Compass

Compass Points

LP L FINANCIAL R E S E AR C H

Bringing you our latest tactical investing ideas October 26, 2011

Awaiting Color Anthony Valeri, CFA Market Strategist LPL Financial

Compass Changes No changes this period

Investment Takeaways Overview This bi-weekly update provides an in-depth look at the latest tactical investment thoughts from LPL Financial Research as presented in the Portfolio Compass. This publication is designed to cover a broad investment landscape and present ideas to assist when considering portfolio strategy and to customize investment solutions.

Like a nature enthusiast seeking fall foliage, we continue to await developments, or color, from Europe as our investment strategy and sector views remain unchanged. As this publication goes to print, European leaders will be holding a key summit on the European debt crisis and are expected to announce details of their “Grand Plan.”

Economic data in the United States continued its recent run of exceeding expectations. On balance, reports released over the last two weeks have exceeded consensus forecasts and, like the earnings data, suggest slow economic growth, but no recession. On the economic front, the market eagerly awaits the preliminary release of third-quarter economic growth as measured by gross domestic product (GDP) on October 27, 2011.

Earnings season has thus far contradicted recession fears. Although still early, roughly three-quarters of companies have surpassed bottom-line earnings forecasts and, perhaps more importantly, roughly two-thirds have exceeded top-line revenue forecasts. Guidance from corporate leaders has been cautious but also pointing towards a slow growth environment and not a recession.

1 Stocks Break Out of the Trading Range 1400

S&P 500 Index

1350 1300 1250 1200 1150 1100 1050 Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct 10 10 10 10 11 11 11 11 11 11 11 11 11 11

Source: Bloomberg, LPL Financial 10/25/11 The S&P 500 is an unmanaged index, which cannot be invested into directly. Past performance is no guarantee of future results.

Economy Economic data in the United States continued its recent run of exceeding expectations. Since our last publication, notable reports include strongerthan-expected monthly retail sales and better-than-expected durable goods orders; the latter may boost expectations for third-quarter economic growth. Weekly jobless claims continue to hover just above 400,000.

While claims data is indicative of a weak labor market, claims have not increased which also contradicts recession fears. We expect the economy to expand at a 2.0% to 2.5% annualized rate over the third and fourth quarter quarters of 2011.

Equity and Commodities Asset Classes The stock market, as measured by the S&P 500 Index, broke above the top end of the two-month trading range [Chart 1] and bodes well for further improvement through year-end. Although a detailed plan to address

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COMPAS S P OI N T S

the European debt crisis is still lacking, stocks have found support from better-than-expected economic data as well as the strong start to earnings season. Furthermore, even without the “Grand Plan” details revealed, stock investors have noted the increased sense of urgency in Europe towards a more aggressive solution to European debt problems. As this publication goes to print, a key European summit will be ending but we will likely see more complete details by early November at the Group of 20 industrialized nations meeting.

We continue to maintain a limited exposure to commodities asset classes even after a difficult September which witnessed the broad Thomson Reuters/Jeffries CRB Commodity Index decline by 13%. We believe weakness was exacerbated by worries over emerging market (EM) countries and fears that faster-growing EM countries led by China, who are big consumers of raw materials, would fall victim to a global recession.

We do not agree with such a view. EM central banks are taking precaution against an economic slowdown and have either stopped raising interest rates, or, in many cases, begun to lower interest rates. We still expect EM countries to grow two to three times faster than the United States and other developed countries. Furthermore, impressive dollar strength, which contributed to commodity weakness in September, has reversed and we expect additional weakness in the US dollar may be a positive for commodities asset classes.

Equity Sectors Earnings season has thus far contradicted recession fears. Just over 20% of S&P 500 companies have reported earnings thus far and roughly threequarters of companies have surpassed bottom-line earnings forecasts and two-thirds have exceeded top-line revenue forecasts. Overall earnings are on pace to grow 14% year-over-year, according to Thomson data. Revenue is on pace to increase by 9% versus the third quarter of last year. We expect overall earnings growth will be slightly lower by the time earnings season is finished but the results are nonetheless impressive. Guidance from corporate leaders has been cautious but also pointing towards a slow growth environment and not a recession.

We make no change to equity sectors and continue to remain exposed to the more cyclical sectors. Our bias remains on Industrials, Materials, Consumer Discretionary and Technology sectors that may benefit from an economy that continues to grow, even if modestly. We find valuations on these sectors compelling and expect earnings season to reveal companies’ resiliency in the face of sluggish economic growth.

Fixed Income High-yield bonds extended their strong run that began at the start of October and posted 14 consecutive days of positive returns through October 25, 2011. Better-than-expected economic data and a good start to earnings season have contradicted overly dire default forecasts. Investors took advantage of attractive valuations and yields that approached 10%.

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We continue to find high-yield bonds attractive even after the impressive run so far in October, but expect a more modest pace of improvement going forward. ƒƒ Treasury yields are roughly unchanged since our last publication. Since commodities asset classes faltered in September, Treasuries were the most effective hedge against European debt fears during the month and are holding ground until further clarity surfaces from Europe. The 0.4% to 0.5% increase in intermediate- and long-term Treasury yields since late September brought out buyers. Treasuries also garnered some strength from talk of quantitative easing (QE3) and another round of large-scale bond purchases.

New York Fed President Bill Dudley joined Governors Elizabeth Duke and Daniel Tarullo (all three vote on Fed policy) in calling for more housingdirected stimulus. Tarullo suggested restarting mortgage-backed securities (MBS) purchases, while Vice Chairman Yellen also suggested another round of securities purchases was possible should growth fail to reaccelerate. We view another round of QE as unlikely with core inflation hovering at 2.0%, the high end of the Fed’s stated comfort zone.

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.

Past performance is no guarantee of future results.

Stock investing may involve risk including loss of principal.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise, are subject to availability, and change in price.

Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.

Consumer Discretionary Sector: Companies that tend to be the most sensitive to economic cycles. Its manufacturing segment includes automotive, household durable goods, textiles and apparel, and leisure equipment. The service segment includes hotels, restaurants and other leisure facilities, media production and services, consumer retailing and services and education services.

Materials Sector: Companies that are engaged in a wide range of commodity-related manufacturing.

Included in this sector are companies that manufacture chemicals, construction materials, glass, paper, forest products and related packaging products, metals, minerals and mining companies, including producers of steel.

Industrials Sector: Companies whose businesses manufacture and distribute capital goods, including aerospace and defense, construction, engineering and building products, electrical equipment and industrial machinery. Provide commercial services and supplies, including printing, employment, environmental and office services. Provide transportation services, including airlines, couriers, marine, road and rail, and transportation infrastructure.

Technology Software & Services Sector: Companies include those that primarily develop software in various fields such as the Internet, applications, systems and/or database management and companies that provide information technology consulting and services; technology hardware & Equipment, including manufacturers and distributors of communications equipment, computers and peripherals, electronic equipment and related instruments, and semiconductor equipment and products.

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.

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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.

The fast price swings in commodities and currencies will result in significant volatility in an investor’s holdings.

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

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.

The Group of Twenty (G-20) Finance Ministers and Central Bank Governors is the premier forum for our international economic development that promotes open and constructive discussion between industrial and emerging-market countries on key issues related to global economic stability. By contributing to the strengthening of the international financial architecture and providing opportunities for dialogue on national policies, international co-operation, and international financial institutions, the G-20 helps to support growth and development across the globe.

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 a fund shares is not guaranteed and will fluctuate.

Mortgage-Backed Securities are subject to credit, default risk, prepayment risk that acts much like call risk when you get your principal back sooner than the stated maturity, extension risk, the opposite of prepayment risk, and interest rate risk.

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

The Commodity Research Bureau (CRB) Index is an index that measures the overall direction of commodity sectors. The CRB was designed to isolate and reveal the directional movement of prices in overall commodity trades.

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.

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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