Archive

Posted by Jeffrey J. Roach, PhD, Chief Economist

Friday, June 30, 2023

Key Takeaways:

• Real consumer spending was stagnant in May after only a modest gain in April as consumers slowed spending habits.
• The savings rate rose to 4.6%, the highest since January last year, indicating consumers are slightly more cautious.
• The Federal Reserve’s (Fed) preferred inflation metric eased in May, slowing down to 3.8% from a year ago.
• Services inflation is still running above 5% year over year, but as consumers near the end of their spending splurge, we expect services inflation to ease, but it may take a couple of quarters before the markets see this category materially improve.
• The spending splurge is likely nearing the end as consumers released most of their pent-up demand for spending. However, the services economy will likely experience a bit more upside from consumer spending in the near term but aggregate demand will likely cool later this year.
• As consumer spending cools, we expect inflationary pressures to ease further throughout the balance of 2023. From a global perspective, the domestic inflation environment is materially better in the U.S. than for our international counterparts.

Consumer Spending Stalls

Consumer spending, adjusted for inflation, was unchanged in May as consumers pulled back demand for durable goods. Investors should see this as the setup for a downshift in consumer activity for the remainder of 2023.

The details of the report are revealing. Real spending on motor vehicles and parts declined over 4% from the previous month, the largest monthly decline since November and an indicator that auto dealers will likely have a rough time heading into the third quarter. Spending on utilities declined as electricity prices fell for the third consecutive month. As rent prices and utility prices ease, we expect some relief for the lower income consumer who has felt the biggest impact from the current inflationary environment.

In contrast to the durable goods space, consumer demand for services is still evident. Services spending rose as individuals travelled extensively in May, despite high transportation prices. It seems there could be a few more months of healthy demand for services such as travel and recreational services. A longer term trend is emerging for growing demand for financial services, including portfolio management and investment advice. When markets are volatile, retail investors want advice and the recent global events reminded consumers about the value of professional counsel. Real spending on advisory services grew over 10% from a year ago, the second consecutive month of double-digit gains.

Getting Cautious?

The savings rate ticked up in May, as consumers seem to be increasingly cautious about the economic outlook. Consumers saved 4.6% of their personal disposable income, the highest since January 2022. The savings rate is still historically low as consumers have a surplus stock of savings. However, the flow of consumer activity seems to suggest the persistence of inflation, the unknowns within regional banking, and the hawkishness of global central bankers which are likely putting a damper on consumer confidence.

Inflation is Easing

The Fed’s preferred inflation index, the Personal Consumption Expenditures (PCE) price index, rose 0.1% from the previous month, pulling the annual rate of inflation down to 3.8%. As base effects will pull the annual rate even lower, investors should look at the annualized 3-month change in inflation which fell to 3.2%. Clearly, the Fed will see this as welcomed news and could become less hawkish in the coming months if consumer demand falls. Fed Chair Jerome Powell has popularized looking at the inflation dynamics of core services excluding housing and as shown in the matrix below, this annual rate rose 0.2% in May, the smallest rise since July 2022, pulling the annual rate to 4.5%.

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Investors will not likely see inflation converge to the central bank’s long run target of 2% until demand for services cools off. As shown in the chart below, consumer spending on goods is significantly above trend, but services spending is slightly below trend.

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Summary

The spending splurge is likely nearing the end as consumers released most of their pent-up demand for spending. However, the services economy will likely experience a bit more upside from consumer spending in the near term but aggregate demand will likely cool later this year. Investors may want to look for opportunities within some of the discretionary sectors, such as the leisure and hospitality sector and the luxury goods sector.

As consumer spending cools, we expect inflationary pressures to ease further throughout the balance of 2023. From a global perspective, the domestic inflation environment is materially better in the U.S. than for our international counterparts.

IMPORTANT DISCLOSURES

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors. To determine which investment(s) may be appropriate for you, please consult your financial professional prior to investing.

Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments. For more information on the risks associated with the strategies and product types discussed please visit https://lplresearch.com/Risks  

References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.

Unless otherwise stated LPL Financial and the third party persons and firms mentioned are not affiliates of each other and make no representation with respect to each other. Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services.

All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

Securities and advisory services offered through LPL Financial, a registered investment advisor and broker-dealer. Member FINRA/SIPC.

Not Insured by FDIC/NCUA or Any Other Government Agency | Not Bank/Credit Union Deposits or Obligations | Not Bank/Credit Union Guaranteed | May Lose Value

Posted by Kent Cullinane, Research Analyst

Wednesday, June 28, 2023

On Friday, June 23, FTSE Russell’s (Russell) U.S. indices went through their annual reconstitution. This process refreshes the breakdown of equities by market capitalization (large, mid, and small) and investment style (value and growth) that make up Russell’s indices.

The reconstitution is required because the criteria that defined stocks by market cap and investment style in the past may no longer apply. The reconstitution is one of the year’s heaviest trading days as asset managers, especially index funds that track Russell indices like the Russell 3000, adjust their portfolios to reflect changes. Approximately $12 trillion in assets are benchmarked to Russell indices and this year, $61.7 billion in securities traded in a span of under one second, more than three times the New York Stock Exchange’s average daily volume.

This year, there were some notable changes amongst some of the underlying indices that compose the Russell universe. The criteria applied to each stock regarding investment style, growth or value, was updated. The Russell 1000 Growth Index, which is comprised of roughly 450 stocks that exhibit growth characteristics, such as high earnings growth rates and sales-per-share growth rates, saw the communication services sector increase from 7.4% to 11.0% of the index. The primary reason for this change was Facebook’s parent company Meta moving back to growth from value. The Russell 1000 Value Index, which is comprised of roughly 850 stocks that exhibit value characteristics, such as high book-to-price ratios, saw the industrials sector weighting decrease the most, as some value stocks migrated to the Russell 1000 Growth Index. The chart below shows a breakdown of the sector changes in the Russell 1000 Value and Russell 1000 Growth post reconstitution:

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Additionally, there were changes amongst the underlying market cap based indices that are components of the Russell 3000 (that represents 98% of the investable U.S. equity market), the Russell 1000 and the Russell 2000. The Russell 1000 Index, which is comprised of the 1,000 largest domestic stocks by market cap, added 33 new stocks to the index, with 24 of those moving up from the Russell 2000 Index— comprised of the next 2,000 largest domestic stocks by market cap. To make room for the additions, 25 stocks were relegated to the Russell 2000, while the remaining 8 stocks were removed from the Russell 3000 universe, delisted, or were the product of a merger or acquisition.

The top 10 components of the Russell 1000 by market weighting made up 10.9% of the index, up from 10.7% percent last year, highlighting the continued concentration at the top of major large-cap indices. The technology sector remained the largest sector by market weighting within the index, increasing from 28.2% to 29.2% largely due to the sector’s price appreciation relative to the broader growth space.

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The Russell 2000 in terms of total market cap decreased meaningfully from last year, as small caps underperformed the broader market. As of April 28, 2023, the day the preliminary lists of the expected reconstitution are set, the market cap of the Russell 2000 was $2.7 trillion, down 10% from $3.0 trillion the prior year, including 192 stocks that moved up to the Russell 2000 from the Russell Microcap Index, along with those moving down from the Russell 1000 and additions from outside the Russell universe or recent initial public offerings, new additions totaled 297. The technology sector increased the most from the prior reconstitution, representing 11.8% of the index, compared to 10.6% previously. The largest sector by weighting remained the industrials sector at 17.7%, followed by health care (17.4%) and financials (14.2%).So, what does the Russell reconstitution mean for your portfolio? While many stocks were reclassified due to the reconstitution, turnover within indexes remained relatively low, typical of past reconstitutions. The uptick in volatility on reconstitution day has also come down in recent years, as Russell releases preliminary changes nearly two months in advance, allowing institutional investors and traders the ability to adjust their portfolios ahead of time. Given the trillions of dollars of assets that are benchmarked to Russell indices we believe it is important to understand how and why the reconstitutions happen but that there are likely no immediate actions required in response.

IMPORTANT DISCLOSURES

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change.

References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.

Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities. All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

For a list of descriptions of the indexes and economic terms referenced in this publication, please visit our website at lplresearch.com/definitions.

All index and market data from FactSet and MarketWatch.

This Research material was prepared by LPL Financial, LLC.

Securities and advisory services offered through LPL Financial (LPL), a registered investment advisor and broker-dealer (member FINRA/SIPC).

Insurance products are offered through LPL or its licensed affiliates.  To the extent you are receiving investment advice from a separately registered independent investment advisor that is not an LPL affiliate, please note LPL makes no representation with respect to such entity.

• Not Insured by FDIC/NCUA or Any Other Government Agency
• Not Bank/Credit Union Guaranteed
• Not Bank/Credit Union Deposits or Obligations
• May Lose Value

Posted by George Smith, CFA, CAIA, CIPM, Portfolio Strategist

Monday, June 26, 2023

It had been a strong recent run for stocks, as measured by the S&P 500 Index, with the index recording five consecutive weeks of gains but the streak came to an end on Friday with a negative 1.4% weekly return. We decided to take a look at what has historically happened next when an S&P 500 weekly streak of this length has come to an end, as well as looking at streaks for the NASDAQ 100 index.

Looking at S&P 500 performance data going back to 1950 there have been 57 occurrences of streaks of positive returns ending after five weeks. The average returns looking out over the next 12 months, after a five-week positive streak, show a return profile that is slightly below the average seen over all weeks during the study period. In the three months after the positive streak ended stocks have shown very tepid returns of 0.4% compared to all week average of 2.1%. Six- and 12-month returns following the end of a 5-week streak have also been below the study period average. Based on the historic data, had the streak extended into a sixth week, performance may have still been muted within a three-to-six-month period compared to the all-week average numbers.

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The NASDAQ 100 Index, which has a higher market weighting to the technology sector and growth-style stocks, also recently went on a streak, of six consecutive up weeks, which ended by finishing very marginally down (0.04%) during the week ending June 9.  Streaks of this length appear to be a bit of a sweet spot for this index historically, with the 14 times this has occurred since 1985 leading to roughly average three-month returns but significantly above average returns over the six- and 12-month periods. Streaks of seven or more up weeks in this index don’t appear to exhibit the same lag in forward returns as the S&P 500. Longer weekly win streaks for the NASDAQ index have actually tended to carry momentum forward over the short term with the three-month returns around average and then above average for six- or 12-month returns.

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What does LPL Research believe this data can tell us about the current environment for stocks? From a tactical asset allocation perspective, LPL Research’s Strategic and Tactical Asset Allocation Committee (STAAC) recently reduced our equity positioning to neutral on the basis that equities may have gotten over their skis a bit. The STAAC recognizes the possibility of more potential upside in equities in a “melt-up” type scenario. However, as shown in the data above, these types of runs often are followed by at least shorter periods of weaker equity returns so further gains for the S&P 500 may be more modest, and could come with more volatility than we’ve experienced during the first half of the year. Based on the historic performance data, stocks that exhibit more growth-style characteristics may continue to ride the positive momentum trend.

The STAAC is overweight fixed income relative to cash, with bond yields at levels that we have not seen in decades outside recent peaks. The equity risk premium has been greatly reduced, and as such the risk reward trade-off between stocks and bonds is much more balanced now. Attractive fixed income yields can help mitigate potential equity market volatility, boost income, and, given the STAAC’s outlook for interest rates, have the potential for capital appreciation over the intermediate term.

IMPORTANT DISCLOSURES

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change.

References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.

Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities. All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

For a list of descriptions of the indexes and economic terms referenced in this publication, please visit our website at lplresearch.com/definitions.

All index and market data from FactSet and MarketWatch.

This Research material was prepared by LPL Financial, LLC.

Securities and advisory services offered through LPL Financial (LPL), a registered investment advisor and broker-dealer (member FINRA/SIPC).

Insurance products are offered through LPL or its licensed affiliates.  To the extent you are receiving investment advice from a separately registered independent investment advisor that is not an LPL affiliate, please note LPL makes no representation with respect to such entity.

• Not Insured by FDIC/NCUA or Any Other Government Agency
• Not Bank/Credit Union Guaranteed
• Not Bank/Credit Union Deposits or Obligations
• May Lose Value

Posted by Adam Turnquist, CMT, VP Chief Technical Strategist

Friday, June 23, 2023

Key Takeaways:

• As expected, the Federal Reserve (Fed) paused its rate-hiking cycle last week after 15 consecutive months of tightening. Over the last 35 years, there have been five other monetary policy periods when the Fed paused after a major rate-hiking cycle. During these periods, it took anywhere from four to 15 months before the Fed started cutting rates, with the average pause lasting 6.8 months.
• Stocks have historically done relatively well after a Fed pause. The S&P 500 has climbed higher over the following 12 months during four of the last five pauses, generating an average gain of 16.4%.
• Value has edged out growth following a Fed pause. The Russell 1000 Value Index has posted an average 12-month gain of 17.4% after a Fed pause, outpacing the average gain of the Russell 1000 Growth Index by 2.7%.
• Interest rates have historically declined after a Fed pause. The 10-year Treasury yield has declined after all five pauses, falling by an average of 13.7% over the following 12 months.

After 15 straight months of raising interest rates, the Federal Open Market Committee (FOMC) kept rates unchanged last week during their June monetary policy meeting. The pause in rate hikes was widely expected. The surprise came in the Fed’s updated Summary of Economic Projections (SEP), where policymakers penciled in two additional 25 basis point rate hikes by year-end.

Fed Chair Jerome Powell echoed the hawkish forecasts during his post-FOMC press conference. Powell noted the Fed will have to “keep at it” as inflation remains stubbornly high against a backdrop of a “very tight” labor market. He doubled down on his hawkish remarks during his Semiannual Monetary Policy congressional hearing this week, telling lawmakers, “Inflation pressures continue to run high, and the process of getting inflation back down to 2% has a long way to go,” while further adding that he considers forecasts for two more rate hikes this year a “pretty good guess of what will happen.”

However, as LPL Research’s Chief Economist Jeffrey Roach noted on last week’s blog (FOMC Recap: Connecting the Dots), “Periods of economic regime shifts are difficult for policymakers to manage,” and “median Fed forecasts rarely, if ever, coordinate with actual policy rates.”

What Historically Happens After a Pause?

Over the last 35 years, there have been five other monetary policy periods when the Fed paused after a major rate-hiking cycle. The chart below provides a before and after perspective of the percent change to the Fed’s target rate during each period and is normalized based on the start of each pause. For example, during the Fed’s pause in December 2018, the Fed’s target rate fell by 90% over the following 15 months (hence the value of “10.0” on the chart). During these periods, it took anywhere from four to 15 months before the Fed started cutting rates, with the average pause lasting 6.8 months.

View enlarged chart

How Have Markets Performed after a Pause?

While the number of occurrences is limited, stocks have done relatively well after a Fed pause following a major rate-hiking cycle. The normalized chart below shows the index traded higher over the following 12 months after four of the last five pauses. The average 12-month return for all five periods was 16.4%. The outlier was the pause in May 2000, two months after the S&P 500’s Dot-com era peak.

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Regarding style, value has edged out growth following Fed pauses. The charts below highlight the 12-month pre- and post-Fed pause performance of the Russell 1000 Growth Index (RLG) and Russell 1000 Value Index (RLV).

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The RLG generated an average 12-month gain of 14.7% after a Fed pause, with four of five periods producing positive returns. The RLV posted an average 12-month gain of 17.4%, with all five periods producing positive returns.

Finally, interest rates have historically receded after a Fed pause. Benchmark 10-year Treasury yields have declined after all five Fed pauses, falling by an average of 13.7% over the following 12 months.

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Summary

The Fed has finally paused its rate-hiking cycle. Despite all of the hawkish Fed rhetoric and their forecasts calling for two additional rate hikes this year, equity markets appear to be calling the Fed’s bluff for future tightening. And history may be on their side, as historical pauses following a major rate-hiking cycle have lasted for an average of 6.8 months. After a pause, stocks have done relatively well historically, with value outpacing growth over the following 12 months. Interest rates have also historically declined, including a drop in 10-year yields after all five of the last Fed pauses.

IMPORTANT DISCLOSURES

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors. To determine which investment(s) may be appropriate for you, please consult your financial professional prior to investing.

Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments. For more information on the risks associated with the strategies and product types discussed please visit https://lplresearch.com/Risks  

References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.

Unless otherwise stated LPL Financial and the third party persons and firms mentioned are not affiliates of each other and make no representation with respect to each other. Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services.

All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

Securities and advisory services offered through LPL Financial, a registered investment advisor and broker-dealer. Member FINRA/SIPC.

Not Insured by FDIC/NCUA or Any Other Government Agency | Not Bank/Credit Union Deposits or Obligations | Not Bank/Credit Union Guaranteed | May Lose Value

Posted by John Lohse, CFA

Wednesday, June 21, 2023

Based on data released this week, the domestic housing market for both single and multi-family units had a very strong month in May. This is important because increased construction, especially of multi-family units, should help relieve some pressure on rents, and shelter has been one of the “sticky” components of inflation that has made it harder for the Federal Reserve (Fed) to justify a pivot in the current interest rate hiking cycle.

The U.S. Homebuilder Confidence Index released on Monday improved to an almost one-year high. The monthly report released by the National Association of Home Builders (NAHB) increased to 55, surpassing forecasts of 51. This marks the sixth consecutive month of improvement and the first time above 50 since July 2022. Additional housing data released by the U.S. Census Bureau on Tuesday indicated a monthly uptick in permits for single-family homes, increasing 4.8% from April to May. This could indicate the housing market for new single-family homes is close to a bottom.

While single-family homebuilder sentiment has warmed to positive territory, the year-over-year (YoY) growth rate of private construction spending on multi-family residences continues to massively outpace that of single-family units. As shown in the chart below, the latest U.S. Census Bureau reading on private construction spending saw a YoY increase of 24.9% for multi-family and a decline of 24.7% for single-family.

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The level of multi-family units under construction has grown to a point that it has now surpassed that of single-family units, the first time this has occurred since the condo and apartment construction boom of the early 1970s.

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Existing home inventories remain scant as owners balk at relinquishing the favorable mortgage rates that were locked in during the period of historically low rates in 2020 to 2021. However, the single-family permits and starts data should provide some solace for homebuyers as they grapple with the affordability challenge of purchasing in today’s market. Demand for condos and apartments from younger generations is strong and should support construction spending in the coming months, with this pipeline of new inventory helping to suppress rent prices, even as early as the end of the year. If we see that materialize it could give the Fed another data point that supports a continued pause, or even a pivot, on the current interest rate hiking cycle.

IMPORTANT DISCLOSURES

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change.

References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.

Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities. All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

For a list of descriptions of the indexes and economic terms referenced in this publication, please visit our website at lplresearch.com/definitions.

All index and market data from FactSet and MarketWatch.

This Research material was prepared by LPL Financial, LLC.

Securities and advisory services offered through LPL Financial (LPL), a registered investment advisor and broker-dealer (member FINRA/SIPC).

Insurance products are offered through LPL or its licensed affiliates.  To the extent you are receiving investment advice from a separately registered independent investment advisor that is not an LPL affiliate, please note LPL makes no representation with respect to such entity.

• Not Insured by FDIC/NCUA or Any Other Government Agency
• Not Bank/Credit Union Guaranteed
• Not Bank/Credit Union Deposits or Obligations
• May Lose Value

Posted by Adam Turnquist, CMT, VP Chief Technical Strategist

Friday, June 16, 2023

Key Takeaways:

• Evidence of a regime shift from high to low implied volatility is building. The CBOE Volatility Index—or more commonly referred to as the VIX or ‘fear gauge’—has recently dropped to multi-year lows after spending most of last year at above-average levels.
• Historically, periods of high volatility have been followed by periods of low volatility, especially during the transition from a bear to a bull market.
• The term structure of the VIX futures curve has reverted back to its normal upward-sloping shape, adding to the evidence of a shift toward a low-volatility market environment.
• What does this mean for market returns? While high implied volatility has historically produced the highest average S&P 500 returns, the standard deviation around these returns is also relatively high. Periods of low volatility have historically generated above-average returns with less dispersion.

While the S&P 500 recently entered a new bull market by climbing 20% above its October 12 low, the same bear market continues for implied equity market volatility. The VIX has been trending lower since January 2022 and recently fell to its lowest level in over three years. For context, the VIX represents implied volatility derived from the aggregate values of a weighted basket of S&P 500 puts and calls over a range of strike prices. Generally, a rising VIX is associated with increased fear in the marketplace and falling stock prices, while a declining VIX is associated with decreased investor fear and rising stock prices. In addition to speculative positioning, the VIX is used as a sentiment gauge and to hedge positions.

Stocks Breaking Out, Volatility Breaking Down

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Regime Shift?

Given the current trend and level of the VIX, many investors are now asking if low volatility is here to stay. The VIX futures can help answer that question. As shown below, the term structure of VIX futures has shifted considerably over the last year. The orange line represents the VIX curve on June 16, 2022, while the dark blue line represents the VIX curve as of the October 12, 2022 market low. During these periods, both curves are in “backwardation,” meaning they slope downward as shorter-term contracts are more expensive than longer-term contracts. This is generally the result of elevated market uncertainty driving up short-term hedging costs from a volatility standpoint. Historically, backwardation is short-lived and often found near major market bottoms including during the throes of the Global Financial Crisis in November 2008, the U.S. credit downgrade in 2011, the near-bear market drop in late 2018, and during the pandemic of 2020.

The current VIX futures curve is upward sloping or what is also called “contango,” which is the opposite of backwardation as longer-term contracts are more expensive than shorter-term contracts. The VIX is usually in contango during a normal, low-volatility environment (80% of the time, according to the CBOE). The higher cost associated with longer-term VIX futures results from an embedded time premium investors pay for hedging against potential future risk. Generally, there is a higher chance of market risk developing over a longer time frame compared to a shorter time frame, hence the higher cost going out on the curve (i.e., a higher chance of stocks dropping 5% over a one-year period vs. a one-week period).

While the shape of the VIX curve can change quickly, the change in term structure from last year’s bear market backwardation curve to the current contango curve adds to the evidence of a regime shift to lower volatility.

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What Does Low Volatility Mean for Stock Returns?

Lower volatility doesn’t always equate to above-average equity returns, as market bottoms are often accompanied by periods of high volatility. The table below breaks down the VIX into quintiles based on closing prices going back to 1990. The first quintile represents trading days with the highest implied volatility, or the top 20% of all VIX closes. In contrast, the bottom quintile represents trading days with the lowest implied volatility, or the bottom 20% of all VIX closes. Forward S&P 500 returns for each VIX quintile group are also shown, along with the standard deviations of each return period.

The first quintile group, representing the highest periods of implied volatility, has historically produced the highest average S&P 500 returns. However, the returns in the first quintile group also come with a wide dispersion, evidenced by the standard deviation of returns being around double that of the fourth and fifth quintile groups. Furthermore, the fourth (where the VIX is currently trading) and fifth VIX quintile groups have still generated above-average S&P 500 returns with less variance.

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Summary

Evidence of a regime shift from high to low implied volatility is building. The VIX has recently dropped to a multi-year low of 14.5 as of June 15, placing it in the fourth quintile group after spending most of last year at above-average levels. Historically periods of high volatility are followed by periods of low volatility, especially during the transition from a bear to a bull market. The term structure of the VIX futures curve has reverted back to its normal contango shape as hedging demand for near-term risk has dissipated. While high implied volatility has historically produced the highest average S&P 500 returns, the standard deviation around these returns is also relatively high. Periods of low volatility have historically generated above-average returns with less dispersion.

IMPORTANT DISCLOSURES

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors. To determine which investment(s) may be appropriate for you, please consult your financial professional prior to investing.

Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments. For more information on the risks associated with the strategies and product types discussed please visit https://lplresearch.com/Risks  

References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.

Unless otherwise stated LPL Financial and the third party persons and firms mentioned are not affiliates of each other and make no representation with respect to each other. Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services.

All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

Securities and advisory services offered through LPL Financial, a registered investment advisor and broker-dealer. Member FINRA/SIPC.

Not Insured by FDIC/NCUA or Any Other Government Agency | Not Bank/Credit Union Deposits or Obligations | Not Bank/Credit Union Guaranteed | May Lose Value

Posted by Jeffrey J. Roach, PhD, Chief Economist

Thursday, June 15, 2023

As expected, the Federal Open Market Committee (FOMC) kept rates unchanged at its meeting yesterday but communicated a hawkish bias to future interest rate decisions. With a slight tweak, the FOMC statement was modestly hawkish but still communicated to investors that the committee is data-dependent when “determining the extent of additional policy firming that may be appropriate.” (emphasis added.) They do not say more tightening “will” be appropriate.

Along with the statement, four times a year, the Committee updates it Summary of Economic Projections (SEP), which is arguably more important than the statement. Within the most recent SEP, most policy makers believe further tightening is needed unless conditions materially weaken. Additionally, forecasts for GDP growth this year were revised higher since growth in the first quarter was so strong. The economy could still slide into recession in the latter half of this year yet still approach 1% growth for the entire year. Our most likely scenarios put the economy is a mild recession by the end of the year as consumers retrench and businesses slow hiring as surveys suggest. Finally, unemployment is expected to rise from current levels but will not likely increase as much as Federal Reserve (Fed) officials originally forecasted. Importantly, the Fed recognizes the ongoing economic resiliency and it doesn’t expect things to get as bad as originally forecasted three months ago, which bodes well for the soft-landing scenario if the Fed is right.

However, the release of the dot plot, which is the individual Committee member’s expectation of the appropriate fed funds rate each year, was the hawkish surprise markets were worried about. Despite raising rates by 5% over the past 15 months, the majority of the committee, not just the median policymaker, sees at least two more 0.25% rate hikes this year, which would take the fed funds rate to 5.625%—the highest level since 2001. Moreover, the committee thinks the fed funds rate should end the year in 2024 at 4.625%, which reflects the potential for some rate cuts, but not as many as markets are expecting, which could put upward pressure on bond yields if the committee’s forecasts are accurate.

That said, and as we know from the great philosopher Yogi Berra, it’s tough to make predictions, especially about the future. And the Fed’s crystal ball is no better than the markets and we know from history that the dot plot is just not a good forecasting tool. As seen in the chart below, analysis by Bloomberg shows the median forecast rarely, if ever, coordinated with actual policy rates (dashed red line). Dot plot medians tended to overestimate policy rates—sometimes by a wide margin. The most egregious example appears to be in 2015 (green line) when the Committee expected interest rates in 2017 to be above 3.5%, when in actuality they were closer to 0.50% that year.  Nonetheless, it is worth watching how these views evolve in the coming months, which means either the Fed lowers its forecasts or the market adjusts higher, putting upward pressure on bond yields.

View enlarged chart

Bottom Line: Periods of economic regime shifts are difficult for policy makers to manage. This current environment could be eerily similar to early 2007 when the Fed held a tightening bias on rates as they believed the housing market was stabilizing, the economy would continue to expand, and inflation risks remained. (See the historical statement from January 2007.)[1] Clearly, those expectations were not met since we know what happened in later quarters. Despite the reference to 2007, our baseline is the economic slowdown does not produce another “2008” yet, investors should anticipate some volatility during these months where the economic outlook remains cloudy.

[1] https://www.federalreserve.gov/newsevents/pressreleases/monetary20070131a.htm

IMPORTANT DISCLOSURES

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors. To determine which investment(s) may be appropriate for you, please consult your financial professional prior to investing.

Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments. For more information on the risks associated with the strategies and product types discussed please visit https://lplresearch.com/Risks  

References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.

Unless otherwise stated LPL Financial and the third party persons and firms mentioned are not affiliates of each other and make no representation with respect to each other. Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services.

All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.  Government bonds, notes and Treasury Bills are guaranteed as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. 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.

For a list of descriptions of the indexes and economic terms referenced in this publication, please visit our website at lplresearch.com/definitions.

Securities and advisory services offered through LPL Financial, a registered investment advisor and broker-dealer. Member FINRA/SIPC.

Not Insured by FDIC/NCUA or Any Other Government Agency | Not Bank/Credit Union Deposits or Obligations |Not Bank/Credit Union Guaranteed | May Lose Value

Posted by Jeffrey Buchbinder, CFA, Chief Equity Strategist

Wednesday, June 14, 2023

Now that the S&P 500 Index has entered a new bull market (by gaining 20% or more since the October 2022 lows), it’s logical to ask the question of when the index might achieve a new all-time high.

At 4,369 on the S&P 500 as of the market close on June 13, 2023, the index is just 9.8% away from eclipsing the record high from January 3, 2022 at 4,796.56. So how long might it take us to get there?

Historically, the index has taken an average of 19 months to recover from bear market declines of 20% or more, as shown in the accompanying table. The current rebound from the bear market low in October 2022 is now just eight months old, suggesting an additional 10% gain could potentially take almost another year to achieve.

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As shown above, recovery times vary widely and depend on the economic environment. When bear markets are not accompanied by recession, recoveries from bear markets only took an average of 10 months to reach a new record high. It might be going out on a limb to predict a 10% rally and a new record high for the S&P 500 by mid-August, but the historical pattern for young bull markets suggests stocks may have some more room to run here. Perhaps the lack of a recession in this environment (so far, at least) means the timetable to return to the January 2022 highs could be closer to 10 months than 19. On the other hand, if recession begins this fall, before those new highs are reached, it could be well into 2024 before the S&P 500 eclipses the 4,796 mark.

This analysis doesn’t change the LPL Research Strategic and Tactical Asset Allocation Committee’s (STAAC) neutral stance on equities from a tactical asset allocation perspective. The STAAC still sees the risk-reward between equities and fixed income as fairly balanced currently, even while acknowledging this analysis points to more gains over the rest of the year. As we wrote about here in last week’s Weekly Market Commentary, the technical evidence that stocks may be due for a pause, coupled with the attractiveness of fixed income relative to equities, suggests it is prudent to keep portfolio risk levels near benchmarks, with a bit of an additional fixed income cushion to help mitigate potential equity market volatility and enhance income. Also, consider the possibility that lower interest rates enhance bond returns, consistent with the end of prior Federal Reserve rate hiking cycles.

In conclusion, with bonds offering some of the richest yields in decades, the risk-reward for stocks is no longer compelling, in our view. Strong momentum may carry the market a bit higher from here, but with the S&P 500 within our fair value range of 4,300 to 4,400, it seems like a logical spot for stocks to take a breather.

For more of LPL Research’s thoughts on the near-term outlook for stocks, see our latest LPL Market Signals podcast here.

IMPORTANT DISCLOSURES

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change.

References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.

Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities. All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

All index and market data from Bloomberg.

This Research material was prepared by LPL Financial, LLC.

Securities and advisory services offered through LPL Financial (LPL), a registered investment advisor and broker-dealer (member FINRA/SIPC).

Insurance products are offered through LPL or its licensed affiliates.  To the extent you are receiving investment advice from a separately registered independent investment advisor that is not an LPL affiliate, please note LPL makes no representation with respect to such entity.

• Not Insured by FDIC/NCUA or Any Other Government Agency
• Not Bank/Credit Union Guaranteed
• Not Bank/Credit Union Deposits or Obligations
• May Lose Value

Posted by George Smith, CFA, CAIA, CIPM, Portfolio Strategist

Tuesday, June 13, 2023

The latest Consumer Price Index (CPI) print came towards the lower end of expectations with the overall headline inflation falling to the lowest level since April 2021. The encouraging trend in consumer prices will provide the Federal Reserve (Fed) some leeway to keep rates unchanged this month and if the trend continues, the Fed will likely not hike for the rest of the year.

• Consumer prices rose 0.1% in May, pulling the annual rate of inflation down to 4.0%, the lowest annual rate since March 2021.
• The largest contributor to the monthly increase in prices was shelter costs.
• Energy prices were the largest negative contributor, falling 3.6% in May.
• Prices for eating out at restaurants are still rising at a fast clip, indicating that consumer demand in that space is still strong.
• The overall theme in recent months has been strong consumer demand for experiences over goods and we are seeing that play out in consumer pricing dynamics.

Inflation is Going in the Right Direction According to the Market

As demonstrated by the positive stock market moves in early trading today, market participants appear to believe that the latest CPI report shows inflation is heading in the right direction and may give the Fed cover to skip a June rate hike or even pause for a longer period. As shown in the chart below, headline inflation remains above the Fed’s long run target of 2%, but the month-on-month changes are well past their peak and back within the range of historic norms.

View enlarged chart

Services Aren’t Slowing Down Yet, but Goods Are Declining Gradually

The strong level of service inflation, which continues to counteract the slowing increase in good prices, is further shown in the May CPI figures. While the costs for items are falling, we expect services to remain popular for a while as consumers demand experiences over goods.

Home Costs Expected to Cool

The housing sector is currently a significant factor impacting inflation in 2023. Shelter costs, which hold a significant weight in the CPI, are expected to ease. There is evidence that rent costs will eventually decrease, as can be seen in the robust multi-family construction activity. As more projects hit the market this year due to the increase in condo and apartment building, the supply of multi-family apartments will rise, which should help bring down rent prices. As such, we don’t think it will be long before official government numbers reflect the decrease in rent prices. In the upcoming months, investors and policymakers alike should anticipate a slowing of housing-related inflation.

We have updated our Inflation Dashboard, designed to provide a snapshot of the inflationary environment, with the latest CPI data. The CPI rent of primary residence is the only one of our dashboard indicators that remains at an elevated level, and even that has fallen from an extreme level since April.

View enlarged chart

Conclusion

We expect that the Fed will keep interest rates where they are for the time being. The Fed may adopt a more hawkish attitude and signal an interest rate increase if any future core inflation readings come in higher than anticipated, but if the inflation trend remains the same, it seems likely the Fed will not hike rates for the rest of the year.

IMPORTANT DISCLOSURES

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change.

References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.

Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities. All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

For a list of descriptions of the indexes and economic terms referenced in this publication, please visit our website at lplresearch.com/definitions.

All index and market data from FactSet and MarketWatch.

This Research material was prepared by LPL Financial, LLC.

Securities and advisory services offered through LPL Financial (LPL), a registered investment advisor and broker-dealer (member FINRA/SIPC).

Insurance products are offered through LPL or its licensed affiliates.  To the extent you are receiving investment advice from a separately registered independent investment advisor that is not an LPL affiliate, please note LPL makes no representation with respect to such entity.

• Not Insured by FDIC/NCUA or Any Other Government Agency
• Not Bank/Credit Union Guaranteed
• Not Bank/Credit Union Deposits or Obligations
• May Lose Value

Posted by Adam Turnquist, CMT, VP Chief Technical Strategist

Friday, June 9, 2023

Key Takeaways:

• The S&P 500 officially entered bull market territory yesterday. It took 165 trading days to surpass the 20% qualifier for a technical bull market, marking the second longest period to confirm a new bull market in nearly 75 years.
• What happens next? Forward returns after a bull market is confirmed have historically been strong. The S&P 500 has posted average and median gains of 18%-19% 12 months after the index has cleared the 20% threshold.
• How long does a bull market last? The duration of a bull market can vary significantly, but historically they have been longer-term. Since 1929, the average S&P 500 bull market has lasted for 39.4 months and produced an average gain of 130.1%.
• Resistance doesn’t care about bull markets. The S&P 500 is retesting key resistance near 4,300, which marks a major retracement level of last year’s bear market and the August highs. At the same time, the technology sector—the main engine of this year’s rally—has become overbought. A consolidation and/or pullback in technology could make 4,300 a challenging hurdle to clear on a sustainable basis.
• If the market can sustainably break out above 4,300, fear of missing out and short covering could accelerate price action to the upside. Money market funds are also at record highs.

The bulls are back in town, at least according to the technical qualifier of a 20% advance off a bear market low. There is additional supporting evidence for the S&P 500’s bull market designation, including, but not limited to, the market’s uptrend formed by consistent higher lows and higher highs since October 2022 and the S&P 500’s short-, medium-, and long-term moving averages all appropriately stacked above one another.

While breadth has been underwhelming over the last month and formed a negative divergence from price action, participation in the latest rally has recently picked up. As shown below, 58% of S&P 500 stocks are trading above their 200-day moving average (dma). This is a move in the right direction, especially with notable improvements in financial and energy sector breadth, but the current reading remains well below the high watermark of 79% reached in February. In addition, overbought conditions have become widespread in the technology sector—the main engine of this year’s rally—and resistance at 4,300 looms for the S&P 500. As noted in our Weekly Market Commentary on June 5, stocks have had a nice run, but at elevated prices, the bar for further gains gets higher, especially with high-quality bonds offering attractive yields and elevated risk of a late-2023 recession.

Given this backdrop, the LPL Research Strategic and Tactical Asset Allocation Committee (STAAC) lowered its recommended equities allocation to neutral this week. Importantly, neutral is not bearish, and this was a tactical call, as we believe there will be a better entry point into this bull market ahead.

View enlarged chart

What Happens Next?

With the S&P 500 officially entering a new bull market, the October 12, 2022 low can also be labeled as a bear market low. It took 165 trading days for the S&P 500 to surpass the 20% threshold off the bear market low, marking the second longest period to confirm a new bull market in nearly 75 years.

Forward returns after a bull market is confirmed have historically been strong. While one-month returns are underwhelming, the S&P 500 has posted average and median gains of 18%-19% 12 months after a bull market officially started, based on the date the index breached the 20% bull market threshold.

View enlarged chart

The duration of a bull market can vary significantly, but historically they have been longer-term. Since 1929, the average S&P 500 bull market has lasted for 39.4 months and produced an average gain of 130.1%. If you exclude the Great Depression era (1929-1939), the average bull ran for 51 months and produced an average gain of 147%.

View enlarged chart

Summary

The S&P 500 officially entered bull market territory yesterday after a 165 trading day climb off the October 12, 2022 low. After a bull market is confirmed, forward returns have historically been strong, although one-month returns have been underwhelming. Resistance at 4,300 could be hard to clear if the overbought technology sector pauses and/or pulls back. We suspect broader participation will be required for a sustainable breakout, and until then, we believe a better entry point into this new bull market lies on the horizon. In the event of the S&P 500 sustainably clearing the 4,300 mark, fear of missing out and short covering could accelerate price action to the upside.

IMPORTANT DISCLOSURES

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors. To determine which investment(s) may be appropriate for you, please consult your financial professional prior to investing.

Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments. For more information on the risks associated with the strategies and product types discussed please visit https://lplresearch.com/Risks  

References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.

Unless otherwise stated LPL Financial and the third party persons and firms mentioned are not affiliates of each other and make no representation with respect to each other. Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services.

All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

Securities and advisory services offered through LPL Financial, a registered investment advisor and broker-dealer. Member FINRA/SIPC.

Not Insured by FDIC/NCUA or Any Other Government Agency | Not Bank/Credit Union Deposits or Obligations | Not Bank/Credit Union Guaranteed | May Lose Value