Wealth Management

Posted by Adam Turnquist, CMT, VP Chief Technical Strategist

Friday, March 10, 2023

Key Takeaways:

• The shift of consumer spending from goods to services has helped revive travel demand. This trend likely has staying power.
• Flight bookings have tripled over the last few years, with leisure travel now back above pre-pandemic levels.
• Load factors, which reflect the percentage of available seats an airline sells on a flight, have climbed to their highest levels since 2019.
• The outlook for airline industry revenues and earnings remains bullish.
• The technical setup for airline stocks points to further outperformance ahead.

Background

After a turbulent descent during the pandemic, the airline industry is finally showing signs of recovering. The transition of consumer spending from goods to services has helped revive travel demand. This trend likely has staying power. According to LPL Research Chief Economist Jeffrey Roach, the share of services spending is still roughly 2.5 percentage points below pre-pandemic levels, meaning consumers would need to spend $450 billion on services to normalize the composition of goods and services spending (see the latest Weekly Market Commentary for more details).

Scheduled Flights are Taking Off

The shift to services spending is evident in scheduled flight data. The chart below highlights the number of scheduled flights booked from May 2020 to August 2023, broken down by all global flights and flights within North America. During this timeframe, scheduled flight bookings for both geographic segments have more than tripled.

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Recovering at a Leisurely Pace

Leisure travel bookings have been a major diver of the recovery in airline demand. The chart below depicts the variance in the total number of leisure and corporate airline tickets purchased compared to the same period in 2019. For example, if the total number of leisure travel tickets sold in December 2019 was 100,000 and the total number of leisure travel tickets sold in December 2022 was 125,000, the leisure line would be at +25%. As highlighted below, the number of leisure travel tickets sold has fully recovered from the pandemic and is now back above 2019 levels. The total number of corporate tickets sold is trending in the right direction but remains 26% below bookings in 2019.

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Flight Path to Profitability

So consumers are spending more on services and flying more—but are airlines making money? The short answer is yes, based on an improving trajectory of available seat miles (ASM) and revenue passenger miles (RPM). ASM represents the total miles of a flight multiplied by the number of available seats on the flight, which ultimately equates to the airplane’s carrying capacity. RPM represents the number of paying passengers on a flight multiplied by the total miles of the flight. If you divide the RPM by ASM you get the load factor, which reflects the percentage of available seats an airline sells on its flight. The higher the load factor the better the airline is at selling seats and generating revenue.

The chart below highlights the ASM, RSM, and load factor trends for the broader airline industry. All three metrics are trending higher, including the load factor, which recently reached its highest level since 2019 (the load factor non-normalized reached 83.5% at the end of 2022).

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The improving load capacity is also showing up in estimates. For the S&P Composite 1500 Airlines Index, sales are expected to climb 28% in both 2023 and 2024, with earnings expected to more than double in 2023.  Glen Hauenstein, President of Delta, one of the world’s largest airlines, echoed the improving industry outlook on their latest earnings call in January. Hauenstein noted, “Consumer demand remains healthy with advanced bookings significantly ahead on both yield and load factor for each month of the March quarter compared to 2019. And in our recent corporate survey, results were positive with 96% of respondents expecting to travel as much or more in 1Q than 4Q, led by financial services. In the new year, bookings reflect the survey optimism and are accelerating.”

Technical Setup

The technical setup for the broader airline space is also improving. The S&P Composite 1500 Airlines Index, shown below, recently broke out from a bottom formation after reversing a two-year downtrend. Momentum is confirming the trend reversal, evidenced by the 50-day moving average crossing above the 200-day moving average (golden crossover) and a recent Moving Average Convergence/Divergence (MACD) buy signal. In addition, relative strength has turned bullish, as the S&P Composite 1500 Airlines Index vs S&P 500 ratio chart has formed a new uptrend, suggesting further airline outperformance ahead.

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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 Jeffrey Buchbinder, CFA, Chief Equity Strategist

Wednesday, March 8, 2023

On March 17, S&P Dow Jones Indices and MSCI will make changes to GICS sector classifications. These changes don’t happen very often so they are noteworthy when they occur. Some of the more recent changes included the reconstitution of the communication services sector, which used to be just telecom, but was expanded to include digital media/interactive entertainment (streaming), and the creation of the real estate sector, which was carved out of the financials.

Here are the changes that will take place next month from Dow Jones and MSCI:

• The Data Processing & Outsourced Services group within the information technology sector will be dissolved and the stocks will be reallocated to financials and industrials. Companies that provide services primarily related to payment processing will join the financials sector under a new group entitled “Transaction & Payment Processing Services.” The reclassification will add several growth stocks to the traditional value stocks in financials (which will be officially renamed “financial services”), most notably Visa (V), MasterCard (MA), and PayPal (PYPL).
• Stocks that offer services focused on human-capital management will move to the industrials sector. Within the S&P 500, this change affects three stocks representing less than 2% of the current info tech sector. Automated Data Processing (ADP) is the largest of these stocks.
• Some consumer discretionary stocks will shift to the staples sector. Within the S&P 500, the affected companies represent less than 5% of consumer discretionary market cap: Target (TGT), Dollar General (DG), and Dollar Tree (DLTR). It never made sense to us to separate Walmart and Target so now they are together as they probably should be.

Implications

The most notable change here is fintech and credit card processing names are moving to financials, giving the sector a bit of a growth boost. On the surface it might seem like the sector would become less interest rate sensitive because it will be less lending heavy, but the move may not affect interest rate sensitivity much. The growth names carry some rate sensitivity because of how much of their value is derived from profits well into the future. The move to financials for these stocks will make active managers who own these names more overweight financials (or less underweight) and less overweight (or more underweight) tech.

This may not sound like a big deal but it is for money managers who are benchmarked against sector performance. These changes are not as dramatic as the previous dramatic overhauls, but they are still meaningful. Tens of billions of sector strategies follow these indices so no doubt some money will be moving around to match these changes.

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LPL Research’s Strategic and Tactical Asset Allocation Committee (STAAC) has a positive view of the industrials sector, is neutral on consumer staples and financials, and negative on consumer discretionary and technology. The technology sector is a candidate for a potential upgrade based on improved technical analysis trends. The sector changes are not significant enough to drive a change in our sector views.

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, March 3, 2023

Key Takeaways:

• Buybacks are back after most companies suspended share repurchase programs in the wake of the pandemic. Total S&P 500 buybacks jumped from $513 billion in 2020 to $918 billion in 2022.
• From a pure performance perspective, the S&P 500 Buyback Index has historically provided excess returns over a long-term investment horizon, including notable outperformance over dividend growth stocks.
• Rising free cash flows should continue to support buybacks this year. However, Washington’s new 1% tax on net buybacks, rising interest rates, and the prospect of a recession could negatively impact repurchase activity. In addition, buybacks are also competing with a ramp-up in corporate capital expenditure spending.
• The technical setup for the S&P 500 Buyback Index remains bullish and points to continued relative outperformance over the S&P 500.

Background

Share repurchases were cast into the spotlight this week after Warren Buffet pushed back against recent political criticism of corporate buyback programs. The “Oracle of Omaha” penned a rebuttal in his closely watched annual letter to Berkshire Hathaway shareholders where he emphasized that gains made from ‘value-accretive repurchases’ benefit all owners and not just CEOs. Buffet further added more colorful commentary aimed at critics, stating, “When you are told that all repurchases are harmful to shareholders or to the country, or particularly beneficial to CEOs, you are listening to either an economic illiterate or a silver-tongued demagogue (characters that are not mutually exclusive).” The pushback comes after President Biden’s State of the Union address last month, where he criticized corporate buyback programs and proposed a plan to quadruple the new 1% tax on share repurchases.

We will leave the debate over the benefit of buybacks between Washington and Omaha and look at share repurchases from a performance perspective.

Performance

The chart below shows the long-term performance of the S&P 500 Buyback Index compared to the S&P 500, S&P 500 Equal Weight, and S&P 500 Dividend Aristocrats indexes. For reference, the S&P 500 Buyback Index represents an equally weighted and quarterly rebalanced basket of the top 100 stocks with the highest buyback ratio (cash paid for common shares during the last four calendar quarters divided by the total market capitalization of common shares). The S&P 500 Dividend Aristocrats Index measures the performance of S&P 500 constituents that have consistently increased dividends for at least 25 consecutive years.

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The S&P 500 Buyback Index has widely outperformed over the last several decades, amassing a price return of 2,328% since 1995, more than doubling the returns of the other indexes. For additional context, the total return of the S&P 500 Buyback Index during this period was 2,763%, compared to total returns of around 1,400% for the other indexes. From a pure performance perspective, the data shows that buybacks have historically provided excess returns over a long-term investment horizon, including notable outperformance over dividend growth stocks.

What Sectors are Buying Back Stock?

Buybacks are back after most companies suspended share repurchase programs in the wake of the pandemic. Total S&P 500 buybacks jumped from $513 billion in 2020 to $918 billion in 2022. According to S&P Dow Jones Indices estimates, buybacks on the S&P 500 will likely exceed $1 trillion in 2023.

The chart below breaks down total buybacks across the S&P 500 sectors since 2020. Technology companies have dominated buyback activity, including nearly $250 billion of share repurchases recorded last year. Technology will likely have another big buyback year in 2023, along with energy, communication services, financials, and health care.

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Follow the Money

Rising free cash flows should continue to support buybacks this year. However, Washington’s new 1% tax on net buybacks, rising interest rates, and the prospect of a recession could negatively impact repurchase activity. In addition, buybacks are also competing with a ramp-up in corporate capital expenditure (Capex) spending, as shown in the chart below.

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Technical Setup

The S&P 500 Buyback Index is trending higher after breaking out from a bottom late last year. The recent pullback from overbought levels has found support near a developing uptrend and the 50-day moving average. We believe the recent weakness represents a buying opportunity.

Relative strength also remains bullish. The S&P 500 Buyback Index vs S&P 500 Equal Weight (SPW) ratio chart remains in an uptrend with positive momentum, suggesting the trend of buyback outperformance will likely continue.

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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 lplresearch

Thursday, March 2, 2023

As the long-term effects of the pandemic continue to unfold, one trend that has been adopted by multinational companies is to repatriate their supply chains in an effort to avoid future disruptions. In both the U.S. and in developed international countries, companies are increasing their focus on supply chain resiliency which often comes with higher material and labor costs. Inflation pressures are already hitting margins, and revenue growth is slowing, making this a challenging transition.

Within Asia, geopolitical tensions have encouraged movement away from China and into other countries within emerging markets. This shift has been welcomed by countries like India where exports to the U.S. increased 43% year-over-year and Vietnam where exports to the U.S. increased by 28% year-over-year in 2021, as shown in the chart below.

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While imports from China into the U.S. broadly increased in 2022, the year-over-year rate of change has slowed and even turned negative in October.

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U.S. firms are also nearshoring to Mexico and Canada in an effort to minimize the potential for supply chain disruptions without dramatically increasing input prices and labor costs. The U.S. has begun to increase imports from both countries, with Tesla’s (TSLA) announcement of a significant investment in Mexico a recent example.

Reshoring and nearshoring increase the potential for margin compression as increased input and labor costs erode earnings. While insulating supply chains from disruption has the potential to improve total revenues as supply constraints abate, we would expect margins to come under pressure when supply chains are moved closer to home. Profit margins for S&P 500 Index companies have already narrowed by more than one percentage point over the past year and, depending on the path of inflation, could narrow further.

China’s reopening could work to offset some of the trends that defined 2022. For instance, the China Manufacturing Purchasing Manager’s Index (PMI) released this week surprised to the upside as manufacturing moved into expansionary territory with China’s reopening. As supply chains are reworked, geographic shifts in demand will be an important area of focus.

Given geopolitical risks, as well as earnings weakness and an uncertain path for the U.S. dollar, LPL’s Strategic and Tactical Asset Allocation Committee (STAAC) maintains an underweight recommendation to emerging market equities. Alternatively, STAAC maintains a positive view on the industrials sector, which could stand to benefit from the increased investment in domestic supply chains.

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 George Smith, CFA, CAIA, CIPM, Portfolio Strategist

Thursday, March 2, 2023

As a rough February for the markets draws to a close, with a 2.3% decline in the S&P 500 Index, we look at what clues seasonality data may give us for stock market performance over the coming months. Turns out that while, historically, March has been a pretty strong month for stocks, in recent years, seasonality trends have seen weaker average returns, before bouncing back with a stronger April.

Based on seasonals it was perhaps no surprise that stocks struggled in February. Looking at average returns by month, dating back to 1950, February is one of only two months (along with September) to post average declines. Over the most recent history of the last 5 and 10 years, February has posted the worst or second worst monthly returns, and the two month period of January to February has been the worst such period over the past 10 and 20 years.

Historically, March has been a strong month for average returns, in the top four or five months, but in the past 5 years it has slipped to be the third worst. In fact, the February to March period has been the worst two month period over the past 5 years. More encouraging is the March to April two month period that has been the second strongest (behind only November to December) over all periods dating back to 1950, and over the past 20 years it has been the strongest two month period. Over more recent periods the weaker March returns have been a drag before a strong April. April has consistently been the second or third strongest month over all the time periods studied. In recent years, May and June have historically been weaker months prior to a blockbuster July.

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Taking a look at this from a slightly different angle, March has been the fourth strongest month as measured by the percentage of positive S&P 500 Index monthly returns (going back to 1950). Although this data has been weakening in recent years, a solid 60% of March monthly returns have been positive over the past 5, 10 and 20 year periods. April is the second best month since 1950, as measured by this statistic, and has been strengthening in recent years. Last April’s negative return (-10.8%) was the first negative April in 10 years and only the second in the prior 17 years.

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As we highlighted in prior to the midterm election last year, a favorable historic longer term trend for stocks is looking at returns a year after the midterm election. Since 1950, stocks have had a positive return one year after the midterm election every single time, with an impressive average of almost 15%. So far, since the midterm election, stocks returns are positive, just by 0.5%, but there is still a long way to go to November.

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Another positive sign from the current stage of the presidential cycle is that we have moved into the stage where historic trends have been a tailwind for stocks. Under new presidents, markets historically struggled in the second year coming into the midterms, as they did last year, before seeing strong returns in the second half of the presidential cycle. In data going back to 1950, year three of a new president’s term has seen the best annual returns of the periods studied—posting an average gain of over 20%.

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In summary, the immediate seasonal picture for March is mixed, but longer term data around the stage of the presidential cycle is more positive, as are the strong returns that April often brings. We maintain a positive but cautious view on equities, as markets could remain volatile as the Federal Reserve tries to break the back of inflation without a deep and/or prolonged recession. Such a recession is not our base case and we see a return to a lower volatility environment as likely, but investors will probably have to wait until later this year for clarity on the ultimate destination of interest rates. Meanwhile, prolonged debt-ceiling debates may cause flare-ups in volatility.

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 Lawrence Gillum, CFA, Fixed Income Strategist

Tuesday, February 28, 2023

Bond investors experienced the worst year ever for core bonds last year (as per the Bloomberg Aggregate Bond Index), -so the prospects of another year like 2022 could be hard to fathom. The good news is we don’t think we’ll see another year like 2022 anytime soon, but despite the higher starting yield levels, we could see periods of negative returns. In fact, after a strong January for core bonds, unless yields fall dramatically today, February returns will be negative. But that is normal. Since inception of the index in 1975, over a third of the monthly returns have been negative and close to 25% of quarterly returns have been negative. Bonds trade daily and interest rates change throughout the day as well, so that means the market value of a bond will change daily as well.

However, fixed income instruments are fundamentally different than other financial instruments. Bonds are financial obligations that are contractually obligated to pay periodic coupons and return principal at or near par at the maturity of the bond. That is, there is a certainty with bonds you don’t get from many other financial instruments—and that is starting yields (yield-to-worst more specifically, which is the minimum expected yield that can be received from a bond absent an issuer defaulting on its debt). Starting yields take into consideration the underlying price of the bond as well as the required coupon payments, therefore, starting yields are the best predictor of future returns. Starting yields and subsequent returns for the Bloomberg Aggregate Bond Index have a very tight relationship. For holding periods as short as five years or as long as ten years, starting yields explain approximately 94% to 95% of returns for the index. That relationship breaks down over shorter periods though with only approximately 40% of 1-year returns explained by starting yields—there is much more variability (noise) over shorter horizons. But if you buy and hold a fixed income investment, the short-term volatility you experience due to changing interest rate expectations is just volatility. It has very little bearing on the actual total return if held to maturity (or if held to the average maturity of a portfolio of bonds).

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After the historically awful year for fixed income investors last year, it may be disheartening to see another month (or more) of negative returns. We would advocate for a longer-term perspective though. Current yields within many fixed income markets are at generationally high levels. Investors can take advantage of these high starting yields but only if they stay invested and look past the (normal) short-term volatility that happens on occasion.

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.

Posted by Adam Turnquist, CMT, VP Chief Technical Strategist

Friday, February 24, 2023

Key Conclusions:

• Recession risk remains front-page news as rising interest rates weigh on economic growth. However, outside of economic data, rising copper prices over the last several months suggest the economy may be doing better than headlines suggest.
• Copper is widely considered a leading indicator for global economic growth based on its extensive use across many sectors, giving it the popular “Dr. Copper” moniker for its “PhD” in economics. Rising copper prices are generally associated with economic expansion and a risk-on backdrop.
• Technically, copper prices are trending higher after climbing out from a bear market late last year. Supply and demand dynamics appear supportive for the strength to continue. Historically, an uptrend in copper does not portend a recession.
• The copper-gold ratio chart is also trending higher, providing additional evidence the economy may be in better shape than expected. However, be careful what you wish for, as the copper-gold ratio chart is also positively correlated with 10-year Treasury yields.

There is no shortage of headlines reminding investors a recession is imminent. Yield curves remain inverted, manufacturing activity is contracting, the housing market is tumbling, and other leading economic indicators continue to decline, all while the Federal Reserve (Fed) continues to raise rates to combat historically high inflation. While inflation data is heading in the right direction, the downward trajectory of reduced pricing pressures may be turbulent, evidenced by today’s hotter-than-expected core personal-consumption expenditures price index. The stubbornly strong jobs market further complicates the inflation outlook, leaving the Fed with little justification to deviate from their higher for longer inflation fighting mantra.

Will all this tightening lead to a Fed-induced recession? Signs outside of economic data suggest the economy may be doing better than headlines indicate. One of those signs comes from copper, which is widely considered to be a leading indicator for global economic growth, given its extensive use across many sectors. Copper’s unique properties make it a fundamental raw material ingrained in nearly everything we use—from electricity, drinking water, heating and cooling systems, and transportation. According to Copper.org, the average single-family home uses 439 pounds of copper.

Technical Setup for Copper

As shown in the chart below, copper prices have been rising steadily following a 37% peak-to-trough drawdown that ended in July. Futures have recently reversed a downtrend and are trading above their 50- and 200-day moving averages (dma). Managed money futures in copper turned net long last fall and continue to build (total speculator long positions are greater than total speculator short positions). Of course, China’s reopening has helped drive demand, along with a drop in the dollar, the ongoing global energy transition, and a favorable supply backdrop. However, whatever the catalysts may be, a bullish uptrend in copper has not historically foreshadowed a pending recession. In fact, at the onset of the last four recessions, copper futures were trading below their 50- and 200-dmas.

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Is Copper Pointing to a Rebound in Manufacturing?

Given copper’s classification as a leading economic indicator and its vast use in manufacturing, it may come as no surprise that changes in copper prices align closely with changes in the Institute for Supply Management (ISM) Manufacturing Purchasing Managers Index (PMI). The chart below highlights this relationship using a 12-month rate of change comparison for copper (top panel) and the ISM Manufacturing PMI. As you may notice, major tops and bottoms tend to form simultaneously, although there recently has been a growing divergence due to the slowdown in manufacturing activity. While it may take more time for this divergence to be resolved, the continued strength in copper certainly helps make a case for a rebound in manufacturing activity. The ISM will release the February Manufacturing PMI data on Wednesday, March 1. Estimates as of February 24 point to another contractionary print of 47.8 (readings of 50 or less are considered contractionary).

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Copper, Gold, and Treasury Yields

Copper is also often compared to gold for assessing risk appetite and where the economy is at within the business cycle. In general, rising copper prices are associated with an expanding economic cycle and a risk-on backdrop, while rising gold prices are associated with slowing economic growth and a risk-off backdrop. Combining the two in a ratio chart, as shown below, helps identify each risk appetite regime. The copper-gold ratio chart is currently trending higher and above its 50- and 200-dma, implying a risk-on backdrop. There is key resistance hovering overhead, and a breakout above this range would be a bullish sign for the economy. However, as shown in the lower panel, be careful what you wish for as the copper-gold ratio chart is also positively correlated with Treasury yields. While the correlation has weakened a bit recently, further upside in the ratio chart points to directionally higher yields, which could create headwinds for the equity market recovery.

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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 Barry Gilbert, PhD, CFA, Asset Allocation Strategist

Thursday, February 23, 2023

The Conference Board’s Leading Economic Index (LEI) for January was released Friday, February 17, 2023. The LEI is an aggregate of 10 economic and market indicators that tend to lead changes in economic activity. The index declined 0.3% for the month and 5.9% for the past year, a slight improvement from the one-year change the previous month. Despite some signs of improvement, the Conference Board noted that their LEI has exhibited the depth, duration, and dispersion that has acted as a reliable indicator of elevated recession risk in the past. (See the Conference Board’s commentary here. For a quick take on the current economic outlook, see LPL Chief Economist Jeffrey Roach’s recent blog here.)

The LEI report left a similar impression as Bloomberg’s latest survey of economists. In the February survey, U.S. and global growth expectations for 2023 had improved but remained tepid. The median estimate of the likelihood of a recession in the next year had ticked down from 65% in January to 60% in February, a positive direction, but still indicating elevated risk. Despite the improvement, a recession remains more likely than not as markets price in more aggressive Federal Reserve policy as it continues to try to tame inflation.

What’s the market takeaway of being in a period of elevated recession risk at current levels? Weakness in leading indicators at roughly the current level have signaled near term risk for markets, with six-month forward returns below average, but looking out over the next year, economic signals may have reached a level where weakness is so readily apparent that it may actually be good for markets in the longer-term. In fact, as shown in the chart below, the current level of the LEI is about where the divergence between historical S&P 500 performance over the next six and twelve months is widest. So indicators suggest choppy markets in the near term but market appreciation by end of the year.

More specifically, we looked at key declining crossovers for the LEI—the one-year change moving below a key level for the first time in over a year. The sample here is small and can be taken only as a rough guide to the potential outlook. Currently, the year-over-year change in the LEI recently crossed below both -5% and -6%, represented by the boxed area below. You can see returns over the next six months (orange line) at this level remain muted, but it is also the level at which returns over the next year (blue line), on average, start to look attractive.

View enlarged chart

Despite the small sample, we think the assessment of market risk historically related to the LEI is sensible and generally in line with other indicators we are watching. There is some reason for optimism one year out, among them that elevated risk of a recession is near consensus, even if the potential damage for higher rates has not worked its way through the economy yet. But near term equity markets may have come too far too fast and the economic outlook still has downside risk. Looking a year out, we maintain cautious optimism, but history says markets may still have some rough patches to get through on the way there.

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.

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Posted by Jeffrey J. Roach, PhD, Chief Economist

Tuesday, February 21, 2023

The “Landing” Analogy

We need to go back a few years to recall the time investors began using the “landing” analogy. During the hot summer of the mid-1990s, the Honorable Alan Greenspan spoke to the Economic Club of New York, where he was introduced as “the pilot we are all counting on for that very smooth and we hope very soft landing.”[1]

Perhaps that was not the first time market watchers used the term, but the conversations at the Economic Club of New York were prescient. The hope for a soft landing came to fruition. The economy started overheating in 1994, so the former chairman of the Federal Reserve (Fed) raised rates, cooled the overheated economy, and the country escaped a second recession that decade.

View enlarged chart

What is a Soft Landing?

A soft landing is when economic growth slows but remains positive as the economy sets up for a long-term sustainable growth path. In contrast, a hard landing means the country falls into recession to break the overheated economic machine. One assumption behind the analogy is an overheated economy is not on a sustainable growth path so policy makers ought to tighten financial conditions to improve the chances the economy can maintain a stable growth rate.

Why a “No Landing” Makes No Sense.

Suggesting an economy makes “no landing” makes no sense. Analogies eventually break down, especially this one. Economic activity does not stop like an airplane eventually does, but rather the economy eventually settles in a steady state where growth is consistent with factors such as population and productivity.

So perhaps it’s time to rethink. One suggestion is using the analogy of a runner. Runners often talk about the various phases of the race. One important phase is when runners transition from the acceleration phase, when runners focus on increasing stride length and frequency, to a steady state, when runners focus on maintaining stride length and frequency over time.

What does this mean for you?

The Fed wants to tighten financial conditions so the economy can smoothly transition from the post-pandemic reopening phase, when the economy grew 5.9% in 2021 and 2.1% in 2022, to a more sustainable rate that neither stokes inflation nor stalls economic growth.

If the economy can break the back of inflation without a deep and prolonged recession, investors will likely experience markets that could return to lower volatility and improved conditions for both bond and equity investors. We think this could be a likely outcome, notwithstanding unforeseen global shocks.

[1] https://www.econclubny.org/documents/10184/109144/1995GreenspanTranscript.pdf

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.