’s House Budget Committee on Wednesday, February 9. Last week, Fisher, a well-known inflation “hawk” (a policy maker more likely to be worried about too much inflation than not enough growth), stated that he would not support another round of quantitative easing when the current round of quantitative easing ends in June.

Quantitative easing is also likely to be a key topic of discussion when Fed Chairman Bernanke is questioned by Congressman Paul. Paul is a well-known Fed critic, is not in favor of QE2, and is author of a book called “End the Fed.” Paul will likely push Bernanke on the Fed’s transparency and also call for a full audit of the Fed, which Bernanke has strongly opposed in the past. It should make for an interesting Wednesday morning in Washington.

The January Employment Report Was Stronger Than the Headline Suggested

The January employments report (released on Friday, February 4) was beset with the same weather-related problems that impacted most of the other data we have in hand for January 2011. Our basic view on the labor market— the economy is growing quickly enough to generate some job growth, but not quickly enough to generate enough job growth to satisfy the Fed—was unchanged by the report. Much of the weakness in the January employment report, including the meager 36,000 gain in employment between December and January, can be explained away by foul weather. Expectations were for the economy to create more than 140,000 jobs in the month. It marked the eighth consecutive January in which the job count fell short of expectations.

There were signs behind the headlines of the report that the underlying health of the labor market continued to improve. Bucking a strong three-decade trend, the December job count was revised higher. In 23 of the last 31 years (dating back to 1980), the December jobs count was revised down along with the release of the January data. In addition, three “weather-sensitive” areas of employment (construction, transportation and leisure) saw a combined 75,000 drop in employment in January relative to December. Over much of 2010, these three sectors combined added around 25,000 jobs per month. The 100,000 swing between the “normal” gain of 25,000 per month for most of 2010 and the 75,000 drop in January (largely due to weather) accounted for all of the disappointment (relative to expectations) in January.

Digging a little deeper, there was also some good news about the underlying health of the labor market in the “household survey.” The household survey revealed that the unemployment rate dropped by 0.4 percentage points in January 2011 to 9.0%. The 0.8 percentage point drop in the unemployment rate over the past two months (December 2010 and January 2011) was the steepest two-month drop in the unemployment rate since 1958. The only other time in the last 50+ years that came close to matching the 0.8% drop over a two-month period was in mid-1983, as the unemployment rate dropped 0.7 percentage points in what turned out to be the start of a very robust recovery in the labor market.

There are certainly reasons to cast some suspicion on the big drop in the unemployment rate since nearly one million people were unable to work in January due to bad weather, according to the household survey, nearly five times the normal amount in a typical January. The Fed and the markets will be watching to see if the unemployment rate continues to drift lower from here in the next several months amid more “normal” weather. If so, the view held by us, the Fed and, to some extent, the consensus of a tepid labor market may be challenged and suggest the labor market is improving more rapidly than is now thought.

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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.

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

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