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LP L FINANCIAL R E S E AR C H Weekly Economic Commentary December 19, 2011 Bucking the Trend John Canally, CFA Economist LPL Financial Highlights Housing, manufacturing and the consumer dominate this week’s economic data in the United States as the economy accelerates into year-end. The struggling state and local government sector is likely to struggle in 2012. Housing, the consumer, and the manufacturing sectors will likely dominate the economic landscape this week in the United States, as the U.S. government’s economic data mills make one final push ahead of the traditional lull in the economic calendar the week between Christmas and New Year’s Day. Of course, the U.S. economic data has taken a back seat to other events in recent weeks, and this week is not likely to be an exception. The debt dilemma in Europe, the final wrangling in Congress over the extension of the payroll tax cut and unemployment benefits, along with the fallout from the death of North Korean leader Kim Jong Il might once again force financial market participants’ focus elsewhere. The state and local government sector is likely to continue exerting downward pressure on U.S. economic growth in 2012, even after restraining growth in gross domestic product (GDP) in all but three of the 15 quarters since the beginning of 2008. Economic Calendar Monday, December 19 NAHB Housing Survey Dec Tuesday, December 20 Building Permits Nov Housing Starts Nov Wednesday, December 21 MBA Mortgage Applications wk 12/16 U of M Consumer Sentiment Dec Leading Indicators Nov Friday, December 23 Durable Goods Shipements and Orders Nov Personal Spending Nov Existing Home Sales Nov Personal Income Nov Thursday, December 22 Initial Claims wk 12/17 New Home Sales Nov GDP Price Index Q3 Real GDP Q3 The Week’s Economic Reports Likely to Take a Back Seat to Washington, Europe and Korea Even as consumers rush to make their final purchases of the 2011 holiday shopping season — Hanukkah begins on December 20 and ends on December 28, and of course Christmas is December 25 — the government’s data mills are making one last push to get all of the economic data out the door. This week’s dataset in the United States is dominated by housing, manufacturing and the consumer. The housing data due this week includes a mix of reports on sales, prices, starts, permits and sentiment for both November and December 2011. In general, the housing reports due this week are likely to show that the modest recovery in the housing market that began nationally in early 2009 continued through the end of 2011. As noted in last week’s Weekly Economic Commentary, “Communications Breakdown?” we expect housing to continue to heal further in 2012, but that the sector still has a long way to go before it can become a reliable contributor to overall economic growth again. Manufacturing is another focus of this week’s data in the United States. In recent months, domestic manufacturing activity has bucked the global trend of deceleration, and has reaccelerated a bit. Part of the reacceleration has come as the global supply chain returned to normal after the Japanese earthquake and tsunami. For example, auto and light truck production in the United States in the latest week (ending December 16) was the strongest since early 2008. Member FINRA/SIPC Page 1 of 3 W E E KLY E CONOMIC CO MME N TAR Y Auto and light truck production has not been sustained at these levels since late 2007, prior to the onset of the Great Recession. This week, data on durable goods orders and shipments in November are likely to provide further evidence that the U.S. manufacturing sector continues to move in the right direction as 2011 draws to a close. Will the likely recession in Europe along with slower growth in China and other emerging markets impact manufacturing in the United States in 2012? It almost certainly will, but it probably already has had an impact. But, despite the slowing, the underlying strength in the manufacturing sector has been stronger than the consensus thought just a few months ago. 1Auto and Light Truck Production Was Hit Another Three and a Half Year High in the Latest Week 375 Car and Light Truck Production (# of Units in Thousands, Weekly) 300 225 150 75 0 07 08 09 Source: Haver Analytics 12/19/11 10 11 (Shaded Areas Indicate Recession) 2State and Local Government Spending Has Been A Drag on GDP Growth in 12 of the Past 15 Quarters State & Local Govt Consumption/Investment: Contribution to Real GDP (% Change) Seasonally Adjusted Annual Rate 1.00% 0.75% 0.50% 0.25% 0.00% -0.25% -0.50% 01 02 03 04 05 06 07 08 09 10 11 Source: Bureau of Economic Analysis, Haver Analytics 12/19/11 (Shaded Areas Indicate Recession) Finally, the consumer will be in the spotlight this week as well with the regular weekly reading on retail sales due out on Tuesday, December 20, the University of Michigan’s consumer sentiment index for December on Thursday, December 22, and the November personal income and spending data on Friday, December 23. Consumer spending, which accounts for two-thirds of the overall economy, has been buoyed in recent weeks by a sharp drop in gasoline and other consumer energy prices, better news on the labor market and more stability in the housing market. Last week (December 12 – 16), the National Retail Federation (NRF) — a trade group of the nation’s retailers — raised its 2011 holiday sales forecast by a full percentage point. The group, which forecast a modest 2.8% year-over-year gain in holiday shopping in 2011 back in early October 2011, now says holiday shopping is likely to rise by 3.8% — above the long-term average gain in holiday sales of 2.6%, but below the robust 5.2% sales gain seen during the 2010 holiday shopping season. In the past, the National Retail Federation has been very conservative in its holiday sales forecasts. Thus, the guidance provided by the NRF last week, along with the return of cold weather to much of the nation in mid-December, and the solid gain in the equity market since September, all suggest that sales are likely to come in at around 4 to 5% when all the receipts are counted. Retailers will report their December sales on Thursday, January 5. State and Local Governments Likely to Continue to Be a Drag on Economic Growth in 2012 Since the onset of the Great Recession in the first quarter of 2008, the state and local government sector — traditionally a reliable, though modest source of strength for the U.S. economy over the past 30 years — has exerted downward pressure on economic growth amid a major disconnect between revenues and spending. Over that time (15 quarters), the state and local government sector has been a drag on overall GDP in 12 quarters, or 80% of the time. Between the end of World War II and the end of 2007, the state and local government sector made a positive contribution to growth 85% of the time. As the Great Recession took hold, state and local governments struggled to match declining revenues — as property taxes, corporate taxes, sales taxes, income taxes and fees all were negatively impacted by the downturn — with rising costs. The most visible realignment of costs to lower revenues came in state and local government employment. Since peaking in August 2008, state LPL Financial Member FINRA/SIPC Page 2 of 3 W E E KLY E CONOMIC CO MME N TAR Y The most visible realignment of costs to lower revenues came in state and local government employment. Since peaking in August 2008, state and local governments have shed nearly 4% of their workers, or more than 610,000 jobs. The net result is likely to be another year in which the state and local government sector provides little support for the overall economy. and local governments have shed nearly 4% of their workers, or more than 610,000 jobs. If anything, that figure probably understates the impact to the overall economy, because it does not take into account that many older state and local government employees are retiring early, and being replaced by lower paid workers, who often are not receiving the same level of benefits. Looking ahead, the decline in state and local government workers is likely to persist into 2012, though likely at a more modest pace than over the past three and a half years. As the economy has stabilized in 2010 and 2011, so too have state and local government revenues. However, the Great Recession did little to relieve state and local governments of their obligations to meet mounting post-retirement benefits like healthcare and pension costs for current and former employees. When continued pressure on federal aid to state and local governments is factored in it leaves state and local governments with very little wiggle room to hire any additional workers or make any major commitments to spend on social programs, education or infrastructure projects. Thus, one of the few avenues left for state and local governments to continue to align short and long term costs with revenues is to continue to pare workers and cut back on expansion of existing programs. The net result is likely to be another year in which the state and local government sector provides little support for the overall economy. 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. International 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 Page 3 of 3 RES 3438 1211 Tracking #1-031423 (Exp. 12/12) LP L FINANCIAL R E S E AR C H Weekly Market Commentary December 19, 2011 Apocalypse Soon Jeffrey Kleintop, CFA Chief Market Strategist LPL Financial Highlights The purported end of the world falls exactly one year from this Wednesday, December 21, 2011. Like a primeval Y2K event, 2012-ers believe that one year from now the earth will experience a catastrophe or an enlightenment. Surprisingly, we agree. The year 2012 will be one of transformation: politically, fiscally, and economically, with profound impacts for investors. A search of the bestsellers with “2012” in their title does not offer the books you might expect such as travel guides, how to crack the SAT exam, or the best new cars to buy. Instead, the top books on the list are among the thousands of books, films, videos, seminars, and websites tied to doomsday predictions about 2012 [see accompanying Table]. In fact, the first non-end of the world entry to make the list does not show up until number 27 when the Dilbert calendar makes the list — then again, the Dilbert universe sure seems like purgatory. Specifically, according to these sources, the apocalypse comes on December 21, 2012 — the purported end of the world falls exactly one year from this Wednesday. Top 10 Best Selling Books on Amazon with “2012” in the Title 1. What Will Happen in 2012 and Beyond? by Veronica Torres and Eloheim and The Council 2. The Mystery of 2012: Predictions, Prophecies, and Possibilities by Sounds True 3. Apocalypse 2012: The Ticking of the End Time Clock by John Claeys 4. 2012: The Fifth World by Edward G. Talbot 5. 2012 The Awakening by Bill Douglas 6. The Source Field Investigations: The Hidden Science and Lost Civilizations Behind the 2012 Prophecies by David Wilcock 7. The 2012 Story: The Myths, Fallacies, and Truth Behind the Most Intriguing Date in History by John Major Jenkins 8. The Complete Idiot's Guide to 2012 by ND, Dr. Synthia Andrews and Colin Andrews 9. Beyond 2012: Catastrophe or Awakening?: A Complete Guide to End-of-Time Predictions by Geoff Stray and John Major Jenkins 10. 2012: The Return of Quetzalcoatl by Daniel Pinchbeck Source: Amazon 12/16/11 Where does this 2012/end of the world stuff all come from? The Mayans, who spread across Central America from about 2000 B.C. to 900 A.D., used a unique Mesoamerican “long count” calendar that marked time in long cycles lasting 394.3 years called b’ak’tun. A “sun”, or era, may be defined as 13 b’ak’tun cycles. The Mayan creation date was in 3114 B.C. and the 13th b’ak’tun cycle will end next year — on December 12, 2012. The 2012-ers have pulled together Mesoamerican archaeology, stories about extraterrestrials, New Age spirituality, and pseudo-scientific analysis to produce a prophecy that on December 21, 2012 a profound transformation will occur. Like a primeval Y2K event, they believe that one year from now the earth will experience a catastrophe or an enlightenment. Member FINRA/SIPC Page 1 of 2 W E E KLY MARKE T CO MME N TAR Y 1Emerging Market Economies Percent of World GDP Hits 50% in 2012 60% Surprisingly, we agree. The year 2012 will be one of transformation: economically, fiscally, and politically with profound impacts for investors. The global economy is emerging. While we expect the U.S. economy to grow about 2% in 2012, the emerging markets will grow much faster. By the end of 2012, emerging market economies will reach 50% of the world’s gross domestic product (GDP) [Chart 1]. The non-advanced economies made up only 38% of global GDP 10 years ago, but reached 49% in 2011 (with currency adjusted for purchasing power parity), according to data from the International Monetary Fund. Non-Advanced Economy Gross Domestic Product on Purchasing Power Parity (PPP) Share of World Total IMF Projections 50% We believe a mild recession emerges in Europe and the debt dilemma continues to grab headlines and move markets as will the outlook for growth and financial stress in China. 40% 30% 1992 1997 2002 2007 2012 Source: LPL Financial, International Monetary Fund World Economic Outlook Database September 2011 In addition, the party that emerges in control following the November 2012 elections in the United States will forge the decisions that will represent one of the biggest shifts in federal budget policy since World War II. Consumer sentiment, business leaders, policymakers and geopolitics are going to have a significant impact on the investment environment in 2012. While volatility is likely to remain elevated, we do not see an end-of-theworld scenario for investors. In fact, the markets may fare better in 2012 than they did in 2011 with stocks posting solid gains (for deeper insight into our 2012 prophesies see our 2012 Outlook). Works from the Mayans, prophesies of UFO cults, and even films from Hollywood (I Am Legend, Blade Runner, The Running Man) all suggest 2012 is likely to be fraught with danger. However, they also appear to feature flying cars — so it may not be all bad. Here is hoping that a transformational new era emerges in 2012 where politicians, business leaders, and individuals’ interests align to produce an environment of respect and much needed action. 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 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. 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 Page 2 of 2 RES 3439 1211 Tracking #1-031262 (Exp. 12/12)