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Weekly Economic CommentaryMay 28, 2013

John Canally, CFAEconomist LPL Financial

Gauging Global Growth in 2013: An Update

HighlightsOur long-held forecast for real GDP growth for the full year 2013—which had been well below consensus in 2012—remains at 2.0% and now matches the consensus forecast.

Over the past six-to-nine months, the most significant shift in growth expectations came as a result of Japan’s actions to revive its long-dormant economy, which is the world’s third largest.

Although we do not expect a “hard landing” (a sharp deceleration to 5 – 6% GDP growth) in China over the next few years, our view remains that investors expecting China to return to the 10%+ growth rates of the early to mid-2000s should continue to be disappointed.

Global GDP growth, a good proxy for corporate revenue growth and corporate earnings, remains in a decelerating trend, with the consensus for global GDP growth in 2013 and 2014 continuing to move lower. We are watching several trends that might change this downward trajectory.

Please see the LPL Financial Research Weekly Calendar on page 3

The outlook for global growth is important to investors since it defines the ultimate pace of activity that creates value for countries, companies, and consumers. The October 22, 2012 edition of the Weekly Economic Commentary titled Gauging Global Growth in 2013, discussed the outlook for global economic growth in 2013, as 2012 drew to a close. In this week’s commentary, we will revisit the 2013 world gross domestic product (GDP) forecast and look ahead to 2014.

Apparent Disconnect

On the surface, there seems to be a disconnect between the markdown of global growth prospects for 2013 and 2014 and the recent surge in equity prices, especially in the United States, where the S&P 500 is up by nearly 18% year to date (through May 28, 2012). Several factors may be at work here.

� First, while global growth estimates have been revised lower over the past six months or so, they have not been marked down as much as in prior years. For example, a year ago, in the spring of 2012, the consensus was looking for global GDP growth of 3.4% for 2012, a substantial markdown in growth expectations from mid-2011, when the consensus for 2012 GDP growth was 4.5%.

� Second, most market participants now think global growth is more durable, and the recovery is now more firmly entrenched than it was in 2010, 2011, or 2012.

� Finally, actions by central banks (like the European Central Bank [ECB] and the Bank of Japan) and by governments in general over the past six-to-nine months have helped to convince market participants for now, at least, that the risk of another global recession due to a policy mistake has greatly diminished.

Gauging Global Growth

On Wednesday, May 29, 2013, the Organization for Economic Cooperation and Development (OECD) will release the spring edition of its semi-annual economic outlook in Paris. The report will likely garner some attention from the financial media, but for the most part, financial market participants will take little notice of the report. Why? Because consensus forecasts for global GDP growth are available monthly from sources like Bloomberg News, and markets react to changes in projected paths of economic growth every day amid the daily, weekly, and monthly drumbeat of economic data and events from around the globe.

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For example, this Thursday, May 30, 2013, the Bureau of Economic Analysis of the U.S. Department of Commerce will release its revised estimate of GDP for the first quarter of 2013. The consensus expects a 2.5% annualized increase in GDP between the fourth quarter of 2012 and the first quarter of 2013. The preliminary estimate of real GDP growth in the first quarter (reported in late April 2013) was also 2.5%. Our long-held forecast for real GDP growth for the full year 2013 — which had been well below consensus in 2012 — remains at 2.0% and now matches the consensus forecast.

Turning to the forecast for 2014, the consensus for real U.S. GDP growth in 2014 now stands at 2.7%, up 0.1% from the 2.6% expected by the consensus in October of 2012. When Bloomberg first began tracking consensus estimates for 2014 U.S. GDP growth back in early 2012, the estimate was 3.1%. The impact of the sequester, the fiscal drag imparted by the tax increases and spending cuts put in place earlier this year, as well as the slowdown in Europe and China help to account for the modest markdown in 2014 economic growth prospects in the United States over the past 18 months.

Why Global GDP Growth Matters

While prospects for U.S. economic growth generate the most headlines, in recent years, markets have focused more on the prospects for global GDP growth. Why does global GDP growth matter? Financial markets, especially equity markets, focus intently on earnings. Broadly speaking, earnings growth is driven by “top-line,” or revenue growth, less the costs incurred earning that revenue, with labor costs accounting for more than two-thirds of costs. A good proxy for global revenue growth is global GDP growth plus inflation. Thus, the pace of growth in the global economy is a key driver of global earnings growth, and ultimately the performance of global equity markets.

The latest (mid-May 2013) Bloomberg consensus forecast for 2013 global GDP growth stands at 3.1%, down from 3.2% a month ago, 3.3% in October 2012, and the 4.1% forecast made at the start of 2012. The downgrade to growth expectations for 2013 reflects several factors:

� The ongoing slowdown in China’s economy in response to the series of monetary and fiscal tightening implemented over 2010 and 2011.

� The ongoing transition in China’s economy from an export- and infrastructure-led growth profile, to a more internally led consumer-oriented growth profile.

� The ongoing uncertainty in Europe surrounding the future of the Eurozone, and the strains those concerns are having on the European financial system and European economy, which remains mired in recession.

� The fiscal drag in the United States.

Impact of Japan’s Government and Central Bank’s Efforts

Partially offsetting the factors above that are weighing on global growth are the actions taken by the Japanese government and central bank beginning

2 Japan Has Seen the Most Significant Shift in Growth Expectations Over the Past Six Months

Source: Bloomberg 05/28/13

* Forecasts for 2013 and 2014 made in 2012 and 2013.

10%

8%

6%

4%

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JapanEurozone ChinaWorld United States

Progression of 2013 and 2014 GDP Forecasts for the World, the U.S., the Eurozone, China, and Japan

2014 Forecasts2013 Forecasts

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1 Global GDP a Good Proxy for Corporate Revenue Growth

Source: Standard & Poor’s, Haver Analytics 05/24/13

100500

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S&P 500 Composite Index: Net Sales% Change, per Share, Year to YearWorld GDP at Current Prices & Exchange Rates% Change, Year to Year, U.S. $ Billions

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2013

27 May

28 May � Case-Shiller Home Price Index (Mar) � Consumer Confidence (May) � Richmond Fed Index (May) � Dallas Fed Index (May)

� Italy: Bond Auction

29 May Rosengren* � OECD Economic Outlook Released � Eurozone: M3 (Apr) � Thailand: Central Bank Meeting � Canada: Central Bank Meeting � Spain: Retail Sales (May) � Brazil: Central Bank Meeting � Brazil: GDP (Q1)

30 May � GDP (Q1) � Initial Claims (5/25) � Pending Home Sales (Apr)

� Italy: Bond Auction � Eurozone: Consumer Confidence (May) � South Korea: Industrial Production (Apr) � Philippines: GDP (Q1) � Japan: Industrial Production (Apr) � India: GDP (Q1)

31 May � Personal Income and Spending (Apr) � Chicago Area Purchasing Managers Index

(May) � Consumer Sentiment (May)

Pianalto � OPEC Meeting � China: PMI (May) � Eurozone: CPI (May)

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)

in late 2012 to combat decades-old deflation — when price and wages fall over a prolonged period of time. The consensus forecast for Japanese GDP growth in 2013 stood at just 1.1% in October 2012. Today, the consensus expects real GDP to grow by 1.4% in 2013. While the mark-up to the consensus view of Japan’s 2013 growth prospects is noteworthy, the shift in the consensus view for 2014 is even more stunning. A year ago, in June 2012, the consensus expected just 0.8% real GDP growth in Japan in 2014. Today, the consensus now expects 1.8% real GDP growth in Japan in 2013. To put that in perspective, over the past 20 years, Japan’s economy has grown, on average, by just 0.9% per year.

It follows that financial markets are expecting a lot of Japan’s economy over the next 18 months or so. The yen has depreciated by more than 20% versus the dollar since the fall of 2012 — helping to make Japan’s exports more attractive to global markets — while Japan’s Nikkei stock market index has risen by almost 70% from the mid-November 2012 low. In short, over the past six-to-nine months, the most significant shift in growth

The pace of growth in the global economy is a key driver of global

earnings growth, and ultimately the performance of global equity markets.

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expectations came as a result of Japan’s actions to revive its long-dormant economy, which is the world’s third largest.

Impact of China on Global Growth

China has been a global growth engine since the early 2000s, as China’s economy posted 10 – 12% real GDP growth between 2001 and 2007. China’s economy was one of the first to bottom out after the global financial market meltdown in 2008, and its economy grew 11% in 2009, reviving hopes that China’s decade-long run of 10% GDP growth would resume. However, Chinese authorities who were worried about a spike in inflation — especially food inflation — began to ratchet up reserve requirements and interest rates in early 2010 and continued to tighten monetary policy until mid-2011.

Since then, investors waiting for a re-acceleration in Chinese economic growth to the 10%+ pace seen in the early to mid-2000s have been disappointed, and market participants continue to mark down their GDP growth outlooks for China for 2013 and 2014. The consensus GDP growth estimate for 2013 now stands at 7.8% versus the 8.0% forecast made in October 2012 and the 8.5% forecast made in mid-2012. Looking out to 2014, the consensus now expects the Chinese economy to grow at 7.8%. As recently as early 2012, the consensus was looking for 8.3% real GDP growth in China in 2014.

The good news is that the recent muted inflation readings in China provide Chinese authorities the scope to cut interest rates further, and the Chinese government remains well positioned to engage in more fiscal stimulus if it chooses to do so. China’s Consumer Price Index (CPI) was up just 2.4% year over year in April 2013, down from a recent high of 6.5% in mid-2011. The bad news is that concerns about China’s overheated property market remain, which could prevent more fiscal or monetary stimulus. In addition, markets may need to be more patient as China’s economy transitions from an export- and infrastructure-led economy to a more consumer-based economy. Despite the slowdown in its pace of growth, China’s economy remains the second largest in the world. We do not expect a “hard landing” (a sharp deceleration to 5 – 6% GDP growth) in China over the next few years. However, our view remains that investors expecting China to return to the 10%+ growth rates of the early to mid-2000s should continue to be disappointed.

What Might Change the Downward Global GDP Growth Trajectory?

Global GDP growth, a good proxy for corporate revenue growth and corporate earnings, remains in a decelerating trend, with the consensus for global GDP growth in 2013 and 2014 continuing to move lower. Among the factors that could change this downward trajectory include:

� A commitment from Chinese authorities to speed up the transition to consumer-led growth, which may lead to a re-acceleration in Chinese (and emerging market) growth.

� An additional burst of fiscal and monetary policy stimulus from Japan.

� As noted in the Weekly Economic Commentary from May 20, 2013,

Over the past 20 years, Japan’s economy has grown, on average,

by just 0.9% per year.

The good news is that the recent muted inflation readings in China provide

Chinese authorities the scope to cut interest rates further, and the Chinese

government remains well positioned to engage in more fiscal stimulus if it

chooses to do so.

WEEKLY ECONOMIC COMMENTARY

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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.

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

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 Federal Open Market Committee (FOMC), a committee within the Federal Reserve System, is charged under the United States law with overseeing the nation’s open market operations (i.e., the Fed’s buying and selling of United States Treasure securities).

INDEX DESCRIPTIONS

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 Nikkei Index is short for Japan’s Nikkei 225 Stock Average, the leading and most-respected index of Japanese stocks. It is a price-weighted index comprised of Japan’s top 225 blue-chip companies on the Tokyo Stock Exchange. The Nikkei is equivalent to the Dow Jones Industrial Average Index in the U.S. In fact, it was called the Nikkei Dow Jones Stock Average from 1975 to 1985.

Purchasing Managers Index (PMI) is an indicator of the economic health of the manufacturing sector. The PMI index is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment.

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.

titled What’s Broken in Europe? a quick repair to the broken financial transmission mechanism in Europe, leading Europe out of recession.

� Less near-term fiscal restraint in the United States combined with more fiscal restraint in the next 10 years to get the U.S. budget on a more sustainable long-term path, along with continued recovery in the U.S. housing and labor markets.

We will continue to monitor these trends in the global economy and provide frequent updates on the pace of global growth. n