"Hard data versus soft sentiment: The Sequel" & "A More Durable Rally"

1. LP L FINANCIAL R E S E AR C H
Weekly Economic Commentary
October 17, 2011
Hard Data Versus Soft Sentiment: The Sequel
John Canally, CFA This week is a busy one for financial market participants, with corporate
Economist earnings reports, economic data and policy all competing for the market’s
LPL Financial attention. The European fiscal situation remains at the top of the list of
worries for markets, as policymakers scramble to hit a self-imposed early
November deadline to have a grand plan in place to address Greece and
Highlights European banks’ exposure to Greek and other troubled sovereign debt. As
„ A busy week for financial market we have noted in several of our recent commentaries, markets are still
participants lies ahead, with Europe and crying out for bold, coordinated policy actions here and abroad. Markets in
corporate earnings data competing with the past week or so have become increasingly confident that such actions
economic and policy events. will be taken — although the devil is in the details.
„ The tug of war between the soft But this week, a barrage of third-quarter corporate results (including
readings on sentiment-based data and guidance for the fourth quarter and next year), key data on housing, inflation
the solid readings on the hard data
and manufacturing in the United States, as well as several speeches from
continues this week.
Federal Reserve officials (including Ben Bernanke) will all also compete
for the market’s attention. The most closely watched report of the week
is likely to be the Fed’s Beige Book, a qualitative assessment of business
and banking conditions in each of the 12 Federal Reserve districts (Boston,
Richmond, Dallas, Kansas City, Cleveland, etc.), compiled eight times a year
prior to each of the Federal Open Market Committee (FOMC) meetings.
Economic Calendar China completes the release of its September and third-quarter data early in
the week, with the third-quarter report on gross domestic product, as well
Monday, October 17 Wednesday, October 19
as the September reports on industrial production and retail sales.
NY Fed Empire State Mfg MBA Mortgage
Oct Applications Index
wk 10/14 The Sentiment Data Versus the “Hard Data”:
Capacity Utilization
Sep Housing Starts The Debate Continues
Sep
Industrial Production We have written extensively over the past several months about the
Sep CPI
conflicting messages being sent by the “hard” data on the economy, and the
Sep
Tuesday, October 18 “soft”, or sentiment, data on the economy. Hard data statistically measures
PPI Fed’s Beige Book what consumers or businesses are doing, for example:
Sep Thursday, October 20
NAHB Housing Survey Initial Claims
ƒ How many homes were sold?
Oct wk 10/08 ƒ How much revenue did a company generate?
Ben Bernanke speaks in Trade Balance ƒ What were a company’s earnings after expenses?
Boston Aug
Treasury Statement ƒ How much did consumers spend on groceries, or computers or television sets?
Sep ƒ How many cars were produced and sold?
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2. W E E KLY E CONOMIC CO MME N TAR Y
ƒ How many jet engines were exported overseas?
ƒ How many new orders for business equipment were placed?
ƒ How many jobs were created (or lost)?
ƒ How much oil or gasoline was produced and/or consumed?
On the other hand, the “soft” data are reports that measure sentiment, and
do not actually measure anything other than how people or businesses feel.
The mood of consumers or businesses is, of course, greatly influenced by
what they see around them every day. It is also impacted by what they see
on television, in newspapers, on the Internet, on talk radio or from friends,
neighbors and colleagues. And of course, lately, the media has been full of
bad news on virtually every topic. However, the media itself is thriving on the
bad news with some of the highest ratings, readers and listeners in history.
We have not seen that yet, but those in In recent months, the hard data has painted a stronger picture of the U.S.
the marketplace calling for a recession economy than that reflected by the sentiment data. But at times, the
believe that the transition from poor opposite is true, and the sentiment runs far ahead of the actual data, as was
sentiment to poor data is inevitable. We the case in 1999 and 2000 at the peak of the tech bubble and in the mid-
2000s as the housing bubble was just about to burst.
do not and continue to place the odds of
recession in the near term at about one We expect, however, that the trend of the hard data painting a better picture
in three. of the economy than the soft data will continue this week. Ultimately, it is
the hard data — not the sentiment (or soft) data — that will tell us whether
or not we have re-entered a recession, have started to shed jobs again, or
seen an uptick in inflation. However, poor sentiment (in both the consumer
and business oriented segments of the economy) can feed on itself, and
lead to a pullback in spending, which would then begin to negatively impact
the hard data. We have not seen that yet, but those in the marketplace
calling for a recession believe that the transition from poor sentiment to poor
data is inevitable. We do not and continue to place the odds of recession in
the near term at about one in three.
1 Sentiment Based Empire State Manufacturing As this report was being prepared, we received hard data for September
Index Shows Contraction, While Hard Data Based (industrial production) and sentiment for October (the Empire State
Industrial Production Shows Moderate Growth Manufacturing Index). Often, the sentiment data has the benefit (from the
market’s perspective) of being timelier. For example, for the most part, this
Industrial Production: Manufacturing
% Change - Year to Year, Seasonally Adjusted, 2007=100 (Left Axis) week’s hard data on the economy references September, but the week’s
Empire State Manufacturing Survey: General Business sentiment-based data is measuring sentiment in October.
Conditions: Diffusion Index
Seasonally Adjusted, % Bal (Right Axis) True to recent form, the industrial production data revealed that overall
18 40
industrial output (factories, utilities, and mining) increased by a modest
12
20 0.2% between August and September, and that output of factories alone
6 increased by 0.4%. Industrial production, a key gauge of whether or not
0 0 the economy is in or out of recession, is up nearly 4% from a year ago and
-6
continues to push higher. Overall, industrial production in the manufacturing
-20 sector has increased in 24 of the past 27 months since the end of the Great
-12
Recession in June 2009 [Chart 1].
-18 -40
01 02 03 04 05 06 07 08 09 10 11 On the other hand, the Empire State Manufacturing Index, which measures
Source: FRB, FRBNY, Haver Analytics 10/17/11 how manufacturing contacts in New York state feel about their overall
(Shaded areas indicate recession) business (as well as employment, shipments, orders, etc.), remained below
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3. W E E KLY E CONOMIC CO MME N TAR Y
zero in October, indicating that manufacturing in the New York state region
2 Hard Data (Leading Economic Indicators) Continue
contracted for the fifth consecutive month. The good news here is that the
to Point to Growth, While Sentiment Data Points
to Recession contraction has not picked up momentum.
Consumer Confidence (Left Axis) The other examples of hard data (mainly for September and early to mid-
Index of Leading Indicators (Right Axis) October) due out this week include:
125
15 ƒ Producer Price Index (PPI)
110
10 ƒ Consumer Price Index (CPI)
95
5 ƒ Housing starts
80 0 ƒ Building permits
65 -5 ƒ Existing home sales
50 -10 ƒ Initial claims for unemployment insurance
1981 1986 1991 1996 2001 2006 2011
Source: LPL Financial, Bloomberg Data 09/14/11 ƒ Weekly retail sales
ƒ Weekly mortgage applications and
ƒ Weekly car and light truck production
This rest of the week’s sentiment based data (for September and
October) includes:
ƒ The National Association of Homebuilders Sentiment Index
ƒ The Fed’s Beige Book
ƒ The Philadelphia Fed Index
In addition, the index of leading economic indicators (LEI) for September
is due out at the end of the week. The index is a compilation of ten data
series. Seven of the components of the LEI are hard data, with two being
sentiment based. The final component of the LEI is the stock market (as
measured by the S&P 500 Index), which is hard data of course, but is often
driven over short periods of time by sentiment. The LEI is expected to
increase by 0.3% month-over-month in September, which would leave the
index a robust 6.0% above its year-ago reading, a clear sign that despite the
negative sentiment, the economy continues to grow, albeit modestly.
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4. 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.
Stock investing involves risk including loss of principal.
Manufacturing Sector: Companies engaged in chemical, mechanical, or physical transformation of materials,
substances, or components into consumer or industrial goods.
International investing involves special risks, such as currency fluctuation and political instability, and may not
be suitable for all investors.
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.
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.
Empire State Manufacturing Survey is a monthly survey of manufacturers in New York State conducted by the
Federal Reserve Bank of New York.
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 Industrial Production Index (IPI) is an economic indicator that is released monthly by the Federal Reserve
Board. The indicator measures the amount of output from the manufacturing, mining, electric and gas
industries. The reference year for the index is 2002 and a level of 100.
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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RES 3361 1011
Tracking #1-013906 (Exp. 10/12)

5. LP L FINANCIAL R E S E AR C H
Weekly Market Commentary
October 17, 2011
A More Durable Rally
Jeffrey Kleintop, CFA The stock market, as measured by the S&P 500 Index, has returned to the
Chief Market Strategist high-end of the trading range of the past two months, as you can see in Chart
LPL Financial 1. This is the fourth time the Index has rebounded to around the 1220 level.
Each of the prior three rebounds were reversed as the market was pulled
lower again by fears of financial crisis and recession. Rather than retreat back
Highlights
to the low end of the trading range over the next week or two, there are
There are several reasons why this stock
several reasons why this rally may be more durable than those that preceded
market rally may be more durable than those
that preceded it in recent months. it in recent months and may sustain much of the of the gains, as the S&P 500
Index takes a volatile path back toward a modest, single-digit gain for the year.
It is possible that the substantial
developments in Europe are taking the fear The substantial positive policy developments in Europe are taking the fear of a
of a repeat of the financial crisis of 2008 repeat of the financial crisis of 2008 off the table. In addition, solid economic
off the table and solid economic data in the data in the United States are taking the fear of a double-dip recession off the
United States is taking the fear of a double- table. These positive developments may allow the stock market to breakout of
dip recession off the table.
the range to the upside, given support from still very low valuations.
Other signs that this rally may be more durable
include: global cyclical sector leadership, Other signs that this rally may be more durable that those that preceded it
declining European “TED spread” and the
, over the past couple of months include:
rising yield on the 10-year Treasury note. ƒ Global cyclical sector leadership – The global economically sensitive
Energy and Materials sectors have led the rally while these sectors were
in the middle of the pack during prior rallies.
Global Cyclical Sectors Materials and Energy No Longer Stuck in the Middle
1 S&P 500 Index Back at Top of Two Month Current Stock Market Rally 10/3-10/14 Average of Three Prior Stock Market Rallies*
Trading Range Sector % Gain Sector % Gain
S&P 500 Index Materials 17.2 Financials 8.7
1400
Energy 16.3 Industrials 8.4
1350
Consumer Discretionary 14.2 Consumer Discretionary 8.0
1300
Information Technology 14.1 Information Technology 7.6
1250
Industrials 13.3 Energy 7.3
1200
Financials 11.9 Materials 7.3
1150
Health Care 6.8 Health Care 6.2
1100
Consumer Staples 5.4 Utilities 5.6
1050 Telecommunications 3.8 Consumer Staples 4.4
Jan Feb Mar Apr May Jun Jul Aug Sep Oct
Source: LPL Financial, Bloomberg 10/14/11 Utilities 3.3 Telecommunications 4.0
The S&P 500 is an unmanaged index, which cannot be invested into *S&P 500 Rallies 8/10/11-8/15/11, 8/22/11-8/31/11, 9/9/11-9/16/11
directly. Past performance is no guarantee of future results. Source: LPL Financial, Thomson Financial, Bloomberg data as of 10/14/11
Past performance is no guarantee of future results.
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6. W E E KLY MARKE T CO MME N TAR Y
ƒ Declining European “TED Spread” – The key gauge of stress in the
2 European “TED Spread” No Longer Rising
financial sector during the financial crisis in 2008 was the widely-watched
3 Month EURIBOR Less EONIA
100 TED Spread, which measured banks’ willingness to lend to one another.
90 The European equivalent of the TED Spread (EURIBOR less the EONIA
80 rate) had been rising during the stock market rallies that failed to break out
70
of the trading range over the past couple of months. However, over the
60
50 past three weeks, the European “TED Spread” has been on the decline as
40 financial risks recede in Europe, as illustrated in Chart 2.
30
ƒ Rising yield on 10-year Treasury note – The 10-year Treasury note yield
20
10 had been steadily declining during the summer stock market rallies that
0 failed to break out of the trading range. Stocks are unlikely to make a
Jan Feb Mar Apr May Jun Jul Aug Sep Oct
Source: LPL Financial, Bloomberg 10/14/11
sustainable rebound when yields are low and falling. The fear of impending
economic doom in the United States weighed on the yield, pulling it to
levels last seen just prior to the United States entering WWII. However,
economic data providing evidence that the United States was not in a
recession nor likely to experience a return to recession anytime soon
helped to change the direction of Treasury yields. [Chart 3]
3 Yield on 10-Year Treasury Note Stopped Falling While the current stock market level has marked an attractive point to sell
10-Year Treasury Yield over the past couple of months as stocks returned to the lows of the year,
4.00
we believe signs increasingly point to a market that is likely to retain much
3.50 of the powerful 10% gain achieved over the past two weeks as it begins a
volatile, upward-sloping path back to a gain for the year. Key drivers to watch
3.00 this week regarding the prospects for a breakout are: the start of the flood
of third-quarter corporate earnings reports and announcements surrounding
2.50
the October 23 European summit.
2.00
IMPORTANT DISCLOSURES
1.50
Jan Feb Mar Apr May Jun Jul Aug Sep Oct The opinions voiced in this material are for general information only and are not intended to provide specific
Source: LPL Financial, Bloomberg 10/14/11 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.
Stock investing may involve risk including loss of principal.
Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly
across many sectors and companies.
Consumer Discretionary Sector: Companies that tend to be the most sensitive to economic cycles. Its
manufacturing segment includes automotive, household durable goods, textiles and apparel, and leisure
equipment. The service segment includes hotels, restaurants and other leisure facilities, media production and
services, consumer retailing and services and education services.
Consumer Staples Sector: Companies whose businesses are less sensitive to economic cycles. It includes
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7. W E E KLY MARKE T CO MME N TAR Y
manufacturers and distributors of food, beverages and tobacco, and producers of non-durable household goods
and personal products. It also includes food and drug retailing companies.
Energy Sector: Companies whose businesses are dominated by either of the following activities: The
construction or provision of oil rigs, drilling equipment and other energy-related service and equipment,
including seismic data collection. The exploration, production, marketing, refining and/or transportation of oil
and gas products, coal and consumable fuels.
Financials Sector: Companies involved in activities such as banking, consumer finance, investment banking and
brokerage, asset management, insurance and investment, and real estate, including REITs.
Health Care Sector: Companies are in two main industry groups—Health Care equipment and supplies
or companies that provide health care-related services, including distributors of health care products,
providers of basic health care services, and owners and operators of health care facilities and organizations.
Companies primarily involved in the research, development, production, and marketing of pharmaceuticals and
biotechnology products.
Industrials Sector: Companies whose businesses manufacture and distribute capital goods, including aerospace and
defense, construction, engineering and building products, electrical equipment and industrial machinery. Provide
commercial services and supplies, including printing, employment, environmental and office services. Provide
transportation services, including airlines, couriers, marine, road and rail, and transportation infrastructure.
Materials Sector: Companies that are engaged in a wide range of commodity-related manufacturing. Included
in this sector are companies that manufacture chemicals, construction materials, glass, paper, forest products
and related packaging products, metals, minerals and mining companies, including producers of steel.
Technology Software & Services Sector: Companies include those that primarily develop software in various
fields such as the Internet, applications, systems and/or database management and companies that provide
information technology consulting and services; technology hardware & Equipment, including manufacturers
and distributors of communications equipment, computers and peripherals, electronic equipment and related
instruments, and semiconductor equipment and products.
Telecommunications Services Sector: Companies that provide communications services primarily through a
fixed line, cellular, wireless, high bandwidth and/or fiber-optic cable network.
Utilities Sector: Companies considered electric, gas or water utilities, or companies that operate as
independent producers and/or distributors of power.
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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RES 3360 1011
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