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LP L FINANCIAL R E S E AR C H
Weekly Economic Commentary
April 26, 2010
Extending the Extended Period?
John Canally, CFA Although there are several notable economic reports due out this week,
Economist including the first look at real gross domestic product (GDP) growth in
LPL Financial the first quarter of 2010, market participants are likely to be focused on
the outcome of the Federal Reserve’s (Fed) FOMC meeting. The meeting
(which is on Wednesday, April 28) is not likely to result in an immediate
ECONOMIC CALENDAR
change in the fed funds interest rate set by the FOMC—the rate at which
Tuesday, Apr 27 Friday, Apr 30 banks lend to each other overnight.
Consumer Confidence Employment Cost Index However, the FOMC may change the language in the statement that is
Apr Q1
released at the conclusion of each FOMC meeting, which occurs eight
Wednesday, Apr 28 Real GDP
FOMC Q1 times a year. Each FOMC statement since March 2009 has included the
phrase “economic conditions are likely to warrant exceptionally low levels
Thursday, Apr 29 Chicago PMI
Initial Claims Apr of the federal funds rate for an extended period.”
wk 04/24 U of Mich Consumer Beginning in November 2009, the FOMC slightly modified the “extended
Sentiment period” language by adding a conditional statement to the phrase:
Apr
“economic conditions, including low rates of resource utilization, subdued
inflation trends, and stable inflation expectations, are likely to warrant
exceptionally low levels of the federal funds rate for an extended period.”
In recent public appearances, Fed Chairman Ben Bernanke and Fed Vice
Chairman Don Kohn, have hinted that the FOMC may be moving away
from a time-based (i.e. rates low for an extended period) promise to a
more data-dependent (i.e. is inflation or economic growth or inflation
expectations tracking to the Fed's forecast) promise on rates. In short,
while the FOMC may leave “extended period” in the next FOMC
statement, it may modify the phrase, making low rates for an “extended
period” dependent on continued low inflation readings, low and stable
inflation expectations and slack resource utilization, as well as the
economy continuing to track the FOMC’s forecast.
Thus, in our view, the economic forecast made by FOMC meeting
participants at this week’s FOMC meeting may take on some importance
for financial markets. The FOMC may establish new forecast ranges for
key economic variables at the April 28 FOMC meeting including:
GDP growth,
Highlights
This week will be dominated by the Federal The unemployment rate,
Open Market Committee’s (FOMC) decision on Overall inflation, and
monetary policy.
Core inflation-inflation excluding food and energy prices.
Fed policymakers are unlikely to raise interest rates
at the April 28 FOMC meeting, but may adjust the Those forecasts will be made available to the public on May 19, along with
language of the policy statement. the minutes of the meeting.
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W E E KLY E CONOMIC COMME N TAR Y
Two aspects of the new forecasts:
How they changed since the last time the FOMC published a forecast,
which was on February 17, 2010 for the forecast made at the January
26-27 FOMC meeting, and
How the updated forecasts jive with the latest consensus forecast for
each of those variables may be the next key event for monetary policy.
Economic Projections of Federal Reserve Governors
and Reserve Bank Presidents, Made at the January 2010 FOMC Meeting
Central Tendency Range
Variable 2010 2011 2012 Longer run 2010 2011 2012 Longer run
Change in real 2.8 to 3.5 3.4 to 4.5 3.5 to 4.5 2.5 to 2.8 2.3 to 4.0 2.7 to 4.7 3.0 to 5.0 2.4 to 3.0
GDP
November 2.5 to 3.5 3.4 to 4.5 3.5 to 4.8 2.5 to 2.8 2.0 to 4.0 2.5 to 4.6 2.8 to 5.0 2.4 to 3.0
Projection
Unemployment 9.5 to 9.7 8.2 to 8.5 6.6 to 7.5 5.0 to 5.2 8.6 to 10.0 7.2 to 8.8 6.1 to 7.6 4.9 to 6.3
Rate
November 9.3 to 9.7 8.2 to 8.6 6.8 to 7.5 5.0 to 5.2 8.6 to 10.2 7.2 to 8.7 6.1 to 7.6 4.8 to 6.3
Projection
PCE Inflation 1.4 to 1.7 1.1 to 2.0 1.3 to 2.0 1.7 to 2.0 1.2 to 2.0 1.0 to 2.4 0.8 to 2.0 1.5 to 2.0
November 1.3 to 1.6 1.0 to 1.9 1.2 to 1.9 1.7 to 2.0 1.1 to 2.0 0.6 to 2.4 0.2 to 2.3 1.5 to 2.0
Projection
Core PCE 1.1 to 1.7 1.0 to 1.9 1.2 to 1.9 1.0 to 2.0 0.9 to 2.4 0.8 to 2.0
Inflation
November 1.0 to 1.5 1.0 to 1.6 1.0 to 1.7 0.9 to 2.0 0.5 to 2.4 0.2 to 2.3
Projection
Source: Federal Reserve, March 2009
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 discount rate: The rate at which member banks may borrow short term funds directly from a Federal Re-
serve Bank. The discount rate is one of the two interest rates set by the Fed, the other being the Federal funds
rate. The Fed actually controls this rate directly, but this fact does not really help in policy implementation, since
banks can also find such funds elsewhere.
PCE inflation and core PCE inflation are the percentage rates of change in, respectively, the price index for
personal consumption expenditures (PCE) and the price index for PCE excluding food and energy. Projections
for the unemployment rate are for the average civilian unemployment rate in the fourth quarter of the year
indicated. Each participant's projections are based on his or her assessment of appropriate monetary policy.
Longer-run projections represent each participant's assessment of the rate to which each variable would be
expected to converge under appropriate monetary policy and in the absence of further shocks to the economy.
The November projections were made in conjunction with the meeting of the Federal Open Market Committee
on November 3-4, 2009.
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 make 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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LP L FINANCIAL R E S E AR C H
Weekly Market Commentary
April 26, 2010
v4
Extended Period For the Rally?
Stocks have now posted eight straight weeks of gains, measured by the
Jeffrey Kleintop, CFA
broad Russell 3000 stock index. The good news on earnings and the
Chief Market Strategist
LPL Financial economy helped sustain market momentum for another week. Last week,
about 80% of S&P 500 companies’ earnings per share exceeded consensus
analyst estimates. On the economic front, business spending and home
Highlights sales were strong. However, this week’s shift in focus to the Federal
Next week’s shift in focus to the Federal Reserve (Fed) threatens to break the winning streak for the stock market.
Reserve (Fed) threatens to break the eight
week winning streak for the stock market. The statement the Fed issues on April 28 will be parsed closely by market
participants for any change in language that may signal rate hikes later this
The last time we saw eight weeks of stock
market gains was January 2004. That rally year. The focus will be primarily on the extended period phrase that refers
ended as the Fed changed the statement to how long the Fed intends to keep rates extraordinarily low. Fed Chairman
language to remove the “considerable Ben Bernanke has omitted the “extended period” phrase from his prepared
period” phrase. testimony and speeches in recent weeks. It was replaced with conditional
The statement the Fed issues on April 28 will language similar to the last time the Fed altered their statement in response
be parsed closely by market participants for to a recovering economy back in January 2004.
any change in language that may signal rate
hikes later this year. Excerpts from FOMC Statements
Fed Chairman Ben Bernanke has omitted the December 9, 2003 January 28, 2004
“extended period” phrase from his prepared
remarks in recent weeks. It was replaced “However, with inflation quite low and resource “With inflation quite low and resource use slack,
with language similar to the last time the use slack, the Committee believes that policy the Committee believes that it can be patient in
accommodation can be maintained for a removing its policy accommodation.”
Fed altered their statement in response to a
considerable period.”
recovering economy back in January 2004.
March 16, 2010 April 28, 2010
If the Fed does change the statement the
stock market’s upward momentum may stall “The Committee…continues to anticipate that We expect the Fed to cite improving economic
and result in a 5-10% pullback. economic conditions, including low rates of conditions and will be watching to see if they drop
resource utilization, subdued inflation trends, and the extended period phrase in favor of signaling the
stable inflation expectations, are likely to warrant pending, gradual series of rate hikes we expect will
exceptionally low levels of the federal funds rate for begin late this year.
an extended period.”
When the Fed refers to inflation in the statement, they are primarily
referring to “core” inflation, meaning general price changes excluding
food and energy prices. It is worth noting that core inflation over the past
12 months, while low at 1.1%, is at the same level it was when the Fed
changed the language in the statement and removed the “considerable
period” phrase in early 2004.
While the Fed used the phrase “considerable period” in the statement
from August 2003 to January 2004, stocks moved steadily higher−just
as they have since March 2009 when the “extended period” phrase was
incorporated into the statement. However, once the Fed removed that
phrase at the end of January 2004, the S&P 500 stock market rally stalled
Member FINRA/SIPC
Page 1 of 3
W E E KLY MARKE T COMME N TAR Y
1 Performance of the U.S. Dollar and S&P 500 and began a series of 5-10% pullbacks as volatility reemerged. Back in 2004,
Around the Time the Fed Used the Phrase the stock market began to price in the transition from a recovery driven
“Considerable Period” by policy in Washington to sustainable growth driven by private sector
businesses and consumers. These economic transitions have often been
Dollar (left scale)
S&P 500 (right scale) uneven and lead to a more volatile pattern of stock market performance.
100 1300
98
One of the reasons the Fed has kept monetary policy so accommodative−
1250
96 with the federal funds rate near zero−is the weak job market. However, last
1200
94 month’s gain of 162,000 U.S. non-farm jobs finally marked the first month of
92 1150 material job creation since the recovery began. The stock market disagrees
90 1100 with the Fed’s tepid outlook for job growth. The stock market had a very
88 1050 good track record of predicting what job growth will be in six months. Stocks
86
1000 have priced in a powerful rebound in job growth by the fourth quarter.
84 “Considerable Period”
82 950
While stocks point to gains of 4-5% for U.S. payrolls, even if job growth
80 900
5/2/2003 8/1/2003 10/31/2003 1/30/2004 4/30/2004 rebounds to just 3% year-over-year over the next six months, job gains by
Source: LPL Financial, Bloomberg 4/23/10 November would be up to 390,000 per month! If the market is right, then
The S&P 500 is an unmanaged index, which cannot be invested the Fed seems sure to begin to hike rates by year end. If the market is
into directly. Past performance is no guarantee of future results. wrong, stock market investors may be in for some disappointment. While
strong gains of about 400,000 jobs per month seems a bit stronger than
2 Year-Over-Year Percent Change in S&P 500 and may actually be achieved by year end, we believe the economy will be better
Non-Farm Payrolls than the Fed’s current official forecast which is for little to no improvement in
the unemployment rate, implying only very modest job growth. Which may
S&P 500 Index Year-Over-Year Change
Advanced 6 Months (left scale) prompt them to continue to revise their growth expectations higher and push
Job Growth Year-Over-Year Change (right scale) their conditional criteria in the direction of rate hikes?
60% 6%
Whether there will be an extended period for the rally in the stock market
40% 4%
depends upon the Fed. We believe there is a strong chance the Fed
20% 2% will change the statement language, although a hold on the change until
0% 0% the next meeting is probably equally likely. If the Fed does change the
statement language to remove or modify the “extended period” phrase, it
-20% -2%
may stall the stock market’s current upward momentum. Stocks may suffer
-40% -4% a 5-10% pullback after eight weeks of consecutive gains not seen since…
-60% -6% yes, you probably guessed it…when it ended in January 2004 as the Fed
Source: LPL Financial, Bloomberg 4/23/10 changed the statement language.
The S&P 500 is an unmanaged index, which cannot be invested
into directly. Past performance is no guarantee of future results.
LPL Financial Member FINRA/SIPC Page 2 of 3
W E E KLY MARKE T COMME N TAR Y
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.
Stock investing involves risk including loss of principal.
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.
The Russell 3000 Index measures the performance of the 3,000 largest U.S. companies based on total market
capitalization, which represents approximately 98% of the investable U.S. equity market. As of the latest
reconstitution, the average market capitalization was approximately $4 billion; the median market capitalization
was approximately $700 million. The index had a total market capitalization range of approximately $309 billion
to $128 million.
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 make 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
Member FINRA/SIPC
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