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Outlook 2014: The Investor's Almanac

Oct 19, 2014

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Economy & Finance

Looking ahead to 2014, LPL Financial has created our own version of a Farmer's Almanac, filled with a wealth of financial wisdom for investors.
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Page 1: Outlook 2014: The Investor's Almanac

Member FINRA/SIPC

LPL FINANCIAL RESEARCH

Page 2: Outlook 2014: The Investor's Almanac

2LPL Financial Member FINRA/SIPC

LPL FINANCIAL RESEARCH

A farming almanac is an annual publication containing a guide for the coming year and a forecast of the times and statistics of events and phenomena important to growing. Farmers' almanacs have been a source of wisdom, rooted in the core values of independence and simple living, for American growers for over 200 years. In the LPL Financial Research's Outlook 2014: The Investor's Almanac, we seek to provide a trusted guide to the coming year filled with a wealth of wisdom for investors.

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Key Components of Our 2014 Outlook

Stronger U.S. economic growth emerges from fertile soil, accelerating to about 3% in 2014 after three years of steady, but sluggish, 2% growth.

The stock market may produce a total return in the low double digits (10 – 15%).

Bond market total returns are likely to be flat as yields rise with the 10-year Treasury yield ending the year at 3.25 – 3.75%.

Economic forecasts set forth may not develop as predicted.

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Source: LPL Financial Research 11/26/13

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Investor Independence

We believe 2014 marks a return to a focus on the fundamentals of investing rather than reading the tea leaves in policy statements or assessing the veracity of politicians’ threats.

As investors become increasingly independent of policymakers in 2014, they may focus more on the reliability and sustainability of growth and key emerging trends in the investing environment.

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U.S. Debt Ceiling Likely to Be Lifted Again in 2014

Source: LPL Financial Research, U.S. Treasury, Haver Analytics 11/15/13

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How to Invest

Active Investing: Active managers have tended to outperform the indexes when the

markets are more volatile.

The average U.S. large cap active manager has historically outperformed the S&P 500 most of the time during periods of heightened volatility, defined by the VIX being more than 2 points above its 3-year average. That compares to outperforming just 38% of the time when market volatility is lower, as measured by the Morningstar U.S. Large Cap Blend category.

The VIX is a measure of the volatility implied in the prices of options contracts for the S&P 500. It is a market-based estimate of future volatility. When sentiment reaches one extreme or the other, the market typically reverses course. While this is not necessarily predictive it does measure the current degree of fear present in the stock market.

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Economy: Fertile Soil

LPL Financial Research forecasts economic growth, as measured by real GDP, to accelerate from the 2% pace of recent years to 3% in 2014.

This marks our first above-consensus annual forecast on GDP in many years.

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Current Economic Expansion Will Be FifthLongest by Year-End 2014

Source: LPL Financial Research, National Bureau of Economic Research as of 11/15/13

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Government Acted as an Economic Drag inEach of the Past Three Years

Source: LPL Financial Research, Haver Analytics 11/15/13

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Stocks: Room to Grow

With long-term interest rates remaining historically low, corporate earnings likely to grow in the high single digits, job growth improving, and inflation remaining below 3%...

Conditions are ripening for stocks to reward investors in 2014.

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How to Invest

U.S. Stocks:We foresee:

Above-average total returns for U.S. stocks;

Below-average total returns for bonds.

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Strong Years for Stocks Are Often Followed by More Strong Years

Source: LPL Financial Research, Bloomberg data 11/14/13

*2013 Year-to-Date Total Return Through 11/14/13

Past performance is no guarantee of future results.

S&P 500 is an unmanaged index which cannot be invested into directly.

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How to Invest

Cyclical Stocks: Accelerating earnings growth and a steeper yield curve over the

course of 2014 favor cyclical companies regardless of growth or value style.

Defensive value sectors that are interest rate sensitive, such as telecom and utilities, may suffer as interest rates rise, and defensive growth sectors like consumer staples may suffer headwinds from a rising dollar as the Fed winds down its bond-buying program.

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Reliable Earnings Indicator Pointing Higher

Source: LPL Financial Research, Bloomberg Data, Thomson Financial 10/11/13

S&P 500 is an unmanaged index which cannot be invested into directly.

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How to Invest

Small Cap Stocks: Historically, an environment of improving growth and rising

valuation has tended to benefit smaller company stocks over their larger company peers.

Tempering this, to some degree, is the fact that they do not have as much exposure to improving foreign sales as larger companies.

The prices of small cap stocks are generally more volatile than large cap stocks.

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Bull & Bear Markets Back to the 1950s

Source: LPL Financial Research, Bloomberg data 08/26/13

The S&P 500 and the Barclays Intermediate-Term Government Bond Index are unmanaged indexes, which cannot be invested into directly. The returns do not reflect fees, sales charges or expenses. Index performance is not indicative of any particular investment. Past performance is no guarantee of future results.

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How to Invest

Emerging Market Stocks:As 2014 matures, the stocks of companies in more emerging market countries may become increasingly attractive due to:

Improving global growth;

Below-average valuations.

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

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How to Invest

International (Developed Market) Stocks: Better economic growth in developed foreign markets, notably

Europe, should lift earnings growth.

Earnings growth in Europe has been negative for much of the past five years, with only a brief period of growth in late 2010 and 2011. The prospects for earnings gains in 2014 similar to those of the United States should help to lift international stocks. European valuations are in line with their average discount to the United States and may rise modestly with U.S. valuations.

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

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

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Bonds: Time to Harvest Yield

Historically, longer-term bond yields have tended to track the change in GDP growth when unleashed from Fed actions.

Our expectation for a 1% acceleration in U.S. GDP over the pace of 2013 suggests a similar move for the bond market.

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How to Invest

Intermediate-Term Bonds We believe that intermediate-term bonds possess a better

combination of interest rate risk mitigation and reward in the form of yield under a range of outcomes.

Long-term bonds provide too much interest rate risk to be attractive in 2014. While short-term bonds offer the least interest rate risk, their low yields make them less attractive.

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We Expect Flat High-Quality Bond Returns in 2014

Source: LPL Financial Research, Barclays Aggregate Bond Index data 11/08/13

Scenario analysis returns assume one-year holding period, no reinvestment of interest income, and a parallel shift in the yield curve.

This is a hypothetical example and is not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing.

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Interest Rate Risk Remains ConcentratedAmong Long-Term Bonds

Source: LPL Financial Research, Barclays Aggregate Bond Index data 11/08/13

Chart shows projected one-year total return for Barclays 1-3yr Gov/Credit Index, Barclays Aggregate Bond Index, and Barclays long-term Gov/Credit Index. Returns reflect parallel shift of the yield curve, no reinvestment of income, and one-year holding period.

This is a hypothetical example and is not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing.

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How to Invest

High-Yield Bonds and Bank Loans High-yield bonds and bank loans are two sectors that have

historically proven resilient and often produced gains during periods of rising interest rates.

In 2013, both sectors were among the leaders of bond sector performance during a year of higher interest rates.

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. Bank loans are loans issues by below investment-grade companies for short-term funding purposes with higher yield than short-term debt and involve risks including interest rate, credit, market, and default risk.

Bank loans are loans issues by below investment grade companies for short term funding purposes with higher yield than short term debt and involve risks including interest rate, credit, market and default risk.

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Intermediate Bonds and a Steep Yield CurveOffer Defensive Properties

Source: LPL Financial Research, Bloomberg 11/08/13

Total returns assume one-year holding period, no reinvestment of interest income, and a parallel shift in the yield curve.

This is a hypothetical example and is not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing.

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High-Yield Bond Valuations Are MoreExpensive Compared to the Start of 2013

Source: LPL Financial Research, Barclays High-Yield Index 11/08/13

Yield Spread is the difference between yields on differing debt instruments, calculated by deducting the yield of one instrument from another. The higher the yield spread, the greater the difference between the yields offered by each instrument. The spread can be measured between debt instruments of differing maturities, credit ratings and risk.

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How to Invest

Investment-Grade Corporate Bonds The higher yield of investment-grade corporate bonds, which

remain supported by good credit quality fundamentals, may therefore be able to provide better protection than Treasuries.

In a rising rate environment, interest income can be a buffer against price declines associated with rising interest rates.

The market value of corporate bonds will fluctuate, and if the bond is sold prior to maturity, the investor's yield may differ from the advertised yield.

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

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How to Invest

Municipal Bonds On a long-term basis, municipal bond valuations remain attractive

as top-quality municipal bond yields often exceed those of comparable-maturity Treasuries.

A favorable supply/demand balance also persists, as tight budgets suggest new issuance may only marginally offset the amount of maturing debt, leading to stagnant overall market growth.

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

Interest income may be subject to the alternative minimum tax. Municipal bonds are federally tax-free, but other state and local taxes may apply.

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How to Invest

International Bonds Emerging market debt is increasingly attractive in 2014.

We remain cautious on developed foreign bond markets given weak growth and unattractive valuations.

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

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We believe it will be safe in 2014 to again tune out much of the antics in Washington, D.C. as the mid-term elections turn up the volume but not the impact.

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The Stock Market Overcame Many Challenges in 2013

Source: LPL Financial Research, Bloomberg Data 11/26/13

The S&P 500 is an unmanaged index, which cannot be invested into directly. The returns do not reflect fees, sales charges or expenses. Index performance is not indicative of any particular investment. Past performance is no guarantee of future results.

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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 security. 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.

Economic forecasts set forth may not develop as predicted, and there can be no guarantee that strategies promoted will be successful.

The Leading Economic Index (LEI) is an economic variable, such as private-sector wages, that tends to show the direction of futureeconomic activity.

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 Barclays Capital Aggregate Bond Index is an unmanaged market capitalization-weighted index of most intermediate term U.S. traded investment-grade, fixed rate, non-convertible and taxable bond market securities including government agency, corporate, mortgage-backed and some foreign bonds.

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.

Not FDIC/NCUA Insured | Not Bank/Credit Union Guaranteed | May Lose Value | Not Guaranteed by any Government Agency | Not a Bank/Credit Union Deposit

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