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Weekly Economic CommentaryAugust 27, 2012

John Canally, CFAEconomist LPL Financial

A Summer Holiday? No, Not This Week

The week before Labor Day is usually a quiet one for financial market participants, with calendars light on meetings and heavy on vacation time. However, financial 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:

� 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 fiscal 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 confirm 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 Court’s ruling on the European Stabilization Mechanism (ESM). The fiscal cliff may come into sharper focus as the Republicans officially 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 confirm that the Chinese manufacturing economy continued to slow in August, setting the stage for another round of monetary and fiscal 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

Please see the LPL Financial Research Weekly Calendar on page 3

HighlightsIn the middle of the week, the Fed’s 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”.

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WEEKLY ECONOMIC COMMENTARY

FOMC this year. Evans is on the FOMC, but does not vote until 2013. In the middle of the week, the Fed’s 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”, “confidence”, “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 Fed’s target growth for 2012 (1.9 to 2.4%) and for the long term (2.3 to 2.5%). The data this week on:

� 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)

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

Preparing For Policy Response in Europe and ChinaIn 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,

� German’s IFO Index, a key gauge of business sentiment, for August,

� Eurozone business and consumer confidence for August, and

� Eurozone unemployment for July.

1 Economic Growth Has Accelerated in the Third Quarter, but Remains Subpar

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

11 12 1309 10080705 06040302

Real Gross Domestic Product Seasonally Adjusted Annualized Rate, % ChangeQ3 2012 Estimate

8

4

0

-4

-8

-12

Fed Forecast

The economy remains on a pace below the Fed’s target growth for 2012 (1.9 to

2.4%) and for the long term (2.3 to 2.5%).

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WEEKLY ECONOMIC COMMENTARY

2012

27 Aug � Dallas Fed Index (Aug.) EvansPianalto*

� Germany: IFO Index (Aug)

28 Aug � Republican National Convention begins (Tentative) � Case-Shiller Home Price Index (Jun) � Richmond Fed Index (Aug) � Consumer Confidence (Aug)

� Italy: Bond Auction

29 Aug � GDP (Q2) � Pending Home Sales (Jul)

� Beige Book � Europe: Germany’s Angela Merkel meets Italy’s Mario Monti

� Brazil: Central Bank Meeting � Norway: Central Bank Meeting � Germany: CPI (Aug)

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

� Italy: Bond Auction � Europe: Angela Merkel visits China � Europe: Estonia votes to ratify ESM � Eurozone: Consumer and Business Confidence

(Aug)

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

� Jackson Hole Conference � Bernanke Speech

� India: GDP (Q2) � Brazil GDP (Q2) � Canada GDP (Q2) � Japan: Industrial Production (Jul) � Eurozone: CPI (Aug) � Eurozone: Unemployment Rate (Jul) � China: PMI (Aug) � IMF’s Lagarde, ECB’s Nowotny, and BOE’s

Posen speak at Jackson Hole

FedGlobal Notables

LPL Financial Research Weekly Calendar

U.S. Data

Hawks: Fed officials who favor the low inflation side of the Fed’s dual mandate of low inflation and full employment

Doves: Fed officials who favor the full employment side of the Fed’s dual mandate

Europe is also on the agenda at the Jackson Hole Symposium, with speeches from the International Monetary Fund's (IMF) Christine Lagarde and the ECB’s 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 confirm 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 first 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 week’s 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 nation’s troubled fiscal situation which, in turn, may lead to investors paying more attention to the topic. For more on our views of the impact of the fiscal 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

2 The Chinese Economy Is Slowing, but is Not Headed for a Hard Landing

Source: CFLP, NBS, Haver Analytics 08/27/1211 1209 10080705 06

China: PMI: Manufacturing Seasonally Adjusted, 50+=Expansion

60

55

50

46

41

36

WEEKLY ECONOMIC COMMENTARY

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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. China’s 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 fiscal policy stimulus in China is also likely to occur in the coming weeks and months, and any such actions would be welcome by markets. �

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.

* Gross Domestic Product (GDP) is the monetary value of all the finished goods and services produced within a country's borders in a specific 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 defined 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 first 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 doesn’t include: - general government employees - private household employees - employees of nonprofit 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 five 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.

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.

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.

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Jeffrey Kleintop, CFAChief Market Strategist LPL Financial

LPL F INANCIAL RESEARCH

Weekly Market CommentaryAugust 27, 2012

Weather or Not: Be Prepared

HighlightsFrom time to time, predicting the weather — or at least paying very close attention to how it is developing — is part of making economic and market forecasts.

Hurricanes cause a temporary weakening in output and employment in those states directly affected. However, the biggest threat to economic growth from hurricanes is the nationwide surge in gasoline prices.

In general, we believe that the best offense is a good defense.

It is difficult to forecast the economy and markets accurately, but accurately forecasting the weather can be downright exasperating. But, from time to time, predicting the weather or at least paying very close attention to how it is developing is part of making economic and market forecasts. The effects of weather could be a major factor affecting the commodities markets and, in turn, the economy in the coming months.

Isaac is the ninth named storm of the Atlantic hurricane season this year. The National Oceanic and Atmospheric Administration latest forecast includes 17 named storms this season, including 5 – 8 hurricanes and 2 – 3 major hurricanes. Storms are being fueled by the warmer-than-normal sea surface temperatures in the Atlantic along with conducive wind patterns. The potential for severe weather activity is a risk that could result in:

� Lost economic output,

� A rise in unemployment in affected areas,

� Downgrades to municipal debt ratings as emergency reserve funds are depleted,

� Losses for insurance companies,

� Higher agriculture prices, and

� Higher energy prices.

The biggest threat to economic growth from hurricanes is the nationwide surge in gasoline prices.

With Hurricane Isaac on the way toward the key production areas of the Gulf of Mexico, energy companies have begun suspending crude and gas operations in the Gulf region, home to 23% of U.S. oil production, 7% of natural-gas output and 44% of refining capacity, according to the U.S. Energy Department. Four back-to-back hurricanes that hit the southern United States in summer 2004 resulted in a loss of 25% of Gulf of Mexico energy production. In 2005 hurricanes Katrina, Rita and Wilma devastated the Gulf Coast and shut down 24% of annual oil production during the six months that followed the storms. In addition, the source of much of the United States foreign oil, the Louisiana Offshore Oil Port, had to be closed. This drove oil prices to increase by over $10 per barrel and gasoline prices at the pump rocketed to near $5 a gallon in some areas. A repeat would be an unwelcome burden to U.S. consumers. After all, 2012 presents a much more fragile economic backdrop than in 2005 when the major hurricanes last struck.

WEEKLY MARKET COMMENTARY

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Gasoline prices have risen nearly 10% above the year-ago level and 30% above the five-year average — but this has not yet deterred consumers. Retail sales grew at a pace of around 3 – 4% year-over-year in June and July 2012. However, a shock from reduced output due to hurricanes could push gasoline prices at the pump higher in the next few months relative to June and July. The burden an additional 50 cents at the pump may place on consumers could total $17 billion.

The impact that severe weather can have is evident in agriculture prices this year. The U.S. drought, excessive heat in Russia, and too much rain in Brazil have produced record prices for grains. We continue to see upside for Agriculture Commodities and related industry stocks. In general, we believe that the best offense is a good defense and an increasingly severe hurricane season may benefit Energy Commodities and stocks in the Energy Services industry.

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 economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

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

1 Gulf of Mexico Offshore Oil Platforms

Source: Bureau of Ocean Energy Management 08/27/12

TX

LA

MS AL GA

FL

Off-Shore Oil Rigs