LP L FINANCIAL R E S E AR C H

Weekly Economic Commentary

April 09, 2012

March Job Report Disappoints, but Labor Market Continues to Heal

John Canally, CFA
Economist LPL Financial

Highlights
The labor market is healing and is probably in better shape than it was last summer. The economy is probably not growing quickly enough to generate more than 200,000 225,000 jobs per month. The Federal Reserve (Fed) may put another round of quantitative easing (QE) on the table in June.

The March employment report, released on Friday, April 6, 2012, was a disappointment relative to both expectations and the labor market data in recent months. Some of the disappointment in March 2012 may have been payback for a much warmer-than-usual winter. On balance, however, the report and its underlying details suggest that the labor market continues to heal, but it still has a long way to go to get back to normal. The lackluster March jobs report also puts another round of quantitative easing (QE) back on the table for the Federal Reserve (Fed). 1 The 120,000 Manufacturing Jobs Added in the First Quarter Were the Third Most in Any Quarter Since the Early 1980s
Change in Manufacturing Employment, Seasonally Adjusted, Thous 400 200 0 -200 -400 -600 -800

85

90

95

00

05

10

Source: Bureau of Labor Statistics, Haver Analytics 04/09/12 (Shaded areas indicate a recession)

The March jobs report does little to change our view that the U.S. labor market is healing, albeit slowly, but still has a long way to go to recoup all of the jobs lost during the Great Recession.

The March employment report revealed that the economy added 121,000 private sector jobs in March, far fewer than the consensus expectation of 215,000, and well below the 250,000 jobs created on average in the three months ending in February 2012. In fact, the result was below the lower end of the range of consensus expectations (+185,000 to +265,000). This has happened in just nine of the 63 months since early 2007. Despite the disappointment, there were some bright spots in the report, including the drop in the unemployment rate to 8.2% from 8.3% in February. The financial markets initially reacted poorly to the data. However, the March jobs report does little to change our view that the U.S. labor market is healing, albeit slowly, but still has a long way to go to recoup all of the jobs lost during the Great Recession.
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LPL Financial Research Weekly Calendar

U.S. Data
2012 9 Apr

Fed

Global Notables

Bernanke Lockhart Rosengren

China: CPI (Mar.)

10 Apr

NFIB Small Business Optimism (Mar) JOLTS (Feb) Wholesale Inventories (Feb) Import Prices (Mar) Budget Statement (Mar)

Fisher Klocherlakota

China: Imports and Exports (Mar.) IMF Global Forecast Bank of Japan Meeting Germany: Bond Auction

11 Apr

Beige Book Rosengren Bullard Yellen Plosser Klocherlakota

12 Apr

Trade Balance (Feb) Initial Claims (4/7) Producer Price Index (Mar)

Italy: Debt auction Indonesia central bank meeting China: Industrial Production (Mar) China: Retail Sales (Mar) China: GDP (Q1) South Korea central bank meeting Iran nuclear talks

13 Apr

Consumer Price Index (Mar) Consumer Sentiment (1H Apr)

Hawks: Fed officials who favor the low inflation side of the Feds dual mandate of low inflation and full employment Doves: Fed officials who favor the full employment side of the Feds dual mandate

Behind the unambiguously disappointing headline job count, there were several bright spots in the March jobs report. With the 120,000 gain in March, the economy has now added jobs in each of the past 25 months, the longest such streak since mid-2005 through mid-2007 . The diffusion index the number of industries adding workers less the number of industries shedding workers stood at a robust 67 .9% in March, and averaged 68% in the first quarter of 2012, one of the highest readings in 20 years. The manufacturing sector added 37 ,000 jobs in March 2012, the 16th time in the last 17 months that manufacturing jobs have increased. Q1 marked the third best quarter (Q3 1987 and Q4 1997) for manufacturing employment since the middle of 1984. State and local government employment, which has been a significant drag on overall employment for almost four years, may be stabilizing. State and local government employment fell just 1,000 between February and March 2012, but actually increased by 14,000 in the first quarter of 2012, the first quarterly gain in nearly four years. In 2011, state and local

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W E E KLY E CONOMIC CO MME N TAR Y

Looking ahead, the recent data from this report, as well as from state and local government budgets and from surveys of layoffs in state and local governments, all suggest that the worst may be over for job losses at the state and local government level.
2

governments shed more than 20,000 jobs per month, and shed more than 650,000 jobs since August 2008, as they struggled to align costs with reduced revenues. Looking ahead, the recent data from this report, as well as from state and local government budgets and from surveys of layoffs in state and local governments, all suggest that the worst may be over for job losses at the state and local government level. The private sector economy created more jobs (635,000) in the first quarter of 2012 or 212,000 per month than in any quarter since the first quarter of 2006, when the economy, as measured by real Gross Domestic Product (GDP), was growing at 5.1%. While some of the increase in jobs was likely due to warmer-than-usual weather during the quarter, the vast majority of the jobs created recently likely represent actual economic activity. Weather-sensitive jobs excluding construction (Retail, Transportation & Warehousing, Services to Buildings and Dwellings, and Leisure & Hospitality) rose just 24,000 in March 2012 after the 26,000 gain in February. This metric posted an average gain of over 100,000 per month in the three months ended in January 2012. In short, the 212,000 jobs created on average, per month, in the first quarter is probably closer to the underlying trend of job growth than the 250,000 or so jobs added in the three months ending in February 2012, which were likely boosted by the warmer-than-usual winter. Between February 2008 and February 2010 during and immediately after the Great Recession the economy shed 8.9 million private sector jobs. Since February 2010, the economy has added 4.1 million private sector jobs. Thus, the economy still needs to add 4.8 million jobs to recoup all the jobs lost during the Great Recession. If the economy creates private sector jobs at the pace it did during the first quarter (210,000 per month), it would take until the beginning of 2014 (another 22 months) for the economy to get back to peak employment. As we have noted in previous commentaries, many of the jobs lost during the downturn (Construction, Financial Services, and Real Estate) may never come back. But as of the end of January 2012, there were over 3.4 million open jobs in the economy (Please see the April 2, 2012 Weekly Economic Commentary for more details). We often get asked about the quality of the jobs being added each month. What are the workers being paid? Are the jobs full-time or part-time? Our answer to that question is simply that the best gauge of the labor market may not be the jobs report at all, but rather the personal income and personal spending report that comes out three weeks after the monthly jobs report is released. In that report (the March 2012 personal income and spending report is due out on April 30, 2012) the personal income data, which basically adds up all the income made throughout the economy, is key. Personal income which includes income from wages and salaries, but also from rental income, interest received and transfer payments (social security, unemployment insurance, Medicare payments, etc.) from the government provides the buying power for personal spending, which in turn accounts for two-thirds of GDP. Recently, personal income growth has been running about 3% above its yearago levels, a big improvement versus the 3 4% year-over-year declines during

The Worst of the Job Losses at State and Local Governments Appears to Be Over
Employees on State and Local Government Payrolls 20 18

Thousands

16 14 12

90

95

00

05

10

Source: Haver Analytics 04/09/12 (Shaded areas indicate a recession)

If the economy creates private sector jobs at the pace it did during the first quarter (210,000 per month), it would take until the beginning of 2014 (another 22 months) for the economy to get back to peak employment.

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Personal Income Growth Is Probably the Best Measure of the Health of the Labor Market
Personal Income, % Change - Year to Year, Seasonally Adjusted Annual Rate, Bil. $ 12 8 4 0 -4

01 02 03 04 05 06 07 08 09 10 11 Source: Bureau of Economic Analysis, Haver Analytics 04/09/12

-8

the Great Recession, but still far below the normal pace of income gains (5 7%). Compensation of employees, which accounts for about two-thirds of personal income, and is a good proxy for employment growth, is running about 4% above year-ago levels. This takes into account that in recent months, about 19% of the jobs in the economy are part-time jobs. During the 2001 2007 economic expansion, only 17 18% of jobs in the economy were part-time jobs. Presented another way, in March 2012, 81% of the jobs in the economy were full-time jobs, and just 19% were part-time jobs. The economy has added 2.7 million full-time jobs over the past year, and shed 233,000 part-time jobs. As recently as June 2012, the economy was still shedding full-time jobs (621,000 in the 12 months ending in June 2011), and adding part-time jobs (878,000 in the 12 months ending June 2011). Thus, despite the disappointment in March 2012 relative to expectations, the labor market today is far stronger than it was in the middle of 2011, but still not booming. While Fed policymakers are likely to take note of all of these crosscurrents in the latest employment report, their key takeaway is likely to be similar to ours: the labor market is healing and is probably in better shape than it was last summer, but the economy is probably not growing quickly enough to generate more than 200,000 225,000 jobs per month. Is job growth at that pace enough to convince Fed policymakers that the economy does not need another round of QE? In our view, probably not, and the conversation in the marketplace about QE3 will likely heat up in the coming weeks. Although we do not expect the Fed to announce QE3 at the next Federal Open Market Committee (FOMC) meeting (April 25), it is likely to be discussed, and it could be introduced as soon as the FOMC meeting in late June. Please see our Weekly Economic Commentary from March 12, 2012 for our insights into what another round of quantitative easing from the Fed might look like.

(Shaded areas indicate a recession)

Thus, despite the disappointment in March 2012 relative to expectations, the labor market today is far stronger than it was in the middle of 2011, but still not booming.

The Ratio of Full-Time Jobs in the Economy Plunged During the Recession, but Is Steadily Climbing Back
Ratio of Full Time Workers to Total Workers 0.840 0.833 0.825 0.818 0.810 0.803 0.795 90 95 00 05 10

LPL Financial Research 2012 Forecasts

GDP 2%* Federal Funds Rate 0%^ Private Payrolls +200K/mo.

Please see our 2012 Outlook for more details on LPL Financial Research forecasts.

Source: Haver Analytics 04/09/12 (Shaded areas indicate a recession)

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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. * Gross Domestic Product (GDP) is the monetary value of all the finished goods and services produced within a country's borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory. ^ Federal Funds Rate is the interest rate at which depository institutions actively trade balances held at the Federal Reserve, called federal funds, with each other, usually overnight, on an uncollateralized basis. Private Sector the total nonfarm payroll accounts for approximately 80% of the workers who produce the entire gross domestic product of the United States. The nonfarm payroll statistic is reported monthly, on the first Friday of the month, and is used to assist government policy makers and economists determine the current state of the economy and predict future levels of economic activity. It doesnt include: - general government employees - private household employees - employees of nonprofit organizations that provide assistance to individuals - farm employees 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. Stock investing involves risk including loss of principal. The Federal Open Market Committee (FOMC), a committee within the Federal Reserve System, is charged under the United States law with overseeing the nations open market operations (i.e., the Feds buying and selling of United States Treasure securities). 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.

This research material has been prepared by LPL Financial. LPL Financial 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/NCUA Insured | Not Bank/Credit Union Guaranteed | May Lose Value | Not Guaranteed by any Government Agency | Not a Bank/Credit Union Deposit

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Weekly Market Commentary

April 9, 2012

What Investors Should Watch This Earnings Season

Jeffrey Kleintop, CFA
Chief Market Strategist LPL Financial

Highlights
While macroeconomic data and events are likely to remain key drivers of the market this week, microeconomics will also garner investors attention as companies begin to release first quarter earnings reports. In each of the past two years, as the last week of April unfolded, the S&P 500 Index peaked and began to decline 16 19% as the back half of the earnings season got underway. We will be watching developments closely to determine if a repeat of that pattern will emerge again this year. During this earnings season, we are paying special attention to the breadth of earnings growth, earnings guidance on upcoming quarters, and profit margins.

After a strong first quarter, the stock market, measured by the S&P 500 Index, got off to a weak start in the second quarter with a decline of -0.7% last week. Investors focused on the Federal Reserves (Fed) lack of support for round three of quantitative easing (QE3) in the minutes that were released from the March Fed meeting. As we noted a few weeks ago in our commentary, this is one of the 10 indicators we are watching that might foreshadow another spring slide in the stock market. While macroeconomic data and events are likely to remain key drivers of the market this week, microeconomics will also garner investors attention as companies begin to release their first quarter earnings reports. While only a handful of S&P 500 companies report results this week, it is widely considered to be the start of earnings season with big, well-known companies like Alcoa and JPMorgan Chase due to report first quarter results. Four times a year investors focus on the most fundamental driver of investment performance: earnings. The close connection between earnings and stock market performance can be seen in the fact that the S&P 500 Index and earnings per share have both risen about 80% over the past three years. A slowdown in earnings growth may indicate the same for the stock market. Stock market momentum has stalled over the past few weeks during the period known as the pre-announcement, or confession, season so called because business leaders often use this period to offer investors guidance on how the quarters results are shaping up relative to expectations. This season, of the companies that pre-announced first quarter earnings guidance in recent weeks, the ratio of negative-to-positive news was 3.0, worse than the average ratio of 2.3 since 1995. The first 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 the breadth of earnings growth, earnings guidance on upcoming quarters, and profit margins.

Breadth of Earnings Growth

We believe first quarter earnings are likely to post a mid-single-digit percentage gain from a year ago as earnings growth continues to decelerate.* The fourth quarter of 2011 marked the first time earnings growth fell into the single digits since the recovery began in 2009. The

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slowing growth rate for S&P 500 company earnings reflects not only slower growth among individual companies, but also reflects the shrinking number of companies expected to post growth in earnings for the quarter with about 20% of companies expected to reveal declines. Just like the recent performance of the stock market, earnings growth is being driven by fewer companies. In fact, just one company, Apple Inc., is expected to account for 1.4 percentage points or about a third of the growth in earnings for the entire S&P 500. The same single company, Apple Inc., accounted for 15% of the performance of the S&P 500 in the first quarter. The fewer the number of companies that drive earnings growth (and stock market performance), the more vulnerable the overall market is to disappointments and declines.

Earnings Guidance and Revisions

1 Spikes in Upward Revisions to Earnings Growth Preceded Stock Market Declines
Change in Earnings Growth Rate Over Next 12 Months for S&P 500 Companies 6 5 4
Percent (%)

3 2 1 0 -1

The first couple of weeks of the first quarter earnings seasons in April 2010 and April 2011 largely contained good news and drove earnings estimates higher. Earnings estimates for S&P 500 companies for the next year rose a greater-than-average 3 25% during the first couple of weeks of reports. But as the second half of the earnings season got underway in early May 2010 and May 2011, forward earnings guidance disappointed analysts and investors, and the pace of upward revisions declined sharply. This year, we will be watching to see how much earnings expectations rise as the initial reports come in and if they begin to taper off sharply. The consensus of analysts tracked by Thomson Financial expects earnings growth of 3% in the first quarter of 2012 (compared to the first quarter of 2011). While the bar of expectations may be low for the first quarter of 2012, looking further out on the calendar to the fourth quarter of 2012, year-overyear earnings growth estimates for S&P 500 companies remain high at 16.3%, according to data from Thomson Financial. Earnings guidance may result in substantial downward revisions to earnings growth for coming quarters, undermining support for the stock market.

-2 Jan Apr Jul Oct Jan Apr 10 10 10 10 10 11 Source: LPL Financial, FactSet 04/09/12

Jul 11

Oct 11

Jan Apr 12 12

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

Profit Margins
The analyst consensus forecast of 3% earnings growth in the first quarter is the slowest growth rate since the recovery in earnings began in 2009. The weakness stems from the end of profit margin expansion. Analysts expect earnings to track revenue growth of about 4%. Over much of the past few years, companies were able to post earnings growth rates that were several times the pace of revenue growth as profit margins expanded, granting more profit per dollar of sales. However, the ability to post faster earnings growth than revenue growth has faded; rising costs have contributed to slower earnings gains relative to revenue. In fact, nearly a quarter of S&P 500 companies are expected to report a year-overyear drop in earnings per share despite year-over-year revenue gains in the

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Slowing Revenue and Earnings Growth

S&P 500 Revenue and Earnings per Share Growth Rates Revenue Growth Year-Over-Year EPS Growth Year-Over-Year

first quarter. Three sectors are expected to post earnings declines despite revenue growth. The most dramatic of these is the Materials sector, where 5% revenue growth is expected to accompany a -15% decline in earnings. In this environment, those areas of the market able to sustain their profit margins are likely to be rewarded by investors. These sectors may include the Information Technology and Industrials sectors. Companies in these sectors are those that appear likely to generate higher-than-average earnings growth rates in the first quarter. Importantly, 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 first quarter are shaping up until early May, when about half of the S&P 500 companies will have reported. In each of the past two years, as the last week of April unfolded, the stock market peaked and began to decline 16 19% as the back half of the earnings season got underway. We will be watching developments closely to determine if a repeat of that pattern will emerge again this year. n
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. * Please see our 2012 Outlook report for a detailed discussion of our earnings growth estimate for 2012. Stock investing may involve risk including loss of principal. 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. 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. 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 company names mentioned herein was for educational purposes only and was not a recommendation to buy or sell that company nor an endorsement for their product or service.

60 50
Percent (%)

40 30 20 10 0 Q1 10 Q2 10 Q3 10 Q4 10 Q1 11 Q2 11 Q3 11 Q4 11
4.0% 3.0%

(Est.)

Q1 12

Source: LPL Financial, FactSet 04/09/12 The S&P 500 Index 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 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.

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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