Wealth Management

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

Thursday, May 18, 2023

The latest weekly data from the American Association of Individual Investors (AAII) showed individual investor sentiment is still at depressed levels. This is perhaps not surprising as investors have built up a “wall of worry” from concerns about lingering inflation, uncertainty over the path of interest rates, recent bank failures, recession fears, and depressed consumer sentiment, not to mention concerns over the debt ceiling and the potential for a U.S. debt default and/or credit downgrade.

The percentage of individual investors who are bullish about short-term market expectations is 23%, down from 29% last week. This marks the lowest level since the end of March and is well below the long-term average of 34%. The percentage of investors who are bearish slightly decreased week-on-week to 40% but was still well above the long-term average of 32%. This puts the spread between the bulls and the bears at -17%, versus a long-term average of +2%.

As shown in chart the below, investor sentiment, as measured by the spread between bulls and bears in the AAII data, is more than one standard deviation below its long-term average. The January rally in the S&P 500 brought some bulls back, with the bull-bear spread getting above zero for a single week, but since then investor sentiment has fallen despite stocks recovering in March and mostly trading sideways since then.

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While the concerns that are feeding into the individual investors’ “wall of worry” are valid, the negative sentiment they have built up is, from a contrarian perspective, a potential catalyst for positive forward returns.  Stock markets are forward looking and if concerns are well known and understood they are also probably largely priced in. Markets typically slump due to surprises and shocks, not known risks. As such, we view the negative sentiment in the AAII data as a contrarian indicator, suggesting support for stocks, as many potential buyers wait in the wings for current worries to subside. Extremes in pessimism in the AAII data are, on average, bullish for near-term stock market returns (and extreme investor optimism tends to be bearish for the near-term outlook). When the bull-bear spread is around where it is now (between 1 and 2 standard deviations below average), we have seen the strongest S&P 500 returns three months and 12 months out, and the second strongest returns six months out.

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Summary

There are many risks out there for markets and the economy that have justifiably built up a significant “wall of worry,” but one remaining asset for stocks, from a contrarian perspective, is all this negative sentiment and positioning. We still maintain a modest overweight to equities funded from cash (where the return profiles of short-term products are very attractive, but reinvestment risk has also risen), as equities may still benefit from falling inflation and the potential end to Federal Reserve rate hikes. We recommend a neutral allocation to fixed income, as valuations have become more attractive relative to equities amid higher interest rates.

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 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 Lawrence Gillum, CFA, Chief Fixed Income Strategist

Tuesday, May 16, 2023

After years of waiting for cash to be a viable asset class again, investors have flocked into money market funds to take advantage of higher Treasury yields. In fact, with over $5 trillion in assets, money market assets under management have never been higher. However, with the ongoing debt ceiling drama in Washington, investors may be concerned about the prospects of delayed payment on Treasury bills (T-bills), which generally make up a sizable allocation within certain money market funds (MMFs). Aggregate data shows that money market fund managers are taking the potential of delayed payment seriously and have been positioning portfolios defensively. Many (not all) managers have been utilizing the Federal Reserve’s (Fed) overnight reverse repo facility (ON RRP) and are selectively adding T-bills that mature outside of the x-date.

The Fed’s ON RRP facility allows certain MMFs to borrow from or lend to the Fed, using government securities as collateral and agreeing to buy or sell back those securities at rates set by the Fed, on an overnight basis. As seen in the chart below, balances at the ON RRP facility remained elevated with over $2 trillion parked there (as of May 15, 2023). Collectively, 95% of the usage of the facility comes from MMFs: Government MMFs made up about 79% of the uptake, prime MMFs close to 16%, and non-MMFs about 5%. With an aggressive rate hiking campaign by the Fed and the ongoing debt ceiling drama in Washington, the Fed’s facility remains an attractive (and comparably risk free) alternative to options in the short end of the Treasury market.

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Additionally, as further precautions, MMFs have been cautious with T-bill allocations by opting for bills that mature outside of the so called x-date. In particular, according to JPMorgan, government MMFs kept investments in T-bills maturing in June through August relatively low as of April-end. Anecdotally, we see this in the nearly 1% difference in yields between bills that mature on May 30 and those bills that mature after June 1^, as investors are demanding additional compensation for the risk of delayed payment.

Our base case remains that Washington will do the right thing and raise the debt ceiling—like it has every single time before. President Biden and House Speaker Kevin McCarthy are scheduled to meet today to continue debt ceiling negotiations, and we’re hopeful further progress will be made. These games of political chicken can introduce volatility to markets in the near term, but we do not think MMFs, in aggregate, are at increased risk of liquidity issues due to a possible technical default of U.S. Treasuries (which again we think is a very low probability). For more information on the debt ceiling, check out our February 27 Weekly Market Commentary.

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.

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 Barry Gilbert, PhD, CFA, Asset Allocation Strategist

Thursday, May 11, 2023

• The Consumer Price Index (CPI) peaked almost a year ago now in June 2022.
• Historically, CPI peaks tend to come around the start of a recession on average. Clearly that wasn’t the case this time
• Stock market risks have been most pronounced as we move toward the CPI peak. Coming off of it, returns have been near the long-term average.
• When the CPI peak is above 9%, as it was this time, the post-peak performance of the S&P 500 Index has been meaningfully stronger, on average.
• The inflation story may not be over, but markets may have already been starting to look past it over the last six months, consistent with post-peak behavior historically.

We are coming up on being a full year removed from the peak in inflation next month, measured by the one-year change in the Consumer Price Index (CPI). CPI peaked in June 2022 at 9.1%. Year-over-year inflation has decline every month since, with the most recent reading for April 2023, released yesterday, at 4.9%. (For some thoughts on yesterday’s CPI report from LPL Chief Economist Jeffrey Roach, see yesterday’s LPL Research blog, “Inflation with a 4 Handle.”)

While every cycle is different, looking at past inflation peaks can provide some insights on both recessions and the outlook for stocks. Perhaps most noteworthy about last June’s inflation peak is that it’s so far behind us while recession risk remains elevated looking forward. When it comes to recessions, peak inflation has on average roughly coincided with the start of a recession but there is a lot of variation. While it’s less common, peak inflation has preceded the start of a recession by a year or more. If the economy were to go into recession in the second half of the year, we could chalk up the more delayed economic downturn to a Federal Reserve (Fed) that was initially behind the curve in fighting inflation along with monetary policy acting with its typical lag. Some economic tailwinds from post-pandemic pent up demand, especially on the services side, might also have contributed to greater economic resilience.

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When it comes to market behavior, it shouldn’t be surprising that S&P 500 Index price returns fared better in the year following peak inflation than in the year prior. Both the median and average returns are negative in the year leading up to the peak. That makes sense: Markets are adjusting to the real time experience of higher inflation and its potential policy impact. By contrast, average returns are positive the year after peak CPI, but just roughly in line with the average overall.

What’s noteworthy is that higher inflation at peak increases the odds of a larger rebound post peak even though inflation generally still remains elevated a year later. Granted it’s a small sample, but the average S&P 500 Index return in the following year when peak inflation has been over 9% has been 20.4%. For markets, it’s been the direction of inflation rather than the level that matters, even though a higher peak meant the economy was still dealing with higher inflation. That might not be all that relevant at this point since the one-year period following the peak looked at in the study is almost behind us. But it does tell us that market risks from higher inflation may be yesterday’s story, even if the full impact of higher interest rates may still be ahead.

The progress already made on inflation is just one of the reasons LPL’s Asset Allocation Committee continues to recommend a modest equity overweight for appropriate investors even as we gauge the potential impact of a recession in the second half 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 Jeffrey J. Roach, PhD, Chief Economist

Wednesday, May 10, 2023

Overview

• The monthly consumer inflation rate rose 0.4% in April from 0.1% the previous month, enough to push the annual rate of inflation down to the lowest since mid-2021.
• Shelter costs continue to be the largest contributor to inflation, illustrating the acute pain felt by renters in this country. This component will not likely be a significant driver of inflation by the end of this year as more multi-family units come to market.
• Airline prices in April declined month-to-month but are still higher than earlier this year as consumers release pent-up demand for travel.
• New vehicle prices declined month-to-month for the first time in 12 months as auto dealers work to jumpstart stalled auto sales.
• Bottom Line: April inflation metrics all but confirm expectations that the Federal Reserve (Fed) will not hike rates next month. The Fed could even justify outright rate cuts in coming months as inflation and the economy slow further. Risk assets will likely become more attractive as investors digest this latest inflation report.

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Markets Believe Inflation Moving in Right Direction

As inflation moves in the right direction, investors are right to believe that the Federal Open Market Committee (FOMC) will keep rates unchanged in the upcoming meeting in June. Headline inflation is showing consistent signs of easing but it could take a while for the inflation rate to hit the Fed’s target because services prices may take longer to materially cool down. Rent prices, for example, rose 0.56% in April, hotter than the average monthly rise before the pandemic but lower than last year’s rate. As more multi-family units come to market, we expect rent prices to cool further. According to Apartmentlist, an online apartment advertisement firm, a combination of softer demand and rising supply is “keeping rent growth in check.”[1]

[1] https://www.apartmentlist.com/research/national-rent-data

The Inflation Dashboard below provides a broad snapshot of the inflationary environment.

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Shelter Coming Off the Highs

The annual rate of rent inflation eased slightly in April from the high in March. We may likely see rent prices ease further throughout the year. Strong multi-family construction activity is clearly a good sign that rent costs will eventually ease. The growth in condo and apartment construction means the supply of multi-family units will increase this year as more projects come to market. Industry data already shows declining rent prices, so it’s just a matter of time before the official government statistics reflect that easing. Investors and policy makers alike should expect a softening in housing-related inflation in the coming months.

Food Gets Slightly More Affordable

Overall, the food index remained stable in April. Grocery prices outright declined in April and in March as four of the six major grocery store food group indexes decreased in April. Both the index for fruits and vegetables and the index for meats, poultry, fish, and eggs declined, with drops of 0.5% and 0.3%, respectively. The dairy and related products index also decreased by 0.7%, driven in large part by the milk index’s decline of 2%, the largest decline seen since February 2015. Declining food prices will help the lower income households most sensitive to consumer staples.

What Does It Mean for You?

The outlook for inflation the rest of the year looks promising. The Fed seems to be shifting to a “wait and see” strategy as the banking sector is tenuous and consumers are slowing spending activity. Further, the banking failure of Silicon Valley Bank seems to be contained and the general financial system appears stable. We expect the Fed to keep the target rate unchanged at the next meeting as economic conditions weaken. As inflation convincingly cools closer to the long-run target of 2%, investors will likely take on more risk for their portfolios.

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.

Posted by Lawrence Gillum, CFA, Chief Fixed Income Strategist

Tuesday, May 9, 2023

The Federal Reserve (Fed) released its quarterly Senior Loan Officer Opinion Survey on Bank Lending Practices yesterday and it continues to show banks are tightening lending standards on commercial and industrial (C&I) loans. C&I loans are an important funding source for companies that can’t (or don’t want to) access capital markets to fund growth initiatives or to just help pay the bills. Moreover, C&I loans are an especially important funding source for lower-rated companies because borrowing (or issuing additional equity shares) can be too restrictive and costs prohibitive at times, whereas C&I loans are short-term loans with variable interest rates that are generally secured by company collateral.

However, with the recent Fed report showing banks are making it harder for some companies to access C&I loans and/or only access them at higher rates, it could mean higher yields and spreads for the high-yield index broadly (Bloomberg U.S. Corporate High Yield Index). Shown below, tighter lending standards (orange line) have historically correlated with higher bond yields and spreads (blue line) for non-investment grade rated companies. This relationship makes sense as C&I loans can provide emergency financing for companies if needed and without that potential lifeline, it could make it harder for some companies to service existing debt.

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According to the report, the percentage of respondents that reported tightening standards for C&I loans to large and medium firms increased marginally in the past three months, to 46% from 44.8% in the prior survey. However, this report only covers the first quarter, when only SVB (March 10) and Signature Bank (March 12) were thought to be at risk. As the regional banking stresses have continued into the second quarter, it’s likely next quarter’s report will continue to show additional tightening. According to Bloomberg Intelligence, this indicator leads actual lending activity by about 12 months, and has produced an accurate leading signal of recessions in the past. The current value is consistent with a sharper pullback in C&I loans in the second half of the year. C&I lending accounts for 10% of GDP.

And while high-yield companies, in general, did a good job of fortifying balance sheets and terming out debt (i.e., issuing a lot of debt at longer maturities at low interest rates) there will most certainly be companies that will need emergency financing and won’t be able to access it. This in turn will likely lead to defaults, especially if the economy contracts at some point this year. The asset class has been resilient so far though given the ongoing regional banking stresses, debt ceiling debate, and over 5% of Fed rate hikes. But high yield spreads are currently trading around historical averages in a year that feels anything like average. So, while we like high yield from a strategic perspective (for investors with a longer-term time horizon), we remain on the sidelines in tactical portfolios awaiting a better entry point.

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.

Posted by Adam Turnquist, CMT, VP Chief Technical Strategist

Friday, May 5, 2023

Key Takeaways:

• Time is running out for Congress to raise the debt ceiling. Treasury Secretary Janet Yellen has warned lawmakers that the government may not be able to service its debt by June 1.
• The fixed income market continues to show signs of concern over a potential technical default. Credit default swap (CDS) rates for U.S. government debt have roughly doubled over the last month, while four-week Treasury bills auctioned at their highest discount on record this week.
• While we view a default as a very low probability event, headline risk over the next few weeks could weigh on risk sentiment.
• What does this mean for stocks? In the event of a prolonged debt ceiling battle similar to 2011, watch for large caps to outperform small caps, growth to outperform value, and defensive sectors to outperform more cyclical sectors.

Backdrop

As if rate hikes, rising recession risk, and another bank rescue were not enough to deal with, the market is now gearing up for a battle inside the Beltway as Democrats and Republicans spar over solutions to avoid a default on the nation’s debt. According to Treasury Secretary Janet Yellen, time is running out for Congress to raise the debt ceiling as she warned lawmakers earlier this week that, while the actual date is unclear, the government may not be able to service its debt as early as June 1, the so called X-date.

A failure by the government to reach a deal by the X-date could trigger a technical default with potentially catastrophic economic consequences. Chair Powell commented on the severity of the situation during this week’s Federal Open Market Committee press conference: “It’s essential that the debt ceiling be raised in a timely way so that the U.S. government can pay all of its bills when they’re due. A failure to do that would be unprecedented. We’d be in uncharted territory, and the consequences to the US economy would be highly uncertain and could be quite averse.”

While we view a default as a very low probability event, headline risk over the next few weeks will likely weigh on risk sentiment.

The fixed income market continues to show signs of concern over a potential technical default, resulting in a delayed payment for bond holders. Credit default swap (CDS) rates for U.S. government debt have roughly doubled over the last month as investors demand a higher premium for the potential default risk. For context, CDS rates reached only 0.80% during the 2011 debt ceiling crisis, about half of where rates are today. Furthermore, four-week Treasury bills auctioned at their highest discount on record this week, yielding 5.84%.

The message from the fixed income market is concerning, although the risk lies more in the government’s willingness versus its ability to service its debt. According to LPL Fixed Income Strategist Lawrence Gillum, “U.S. bond market investors have taken for granted the government’s ability and willingness to pay its debt. While its ability to repay its obligations is not in question, the debt ceiling debate complicates the country’s willingness to pay its debts.” Read more from his April blog titled The Treasury Market is Starting to Show Signs of Worry Over Debt Ceiling.

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Flashback to 2011

While we view a default as a very low probability event, headline risk over the next few weeks could weigh on risk sentiment. Unfortunately, the market has also seen this film before, with the most recent edition playing out in 2011. As a quick backdrop, a debt ceiling spring showdown in Washington resulted in the government hitting its debt limit on May 16, 2011. However, the Treasury pulled off some accounting maneuvers to narrowly avert a crisis and fund the government until August 2, exactly how long it took Congress to get a deal done. The damage during this period included a sizable sell-off across equity markets, lower yields underpinned by a flight to safety, and a credit downgrade of U.S. debt to AA+ from AAA by Standard & Poor’s.

While there are many economic differences between now and then, the 2011 analog at least provides a potential roadmap for stocks if the debt ceiling drama continues. The chart below shows how several major indices performed during this period, encapsulated by the market’s April high to the October low.

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At the market cap level, small cap stocks clearly underperformed during this period, evidenced by sizable drawdowns on the Russell 2000 and S&P Small Cap 600 Index. Large caps and growth outperformed but still posted double-digit declines.

The following chart breaks down the S&P sector performance during the 2011 debt ceiling crisis.

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Defensive leadership was a major theme during this period as utilities and consumer staples topped the sector leaderboard with minimal relative losses compared to peers. The more offensive cyclical sectors widely underperformed, led by financials. Under a prolonged kick-the-can down the road scenario similar to 2011, we suspect defensive sectors could be in a similar position this year.

Summary

We believe the odds of the government defaulting on its debt obligations remain low. However, without a debt ceiling deal, the probabilities of a technical default are not zero and headline risk will remain elevated until a resolution is passed. The fixed income market continues to price in increased credit risk in U.S. Treasuries as the X-date approaches. In the event of a prolonged debt ceiling battle similar to 2011, watch for large caps to outperform small caps, growth to outperform value, and defensive sectors to outperform more cyclical sectors.

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, May 4, 2023

Overview

• The Federal Reserve (Fed) increased its policy rate for the tenth consecutive time, pushing the upper bound of the fed funds rate to 5.25%, the highest since August 2007.
• In the press conference, Chairman Powell was careful to strike a balance between the committee’s commitment to fight inflation and the committee’s view that policy is sufficiently tight.
• So far, the labor market has been a bright spot for the committee, giving them reason to increase rates yesterday, despite uncertainty within the banking sector.
• It takes time for the real economy to react to tighter financial conditions so we can legitimately infer that the Fed can pause in June, especially since investors are still waiting for the cumulative impact of the last 10 hikes.
• Looking ahead, the Fed will release its updated Summary of Economic Projections at the next meeting, likely providing greater guidance for monetary policy over the balance of 2023.
• As inflation further decelerates, and the job market cools, investors should anticipate some rate cuts in the latter half of the year. We will not likely see a negative jobs report this coming Friday, but by summer, investors should expect a weaker labor market, giving support for those expecting rate cuts by the end of this year.

Softer Language

The Fed raised rates for the tenth consecutive time, pushing the upper bound of the fed funds rate to 5.25%, the highest since August 2007. Markets were not surprised by that decision but many took note of the conspicuous removal of the key word, “anticipates.”

Investors should note the evolution within the Federal Open Market Committee’s (FOMC) statements over the past several meetings. Let’s go back in time. In January, the “committee anticipates ongoing increases in the target range will be appropriate” and then in March, they thought “additional policy firming may be appropriate” and in May, they no longer anticipate additional tightening, but rather remain focused on economic and financial developments [emphasis added].

A key takeaway is the Fed has set themselves up for keeping their target rate unchanged in June. We already know the Fed is monitoring the long and variable lags to monetary policy, which is just another way of saying it takes time for the real economy to react to tighter financial conditions. So, if the Fed is concerned about the time it takes for tighter credit conditions to slow down the economy, we can infer the Fed will be inclined to pause at the next meeting and wait and see. The good news for market watchers is that the Committee will publish an updated Summary of Economic Projections at that June meeting, likely providing greater guidance on monetary policy for the balance of 2023.

Looking Ahead

Now this begs the question: what about July? That meeting is in late July and we expect that by then we will have slower inflation and weaker job growth.

During the press conference, Chairman Powell referenced the tight labor market as a reason to remain hawkish in the near term. As the Federal Reserve moves to restore price stability, they rely on a host of statistics to gauge risks to their outlook. One metric is the openings-to-unemployed ratio. This metric seeks to provide a concise reading of the supply and demand of the American labor market by measuring how many job openings exist per unemployed individual. In the fight against inflation, the Federal Reserve has regularly relied on labor figures when marking their progress. In comments from a November 2022 press conference, Powell remarked the labor market is “especially important” when looking at inflation. This ratio must fall further to convince the Fed that the labor market will not create inflationary headwinds.

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Conclusions and Market Implications

The U.S. is poised to slip into recession later this year, which has implications for future rate decisions. Markets are convinced the Fed will cut rates and we agree but perhaps not in the magnitude of cuts. How will markets react? Although 2023 has its fair share of risks, we do not think markets will retest last year’s lows, despite the likelihood of a recession later this year. Perhaps the relationship between the equity markets and the 1990-91 recession is most informative for today’s most likely scenario as shown in the chart below. As recession risks rise, we think the Fed will eventually cut rates later this year, which may provide some added support for markets.

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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.

Posted by Lawrence Gillum, CFA, Chief Fixed Income Strategist

Tuesday, May 2, 2023

In this week’s Weekly Market Commentary, we noted the seasonal stock market pattern in which stocks generally produce the best returns from November through April and the worst returns from May through October (although we note this pattern hasn’t been true recently). But most investors may not be as familiar with the seasonal patterns in fixed income markets. Because of the seasonal pattern in equity markets, changing investor sentiment has translated into a strong demand tailwind for fixed income markets and the summer months have generated, on average, some of the best monthly returns of the year.

As seen in the chart below, some months appear more or less favorable for core fixed income, as measured by the Bloomberg U.S. Aggregate Bond Index, with August generally being the best performing month. However, May through August has, historically, represented the best stretch of average returns for the index over the last 20 years. Moreover, that stretch has also seen the highest median returns (averages can be misleading when you’re dealing with smaller numbers) and, except June, have seen the fewest negative monthly returns.  All this suggests the preferred destination for the “sell in May” crowd may be the fixed income markets.

View enlarged chart

Now, we would certainly not advocate repositioning portfolios due to these popular patterns because, again, average returns can be misleading, especially during a year that feels anything but average. So, whether the seasonal patterns in the equity or fixed income markets persist this year or not, we think owning core bonds in a diversified portfolio makes sense. The fact that fixed income markets have performed best over the summer months, when equity market volatility has tended to increase, is no coincidence. Core bonds have historically been the best diversifier to equity market risk and despite that lack of protection last year, we think the back up in yields now allows bonds to regain that role in portfolios.

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.

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.

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.

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