Member FINRA/SIPCPage 1 of 4

L P L F IN A NCI A L RESE A RCH

Weekly Economic CommentaryOctober 15, 2012

John Canally, CFAEconomist LPL Financial

Hard Data on China Still Point to Soft Landing

HighlightsWe continue to expect a “soft landing” — growth between 7% and 8% — for China’s economy in 2012. Our forecast remains below consensus.

We do not expect Chinese authorities to publish a hard-landing-like Gross Domestic Product (GDP) report, especially after promising in March of 2012 that GDP growth in 2012 would be 7.5%.

China will likely continue relying on exports to emerging markets until the United States re-accelerates and Europe emerges from its recession.

Please see the LPL Financial Research Weekly Calendar on page 3

We continue to expect a soft landing in China in 2012, i.e., Gross Domestic Product (GDP) growth between 7% and 8%, which is below consensus estimates. When we last focused on China in the Weekly Economic Commentary in mid-August 2012, we noted that additional monetary and fiscal stimulus in China could happen at any time, and markets would welcome these additional steps.

Since then, the 2012 consensus forecast for China has continued to move lower — from 8.25% in August 2012 to 7.75% today — and is now only a bit higher than the midpoint of our long-held forecast for Chinese GDP in 2012. China, in the middle of a once-a-decade transition to new leaders, has announced a few monetary and fiscal policy initiatives since then, but it has not cut the overnight lending rate or the reserve ratio requirement — the two key monetary policy levers in China. On the fiscal side, China has not unveiled any major new government spending projects either. With each passing day and week that China does not make a major monetary or fiscal policy announcement, the market becomes increasingly concerned about a

“hard landing,” or sharper slowdown in economic momentum. This week’s GDP report is a high-profile opportunity for the markets to get a read on the Chinese economy in the recently completed third quarter of 2012. In our view, it is unlikely that, even if China were in a hard landing, Chinese authorities would publish a hard-landing-like GDP report, especially after promising in March of 2012 that GDP growth in 2012 would be 7.5%.

China will release its third quarter 2012 GDP report later this week. The market is looking for a 7.4% year-over-year increase, following the 7.6% year-over-year reading recorded in the second quarter of 2012, reported in mid-July 2012. In addition to reporting its GDP data on a year-over-year basis, China also reports GDP on a year-to-date basis (YTD), tallying up GDP in the first three quarters of the year and comparing that to GDP in the first three quarters of 2011. On that basis, the consensus expects a 7.7% year-over-year gain in YTD GDP, versus the 7.8 % YTD reading in the second quarter of 2012. China also reports its GDP on a quarter-over-quarter basis, similar to the way GDP in the United States is reported. On that quarter-over-quarter basis, China’s GDP is expected to expand by 2.0% between the second and third quarters of 2012. Of the three ways China reports its GDP data (year-over-year, year-to-date year-over-year, and quarter-over-quarter), the market pays most attention to the year-over-year data.

To say transparency is not a hallmark of China’s economic data reports, is similar to saying transparency is not a major attribute of granite. Like trying to get blood

1 China’s Exports to Europe Have Declined 6% Year-Over-Year as Europe Struggles Through a Recession

Source: China Customs, Haver Analytics 10/15/12

100908 11 120705040302 06

60

40

20

0

-20

-40

China: Cumulative Exports to European Union, % Change, Year to Year, YTD, Mil. US$

LPL Financial Member FINRA/SIPC Page 2 of 4

WEEKLY ECONOMIC COMMENTARY

from a stone, China does not release the details of the composition of its GDP data, unlike in the United States and virtually every other economy in the world.

For example, in the U.S. GDP accounts, the Bureau of Economic Analysis of the U.S. Department of Commerce — the government agency responsible for tracking, collecting and disseminating U.S. GDP data — provides detail on hundreds of categories including: consumer spending, business capital spending, residential construction, inventories, imports, exports, and government spending within the GDP accounts. This is so that the markets (and the public) can get a better understanding of what is driving U.S. GDP. China’s National Bureau of Statistics (NBS), the Chinese government agency responsible for tracking, collecting, and disseminating the Chinese GDP data, provides no such detail, leaving the public in China, as well as global market participants, guessing about the composition of the Chinese economy.

Although the Chinese government does not publish details of its GDP data, organizations outside China do provide estimates of the composition of China’s economy. The World Bank estimates that between 40% and 50% of China’s GDP is accounted for by consumer spending (versus about 70% in the United States), leaving China’s net exports to carry a large burden. The World Bank estimates that China’s exports account for one-third of China’s GDP; exports account for 15% of U.S. GDP. Through September 2012, China’s exports were up just 10% from a year ago. In the first nine months of 2012, China’s exports to the European Union were down 6% from the first nine months of 2011, and exports to the United States were up 9% in that same period. With Europe in recession, and the United States growing at just 2.0%, China’s exports have slowed dramatically this year to around 10%, after year-over-year export growth was 15 – 20% in 2010 and 2011.

The one bright spot for China’s exports continues to be emerging markets, where central banks have been aggressively cutting rates for more than a year now to stimulate growth. China sends 52% of its exports to other emerging market nations. China’s exports to other emerging markets are still running 12% ahead of year-ago levels year-to-date through September 2012, and have accelerated through the spring and summer months. Until the United States re-accelerates, and Europe emerges from its recession, China is likely to continue relying on other emerging markets to pick up the slack, as China continues to transition from an export-led economy to a more consumer and domestically focused economy. n

2 China's Export Partners

Export Destination % of China's Exports

Europe 17%

United States 17%

Japan 8%

Other Developed Economies 6%

Emerging Markets 52%

Source: Haver Analytics 10/15/12

3 China’s Exports to Other Emerging Markets Have Accelerated in Recent Months as the United States Slows and Europe Remains in Recession

Source: Haver Analytics 10/15/12100908 11 120705040302 06

60

40

20

0

-20

-40

China’s Exports To Emerging Markets, % Change, Year to Year

China's Economic DataUnlike many other nations, China does not have a set schedule for the release of its monthly economic data, and Chinese authorities typically only provide a range of possible release dates for the data. Typically, the bulk of the economic data in China is released between the 9th and 15th day of the month. For example, over the past several days (October 12 – 15), China released September data on consumer prices (CPI), producer prices (PPI), new loan growth, money supply, exports, and imports. Industrial production and retail sales for September will be reported later this week. Another round of data releases occur at the end of each month (usually the last few days of the month), as China and private sector entities in China release the Purchasing Managers’ Index (PMI) on manufacturing.

On balance, the economic data in China are not as transparent as economic data in the United States and the developed world, and are subject to a great deal of “political nudging” as well. Still, it is much timelier than most data in the United States, and financial market participants pay very close attention to this data.

Of the three ways China reports its GDP data (year-over-year, year-to-

date year-over-year, and quarter-over-quarter), the market pays most attention

to the year-over-year data.

LPL Financial Member FINRA/SIPC Page 3 of 4

WEEKLY ECONOMIC COMMENTARY

2012

15 Oct n Empire Manufacturing Index (Oct) n Retail Sales (Sep) n Business Inventories (Sep)

Dudley*Lacker*BullardWilliams*

16 Oct n CPI (Sep) n Industrial Production (Sep) n Capacity Utilization (Sep) n NAHB Homebuilder Sentiment Index (Oct)

n German: ZEW Economic Sentiment (Oct)

17 Oct n Housing Starts (Sep) n China: GDP (Q3) n China: Industrial Production (Sep) n China: Retail Sales (Sep) n China: Fixed Asset Investment (Sep) n Thailand: Central Bank Meeting

18 Oct n Initial Claims (10/13) n Philadelphia Fed Index (Oct) n Leading Indicators (Sep)

n Eurozone: Leader's Summit n Spain: Bond Auction n France: Bond Auction

19 Oct n Existing Home Sales (Sep) n Eurozone: Leaders Summit

Fed Global Notables

LPL Financial Research Weekly Calendar

U.S. Data

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

Doves: Fed officials who favor the full employment side of the Fed’s dual mandate

* Voting members of the Federal Open Market Committee (FOMC)

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.

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 doesn’t include: - general government employees

WEEKLY ECONOMIC COMMENTARY

Member FINRA/SIPCPage 4 of 4

RES 3923 1012Tracking #1-109531 (Exp. 10/13)

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

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.

- 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.

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

China CPI: In total there are about 600 "national items" used for calculating the all-China CPI. The list of items is revised annually for representativeness based on purchases reported in the household surveys. The number of items can change from year to year, but rarely by more than 10 in any given year.

The Empire State Manufacturing Index is a seasonally-adjusted index that tracks the results of the Empire State Manufacturing Survey. The survey is distributed to roughly 175 manufacturing executives and asks questions intended to gauge both the current sentiment of the executives and their six-month outlook on the sector.

The NAHB/Wells Fargo Housing Market Index gauges builder perceptions of current single-family home sales and sales expectations for the next six months as "good," "fair" or "poor." The survey also asks builders to rate traffic of prospective buyers as "high to very high," "average" or "low to very low." Scores from each component are then used to calculate a seasonally adjusted index where any number over 50 indicates that more builders view conditions as good than poor.

The Michigan Consumer Sentiment Index (MCSI) is a survey of consumer confidence conducted by the University of Michigan. The Michigan Consumer Sentiment Index (MCSI) uses telephone surveys to gather information on consumer expectations regarding the overall economy. This research material has been prepared by LPL Financial.

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.

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.

ZEW Survey is a main indicator of investors' confidence. It is calculated on basis of 350 analysts' and institutional investors' polling. The indicator reflects the difference between analysts who are optimistic about forthcoming economic development of Germany within six months and those who are pessimistic. The Survey is used for German economic prospects estimation. ZEW Survey growth causes the euro growth.

Member FINRA/SIPCPage 1 of 3

Jeffrey Kleintop, CFAChief Market Strategist LPL Financial

LPL F INANCIAL RESEARCH

Weekly Market CommentaryOctober 15, 2012

Companies Finding It Harder To Manufacture Profits

HighlightsEarnings expectations for the third quarter of 2012 are now low enough that companies are likely to be able to beat them as they report results this week.

However, investors should be cautious in extrapolating these beats to coming quarters.

Third quarter earnings are expected to be flat to slightly negative compared with a year ago. So far, 35 companies in the S&P 500 have reported earnings for the third quarter of 2012. This week, 80 companies are scheduled to report. While investors are very focused on what the profits were for the past quarter, it is what they may turn out to be over the next several quarters that will likely have the most impact on the markets.

Year-over-year earnings growth for the companies in the S&P 500 has slowed over the prior four quarters from 18% in the second quarter of 2011 to 8% in the second quarter of 2012, now followed by an expected -3% drop in earnings in the just-ended third quarter of 2012. Earnings expectations are now low enough that companies are likely to be able to beat them. Indeed, last week, global companies Alcoa and FedEx reported third quarter earnings that exceeded analysts’ expectations. However, investors should be cautious in extrapolating these beats to coming quarters.

Over the next four quarters, the consensus of Wall Street analysts’ estimated earnings growth rate is for a re-acceleration of earnings growth from about 7% to 17%. This seems unlikely, and exceeding these lofty estimates may prove nearly impossible. The stall in profit momentum is unlikely to be a mere one-quarter event. Not merely because the economic drag from some combination of higher taxes and spending cuts is likely to further slow the economy in 2013 from its currently sluggish pace of 1 – 2%, but also because of signs that demand and pricing gains have stalled. This can be seen in the recent release of the ISM (Institute for Supply Management) Index and this week’s release of the CPI (Consumer Price Index).

ISM Suggests Sluggish Environment for Economic Growth

The ISM is one of the best leading indicators for the economy and markets. The Institute for Supply Management is a group that represents purchasing managers at U.S. corporations. The ISM surveys these purchasing managers each month and publishes the results in the form of an index. Purchasing managers are at the front of the line when it comes to activity in manufacturing. Manufacturing companies need supplies to produce products, and purchasing managers order these supplies. When demand starts to pick up for manufactured goods, these managers need to order more supplies. Conversely, when demand pulls back, they respond by trimming their orders.

WEEKLY MARKET COMMENTARY

LPL Financial Member FINRA/SIPC Page 2 of 3

Although manufacturing businesses make up only about 40% of S&P 500 company earnings, demand for manufactured goods has been a timely barometer of business activity of all types. This index is published at the beginning of each month, offering one of the earliest signals as to how the economy and outlook for business is faring each month.

The long history of the ISM shows us how effective it has been in signaling each recession and recovery. While the ISM has given a consistent signal when the recession is ending, it has also signaled when the recovery momentum peaks and the economy and profits slow. Looking back at the ISM over the past 30 years, we can see that there have been a number of peaks and troughs that led the direction of profit growth. The index has typically troughed around 30 – 40 and peaked around 60. Currently at about 50, the ISM suggests a sluggish environment for profit growth. The level of the ISM Index indicates that earnings growth may be slightly positive this quarter, but unless it picks up meaningfully — which seems unlikely given the recession in Europe and slowdown in China among other challenges — profit growth is likely to be only half as strong as the consensus expects in coming quarters.

1 Companies Are Not Manufacturing Profits

080682 10 129086 94 040200988884 92 96

70

65

60

55

50

45

40

35

30

50%

40%

30%

20%

10%

0%

-10%

-20%

-30%

-40%

ISM Index (Left Scale)S&P 500 EPS Growth Rate (Right Scale)

Source: LPL Financial, Bloomberg data 10/15/12

CPI Shows Businesses Having Trouble Raising Prices

A sign of weak pricing power by businesses can be seen in the Consumer Price Index, to be released on Tuesday of this week. A year ago, the CPI was running at about 4% year-over-year, but now is only running at about 1.7%. Businesses are finding it increasingly hard to raise prices. In fact, the prices manufacturers pay — detailed in the Producer Price Index report released last week — shows that producer prices are rising faster than consumer prices. Limited job opportunities and after-tax income growth per capita in the United

WEEKLY MARKET COMMENTARY

Member FINRA/SIPCPage 3 of 3

RES 3922 1012Tracking #1-109365 (Exp. 10/13)

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

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.

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.

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.

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 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.

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.

States of less than 3% are making it harder for companies to pass along higher prices to their customers. This is further depressing profit growth.

The trajectory of revisions to earnings estimates is likely to remain downward, despite companies exceeding profit estimates for the third quarter. This may limit the upside in the stock market during the earnings season, which runs from last week through the first couple of weeks of next month, and has typically been a time for above-average performance for the market. n