LP L FINANCIAL R E S E AR C H

Weekly Economic Commentary

October 10, 2011

The Next Two Million Jobs: An Update

John Canally, CFA
Economist LPL Financial

Highlights

The focus this week is likely to be on corporate and Chinese data, rather than U.S. economic data. The economy is tracking to our bear case for creating the next two million jobs.

The light calendar for U.S. economic data this week will allow market participants to focus on corporate data (the unofficial start of the third quarter earnings reporting season for S&P 500 companies is this week), Chinese economic data, and monetary policy here and abroad (please see this weeks Weekly Market Commentary for a full preview of the earnings season). However, the scramble to shore up the European banking system by European officials remains the markets utmost concern. As we have noted in several of our recent commentaries, markets are still calling out for bold, coordinated policy actions here and abroad, and markets in the past week or so have become increasingly confident that such actions will be taken although the devil is in the details. The market-moving economic data reports released in the United States this week are: the September retail sales report, weekly readings on retail sales, mortgage applications, and initial claims for unemployment insurance. In addition, the full slate of Chinese economic data for September is set to be released this week: money supply, new loans, imports, exports and, most importantly, the producer and consumer price data. Market participants continue to try to gauge the impact of the global economic slowdown on both the Chinese economy and Chinese inflation. The next policy move by the Chinese central bank, the Peoples Bank of China (PBOC), could very well be more important for markets than the next move by either the Federal Reserve (Fed) or the European Central Bank (ECB). If the September inflation readings in China continue to show that inflation peaked in July 2011, it may clear the way for a rate cut by the PBOC. On the other hand, a reacceleration of inflation in September might push the PBOC to tighten. Clearly, the market would prefer the former outcome rather than the latter. We continue to expect the next move by the PBOC will be to signal that it is finished raising rates for this cycle, but any rate cut may not occur until late in the year. Outside of China, there are several key ECB and Fed officials slated to make public appearances this week. Notably, outgoing ECB President Jean Claude Trichet is scheduled to make three public appearances this week, while the man who is set to replace Trichet as ECB President at the end of the month (Italys Mario Draghi) is also on the docket. This weeks contingent of Fed speakers is clearly skewed to the hawkish (more concerned about inflation than growth) side of the Fed, so we would not be surprised to see several headlines in the popular press this week citing

Economic Calendar
Tuesday, October 11 NFIB Small Business Optimism Index Wednesday, October 12 MBA Mortgage Applications Index wk 10/07 FOMC Minutes Thursday, October 13 Initial Claims wk 10/08 Trade Balance Aug Treasury Statement Sep Friday, October 14 Retail Sales Sep Import Price index Sep U of Mich Consumer Sentiment Oct Business Inventories Aug

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Our view here remains that Fed Chairman Bernanke, Vice Chair Janet Yellen and New York Fed President Bill Dudley form the center of gravity at the Fed, and any move by these three to signal less stimulus from the Fed would be significant.

Fed officials worried about too much monetary policy stimulus in the United States. Our view here remains that Fed Chairman Bernanke, Vice Chair Janet Yellen and New York Fed President Bill Dudley form the center of gravity at the Fed, and any move by these three to signal less stimulus from the Fed would be significant.

The Next Two Million Jobs: An Update

The private sector economy added 137,000 jobs in September, beating expectations (+90,000) and accelerating from the 42,000 jobs added in August. The report was all the more encouraging given the simply horrendous policy and sentiment backdrop during the month of September here in the United States and overseas. Some of the bounce in jobs in September can be attributed to the return of 45,000 Verizon workers who went on strike in August. Looking at the past three months to smooth out the Verizon impact, the economy added around 120,000 jobs per month. Year-to-date, private payrolls have grown an average of 149,000 per month. While not a booming number, it is not a recessionary number either, and confirms our view that while employers are not doing much hiring, they are not laying off workers as they did in 2007, 2008, and 2009. The monthly job count culled from a survey of 440,000 businesses across the nation, was not spectacular in September, but was solid and the details were modestly encouraging.

Temporary Help Jobs Are Increasing Again, a Good Sign for Future Job Growth
80 40 0 -40 -80 Change in Temporary Help Services Employment Seasonally Adjusted, Thousands

01 02 03 04 05 06 07 08 09 10 Source: Bureau of Labor Statistics, Haver Analytics 10/10/11

-120

11

First, the prior two months' employment readings were revised up by a total of 99,000. Second, Hurricane Irene and severe flooding as a result of the remnants of Hurricane Lee likely held the job count down by around 25,000 in September. These jobs are likely to return in October. Finally, the September report noted the third consecutive increase in temporary help employment. This category is a very good leading indicator of future job gains.

(Shaded areas indicate recession)

Job Creation in This Recovery Is Running In Line With the Prior Two Economic Recoveries
2010 2003 1991

On the downside, there was yet another loss (33,000) in state and local government jobs in September, the tenth time in the past 12 months that state and local governments shed jobs. Since August 2008, state and local governments have shed 615,000 jobs, as states and municipalities continue to struggle to align costs with revenues. The nation's unemployment rate, culled from a survey of 60,000 households, found that the unemployment rate remained at 9.1% in September. The unemployment rate is defined as the number of unemployed persons (totaling about 14 million) as a percentage of the labor force (totaling about 154 million). In order for the unemployment rate to fall steadily, the economy must grow above its long-term potential growth rate of around 2.5%. Currently, the economy is growing, but only by around 2.0% or so.

6% 5% 4% 3% 2% 1%

0 6 12 18 24 Source: LPL Financial, Bloomberg Data 09/14/11

0%

30

36

The July 5, 2011 edition of the Weekly Economic Commentary was entitled: The Next Two Million Jobs. In that report, we noted that the economy had created over two million private sector jobs in the 14 months between

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February 2010 and April 2011, and outlined a bull, base and bear case for how long the economy would take to create the next two million jobs. Since then, of course, the U.S. economy has hit another soft patch amid a torrent of bad news at home that included:

The lingering impact of the Japanese earthquake on the global supply chain. The debt ceiling debate in July and early August. The downgrade of the United States AAA-credit rating in early August. The effects of Hurricane Irene. Further declines in both consumer and business confidence. The near 20% decline in the equity market, as measured by the S&P 500, between late July and early October.

Abroad, conditions also deteriorated with yet another flare-up of the European sovereign debt crisis that has dominated the landscape since mid-July. During this period (May September 2011), the private sector economy created another 526,000 jobs, or an average of just over 100,000 per month. While, the September employment report (released last Friday, October 7) was a relief to financial market participants who were expecting another dour report on the nations labor market, the September jobs report (and the revisions to prior months data) leave the nations job creation engine tracking much closer to our bear case than to our base case for creating the next two million jobs. Various Outcomes for Job Creation
Date By Which Next Two Million Jobs Are Created Early 2012 Months To Create The Next Two Million Jobs 12 How Many More Years To Recoup All Jobs Lost in Great Recession 2 Years, 4 Months 1 Year, 8 Months Date By Which All Jobs Lost During Recession Would Be Recouped Early 2014

Jobs Created Per Month Base Case Bull Case 225,000

Economic Outlook Under This Scenario Modest GDP Growth Near 3.0% Robust GDP Growth near 4.0%

Fed Outlook Under This Scenario On hold until mid2012 Stimulus starts to be removed in late 2011 More stimulus from the Fed More stimulus from the Fed

325,000

Early 2012

10

Mid 2013

Bear Case

125,000

Late 2012

17

4 Years, 3 Months

Late 2015

Very Sluggish GDP growth below 2.0% Very Sluggish GDP growth below 2.0%

Current Pace

105,000

Late 2012

19

5 Years

Late 2016

Source: LPL Financial Research 10/10/11

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Using the prior two recoveries as a baseline, a goal of creating the next two million jobs in the ensuing eight to 12 months is consistent with monthly job growth of between 200,000 and 250,000 jobs per month, which has been our forecast since the beginning of 2011.

Setting aside the robust employment recoveries from the recessions in the mid-1970s and the early-1980s, we can compare how quickly the next two million jobs were created in the so-called jobless recoveries in the early 1990s and early 2000s. After the private sector economy created two million jobs in the aftermath of the 1990-91 recession, it took the private sector economy only another eight months to create the next two million jobs. Over this eight-month period (mid-1993 through early 1994), the economy created around 250,000 jobs per month as the Fed remained on hold and the economy reacted to an increase in tax rates in mid-1993. After the private sector created roughly two million jobs in the aftermath of the mild 2001 recession, it took another ten months to create the next two million jobs. Over this ten-month period in 2005, the economy created around 200,000 jobs per month as the Federal Reserve raised interest rates by 175 basis points, the housing market boomed and fiscal policy in the United States tightened somewhat. Using the prior two recoveries as a baseline, a goal of creating the next two million jobs in the ensuing eight to 12 months is consistent with monthly job growth of between 200,000 and 250,000 jobs per month, which has been our forecast since the beginning of 2011. At this pace of job growth, it would take another two and a half years (early 2014) for the economy to recoup all the jobs lost in the Great Recession. Under this scenario, the unemployment rate would likely decline modestly, the Fed would remain on hold until mid-2013, and the overall economy would probably grow at around 3.0%, just slightly above its long-term average. A faster pace of job growth (around 300,000 to 350,000 per month) would create the next two million jobs by early 2012, and that outcome would certainly push down the unemployment rate, speed up the Feds exit from quantitative easing, and ease concerns about the durability of the recovery. At this pace, it would take around two years (mid-2013) to recoup all the jobs lost during the Great Recession. The economy would grow at around 3.5 to 4.0% under this scenario. Unfortunately for the still nearly 14 million unemployed workers, neither our bull case nor our base case for the next two million jobs is unfolding so far. As noted in the "Various Outcomes" table (See page 3), the private sector economy is creating around 100,000 jobs per month over the past three months. At this pace, it would take until late 2012 for the economy to create the next two million jobs, and would leave the unemployment rate about where it is now (9.1%). At this pace of private sector job creation, it would take five more years (late 2016) before the economy recoups all the private jobs lost in the Great Recession. Under this scenario, the economy would continue to struggle to grow at around 2.0% per year. This outcome has already prompted the Fed to enact more stimulative monetary policy (committing in August 2011 to keep rates low until mid2013 and embarking on Operation Twist in September 2011) and could prompt more monetary stimulus from the Fed if the slow pace of job creation persists. The slow pace of job growth has already led to continuous

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talk about a double-dip recession, and that talk is likely to persist until the pace of job creation picks up. While we expect the pace of job creation to reaccelerate back toward our base case (200,000 to 250,000 jobs per month) in the coming months and quarters as the factors restraining hiring fade, we continue to expect that the labor market will remain relatively subdued by historical standards, but grow just enough to promote near trend-like GDP growth in the quarters ahead.
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. The Federal Open Market Committee action known as Operation Twist began in 1961. The intent was to flatten the yield curve in order to promote capital inflows and strengthen the dollar. The Fed utilized open market operations to shorten the maturity of public debt in the open market. The action has subsequently been reexamined in isolation and found to have been more effective than originally thought. As a result of this reappraisal, similar action has been suggested as an alternative to quantitative easing by central banks. The Standard & Poors 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. Credit rating is an assessment of the credit worthiness of individuals and corporations. It is based upon the history of borrowing and repayment, as well as the availability of assets and extent of liabilities. An obligation rated 'AAA' has the highest rating assigned by Standard & Poor's. The obligor's capacity to meet its financial commitment on the obligation is extremely strong. 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.
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Weekly Market Commentary

October 10, 2011

Earnings Season: What to Watch

Jeffrey Kleintop, CFA
Chief Market Strategist LPL Financial

Highlights
While macroeconomic factors are likely to remain key drivers of the market this week, microeconomics will also garner investors attention as companies begin to release their third quarter earnings reports. Market participants have priced declines in earnings into stock market valuations. Yet, analysts have high, double-digit growth expectations for earnings as profits reach a new record high for the first time since the Great Recession. During this earnings season we are paying special attention to sales growth, exposure to Europe, and how companies are putting cash to work (or not) and the impact on the outlook for coming quarters.

U.S. stocks rose last week by 2.1%, as measured by the S&P 500 Index, once again rebounding off the low end of the range from about 1100 to 1200 that has constrained the Index for the past couple of months. The rebound was driven by a combination of solid and better-than-expected economic data, few negative earnings pre-announcements, supportive actions by foreign central banks, and talk among European policymakers of injecting capital into Europes banks to insulate them from a potential Greek default and recession. While macroeconomic factors are likely to remain key drivers of the market this week, microeconomics will also garner investors attention as companies begin to release their third-quarter earnings reports. Four times a year investors focus on the most fundamental driver of investment performance: earnings. As you can see in Chart 1, the performance of the S&P 500 and analysts revisions to their earnings per share (EPS) estimates are closely linked. Market participants have priced declines in earnings into stock market valuations, as we detailed in the Weekly Market Commentary from September 9 entitled Recession Obsession. Yet, analysts have high expectations for earnings. The consensus of analysts expects doubledigit, 13% profit growth (compared to the third quarter of 2010) in the third quarter of 2011, as profits reach a new record high for the first time since the Great Recession, and 15% year-over-year growth for the fourth quarter for S&P 500 companies. Who is right? The truth is likely to be in the middle as earnings expectations are revised modestly lower and markets price in a less dire outlook for profits as results are reported and guidance on coming quarters is provided by corporate leaders. In recent weeks, third-quarter earnings estimates have been falling. Of the 127 companies that pre-announced third quarter earnings guidance in recent weeks, the ratio of negative-to-positive news was 2.6, worse than the average ratio of 2.3 since 1995. For S&P 500 companies that have reported third-quarter earnings so far, 21 of 29 (72%) have exceeded estimates, while six have missed estimates. The third-quarter earnings season runs about four to six weeks starting around two weeks after the close of the quarter. During this earnings season we are paying special attention to sales growth, exposure to Europe,

S&P 500 Performance and Earnings Outlook Closely Linked

S&P 500 Year-Over-Year Performance and Number of Upward EPS Revisions Divided by Downward Revisions Over Past Month for S&P 500 Companies (Three-Month Moving Average) Revision Ratio (Up/Down) (Left Axis) S&P 500 Year Over Year (Right Axis)

2.50 2.00 1.50 1.00 0.50 0.00

80% 60% 40% 20% 0% -20% -40% -60%

Source: LPL Financial, Factset 10/07/11

00

01

02

03

04

05

06

07

08

09

10

11

The S&P 500 is an unmanaged index, which cannot be invested into directly. Past performance is no guarantee of future results.

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and how companies are putting cash to work (or not) and the impact on the outlook for coming quarters. Sales Growth We will be putting more emphasis this season on top-line rather than bottom-line growth. Sales growth is expected by analysts to come in around a strong 10%. One headwind companies face is sluggish economic growth around the world, although they were able to post strong growth in the first half of 2011 despite sluggish economic growth. Another headwind is the movement in the value of the dollar. During the third quarter, the dollar was down about 10%, on average, from a year earlier boosting the translation value of foreign-sourced profits. However, entering the fourth quarter the dollar is flat compared to a year ago, eliminating a positive for profits. European Exposure Economic growth may likely continue, albeit below average, in the United States over the next year and emerging markets are expected to continue to grow. However, developed foreign economies, particularly in Europe, may enter a recession in the next 12 months. S&P 500 companies revenues are composed regionally; about 46% of profits come from foreign markets with about 29% of foreign profits derived from Europe. However, that varies widely by sector and industry. 2 S&P 500 Dividend Payout Ratio Lowest in History
S&P 500 Dividend Payout Ratio

It is important to keep in mind that the companies that report early in the season are most often not the bellwethers they are commonly thought to be.

70% 60% 50% 40% 30% 20% 10%

0% 1977 1982 1987 1992 1997 2002 2007 Source: LPL Financial, Standard and Poors, Thomson Financial 10/07/11

Putting Cash to Use Pressure is building for higher dividends as U.S. companies sit on record cash stockpiles and payouts remain at all-time lows. S&P 500 companies paid out 26% of earnings in the form of dividends over the past year, down from 30% for much of the 2000s and below the 30-year average of 40%. Company cash and equivalents have soared to record highs even as companies have paid down debt in a dramatic deleveraging over the past few years. A return to higher dividend payouts would help attract investors seeking income in an environment of very low bond yields. The S&P 500s dividend yield stands at 2.2%, above the yield on the 10-year Treasury for one of the few times in history. Also, share repurchases are a way of putting cash to work. This week, just ten S&P 500 companies are due to report earnings. It is important to keep in mind that the companies that report early in the season are most often not the bellwethers they are commonly thought to be. We may not really know how overall corporate results for the third quarter of 2011 are shaping up until just after the end of the month of October, when about half of the S&P 500 companies will have reported.

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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. Earnings per share (EPS) is the portion of a companys profit allocated to each outstanding share of common stock. EPS serves as an indicator of a companys profitability. Earnings per share is generally considered to be the single most important variable in determining a shares price. It is also a major component used to calculate the price-to-earnings valuation ratio. The Standard & Poors 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.

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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