1. LP L FINANCIAL R E S E AR C H
Weekly Economic Commentary
October 24, 2011
Economic Uncertainty Remains in Place
John Canally, CFA Third quarter gross domestic product (GDP), along with housing and
Economist manufacturing data, is likely to dominate this week's economic calendar,
LPL Financial although the market is still likely to be focused on eurozone issues and
corporate earnings. The third quarter GDP figures — expected to show
that the economy grew at 2.0 to 2.5% in the third quarter — highlight the
Highlights week's busy economic calendar. There are three housing related reports
„ A busy week for economic data in the for September (new home sales, pending home sales, and home prices),
United States, highlighted by the third along with several key reports on manufacturing, durable goods orders and
quarter GDP report which is likely to be shipments for September, and the Richmond Fed index for October. Two
the strongest of the year. of the three members of the Federal Reserve’s (Fed) “center of gravity”
„ Uncertainty continues to dominate the (Vice Chair Janet Yellen and the New York Fed president Bill Dudley) speak
economic landscape. this week, offset by several inflation hawks (Dallas Fed’s Richard Fisher,
„ A closer look at the labor market and outgoing Kansas City Fed president Thomas Hoenig and Minneapolis Fed
initial claims for unemployment insurance president Narayama Kocherlakota). The Bank of Canada, the Reserve Bank
reveals a labor market stuck in neutral of New Zealand and the Bank of Japan all meet this week to set rates.
Meanwhile, incoming economic data continue to point to slow growth, not
Economic Calendar recession. The Beige Book — a qualitative assessment of business, banking
and economic conditions by bankers, and small and large businesses in
Monday, October 24 Thursday, October 27
each of the 12 regional Federal Reserve districts — suggested that while
Chicago Fed National Initial Claims
Activity Index wk 10/22 economic uncertainty remained elevated, the economy continued to post
Sep modest growth. The other data released last week all continue to suggest
GDP Price Index
Tuesday, October 25 Q3 that despite the unprecedented level of uncertainty among consumers and
Consumer Confidence Real GDP businesses surrounding the economic, political and geopolitical situation,
Oct Q3 the U.S. economy continues to grow, albeit modestly and below its long-
Richmond Fed Index Pending Home Sales term potential:
Oct Sep
„ Industrial production for September
Wednesday, October 26 Friday, October 28
MBA Mortgage Employment Cost Index „ Empire State Manufacturing Index for October
Applications Index Q3 „ National Association of Homebuilders Sentiment Index
wk 10/21 Personal Consumption
Expenditures
„ Housing Starts for September
Durable Goods Orders
and Shipments Sep „ Index of leading economic indicators for September
Sep Personal Income „ Philadelphia Fed manufacturing index for October
New Home Sales Sep
Sep U of M Consumer „ Existing home sales for September
Sentiment The latest reading on initial claims for unemployment insurance for mid-
Oct October suggests that the labor market is healing, but not quickly enough to
push the unemployment rate much lower.
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2. W E E KLY E CONOMIC CO MME N TAR Y
Still, the point we made back in early Uncertainty Reigns Among Bankers and Business Owners
September bears repeating here: Returning to the Beige Book — a qualitative report prepared several weeks
it is clear that the certainty craved prior to each of the eight Federal Open Market Committee (FOMC)
by businesses, consumers and meetings held each year — we note that the word “uncertainty” appeared
policymakers is still sorely lacking. in the most recent Beige Book 26 times. While this is less than the 33
mentions of the word uncertainty in the early September version of the
Beige Book, it nonetheless is an extremely elevated number of instances.
Not all of the uncertainty was attributed to the near-term economic outlook
or the ongoing financial turmoil in Europe. There were 19 mentions of the
upcoming holiday shopping season in the most recent Beige Book, half of
which were in a negative context. Still, the point we made back in early
September bears repeating here: it is clear that the certainty craved by
businesses, consumers and policymakers is still sorely lacking.
Chart 1 describes how many times the words “uncertain” or “uncertainty”
appeared in the Beige Book since January 2010. We also looked at how
many times, on average, those words appeared in the Beige Book in pre-
recession years (2005 and 2006, right in the middle of the 2002 – 2007
recovery), as well as the years of the Great Recession (2007, 2008 and
2009). Prior to 2011 we note that the use of the word uncertainty peaked in
2009, just as equity markets were making multi-year lows.
1 Elevated Economic and Policy Uncertainty Evident in the Beige Book
Number of Times “Uncertain” or “Uncertainty” Appears in the Beige Book
35
30
25
20
15
10
5
0
Pre 2007 2008 2009 Jan Mar Apr Jun Jul Sep Oct Dec Jan Mar Apr Jun Jul Sep Oct
Recession 10 10 10 10 10 10 10 10 11 11 11 11 11 11 11
Source: LPL Financial Research, Federal Reserve 10/24/11
As we wrote in the September 12, 2011 edition of Weekly Economic
Commentary, we want to make it clear that not all periods of uncertainty
are resolved the same way. At times, the uncertainty can clear up quickly
in response to an economic event, policy action, or series of policy actions,
and the clarity this provides to economic agents often leads to better results
for financial markets and economies. An example of this type of uncertainty
was the initial flare-up of the concerns surrounding European peripheral
debt during the spring and summer of 2010. This flare-up coincided with a
spike higher in the number of times the word “uncertain” showed up in the
Beige Book over the summer and early fall of 2010 [Chart 1].
This heightened level of uncertainty led to a 15% peak-to-trough drop in
S&P 500 Index over the late spring and summer months of 2010, and took
four or five months to resolve. Low expectations for the economy, bold
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3. W E E KLY E CONOMIC CO MME N TAR Y
policy action (the announcement and enactment of QE2), and a series of
better-than-expected results for global economies and companies helped to
end that spate of uncertainty.
In the current period, the uncertainty led to a nearly 20% drop in U.S. equity
prices between July and October 2011, and it appears that the uncertainty
is being resolved in much the same way it was in 2010:
„ Bold policy action from policymakers around the globe, as Europe works
toward a plan to stabilize its financial system and central bankers begin
to loosen monetary policy that had been getting more restrictive over the
past several years.
„ Better-than-expected economic data (the U.S. economy in the recently
completed third quarter is on pace to more than double the pace of
growth seen in the first half of the year) and expectations remain low.
„ Solid corporate earnings, which ultimately drive equity prices. Thus far,
corporate earnings results for the third quarter of 2011 have exceed
lowered expectations and guidance from corporate management for the
fourth quarter of 2011 and 2012 has been solid.
Of course, some uncertainty is likely to remain in place, despite the
progress noted above. There is still plenty of work to be done on the fiscal
side in the United States, the labor and housing markets in the United
States remain tepid at best, and the 2012 Presidential and congressional
election cycle will keep legislative initiatives aimed at reducing the deficit in
the United States on hold until early 2013.
What Does the Level of Unemployment Benefits Tell Us
About the Labor Market?
In fact, at around 400,000 per week, The labor market remains tepid at best, but last week’s data on initial claims
initial claims for unemployment for unemployment benefits in the week ending October 14 continued to
show a labor market that is stuck in neutral. Companies are not laying off
insurance are the lowest since mid-
workers, but they are not hiring either. For the week ending October 14,
2008, just prior to the collapse of
2011, 403,000 individuals filed for unemployment insurance, 1,000 fewer
Lehman Brothers and the onset of the than in the prior week, and about the same number that have filed each
worst of the global credit crunch and week over the past several months. In fact, at around 400,000 per week,
Great Recession. initial claims for unemployment insurance are the lowest since mid-2008,
just prior to the collapse of Lehman Brothers and the onset of the worst of
the global credit crunch and Great Recession.
Claims accelerated quickly during that period, moving from just under
400,000 per week in the spring and early summer of 2008 to over 550,000
per week by the end of 2008. Claims peaked in March and April 2009, when
more than 650,000 people per week were filing claims for unemployment
benefits as businesses large and small cut staff to align with a much lower
level of economic growth and slower growth prospects.
Thus, at around 400,000 per week, claims stand some 250,000 per
week less than they did in early 2008 but, most importantly, have shown
few signs of accelerating as they did from mid-summer 2008 through
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4. W E E KLY E CONOMIC CO MME N TAR Y
2 Labor Market Still Showing Signs Of Stress, But early spring 2009. Claims at around 400,000 per week suggest that the
Has Improved Noticeably Over the Past 18 Months unemployment rate is not likely to move much lower (from the current
reading of 9.1%), but that it is not likely to move sharply higher either.
Persons Recieving Some Type of
Unemployment Benefit (% of Labor Force) One final observation on unemployment benefits: While the Great
0.08% Recession of 2007-2009 officially ended in June 2009, the labor market
continued to suffer throughout 2009 and into 2010. The labor market always
0.06% lags the overall economy, so it is not a surprise that the economy continued
to shed jobs (3.3 million of them) between the end of the recession and
0.04%
early 2010. In late 2009, as these job losses were mounting, close to 12
million people were receiving some type of unemployment benefit from the
0.02%
government. The labor force — people over 16 years old and actively looking
for work — at the time was 154 million, so about 8% of the labor force was
0.00%
04 05 06 07 08 09 10 11 receiving some type of unemployment assistance.
Source: Haver Analytics 10/24/11
As of mid-October 2011, just over 6.5 million people were receiving
(Shaded areas indicate recession) some type of government unemployment assistance, down from the 12
million in late 2009. Although there is no official data on this, a sizeable
number — estimates range from three million to five million workers — of
people have probably exhausted their unemployment benefits. The labor
force has decreased to around 153 million, as about one million people have
given up looking for work, or have returned to school or retired since late
2009. This means that approximately 4.2% of the labor force is receiving
some type of government unemployment assistance. As shown in the
Chart 2, on average during the mid-2000s (2002 – 2007) economic recovery,
around 2% of the labor force was receiving unemployment benefits.
Thus, the labor market remains stuck in neutral. The economy is growing
just enough to produce some job growth, but not quickly enough to
substantially lower the unemployment rate or the number of people filing for
new unemployment benefits each week. In short, the economic and policy
uncertainty that is restraining the rest of the economy is still clearly being
felt in the labor market, and only a resolution of that uncertainty will lead to
an improved labor market in the months and quarters ahead.
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5. W E E KLY E CONOMIC CO MME N TAR Y
IMPORTANT DISCLOSURES
The opinions voiced in this material are for general information only and are not intended to provide specific
advice or recommendations for any individual. To determine which investment(s) may be appropriate for you,
consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of
future results. All indices are unmanaged and cannot be invested into directly.
Quantitative Easing is a government monetary policy occasionally used to increase the money supply by buying
government securities or other securities from the market. Quantitative easing increases the money supply by
flooding financial institutions with capital in an effort to promote increased lending and liquidity.
Stock investing involves risk including loss of principal.
The 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 Empire State Manufacturing Index is a seasonally-adjusted index that tracks the results of the Empire State
Manufacturing Survey. The survey is distributed to roughly 175 manufacturing executives and asks questions
intended to gauge both the current sentiment of the executives and their six-month outlook on the sector.
The Philadelphia Fed Survey is a business outlook survey used to construct an index that tracks manufacturing
conditions in the Philadelphia Federal Reserve district. The Philadelphia Fed survey is an indicator of trends
in the manufacturing sector, and is correlated with the Institute for Supply Management (ISM) manufacturing
index, as well as the industrial production index.
The index of leading economic indicators (LEI) is an economic variable, such as private-sector wages, that tends
to show the direction of future economic activity.
The NAHB/Wells Fargo Housing Market Index gauges builder perceptions of current single-family home sales
and sales expectations for the next six months as "good," "fair" or "poor." The survey also asks builders to rate
traffic of prospective buyers as "high to very high," "average" or "low to very low." Scores from each component
are then used to calculate a seasonally adjusted index where any number over 50 indicates that more builders
view conditions as good than poor.
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
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RES 3369 1011
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6. LP L FINANCIAL R E S E AR C H
Weekly Market Commentary
October 24, 2011
The Greek Haircut
The euro was born in January 1999, which means the European common
Jeffrey Kleintop, CFA
Chief Market Strategist
currency will turn 13 in January. When I was 13, I never wanted my hair
LPL Financial cut as short as my mother did. So we would negotiate — sometimes right
down to the final snip in the barber chair. Neither of us was happy, but we
could both live with the outcome. This appears to be the key issue for the
Highlights
stock market as it reacts to the amount of the “haircut” in the ongoing
Despite all the headlines, yields for Italy,
Greek debt negotiations.
Spain, Portugal and Ireland’s sovereign debt
are at or below where they were in mid- The S&P 500 Index gained for a third consecutive week, marking the first
July when the second rescue package for time that has happened since February. Last week once again featured
Greece was drafted. solid and better-than-expected economic data and earnings reports and no
While the second Greek rescue stemmed breakthroughs on European debt problems — although discussions seemed
the decline in the sovereign bond market, to progress on the amount of the Greek bond “haircut”. The S&P 500 Index
as intended, stocks have plunged since then closed the week at 1238, basically flat for the year, and up 13% from the
as investors increasingly priced in a greater
low of October 3.
“haircut” the banks may have to take on
their Greek bond holdings. Another European summit is set for this week, as European policymakers
The stock market’s rise, despite move toward finalizing the details of the grand plan to deal with the debt
no resolution on the terms of the problems that were promised by the leaders of Germany and France for
comprehensive rescue package, appears early November. The fact that the various factions could not reach an
tied in part to the increased clarity around agreement on the exact elements of the plan this weekend is obviously
limiting the amount of the haircut, lowering a negative. Yet, the policymakers would not have scheduled a second
the odds of further bank failures and a summit if they did not have the urgency and the political will to come to
2008-style financial crisis.
an agreement very soon, which could be viewed as an offsetting positive.
In addition, there is the possibility that there could be support from
international sources, such as the International Monetary Fund (IMF) or
China. The IMF has about $650 billion in uncommitted resources that could
be directed towards bolstering the rescue plan.
The sticking point in the deliberations seems to be Germany’s insistence
that the rescue fund (The European Financial Stability Facility, or EFSF) be
denied the ability to borrow potentially limitless sums from the European
Central Bank, as France has favored. The final plan to contain the problem is
likely to have two key components:
„ First, the EFSF will be used to guarantee investors against principal
losses on government bond sales or to set up an EFSF-insured fund
that would allow for private investors to participate. The resources of
the EFSF will offer insurance on new government debt issues by Italy
and Spain likely covering the first 20 – 30% of any principal losses in a
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7. W E E KLY MARKE T CO MME N TAR Y
1 Troubled European Countries’ Bond Yields At or default or restructuring. This guarantee could cover all the sovereign debt
Below Mid-July Levels issuance of Italy and Spain for the next several years as they regain the
market’s confidence in their fiscal health, while still providing assistance
10-Year Government Note Yield for
Selected European Countries to Greece, Portugal and Ireland.
Portugal Ireland Italy Spain „ Second, a program for bank recapitalization to fill a shortfall resulting
16
from the “haircut” taken by the banks on holdings of Greek debt. The
14
bank capital needs are dependent upon additional debt relief for Greece
12
in the form of a deeper, voluntary haircut on government debt. To meet
10
the requirement that a debt exchange be voluntary and avoid a technical
8
default that would trigger other problems, the haircut will likely be limited
6
to the 40-50% range, rather than the 60%-plus demanded by Germany
4
earlier this month. The bank recapitalization would be met first by banks
2
themselves then by national governments and then possibly some ECB
0
Apr May Jun Jul Aug Sep Oct or IMF contributions.
11 11 11 11 11 11 11
This haircut issue is a major one for the stock market. The draft agreement
Source: LPL Financial, Bloomberg data 10/22/11
on a second rescue package for Greece (to cover 2012 and 2013 funding)
took place on July 21, 2011. It was a big event in terms of halting the
contagion. So big, in fact, that it stabilized yields for other European
2 Stock Market Plunged After July Greek Bailout Deal countries: Spain, Italy, Ireland and Portugal [Chart 1]. Despite all the
S&P 500 Index headlines, yields for these countries’ sovereign debt are at or below where
1450 they were in mid-July. However, while that massive policy action stemmed
1400
the decline in the sovereign bond market as intended, as you can see in
1350
Chart 1, stocks plunged following that day [Chart 2].
1300
1250 The stock market slide that began after the second bailout deal for Greece
1200 on July 21 may have been driven by the unrelated debt ceiling debacle in
1150 late July and the first few days of August and the ensuing downgrade of
1100
U.S. sovereign debt by S&P in early August. But, following these events, a
1050
1000
key contributor to the stock market decline may have been the actual terms
Apr May Jun Jul Aug Sep Oct of the bailout deal. There were over a dozen points to the bailout agreement.
11 11 11 11 11 11 11 One of these was that banks and other private bondholders would
Source: LPL Financial, Bloomberg data 10/22/11 voluntarily agree to contribute to the rescue package for Greece in the form
The S&P 500 is an unmanaged index, which cannot be invested into of debt exchanges targeting losses of 21% in a one-off, voluntary haircut.
directly. Past performance is no guarantee of future results.
Investors have been pricing in the risk that banks will ultimately be faced
with a greater haircut. These rising bank losses have kept the European
banks pulling the stock market lower and raising fears of more bank failures
and a 2008-style financial crisis erupting in Europe.
On October 3, German officials suggested the haircut may have to be
increased — from 21% possibly to as much as 60% — in light of a new
funding shortfall and changed market conditions. As these statements were
made stocks broke through the early August 2011 low and marked the low
point of the year as the market feared bigger and bigger haircuts and the
application of those haircuts to the debt of every entity receiving aid from
the EFSF.
The stock market’s rise last week, despite no resolution on the terms of
the comprehensive rescue package in Europe, appears to be tied in part to
the increased clarity around the amount of the haircut banks will be forced
to “voluntarily” take being more limited than what Germany was pushing
LPL Financial Member FINRA/SIPC Page 2 of 3

8. W E E KLY MARKE T CO MME N TAR Y
for. This is viewed by markets as reducing the odds of additional bank
failures and a 2008-style financial crisis. Ultimately, it may be that finding
the haircut that all parties, including the European Central Bank, Germany,
France and others, could agree to — if not be happy about — may be the
key to restoring confidence.
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.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values and yields will decline as
interest rates rise and bonds are subject to availability and change in price.
Government bonds and Treasury Bills are guaranteed by the U.S. 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. However, the
value of a fund shares is not guaranteed and will fluctuate.
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 International Monetary Fund (IMF) is an organization of 187 countries, working to foster global monetary
cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable
economic growth, and reduce poverty around the world.
International and emerging markets investing involves special risks such as currency fluctuation and political
instability and may not be suitable for all investors.
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
Member FINRA/SIPC
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