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Weekly Economic CommentaryOctober 22, 2012

John Canally, CFAEconomist LPL Financial

Gauging Global Growth in 2013

HighlightsWe continue to maintain our below-consensus forecast for 2.0% Gross Domestic Product (GDP) growth for all of 2012. The consensus estimate for GDP growth has come down to 2.1%

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 downward trajectory of global growth forecasts could be changed by a resolution to the U.S. fiscal cliff, policy actions aimed at stemming the nearly three-year-old sovereign debt/banking crisis in Europe, and more aggressive fiscal and monetary policy stimulus in China.

Please see the LPL Financial Research Weekly Calendar on page 3

The broadest measure of the health of the U.S. economy is Gross Domestic Product (GDP). This Friday, October 26, 2012, the Bureau of Economic Analysis of the U.S. Department of Commerce will release its initial estimate of GDP for the third quarter of 2012. The consensus is looking for a 1.8% annualized increase in GDP between the second and third quarters, a slight acceleration in growth from the 1.3% pace in the second quarter. We continue to maintain our below-consensus forecast for 2.0% GDP growth for all of 2012. The consensus estimate for GDP growth in 2012 is now 2.1%. (We last wrote about the overall health of the U.S. economy and GDP in late July 2012, just after the release of second quarter 2012 GDP figures.)

While the media and politicians on the campaign trail may pay a great deal of attention to third quarter GDP, the markets will likely largely look past the report and increasingly focus on the pace of U.S. and global economic growth in the current (fourth) quarter, and, more importantly, in 2013. 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-October 2012) Bloomberg consensus forecast for 2013 global GDP growth stands at 3.3%, down from 3.5% a month ago, 3.7% at mid-year 2012, and the 4.1% forecast made at the start of 2012. The downgrade to growth expectations for 2013 reflects several factors:

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

� 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 uncertainty in the United States over the elections, fiscal cliff, looming debt ceiling, and long-term budget outlook.

The markdown of global GDP growth forecasts for 2013 partly reflects the markdown of 2013 U.S. GDP forecasts. In late 2011, the consensus forecast for U.S. GDP growth in 2013 was 2.5%. By mid-year 2012, the consensus

1 Global GDP a Good Proxy for Corporate Revenue Growth

Source: Standard & Poor's, Haver Analytics 10/21/12

1205 111009080706040301009998 02

S&P 500 Revenue, % Change - Year to Year, $/ShareWorld GDP at Current Prices & Exchange Rates, % Change - Year to Year, US $ Bil.

15

10

5

0

-5

-10

-15

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WEEKLY ECONOMIC COMMENTARY

forecast for 2013 was 2.4%. The latest (October 2012) consensus forecast for 2013 is just 2.0%.

The Eurozone has seen its 2013 growth prospects cut the most relative to other regions over the past year. In late 2011, the consensus was looking for a 1.6% growth rate in GDP in 2013. By mid-2012, the consensus reduced its forecast for 2013 to just 0.8%. The latest (October 2012) forecast pegs growth in the Eurozone in 2013 at just 0.3%, a very meager bounce after the 0.5% drop in Eurozone GDP in 2012.

What Could Change the Downward Trajectory of Global Economic Growth Forecasts?

In the United States, a relatively quick (and growth-friendly) resolution of the fiscal cliff, and to a lesser extent a similar outcome for the looming debt ceiling (late winter 2013) and the longer term deficit reduction task facing the next president and Congress, would provide consumers and businesses more long-term certainty around taxes and the legislative and regulatory backdrop. That lifting of uncertainty could help support U.S. GDP growth next year.

Barring a prolonged fiscal-cliff-induced recession in 2013, housing will continue to be a modest plus for the U.S. economy in 2013. However, at less than 5% of GDP, housing alone cannot push overall GDP growth significantly higher. Consumers (nearly 70% of GDP) and business spending (10% of GDP) need to do most of the heavy lifting in the economy. Consumers will of course benefit from higher housing prices (and equity prices) via the wealth effect (see the Weekly Economic Commentary: Are You Better Off?, October 1, 2012), but a surge in consumer spending in 2013

2 Progression of 2013 GDP Forecasts for the World, the United States, the Eurozone, and China

Source: Bloomberg 10/22/12

* Forecasts made in 2012 are for 2013.

World

4.13.7

3.3

United States

2.5 2.42.0

Eurozone

1.60.8

0.3

China

8.4 8.58.0

10%

8%

6%

4%

2%

0%

Early 2012* June 2012* October 2012*

Note: For ease of comparison across countries, the GDP figures in the text and the figures are annualized growth rates and adjusted for inflation.

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.

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2012

22 Oct

23 Oct � Richmond Fed Index (Oct) � China: HSBC Flash PMI (Oct) � Japan: Trade Data (Sep) � Canada: Central Bank Meeting

24 Oct � Markit PMI (Oct) � New Home Sales (Sep)

� Federal Open Market Committee (FOMC) Decision

� Mario Draghi Speech in Berlin � Eurozone: Flash PMI (Oct) � Germany: IFO (Oct) � Germany: Bond Auction � New Zealand: Central Bank Meeting

25 Oct � Durable Goods Orders and Shipments (Oct) � Initial Claims (10/20) � Pending Home Sales (Sep)

� UK: GDP (Q3) � Sweden; Central Bank Meeting � Philippines: Central Bank Meeting

26 Oct � GDP (Q3) � Consumer Sentiment (Oct)

� Italy: Bond Auction � Mexico: Central Bank Meeting

Fed Global Notables

LPL Financial Research Weekly Calendar

U.S. Data

after the modest 2 – 3% gain in consumer spending in 2011 and 2012 seems unlikely, even with a more settled fiscal, legislative, and regulatory backdrop in place.

Business spending in 2013 is likely to be highly sensitive to the legislative and fiscal backdrop put in place by Congress and the next administration. Business capital spending has increased approximately 10% per year over the past two years — the fastest pace over two years since the late 1990s. A swift and growth-friendly outcome to the fiscal cliff and long-term certainty in the tax and regulatory codes would need to be in place for most of 2013, in order for business capital spending growth to approach 10% again in 2013. Government spending at any level (federal, state, or local), which accounts for around 20% of GDP, is unlikely to add to growth next year, after contracting at a 2 – 3% pace per year over the last two years. Net exports, which have not been a big driver of U.S. GDP growth since the end of the Great Recession in 2009, could help boost growth next year if:

1. China turns the corner and reaccelerates — dragging the other emerging markets (EM) with it; and

2. Europe can manage to eke out any growth at all. U.S. exports to EM (including China) and Europe account for more than 70% of U.S. exports.

In order for Europe to emerge from recession in 2013, policymakers in Europe, including the European Union (EU), the European Central Bank (ECB), and governments in Germany, Spain, Italy, Greece, etc., need to hasten the pace of policy actions aimed at stemming the nearly three-year-old European sovereign debt/banking crisis. The pieces of the puzzle include, but are not limited to:

Business capital spending has increased approximately 10% per year over the

past two years — the fastest pace over two years since the late 1990s.

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� A tighter banking union across the Eurozone;

� A European-wide banking regulator and deposit insurance scheme;

� A well-funded mechanism to provide aid to countries (like Spain) that need additional help paying back debt;

� Greater fiscal union across Eurozone countries; and

� More flexible labor market rules.

Although these issues appear to be on the table, more progress needs to be made on all fronts sooner rather than later. While policy actions taken by the ECB and governments in Europe over the past year have likely greatly diminished the odds of the worst-case scenario — a breakup of the Eurozone — a recession is still the most likely outcome for Europe in 2013, if the ongoing severe dysfunction in European financial markets continues into 2013. Please see the Weekly Economic Commentary: Dysfunction Drives the ECB, September 3, 2012, for more detail. A modest recovery in Europe (which would help to boost U.S. and Chinese exports and lift global growth) in 2013 may occur if Europe moves faster in resolving the issues at hand. However, any backsliding by any single government, the ECB, or the Eurozone itself in moving ahead with the progress already made could push the Eurozone deeper into recession in 2013, putting further downward pressure on global growth in 2013.

In China, the once-a-decade leadership transition has thus far prevented the Chinese authorities from more aggressively reversing the policies put in place in 2010 and 2011, which were aimed at slowing the Chinese economy. A smooth leadership transition, and more aggressive fiscal and monetary policy stimulus in China would likely put a floor on Chinese (and global) growth in 2013, providing a lift for earnings prospects for global companies. On the other hand, if China continues to be reluctant to act more aggressively, fears of a “hard landing” (5 – 6% GDP growth in 2013) would likely persist well into 2013. Very aggressive stimulus measures similar in size and scope to the measures put into place in 2008 and 2009 would likely see a sharp rebound in China’s GDP growth (to close to 10%), which would likely result in a ratcheting up of the market’s global GDP growth forecasts for 2013. Please see the Weekly Economic Commentary: Hard Data on China Still Point to Soft Landing, October 15, 2012, for more detail.

On balance, while the media and politicians may have a field day with this week’s U.S. GDP report for the third quarter of 2012, most market participants continue to be focused on the drivers of — and changes to — the 2013 global GDP forecast. �

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.

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.

* 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 - 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.

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.