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Weekly Market Commentary 10/22/2012

Weekly Market Commentary 10/22/2012

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Published by: monarchadvisorygroup on Oct 23, 2012
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Member FINRA/SIPCPage 1 of 3
Jeffrey Kleintop, CFA
Chief Market StrategistLPL Financial
LPL FINANCIAL RESEARCH
Weekly Market Commentary
October 22, 2012
Battle of the Central Banks
Highlights
Among the events vying for investors’ attentionthis week will be the Federal Reserve meeting onTuesday and Wednesday.Nearly all of the world’s major central banks haveeach engaged in a battle to provide aggressivestimulus of similar size relative to their economy inan effort to boost growth and battle the currencyimpact of the actions by other central banks.With the world’s central banks locked in acurrency war, the winner may be precious metals.
Despite Friday’s sharp drop as companies reported poor earnings results,the S&P 500 Index posted a gain last week. This week, vying for investors’attention from the flood of generally weak earnings reports will be theFederal Reserve (Fed) meeting on Tuesday and Wednesday. The Fed ishighly likely to confirm on Wednesday that it is continuing the third roundof aggressive stimulus in the form of bond buying, known as quantitativeeasing (QE), announced at the last meeting. That highly anticipated moveby the Fed helped stocks to rally to the highs of the year, despite the mostwarnings issued by S&P 500 companies ahead of an earnings season in overa decade as companies lowered earnings expectations.The QE program is part of the Fed’s battle against recession, given howweak the economy is — not to mention the threat of the impending fiscalcliff. But it is also a battle in a war against other central banks. The Fedhas engaged in a massive amount of bond buying, yet as a percentage ofthe economy (GDP) the Fed’s actions pale in comparison to those of theEuropean Central Bank (ECB) and the Bank of Japan.
1
Central Bank Assets to GDP
Source: Bloomberg, LPL Financial 10/22/12
2005200320011999 200920072011
ECB
Sep 2008Lehman Brothers Bankruptcy
Bank ofJapanU.S. Fed
35%30%25%20%15%10%5%0%
Nearly all of the world’s major centralbanks have each engaged in a battle toprovide aggressive stimulus of similar sizerelative to their economy.
 
WEEKLY MARKET COMMENTARY
LPL Financial Member FINRA/SIPC Page 2 of 3
Since mid-2008, when the world’s central banks aggressively appliedstimulus through bond-buying programs and expanding the amount ofassets on their balance sheets, the ECB has increased its holdings by 17%of GDP — more than doubling assets from 16% of GDP to 33% currently.The ECB’s balance sheet grew sharply after the collapse of Lehman Brothersin September 2008, and then jumped further as the two “LTROs,” or three-year loan long-term refinance operations, took place in December 2011 andlate February 2012. These most recent operations pumped more than 1trillion euros into the banking system for the benefit of struggling Spanish,Italian, and other European banks.Over the same mid-2008 to current time period, the Bank of Japan increasedthe assets it holds by 11% of GDP, going from 20% to 31%, and the Bank ofEngland took assets up by 14%, from 7% to 21%. The U.S. Fed accumulatedassets equivalent to 12% of GDP, from 6% to 18%. Other central bankshave assets relative to GDP well beyond that of the Fed, especially amongthe emerging markets. For example, the People’s Bank of China holds assetsequivalent to about 25% of GDP.Nearly all of the world’s major central banks have each engaged in a battleto provide aggressive stimulus of similar size relative to their economy.This similar percentage has been not merely to battle recession. It has alsobeen to battle the currency impact of the actions by other central banks.While certainly not the only factor affecting currency values, the central bankactions pump more liquid money into an economy and have the tendency toweaken the currency relative to those of trading partners—unless the centralbanks of those trading partners are also engaging in a similar amount ofaggressive actions. Those countries that have engaged in more bond-buyingas a percent of their GDP than the U.S. Fed have seen their currenciesdepreciate relative to the dollar, while those that have done less have seentheir currencies rise versus the dollar.
2
Central Bank Currency War
Mid-2008 – Present 
Central BankCurrencyChange in Central Bank Assets as % of GDPRelative to Change in U.S. Fed AssetsChange in Currency Relative toUS DollarEurozoneEuro+5%-6%JapanYen-1%+34%UnitedKingdomPound+2%-20%Source: LPL Financial, Bloomberg 10/22/12Currency Risk is a form of risk that arises from the change in price of one currency against another. Wheneverinvestors or companies have assets or business operations across national borders, they face currency risk iftheir positions are not hedged.
The Fed’s efforts are aimed at both keeping interest rates low for borrowersto stimulate economic activity and keeping the dollar from appreciating versustrading partners and risking damage to the economy from falling U.S. exports.
Since mid-2008, when the world’scentral banks aggressively appliedstimulus through bond-buying programsand expanding the amount of assetson their balance sheets, the ECB hasincreased its holdings by 17% of GDP.Those countries that have engaged inmore bond-buying as a percent of theirGDP than the U.S. Fed have seen theircurrencies depreciate relative to the dollar,while those that have done less have seentheir currencies rise versus the dollar.

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