member finra/sipc the economy and financial markets february 22, 2008

Member FINRA/SIPC

The Economy and Financial Markets

February 22, 2008

2


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Economy and Financial Markets:Current Conditions

Economy strong in Q3, slow in Q4 and Q1.

Inflation contained – core around 2-2.5%.

Profits / Earnings big short-term hit – sub prime related.

Stock price gains in 08 expected to match earnings growth.

Risks are: terrorism, Iraq, oil prices and subprime reaction.

Bond market risk moderate due to good inflation outlook.

Credit market concerns appear overblown, damage limited.

$ exchange rate bouncing off a new record low.

3


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Quarterly % Change in Real GDP % Change - Annual Rate

12-Month % Change in Payroll Employment % Change - Year to Year

0500959085

Sources: BEA, BLS /Haver 02/22/08

12

8

4

0

-4

-8

12

8

4

0

-4

-8

Q3 GDP Up 4.9%, Q4 +0.6% (Lower Due to Housing & Inventory Drop), Employment Growth +0.7%

4


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ECRI Weekly Leading Index1992=100

Dow Jones U.S. Business Barometer Index2000=100

05009590Sources: ECRI, BTMU /Haver 02/22/08

160

140

120

100

80

104

100

96

92

88

84

80

ECRI and Dow Barometer Down, Expect Slowdown, Not Recession

5


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Real After-Tax Personal IncomeSAAR, Bil.Chn.2000$

Real Personal Consumption ExpendituresSAAR, Bil.Chn.2000$

05009590Source: Bureau of Economic Analysis /Haver Analytics 02/22/08

9000

8250

7500

6750

6000

5250

4500

9000

8250

7500

6750

6000

5250

4500

Real Personal Income Rising, as is Spending: Not Much Housing Impact

6


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Shipments of Manufacturing Durable GoodsSA, Mil.$

New Orders for Manufacturing Durable GoodsSA, Mil.$

05009590Source: Census Bureau /Haver Analytics 02/22/08

250000

225000

200000

175000

150000

125000

100000

250000

225000

200000

175000

150000

125000

100000

New Orders Surge But Shipments Still Flat – Business Cost Control

7


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Unfilled Orders for Durable Goods: Order Backlog Very HighSA, Mil.$

Ratio of Inventories to Shipments: Low - No Inventory OverhangRatio

05009590Source: Haver Analytics 02/22/08

825000

750000

675000

600000

525000

450000

375000

2.4

2.2

2.0

1.8

1.6

1.4

1.2

Order Backlog Very High, Inventories Low Relative to Shipments

8


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Median Sales Price: Existing 1-Family Homes$

Ratio: Median Price / Disposable Income per CapitaMeasure of housing P/E


240000

200000

160000

120000

80000

40000

0

8.0

7.5

7.0

6.5

6.0

5.5

5.0

Home Prices Weak, Income Up So Housing “P / E” Now Way Down (Especially Given Low Interest Rates)

9


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Housing StartsSAAR, Thous.Units

New Single Family Home SalesSAAR, Thous

05009590Source: Census Bureau /Haver Analytics 02/22/08

2400

2000

1600

1200

800

400

1400

1200

1000

800

600

400

Home Sales and Starts Now Way Down – After 2 Years of Decline, The Worst Likely Behind Us.

10


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Loan Delinquency Rate: All Commercial BanksSA,%

Loan Charge-Off Rate: All Commercial BanksSA,%

0500959085

Source: Federal Reserve Board /Haver Analytics 02/22/08

7

6

5

4

3

2

1

0

7

6

5

4

3

2

1

0

Major Credit Threat? No – Total Bank Problem Loans Low. Q4 Residential Loan Delinquency 3.1%, Defaults 0.4%, Low, But Likely to Rise

11


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Growth in Real U.S. Exports % Change - Year to Year

Growth in Real U.S. Imports % Change - Year to Year

080706050403020100999897969594Source: Bureau of the Census /Haver Analytics 02/22/08

20

10

0

-10

-20

20

10

0

-10

-20

US Trade Upturn Offsets Housing Weakness. U.S. Exports Are Three Times As Big As Residential Construction.

12


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Unemployment RateSA, %

Weekly Initial Claims for Unemployment InsuranceSA, Thous

05009590Sources: BLS, DOL /Haver 02/22/08

8.25

7.50

6.75

6.00

5.25

4.50

3.75

600

525

450

375

300

225

Claims Lead Unemployment Rate (4.9%), Claims Are Up Some, So Unemployment May Drift a Bit Higher.

13


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Change in Total Employment Cost Index (Wages + Benefits)Private Sector: 4-Quarter % Change

Change in Benefits Cost - Has Slowed Considerably4-Quarter % Change

05009590

Source: Bureau of Labor Statistics /Haver Analytics 02/22/08

8

7

6

5

4

3

2

1

8

7

6

5

4

3

2

1

Private Sector Employment Cost Inflation at 3% - Benefit Costs Under Control

14


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Total CPI Inflation % Change - Year to Year

Core CPI Inflation (Excludes Food & Energy % Change - Year to Year

05009590Source: Bureau of Labor Statistics /Haver Analytics 02/22/08

7

6

5

4

3

2

1

7

6

5

4

3

2

1

Total CPI Inflation Up Due to Oil Prices, Core Still Down at 2.4%

15


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Fed Funds Target RateEOP, %

Sum of Core CPI Inflation and Payroll Employment Growth%


10

8

6

4

2

0

10

8

6

4

2

0

Fed Target is (Roughly) Core Inflation + Employment Growth. We Think Rate Cuts are the Right Policy Action

Fed funds rate finally below the 3.2% sum of core CPI inflation of 2.5% and job growth of 0.7%.

Fed over did it in late 1999 - 2000

16


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Crude Oil Price - West TexasEOP, $/Barrel

Dollar Exchange Rate - Major Currency IndexAvg, 3/73=100

05009590Sources: WSJ, FRB /Haver 02/22/08

120

100

80

60

40

20

0

112.5

105.0

97.5

90.0

82.5

75.0

67.5

Risks? Sure – Sky High Oil Prices & Lack of Dollar Rebound

Record Dollar lows behind us?

Record oil price behind us?

17


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S&P 500: After-tax Earnings with Next Quarter Estimate$/Shr

S&P 500: Operating Earnings with Next Qtr Estimate$/Share

05009590

Source: Standard & Poor's /Haver Analytics 02/22/08

24

20

16

12

8

4

0

28

24

20

16

12

8

4

Company Earnings Outside Financials Okay, but Big Q3-Q4 Hit on Financials From the Sub-Prime Fiasco.

18


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P/E Ratio: S&P 500 Stock Price Divided By Same Quarters Earnings

P/E calculated using current quarter operating earnings times 4

05009590

Source: Haver Analytics 02/22/08

0.35

0.30

0.25

0.20

0.15

0.10

0.35

0.30

0.25

0.20

0.15

0.10

Current Quarter S&P 500 P / E is around 22 – Spike Due to Subprime Hit Higher Risk on the Value Side, Lower Risk on the Growth Side

Higher Risk Region

Lower Risk Region

19


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US Net New Equity Issues: Record High Stock Buybacks!

New Equity Issued less Stock Bought Back in $Billions at Annual Rates

050095908580757065605550


200

0

-200

-400

-600

-800

200

0

-200

-400

-600

-800

Record U.S. Net Stock Repurchases - $610 Billion Last Four Quarters

20


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Financial Assets Less Liabilities of All US Nonfinancial Corps.

billions - US companies are now net lenders

0500959085807570656055


1500

1000

500

0

-500

-1000

-1500

1500

1000

500

0

-500

-1000

-1500

Corp. Balance Sheet – Companies’ Financial Assets Exceed Liabilities by $1.4 Trillion. Now Net Lenders, Usually are Net Borrowers

Total U.S. non-financial companies net lenders

Total U.S. non-financial companies net borrowers

21


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Equity Total Return Beats Fixed Income, but with Volatility

S&P 500 Total ReturnEOMLehman Bond Index: US Aggregate Total ReturnEOP, Dec-31-75=10005009590 Sources: Standard & Poor's, Lehman Brothers/ Haver Analytics 02/22/0825002000150010005000 25002000150010005000

22


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Total Return: Russell 3000 Value Index5/31/95=1000

Total Return: Russell 3000 Growth Index5/31/95=1000

0807060504030201009998979695Source: Frank Russell Company /Haver Analytics 02/22/08

4500

3750

3000

2250

1500

750

4500

3750

3000

2250

1500

750

Value Has Outperformed Growth Since 2000 – is Now Reversing

23


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Cumulative Total Return of Value Relative to Growth

Ratio: Russell 3000 Value / Growth Total Return Indices


1.8

1.6

1.4

1.2

1.0

0.8

0.6

1.8

1.6

1.4

1.2

1.0

0.8

0.6

About 110% Outperformance of Value Since 2000 Now Reversing

24


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Total Return: Russell 1000 Large Cap IndexAvg, 12/31/78=100

Total Return: Russell 2000 Small Cap IndexAvg, 12/31/78=100

080706050403020100999897969594Source: Frank Russell Company /Haver Analytics 02/22/08

4500

3750

3000

2250

1500

750

4500

3750

3000

2250

1500

750

Small Caps Outperformed Large Caps Since 1999 – Now Reversing

25


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Cumulative Total Return of Small Relative to Large Caps

Ratio: Russell 2000 / Russell 1000 Total Return Indices


1.6

1.4

1.2

1.0

0.8

0.6

0.4

1.6

1.4

1.2

1.0

0.8

0.6

0.4

Last 28 Years Small Caps have NOT Outperformed Large Caps. Back to Underperforming

26


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EAFE Total Return Index in DollarsEOP US$

S&P 500 Total ReturnEOP

050095908580Sources: MSCI Inc. , Standard & Poor's /Haver Analytics 02/22/08

8000

6000

4000

2000

0

8000

6000

4000

2000

0

Large Cap International Equities (EAFE Index) Now Underperforming The U.S.

27


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30-Year Treasury Bond YieldAvg,%

2-Year Treasury Note YieldAvg, %

05009590Sources: Haver Analytics, U.S. Treasury 02/22/08

10

8

6

4

2

0

10

8

6

4

2

0

Fast, Deep Short-term Rate Cuts Sharply Lower Recession Probability. Low Long-term Rates Help.

28


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High Yield RateSource: Merrill Lynch

Yield Spread: High Yield Rate Less 5-Year Treasury Rate%


15.0

12.5

10.0

7.5

5.0

2.5

0.0

15.0

12.5

10.0

7.5

5.0

2.5

0.0

High Yield – Spreads Up On Sub Prime Worries

29


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Ratio: Russell 3000 Value to Russell 3000 Total Return IndicesMeasures cumulative total return of Value relative to the Total market

Ratio: Russell 3000 Growth to Russell 3000 Total Return IndicesMeasures cumulative total return of Growth relative to the Total market


1.3

1.2

1.1

1.0

0.9

0.8

0.7

1.3

1.2

1.1

1.0

0.9

0.8

0.7

Shark Chart: Return of Value & Growth Relative to Total Market

30


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Conclusions

GDP growth for 08 expected to be in the 2% range.

$80+ oil knocks 1-2%+ off GDP & cut jobs gain by a million.

Total inflation up on oil prices, but core inflation remains low.

Earnings are generally okay – expect 5-10% in 2008.

S&P 500 P/E spiking up, but expect prices to track 08 earnings.

Non-Financial Co. Earnings and Balance Sheet quality look high.

Bond risk moderate, subprime problems concentrated.

Dollar exchange rate risk now low (recovering from record low).

Further fed funds rate cut to 2.5% likely.

31


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The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The Russell 1000 Index measures performance of 1000 large cap, US companies. The Russell 2000 Index measures performance of 2000 small cap, US companies. The Russell 3000 Growth and Value Indices measure the performance of growth and value stocks respectively.

The Dow Jones Industrial Average is comprised of 30 stocks that are major factors in their industries, and widely held by individuals and institutional investors. These 30 stocks represent about a fifth of the $8 trillion-plus market value of all U.S. stocks and about a fourth of the value of stocks listed on the New York Stock Exchange. It is not possible to invest directly in an index.

The Lehman Brothers Aggregate Bond Index is composed of securities from the Lehman Government/Credit Bond Index, Mortgage Backed Securities Index and Asset Backed Securities Index.

The Merrill Lynch High Yield Index is an unmanaged index consisting of bonds that are issued in U.S. Domestic markets with at least one year remaining maturity. All bonds must have a credit rating below investment grade but not in default.

Government bonds and Treasury Bills are guaranteed by the US government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value.

High yield/junk bonds are not investment grade securities, involve substantial risks and generally should be part of the diversified portfolio of sophisticated investors.

Small cap stocks may be subject to a higher degree of risk than more established companies’ securities. The illiquidity of the small cap market may adversely affect the value of these investments.

P/E Multiple: A tool for comparing the prices of different common stocks by assessing how much the market is willing to pay a share of each corporation’s earnings. It is calculated by dividing the current market price of a stock by the earnings per share.

Past performance is no guarantee of future results. Indices such as the S&P 500 may not be invested into directly.

The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual. To determine which investments may be appropriate for you, consult your financial advisor prior to investing.

The Morgan Stanley Capital International (“MSCI”) Europe, Australasia, Far East Index (“EAFE”) is an unmanaged index of over 900 companies, and is a generally accepted benchmark for major overseas markets. Index weightings represent the relative capitalizations of the major overseas makers included in the index on a U.S. dollar adjusted basis. The index is calculated separately; without dividends, with gross dividends reinvested and estimated tax withheld, and with gross dividends reinvested, in both U.S. Dollars and local currency.

Important Disclosures

This research material has been prepared by LPL Financial. The LPL Financial family of affiliated companies includes LPL, UVEST Financial Services Group, Inc., IFMG Securities, Inc., Mutual Service Corporation, Waterstone Financial Group, Inc., and

Associated Securities Corp., each of which is a member of FINRA/SIPC.

Not FDIC/NCUA Insured Not Bank/Credit Union Guaranteed May Lose Value

Not Guaranteed by any Government Agency Not a Bank/Credit Union Deposit

Tracking# 396827 (Exp 12/08)

member finra/sipc the economy and financial markets february 22, 2008

Documents

housing impact slide

recession slide

real income

commercial banks sa

loan delinquency rate

real personal income

home sales

loan charge