LP L FINANCIAL R E S E AR C H

Weekly Economic Commentary

August 27, 2012

A Summer Holiday? No, Not This Week

John Canally, CFA
Economist LPL Financial

The week before Labor Day is usually a quiet one for nancial market participants, with calendars light on meetings and heavy on vacation time. However, nancial markets face a series of key economic and policy events that could make this week (August 27 31) anything but quiet. The events this week could provide market participants with more insight into:

Highlights
In the middle of the week, the Feds Beige Book is likely to show that the economy is still moving ahead, albeit sluggishly, with more help than in any recent year from housing. Europe remains in recession, as sovereign debt woes have severely reduced the health of the European banking system, and, in turn, the European economy. Our view remains that Chinese authorities have the scope, ability, and desire to engineer a soft landing.
Please see the LPL Financial Research Weekly Calendar on page 3

The Federal Reserve (Fed) and prospects for more quantitative easing, The health of the U.S. economy in the third quarter of 2012, The European sovereign debt crisis and the state of the European economy, The scal cliff, and The health of the Chinese economy and prospects for more policy action.

On balance, the events of this week are likely to reinforce the notion that the Fed will take more action soon to stimulate the economy and the U.S. economy is growing more rapidly in recent weeks than it did in the second quarter, but not fast enough to satisfy the Fed. The data in Europe this week is likely to conrm that the continent remains in recession (with several economies in a depression), and that the next steps toward resolving the crisis revolve around the European Central Bank (ECB), requests for aid from Spain, and the German Constitutional Courts ruling on the European Stabilization Mechanism (ESM). The scal cliff may come into sharper focus as the Republicans ofcially nominate Mitt Romney as their Presidential candidate and Paul Ryan as their Vice Presidential candidate for the upcoming election. The release of the Chinese Purchasing Managers Index for August will likely conrm that the Chinese manufacturing economy continued to slow in August, setting the stage for another round of monetary and scal stimulus in that nation.

Will Bernanke Hint at QE3?

For the Fed, the week kicks off with public appearances on Monday, August 27, 2012 (as this report was being prepared for publication) from two doves (see nearby calendar for details) on the Federal Open Market Committee (FOMC), Chicago Fed President Evans and Cleveland Fed President Pianalto. In recent public appearances, both have advocated more stimulus from the Fed, and it would not be surprising to see both maintain that stance this week. Of the two, only Pianalto is a voting member of the

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FOMC this year. Evans is on the FOMC, but does not vote until 2013. In the middle of the week, the Feds Beige Book, a qualitative assessment of business conditions in each of the 12 Federal Reserve districts (Boston, New York, Kansas City, Cleveland, Dallas, etc.), is likely to show that the economy is still moving ahead, albeit sluggishly, with more help than in any recent year from housing. Words like drought, condence, Europe, and uncertainty which had nearly disappeared from the Beige Books released in early 2012 reappeared in the July 2012 Beige Book, and are likely to be prominent again in the Beige Book released this week. The next FOMC meeting is not until September 13, but prior to that Fed Chairman Bernanke will speak at a Kansas City Fed symposium on monetary policy in Jackson Hole, WY on Friday, August 31. If Bernanke and the Fed are ready to act as soon as the September FOMC meeting, his comments are likely to tilt toward the potential rewards of doing more quantitative easing. If Bernanke remains undecided at this point, his comments would include discussion of the rewards and risks of more quantitative easing. We, and increasingly most market participants, expect Bernanke to hint that another round of Fed policy actions is imminent. In our view, unless, as noted by the minutes of the August 1, FOMC meeting, there is a substantial and sustainable strengthening in the pace of the economic recovery", it is a matter of when, not if, the Fed does more. In recent weeks, U.S. economic data has pointed to a slight acceleration in growth (to around 2.0 to 2.5% in the third quarter of 2012) from the moribund 1.5% pace seen in the second quarter, as measured by gross domestic product (GDP). However, the economy remains on a pace below the Feds target growth for 2012 (1.9 to 2.4%) and for the long term (2.3 to 2.5%). The data this week on:

The economy remains on a pace below the Feds target growth for 2012 (1.9 to 2.4%) and for the long term (2.3 to 2.5%).

Economic Growth Has Accelerated in the Third Quarter, but Remains Subpar
Real Gross Domestic Product Seasonally Adjusted Annualized Rate, % Change Q3 2012 Estimate 8 4 0 -4 -8
Fed Forecast

Manufacturing in August (Dallas Fed, Richmond Fed, and Kansas City Fed manufacturing indices as well as the Chicago Area Purchasing Managers Index), Housing (pending home sales in July and home prices in June), and The labor market (initial claims for unemployment insurance for the week ending August 25)

-12 02 03 04 05 06 07 08 09 10 11 12 13

Source: Bureau of Economic Analysis, Haver Analytics 08/27/12

are all likely to conrm the recent modest acceleration in growth and an improved housing market, but are not likely to be robust enough to convince most Fed ofcials that more policy stimulus is unwarranted.

Preparing For Policy Response in Europe and China

In Europe this week, markets will have to digest several sovereign debt sales from Italy, and assess the implications of key meetings between German Chancellor Angela Merkel and Italian Prime Minister Mario Monti. There are a number of key economic events in Europe this week including:

Consumer prices for August, Germans IFO Index, a key gauge of business sentiment, for August, Eurozone business and consumer condence for August, and Eurozone unemployment for July.

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LPL Financial Research Weekly Calendar

U.S. Data
2012 27 Aug 28 Aug

Fed

Global Notables

Dallas Fed Index (Aug.) Republican National Convention begins (Tentative) Case-Shiller Home Price Index (Jun) Richmond Fed Index (Aug) Consumer Confidence (Aug) GDP (Q2) Pending Home Sales (Jul)

Evans Pianalto*

Germany: IFO Index (Aug) Italy: Bond Auction

29 Aug

Beige Book

Europe: Germanys Angela Merkel meets Italys Mario Monti Brazil: Central Bank Meeting Norway: Central Bank Meeting Germany: CPI (Aug) Italy: Bond Auction Europe: Angela Merkel visits China Europe: Estonia votes to ratify ESM Eurozone: Consumer and Business Confidence (Aug) India: GDP (Q2) Brazil GDP (Q2) Canada GDP (Q2) Japan: Industrial Production (Jul) Eurozone: CPI (Aug) Eurozone: Unemployment Rate (Jul) China: PMI (Aug) IMFs Lagarde, ECBs Nowotny, and BOEs Posen speak at Jackson Hole

30 Aug

Personal Income and Spending (Jul) Initial Claims (8/25) Chain Store Sales (Aug)

31 Aug

Chicago PMI (Aug) Factory Orders (Jul) Consumer Sentiment (Aug)

Jackson Hole Conference Bernanke Speech

Hawks: Fed ofcials who favor the low ination side of the Feds dual mandate of low ination and full employment Doves: Fed ofcials who favor the full employment side of the Feds dual mandate

The Chinese Economy Is Slowing, but is Not Headed for a Hard Landing
China: PMI: Manufacturing Seasonally Adjusted, 50+=Expansion

60 55 50 46 41 36 05 06 07 08 09 Source: CFLP, NBS, Haver Analytics 08/27/12 10 11 12

Europe is also on the agenda at the Jackson Hole Symposium, with speeches from the International Monetary Fund's (IMF) Christine Lagarde and the ECBs President Mario Draghi. Europe remains in recession, with nations like Greece and Spain in deep recession and near depression, as sovereign debt woes have severely reduced the health of the European banking system, and, in turn, the European economy. The data and events this week in Europe are likely to conrm the economic downturn in Europe, and that the next step toward resolving the long-term problems in Europe is likely a formal request by Spain for aid from the ESM. The rst of the back-to-back national political conventions kicks off the week as the Republican Party holds its convention in Tampa, Florida. This event may be overshadowed by the arrival of Hurricane Isaac (Please see this weeks Weekly Market Commentary for details). The Democratic National Convention in Charlotte, North Carolina begins the day after Labor Day, September 4. The arrival of convention season may usher in more debate around the nations troubled scal situation which, in turn, may lead to investors paying more attention to the topic. For more on our views of the impact of the scal cliff, please see our 2012 Mid-Year Outlook publication. Late in the week, Friday night, August 31, at 9:00 PM ET, China will release its Purchasing Managers Index for August. Since peaking at 56.6

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A hard landing reading on the Chinese Purchasing Managers Index would be in the mid 40s or below, readings last seen during the Great Recession of 2008.

in late 2009, the Chinese PMI has been moving back toward 50, which is the dividing line between an expanding and contracting manufacturing economy, raising fears of a hard landing or 5 to 6% growth in real GDP. A hard landing reading on the Chinese Purchasing Managers Index would be in the mid 40s or below, readings last seen during the Great Recession of 2008. Our view remains that Chinese authorities have the scope, ability, and desire to engineer a soft landing, or 7 to 8% GDP growth this year. Chinas economy has been hit by the slowdown in Europe, but also by the lagged effect of the rate hikes engineered by the Peoples Bank of China in 2010 and 2011. China has been easing monetary policy since the middle of 2011 to combat the slowdown, and may act to ease monetary policy further at any time. Another round of scal policy stimulus in China is also likely to occur in the coming weeks and months, and any such actions would be welcome by markets.

LPL Financial Research 2012 Forecasts

GDP 2%* Federal Funds Rate 0%^ Private Payrolls +200K/mo.

Please see our 2012 Outlook for more details on LPL Financial Research forecasts. IMPORTANT DISCLOSURES The opinions voiced in this material are for general information only and are not intended to provide specic advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your nancial 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. * Gross Domestic Product (GDP) is the monetary value of all the nished goods and services produced within a country's borders in a specic time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a dened territory. ^ Federal Funds Rate is the interest rate at which depository institutions actively trade balances held at the Federal Reserve, called federal funds, with each other, usually overnight, on an uncollateralized basis. Private Sector the total nonfarm payroll accounts for approximately 80% of the workers who produce the entire gross domestic product of the United States. The nonfarm payroll statistic is reported monthly, on the rst Friday of the month, and is used to assist government policy makers and economists determine the current state of the economy and predict future levels of economic activity. It doesnt include: - general government employees - private household employees - employees of nonprot organizations that provide assistance to individuals - farm employees The branch of the Federal Reserve Board that determines the direction of monetary policy. The FOMC is composed of the board of governors, which has seven members, and ve reserve bank presidents. The president of the Federal Reserve Bank of New York serves continuously, while the presidents of the other reserve banks rotate their service of one-year terms. China CPI: In total there are about 600 "national items" used for calculating the all-China CPI. The list of items is revised annually for representativeness based on purchases reported in the household surveys. The number of items can change from year to year, but rarely by more than 10 in any given year.
This research material has been prepared by LPL Financial. To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an afliate of and makes no representation with respect to such entity.
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