member finra/sipc lpl financial research the path of least resistance

Member FINRA/SIPC

LPL FINANCIAL RESEARCH

The Path of Least Resistance

2LPL Financial Member FINRA/SIPC


Compromise in Washington

Open-ended Quantitative Easing (QE) from the Fed

Slow continued European integration

Flat-to-weak growth for the U.S. economy

In 2013, many different forces will combine to influence the direction of the markets to follow the path of least resistance leading to modest single-digit returns in the U.S. stock and bond markets.*

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.

*Equity market forecast is for the S&P 500 Index and is based upon a low-single-digit earnings growth rate supported by modest share buybacks combined with 2% dividend yields and little change in valuations. Bond market forecast is for the Barclays Aggregate Index and is based upon <1% rise in rates, with price declines offset by interest income.



Calendar of Events That Impact the Path Taken

Source: LPL Financial Research 11/26/12

*Medicare physician reimbursement

Mid-Nov – Jan 2 “Lame duck” session

Late DecemberDebt ceiling reached: Treasury will use “extraordinary measures” to extend this date until February/March 2013

December 31Fiscal cliff: Bush tax cuts expire, 2% payroll tax cut expires, extended unemployment benefits and “doc fix*” end*

January 2, 2013Sequester goes into effect: A series of prearranged across-the-board cuts to spending agreed to in August 2011

January 3, 2013 New Congress sworn in

January 21, 2013 Inauguration day

Feb/March 2013 Debt ceiling reached

Feb/March 2013 Possible ratings downgrades

March 31, 2013 Possible government shutdown as temporary funding expires



The Paths of 2013


Based on our assessment of market conditions, fundamental, technical, and valuation analysis and the backdrop of the situation in Washington, D.C.

There is no assurance that the techniques, outcomes, or strategies discussed are suitable for all investors or will yield positive outcomes. The purchase of certain securities may be required to effect some of the strategies. Investing involves risk including possible loss of principal.



\

The negotiations will center on which expiring tax cuts to extend and which discretionary programs to shield from spending cuts in an effort to avert a recession. Each party has different priorities, but both face the same realities. A compromise is likely to be struck either in the lame duck session in December 2012 or early in 2013. As a result, we believe this is the most likely path with a 55 – 65% likelihood.

The Base PathThe Compromise



Dow Jones Industrial Average and Congressional Control Since 1901

Source: Ned Davis Research 11/19/12

Dow Jones Industrial Average is the most widely used indicator of the overall condition of the stock market, a price-weighted average of 30 actively traded blue chip stocks, primarily industrials. The 30 stocks are chosen by the editors of the Wall Street Journal. The Dow is computed using a price-weighted indexing system, rather than the more common market cap-weighted indexing system.

Party Annualized Return % % of Time

Democrats 5.5% 55.4%

Republicans 7.8% 32.2%

Split -3.1% 12.4%



Source: LPL Financial Research, Thomson Reuters, Standard & Poors, and Bloomberg 11/26/12

Drivers of Total Returns Come From Different Sources:Recently Earnings Have Been the Primary Driver



Source: LPL Financial Research, Thomson Financial, Standard & Poor’s, Bloomberg 10/08/12

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

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

The P/E ratio (price-to-earnings ratio) is a measure of the price paid for a share relative to the annual net income or profit earned by the firm per share. It is a financial ratio used for valuation: a higher P/E ratio means that investors are paying more for each unit of net income, so the stock is more expensive compared to one with lower P/E ratio.

Back at the Top of the S&P 500 15-Year Range



Facts and Feelings Have Almost Reconnectedand a Crossover May Occur

Source: LPL Financial Research, Standard & Poor’s, Bloomberg 11/12/12

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 University of Michigan Consumer Sentiment Index (MCSI) is a survey of consumer confidence conducted by the University of Michigan. The University of Michigan Consumer Sentiment Index (MCSI) uses telephone surveys to gather information on consumer expectations regarding the overall economy.

Past performance is no guarantee of future results.



China’s Growth Plan Takes China From 40%to 67% of the Size of the U.S. Economy

Source: LPL Financial Research, World Bank 11/12/12

Note: Assumes continued 2% GDP growth rate for United States and stated 2020 target for China.

Investing in foreign securities involves special additional risks. These risks include, but are not limited to, currency risk, political risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks.



Although Yield Spreads Have Contracted,High-Yield Bonds Still Stand Out In a Low-Yield World

Source: Barclays Index data, LPL Financial Research 11/19/12.

Average yield of high-yield bonds is 7x greater than average Treasury yield.




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.

Investment-grade corporate bonds: The risks associated with investment-grade corporate bonds are considered significantly higher than those associated with first-class government bonds.

Municipal bonds are subject to availability, price, and to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rate rise. Interest income may be subject to the alternative minimum tax. Federally tax-free but other state and local taxes may apply.

Stock investing involves risk including loss of principal.

Value investments can perform differently from the market as a whole. They can remain undervalued by the market for long periods of time.

How to Invest: The Base Path

The following should be considered:

Stocks:• Growth, cyclical, small cap (1H13)• Value, defensive, large cap (2H13)

Bonds: • Investment-grade corporate bonds and municipal bonds will

likely benefit



The lack of any compromise over the sequester spending cuts during the past year, the unwillingness to embrace any of the proposed bipartisan reforms (from the Simpson-Bowles commission and so-called Gang of Six) and perhaps, most importantly, the debt ceiling debacle of August 2011 has taught us not to expect our leaders to always see the value in expedient compromise over grand gestures and winning political points. As a result, we must place a meaningful probability of taking this path at about 25 – 30%.

The Bear PathGoing Over the Cliff



2013 Fiscal Headwinds ($ billions)

Source: LPL Financial Research, Congressional Budget Office, Office of Management and Budget 11/26/12

Expiration of Bush tax cuts for middle income earners 102

Expiration of Bush tax cuts for high income earners 42

Payroll tax cut for workers 85

Alternative minimum tax “patch” 103

Debt ceiling annual spending sequester 54

Expiration of extended unemployment insurance 34

Medicare tax of 3.8% on investment income from the Affordable Care Act 18

Medicare physician reimbursement 10

Other provisions scheduled to expire 65

Total 513

Total as % of estimated 2013 GDP 3 – 4%



Manufacturing Activity Impacts the Stock Market

Source: Institute for Supply Management, Haver Analytics, LPL Financial Research 11/26/12

The Institute for Supply Management (ISM) index is based on surveys of more than 300 manufacturing firms by the Institute of Supply Management. The ISM Manufacturing Index monitors employment, production inventories, new orders, and supplier deliveries. A composite diffusion index is created that monitors conditions in national manufacturing based on the data from these surveys.

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

Past performance is no guarantee of future results.



Large Fiscal Issues Drag Down the Market


*This is the peak-to-trough pullback associated with the fiscal drag.

The Standard & Poor’s 500 Index is an unmanaged index, which cannot be invested into directly. Past performance is no guarantee of future results.

Fiscal Drag S&P 500 Pullback*

1947 -10.4% -28%

1951 -2.7% -8%

1956 -1.6% -9%

1960 -2.1% -13%

1969 -3.1% -36%

1977 -1.4% -19%

1987 -1.8% -34%

Average -21%


LPL FINANCIAL RESEARCHMunicipal Valuations Have Improved but Remain Attractive Compared to Long-term History and the pre-Bush Tax Cut Era

Source: Barclays Index data, LPL Financial Research 11/19/12

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.

Municipal bonds are subject to availability, price, and to market and interest rate risk if sol prior to maturity. Bond values will decline as interest rate rises. Interest income may be subject to the alternative minimum tax. Federally tax-free but other state and local taxes may apply.





Treasuries: A marketable, fixed-interest U.S. government debt security. Treasury bonds make interest payments semi-annually and the income that holders receive is only taxed at the federal level.

Stock investing involves risk including loss of principal.

How to Invest: The Bear Path


Stocks:• Stocks underperform bonds and cash• Defensives, large caps

Bonds: • Safe-haven buying returns and benefits Treasuries• High-quality bonds benefit



If there ever were a time to enact long-term fiscal discipline, now is that time. The United States’ large and unsustainable budget deficits helped push total U.S. debt over 100% of GDP in 2012. Typically considered taboo by both parties, wide-reaching bipartisan proposals have been unveiled to put the United States back on a path to fiscal sustainability. We estimate a 10 – 15% chance that a long-term solution of permanent changes to tax rates and entitlement programs emerges in 2013.

The Bull PathThe Long-Term Solution



Debt ceiling must be lifted again in 1Q13

United States could lose AAA credit rating

Spending sequester must be dealt with

President and Congress will be in first year of their terms

Closing “loopholes” in tax code requires broader tax reform

Drivers that bode well for a long-term solution beyond a compromise on the fiscal cliff:

The Long-Term Solution





Investment-grade corporate bonds: The risks associated with investment-grade corporate bonds are considered significantly higher than those associated with first-class government bonds.

International and emerging market investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors.

The prices of small cap stocks are generally more volatile than those of large cap stocks.

High yield/junk bonds (grade BB or below) are not investment grade securities, and are subject to higher interest rate, credit, and liquidity risks than those graded BBB and above. They generally should be part of a diversified portfolio for sophisticated investors.

How to Invest: The Bull Path


Stocks:• Stocks outperform bonds• Cyclicals, small caps, domestic markets

Bonds: • High-yield bonds lead• Credit sensitive invest-grade corporate bonds and emerging market

bonds follow



Although Europe is still mired in recession, European stocks and bonds have performed well, and the European Central Bank appears to be standing behind Spain and Italy. Central Banks throughout Europe and the Bank of Japan will continue their currency war. Regional tensions over Iran and Syria will remain high and serve as a remainder of risks to the global economy beyond U.S. borders.

The Pathsfor Europe,Central Banks,and Geopolitics



World’s Central Banks Have Aggressively Applied Stimulus

Source: Bloomberg, LPL Financial Research 10/22/12



Stimulus of Other Countries Surpass the Fed

Central Bank

Assets as a %of GDP

DifferenceMid-2008 2012

Bank of Japan 20% 31% +11%

Bank of England 7% 21% +14%

Federal Reserve 6% 18% +12%

European Central Bank 16% 33% +17%




Central Bank Currency WarMid-2008 – Present

Central Bank Currency

Change in Central Bank Assets as % of GDP Relative to Change in U.S. Fed Assets

Change in Currency Relative to US dollar

Japan Yen -1% +34%

England/United Kingdom Pound +2% -20%

Eurozone Euro +5% -6%


Currency Risk is a form of risk that arises from the change in price of one currency against another. Whenever investors or companies have assets or business operations across national borders, they face currency risk if their positions are not hedged.



Fiscal cliff issues will likely be resolved

Debt ceiling will likely have been lifted

Obama administration’s news trade case against China should be clarified

Framework for long-term solution to U.S. fiscal challengesmay emerge

Developments on Capitol Hill will provide much clearer visibility of the path upon which the economic and market landscape will pass over the remainder of the year. For example, by the end of the first quarter of 2013:

Over the (Capitol) Hill:The View From the End of the First Quarter of 2013

LPL Financial Member FINRA/SIPC

Thank you for your business



Important Disclosures

The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. All performance referenced 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.

Investing in specialty market and sectors carry additional risks such as economic, political or regulatory developments that may affect many or all issuers in that sector.

International and emerging market investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors.


Municipal bonds are subject to availability, price, and to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rate rise. Interest income may be subject to the alternative minimum tax. Federally tax-free, but other state and local taxes may apply.

Corporate bonds are considered higher risk than government bonds, but normally offer a higher yield and are subject to market, interest rate, and credit risk as well as additional risks based on the quality of issuer, coupon rate, price, yield, maturity, and redemption features.

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 fund shares is not guaranteed and will fluctuate.

Treasuries: A marketable, fixed-interest U.S. government debt security. Treasury bonds make interest payments semi-annually and the income that holders receive is only taxed at the federal level.

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.

The P/E ratio (price-to-earnings ratio) is a measure of the price paid for a share relative to the annual net income or profit earned by the firm per share. It is a financial ratio used for valuation: a higher P/E ratio means that investors are paying more for each unit of net income, so the stock is more expensive compared to one with a lower P/E ratio.

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



Important Disclosures

Default rate is the rate in which debt holders default on the amount of money that they owe. It is often used by credit card companies when setting interest rates, but also refers to the rate at which corporations default on their loans. Default rates tend to rise during economic downturns, since investors and businesses see a decline in income and sales while still being required to pay off the same amount of debt. Index Definitions: INDEX DESCRIPTIONS:

The ISM index is based on surveys of more than 300 manufacturing firms by the Institute of Supply Management. The ISM Manufacturing Index monitors employment, production inventories, new orders, and supplier deliveries. A composite diffusion index is created that monitors conditions in national manufacturing based on the data from these surveys.

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.

Dow Jones Industrial Average (DJIA): The Dow Jones Industrial Average Index is comprised of U.S.-listed stocks of companies that produce other (non-transportation and non-utility) goods and services. The Dow Jones Industrial Averages are maintained by editors of The Wall Street Journal. While the stock selection process is somewhat subjective, a stock typically is added only if the company has an excellent reputation, demonstrates sustained growth, is of interest to a large number of investors, and accurately represents the market sectors covered by the average. The Dow Jones averages are unique in that they are price weighted; therefore, their component weightings are affected only by changes in the stocks’ prices.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualifiedtax advisor.

This research material has been prepared by LPL Financial

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/NCUA Insured | Not Bank/Credit Union Guaranteed | May Lose Value | Not Guaranteed by any Government Agency | Not a Bank/Credit Union Deposit

LPL Financial, Member FINRA/SIPC

Tracking# 1-120352 | Exp. 12/13

member finra/sipc lpl financial research the path of least resistance

Documents

modest singledigit

bond market forecast

bond markets

equity market forecast

digit earnings growth

weak growth

modest share buybacks

barclays aggregate index