Multifamily Construction Rising, Bucking Trend of Single Family
It’s no surprise that residential activity is slowing. The housing market is coming off a euphoric run during the post-pandemic period of historically low interest rates. But, the slowing housing activity does not look as bad when compared with 2019. Still, housing starts were over 6% above the November 2019 levels, illustrating this unique cool-down period amid a nationwide housing shortage. Rising borrowing costs and hesitant home builders could make the nationwide housing shortage worsen in the near term as activity likely cools further.
Higher mortgage rates and uncertain economic prospects impacted the housing market and will continue to depress housing in the months ahead. As home sales stalled in recent months, housing starts and permits have also stalled. But that’s just at the aggregate level. Can we uncover any other trends in the details? Yes. Housing activity for multifamily dwellings improved in November and has been growing for the past few years as builders respond to the acute shortage in this sector. Single-family construction spending has consistently shrunk for the last several months. (See chart below.)
Rising Multifamily Construction Will Likely Suppress Rents
Building activity for 5+ units maintains its uptrend and an increase in supply of units should put a damper on future rent prices. November construction spending rose 0.2% from a month ago, supported by strong multifamily building projects. Multifamily construction spending is up over 8% from three months ago, as building activity for 5+ units remains strong.
Construction spending on manufacturing plants has also grown considerably over the last year. Firms are building manufacturing plants as reshoring is attractive, despite rising labor costs. This building activity, which helped contribute to solid performance for the industrials sector in recent months, should support job creation in the construction space amid a broader slowdown.
Conclusion
It’s the tale of two residential construction economies. Construction activity for single family homes is shrinking but apartment and condo construction spending is on the rise. The diverging trends will likely attract investors’ attention. Construction firms with a diversified portfolio should be able to weather any upcoming economic storm better than firms focused on single family home building. The recent trends will also affect inflation this year. Roughly one million apartments were under construction in November, roughly four times the amount from ten years ago. Increased supply in multifamily construction should ease future rent prices as vacancy rates rise.
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.
As of November, the Conference Board’s Leading Economic Index (LEI) continues to decline, signaling an impending recession. However, the current state of the economy is somewhat solid as firms add to their payrolls and consumers spend on both goods and services, despite high inflation. Consumer debt ratios are lower than previous periods of weakness and suggest that a bloated stock of savings and high nominal wage growth continues to buffer the consumer from high prices. But the outlook is gray as the LEI illustrates. So what do we make of the current situation?
Tracking the Three D’s of Recessions
The National Bureau of Economic Research (NBER) is the official arbiter for the U.S. business cycle and this group will most likely declare the economy will dip into a recession in 2023. When determining the state of the economy, the NBER looks at three factors–the three D’s–which are depth, diffusion, and duration. The Conference Board’s Leading Economic Index (LEI) is often a favorite metric for two of the three D’s. The six-month percent change of the LEI shows depth and duration. As of November, the six-month percent change is -3.7%, indicating rising recession risks. The six-month change has never been this low without a recession materializing soon thereafter. Falling building permits and rising unemployment insurance benefits claims were the main contributors to the decline in November.
An oft-overlooked component of the LEI can also shed light on the third D, the diffusion of an economic contraction. Diffusion is a measure of breadth. Earlier in 2022, the housing market was contracting but other areas of the economy were not, thus, economic weakness was not widespread. Since the economy was not experiencing a broad-based decline, the economy was not likely in recession.
The LEI is made up of 10 leading indicators and if a majority of indicators are declining, the diffusion of the LEI is below 50. As stated by the Conference Board, “the diffusion index of the LEI ranges from 0 to 100 and numbers below 50 indicate most of the components are weakening.”
Now that the economy is satisfying the 3 D’s of a recession, investors should anticipate the rising risks that the economy could fall into recession in 2023.
The U.S. is not currently in recession, given the strength of the consumer sector, but a recession looks increasingly likely in the New Year. The trajectory for growth looks weak. A deteriorating housing market, nagging inflation, and an aggressive Federal Reserve (Fed) puts the economy on unsure footing for 2023. The silver linings are markets have possibly priced in much of the near-term recession risks and the Fed will likely further downshift the pace of its future rate hikes.
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.
Most investors would like to put 2022 behind them. Before we close the book on the year, we’ve assembled 10 charts that defined the year—the year in pictures. Not surprisingly, most of the charts remind us of how difficult the year was for both stock and bond markets. However, we have included some positive messages in several of these charts, including the energy sector’s strong performance, the resilience of alternative investments, and the stock market’s impressive record of strong bounces coming out of bear markets.
1) Energy sector laps the field
The energy sector delivered remarkable gains in 2022, returning more than 60% to significantly outperform every other S&P 500 sector—no other sector has gained even 5% year to date as of December 27. Not only did energy stocks surge, they did so without help from rising oil prices. West Texas Intermediate (WTI) Crude Oil currently sits near $78, only a few dollars over where WTI crude oil started 2022 at around $76.
The energy sector may still have a spark in it and keep its momentum in 2023, bolstered by a potential rebound in Chinese demand. The path of the war in Ukraine remains a wildcard. LPL Research’s Strategic and Tactical Asset Allocation Committee maintains its overweight recommendation for the energy sector.
2) One of the most dramatic Fed rate hiking cycles ever
With inflation reaching levels not seen in 40 years, the Federal Reserve (Fed) took aim at a soft landing and believed there was a plausible path to avoid a recession. With that goal in mind, the Fed instituted a series of interest rate hikes that were the most aggressive in decades.
More rate hikes are coming, though the pace will likely slow to 0.25% increments after New Year’s. We don’t expect the Fed to cut interest rates until mid-to-late 2023 at the earliest.
Few, if any, historical indicators have been as good at signaling a recession as inversions in the U.S. Treasury yield curve—when short-term interest rates are higher than long-term rates. Although a recession in 2023 has become a consensus call based on a variety of economic indicators, the yield curve may be the most convincing. The 3-month/10-year curve inversion—historically the most predictive measure of the yield curve—is currently -0.65% (4.5% vs. 3.85% as of December 27), a strong indication of a potential recession in 2023.
In the event a recession does occur, it may be mild based on the strength of the consumer, still-healthy labor markets, and the amount of time corporate America has had to prepare for a widely-anticipated economic downturn.
When stocks are down investors typically re-allocate to bonds, as bonds have historically exhibited a negative correlation to their stock counterparts. Unfortunately for traditional investors, that relationship did not hold in 2022, as both bonds and stocks have suffered double-digit losses over the calendar year with just three trading days left. Only four other times since inception has the Bloomberg (formerly Barclays/Lehman) Aggregate Bond Index (Agg) realized a negative calendar year return, with 2022 realizing the worst return by far. The previous worst year on record was 1994 with a 2.9% loss, far better than 2022’s year-to-date loss of nearly 13%.
2022 has made many investors question whether the 60/40 portfolio was dead. This year has been unprecedented in many ways. Since the inception of the Agg, the S&P 500 and the Agg have never been negative in the same year. Not only did that happen this year, it was also the third worst year for stocks and the worst year for the Agg since its inception in 1976. We believe the 60/40 portfolio still has some life in it and will fare much better in 2023 with support from both stocks and bonds.
If the rise in interest rates—closely tied to inflation—wasn’t the biggest story for capital markets in 2022, then it was second. Surging interest rates pressured stock valuations and caused significant losses in the bond market while putting significant pressure on the housing market by sending mortgage rates skyrocketing higher. In fact, the rate on a traditional 30-year fixed-rate mortgage rose from around 3% to a recent quote of over 7%. Although housing prices have not come down much in most markets around the country, they are unlikely to generate any gains in the coming year if mortgage rates stay high. Some of the downside pressure in home prices has been mitigated by geographic reshuffling.
It will come as no surprise to anyone reading about the performance of capital markets in 2022 that inflation showed up in a list of 10 charts that defined 2022. The accompanying chart really puts it into perspective, as you have to go back to the 1970s to find bigger price surges. Supply chain and labor disruptions from the COVID-19 shutdowns, pandemic stimulus, and the impact on energy prices from Russia’s Ukraine invasion were among the primary causes.
But where does inflation sit as of today? After many months of inflation coming in above expectations, investors finally got another favorable report with the November data reported earlier this month. Inflation is indeed easing and the Fed is on track to downshift the pace of rate increases.
Overall, investors should respond favorably to these encouraging moves in consumer prices. Inflation and stock valuations have historically exhibited strong inverse correlations (the story is the same with interest rates and stock valuations).
The U.S. dollar had one of its strongest rallies in history in 2022, surging 18% from the start of the year through its 2022 peak in late September. Those extraordinary gains have subsequently been cut in half (with 3 trading days left in the year), leaving the greenback up a still-very strong 9% this year. The reversal coincided with the Fed shifting to a less hawkish stance and signaling smaller rate hikes going forward. Going a step further, the fed funds futures market has priced in cuts in the fed funds rate (the rate the Fed controls) in the second half of 2023, which could explain some of the recent weakness in the dollar.
The dollar influences markets and economies in several ways. One way is through currency translation of foreign-sourced profits. A strong dollar hurts earnings for U.S. multinationals operating outside the U.S. (and vice versa for a weak dollar). The dollar’s strength was a big reason why S&P 500 earnings grew only 2-3% during third quarter 2022.
The dollar also influences returns on international investments for U.S.-based investors, and trade, as a weaker dollar supports exports, while a strong dollar is a drag on exports. Finally, the dollar influences inflation by affecting the cost of U.S. imports for domestic consumers and businesses.
The S&P 500 entered a bear market in June of this year and, despite a valiant effort in August, was unable to dig its way out. We mark a bear market by a 20% or more decline from the closing high price for an index and the index exits a bear once a rally of 20% or more is achieved. The bounce off of the June 2022 lows through mid-August reached 17% but failed to broach the 20% level. At nearly one year old, the current bear market is now longer than the average post-WWII bear (11 months). At the October S&P 500 lows, the 25.4% peak-to-trough decline was larger than the average non-recession bear market decline since WWII (23.8%) and four percentage points shy of the average decline for all post-WWII bear markets (29.4%).
That’s the bad news. But keep in mind stock market rebounds following bear markets have been powerful historically. The S&P 500 has bounced back an average of more than 20% within 12 months coming out of bear markets. Looking at just the last seven bear markets since the 1987 crash, we have seen the market bounce back an average of 43.6% after dropping 33.1%. LPL Research expects the S&P 500 to produce double-digit gains in 2023, which seems quite reasonable based on this analysis.
10) Alternative investments have been resilient performers as advertised
It’s no surprise that liquid alternative strategies have held up better than equities in 2022 given the bear market in stocks. However, liquid alternatives have also had quite a run against traditional fixed income strategies. While fixed income, as measured by the Bloomberg U.S. Aggregate Bond Index, took a tumble, liquid alternatives largely remained flat, with some categories even providing small positive absolute returns. In 2023, we’ve advocated for market-neutral, event-driven, and multi-strategies as top picks in the alternative investments space.
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.
History Says 10-Year Treasury Yield More Likely to Fall
The 10-year Treasury yield has moved dramatically in 2022. But while the size of the move is in rare territory, it is far from unprecedented. The 10-year Treasury ended 2021 at 1.52%. The closing yield on Friday, December 23 was 3.75%, which would give us a calendar year advance to date of 2.23% (2.23 percentage points). As shown in the LPL Research Chart of the Day, that would make it one of the highest rolling one-year changes, based on data since 1963, but still below the peak one-year change in early November of 2.72 percentage points and well below the peaks seen in 1980 and 1981.
But most investors don’t want to know where the 10-year Treasury yield has been, as interesting as it might be, but where it’s going. To get our bearings, we looked at a range of historical increases in the 10-year yield over a year and what it’s done in the following year. At a 0.5 percentage point (0.5%) move or higher in the last year, there has not been a clear historical bias toward higher or lower in the next year, but as the prior year move goes up from there, it became increasingly likely the 10-year yield would decrease in the next year, as did the average size of the decrease.
In the territory where we are now, the 10-year yield has averaged a decline of almost a full 1% over the next year, although about 1/3 of the time it’s actually been higher. Rates aren’t on a strict clock for when extended periods of higher rates will end, but additional moves higher have tended to be muted. It’s also important to recognize that in most prior cases of moves of at least 2% the starting yield was at a much higher starting level, leaving greater scope for the size of a potential decline.
As discussed in our Outlook 2023: Finding Balance, LPL Research expects the 10-year Treasury yield to end 2023 at 3.25–3.75%, which is mostly lower from here and would be consistent with history. The economic fundamentals also likely support a steady to lower 10-year yield. The Federal Reserve (Fed) has moved aggressively to try to tame inflation, keeping inflation expectations well anchored, while pumping the brakes on the economy. On top of that, Fed rate hikes tend to act with a lag, increasing recession risks as the economy continues to try to find balance following soaring prices in 2022. Lower inflation and a slowing economy would both point to a downward bias on yields. If yields do move lower, it would help Treasuries, and higher quality bonds more broadly, rebound from a very rough 2022 and potentially provide positive returns even if the economy enters recession.
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.
Tis’ the season for the Santa Claus Rally! This unique seasonal pattern was first discovered by Yale Hirsch in 1972. Hirsch, creator of the Stock Trader’s Almanac, defined the period as the last five trading days of the year plus the first two trading days of the new year. This year’s Santa Claus Rally window officially opens on Friday, December 23. Given the challenging year for U.S. equity markets, including what could be one of the worst Decembers for the S&P 500 since 1950, investors are hoping Santa can deliver some positive returns and holiday cheer as we approach year-end.
The Santa Claus Rally usually generates headlines across financial media due to the historically strong market returns during this relatively short timeframe. As shown in the chart below, the S&P 500 has generated average returns of 1.3% during the Santa Claus Rally period, compared to only a 0.2% average return for all rolling seven-day returns.
Lucky Number 7? If the S&P 500 finishes higher during this year’s Santa Claus Rally, it would mark the seventh consecutive period of positive returns. The longest streak was 10 back in the mid-1960s. However, positive returns during the Santa Claus Rally are relatively common, as the market has advanced 79% of the time during this period. For additional context, all rolling seven-day returns for the S&P 500 since 1950 have a positivity rate of only 58%.
One of the other primary aspects of the Santa Claus Rally is its application as an indicator for future market returns. As Yale Hirsch stated, “If Santa Claus should fail to call, bears may come to Broad and Wall.” Historical returns, as shown below, give merit to his maxim, as the S&P 500 historically underperforms in January and over the following year when Santa no shows and doesn’t deliver investors a year-end rally.
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.
Many financial markets are on pace for their worst year in quite some time, or in the case of core bonds, the worst year since inception of the Bloomberg Aggregate Bond Index, which is the main core bond index. With inflationary pressures running much hotter than central bank targets, many central banks were forced to respond by raising policy rates at a speed and magnitude unlike any other year, which was a decided headwind to many financial assets this year.
As mentioned in this week’s Weekly Market Commentary (found here), the Fed’s 0.50% rate hike last week capped a year in which the Federal Reserve (Fed) raised short-term interest rates at the fastest clip in four decades. Moreover, the magnitude of rate hikes brought the fed funds rate to its highest levels in over a decade. However, we think most of the rate increases have either already taken place or (mostly) priced into market’s expectations at this point. And since we’re starting to see positive signs of inflationary pressures easing, it is likely the Fed can step down the pace and magnitude of rate hikes in 2023 and perhaps even pause rate hikes, which could be welcome news for core bonds.
Historically, core bonds have performed well during Fed rate hike pauses. Since 1984, core bonds were able to generate average 6-month and 1-year returns of 8% and 13%, respectively, after the Fed stopped raising rates. Moreover, all periods generated positive returns over the 6-month, 1-year and 3-year horizons.
While we don’t think monetary policy will become accommodative anytime soon—absent a financial crisis or deep recession, which isn’t our base case—the central bank headwind that took place in 2022 may not be as strong in 2023, which could help many financial markets in 2023. This year will most certainly be the worst year for core bonds on record and it will take time to recover the price declines experienced this year. However, while there is certainly no guarantees that history will repeat or even rhyme this time, the back-up in yields, for many fixed income markets, provides an attractive opportunity, in our view.
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.
It has been a painful week for those investors hoping for a shift toward dovish monetary policy. The Federal Open Market Committee (FOMC) raised rates by an expected 50 basis points (bps) on Wednesday. The surprise factor came from the updated Summary of Economic Projections (SEP), which showed policymakers moving their 2023 federal funds rate forecasts from 4.6% in September to 5.1% this month. Furthermore, several FOMC members penciled in a peak terminal rate of 5.25% or higher for next year. The SEP also showed upgraded forecasts for inflation and downgraded growth estimates for 2023 and 2024.
Outside of the U.S., the European Central Bank (ECB) also raised interest rates by 50 bps yesterday, as expected. Similar to the FOMC, forecasts for future rate hikes and commentary leaned hawkish. The accompanying policy statement noted, “We decided to raise interest rates today, and expect to raise them significantly further, because inflation remains far too high and is projected to stay above our target for too long.”
Finally, the Bank of England raised rates by 50 bps yesterday, although based on the 1.9% drop in the British pound, and reduced implied rate hike probabilities for next year, the market appeared to digest the outcome with a dovish tilt.
A notable divergence has developed in the aftermath of this week’s FOMC meeting. The Federal Reserve’s (Fed) projected federal funds rate and the implied terminal rate based on the federal funds futures market remain divided. The chart below compares the current fed funds target rate projections (orange) to the September SEP projections (grey). In addition, the fed funds futures implied rate is shown in blue. For 2023, futures are pricing in a federal funds rate of 4.4% for December 2023, compared to the actual Fed forecast of 5.1%. In addition, the futures market is also pricing in rate cuts starting as early as November 2023. From our perspective, this variance equates to elevated market uncertainty, and until market expectations and Fed forecasts align more closely, we suspect volatility could remain elevated. According to LPL Chief Economist Jeffrey Roach, “The Fed has demonstrated a penchant for forecast revisions, so we should not be surprised if the Fed revises the expected peak fed funds rate as inflation, including the sticky components, starts to moderate.”
In terms of price action, U.S. equity markets extended their post-FOMC decline yesterday and erased intraweek gains. An unexpected drop in weekly jobless claims from 231,000 to 211,000 (estimates: 232,000) further exacerbated concerns over a tight labor market, a key risk factor for a higher-for-longer policy path. The S&P 500 dropped 2.5% on the day and closed just below key support at 3,900.
Given the negative reaction to this week’s FOMC meeting, we also researched if market performance on the day of a rate hike has any implications for future equity market returns. We identified 100 rate hikes going back to 1970, filtered for rate increases occurring at least three weeks apart (there were several intra-month adjustments made back in the 1970s and 1980s that were filtered out).
As shown in the bar chart below, S&P 500 returns have been mixed immediately following a rate hike, although returns tend to improve over the following four-week period. On a more positive note, when the S&P 500 traded lower on the day of a rate hike announcement, returns over the following eight weeks averaged 0.6%, compared to only 0.1% when the index traded higher on the day of a rate hike announcement.
Overall, risk for continued volatility appears elevated until there is greater alignment between Fed policy and market expectations. Continued signs of abating inflation pressure, especially in the non-housing core services sector could help bridge the gap and reduce the degree of FOMC hawkishness.
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.
As expected, the Federal Open Market Committee (FOMC) increased the fed funds rate yesterday by 0.50% and made upward revisions to both inflation forecasts and interest rate forecasts in the next few years. The target range is now 4.25–4.50%. This meeting signaled the beginning of a downshift in the pace of rate hikes, as the previous four meetings concluded with a 0.75% increase to the target rate. The Committee delivered a well-telegraphed move, barely changing any verbiage from the previous statement, and unlike the recent rate decision in the U.K., the FOMC was unanimous.
The FOMC released an updated Summary of Economic Projections (SEP) after this meeting and from all appearances, the Committee is more pessimistic about growth and inflation than they were in the September edition of the SEP.
The Committee downwardly revised growth forecasts for both 2023 and 2024 as high inflation is expected to weigh heavily on consumer spending. As inflation is expected to erode purchasing power, growth will likely stall next year. Short-term interest rates will likely be higher next year, as the Committee believes inflation will not come down as fast as projected in September. The Committee did not change the long-run estimate of the fed funds rate but the Committee revised up projections for fed funds in 2023 and 2024. A healthy minority of committee members are forecasting fed funds above 5.25%, creating a hawkish tilt to the overall forecast. In the press conference, Chairman Powell focused on the imbalances in the labor market, indicating that the job market is the linchpin for economic growth in the coming year.
The Fed is uncertain about the future path for inflation and therefore, has remained decidedly hawkish on short-term rates. However, the Fed has demonstrated a penchant for forecast revisions, so we should not be surprised if the Fed revises the expected peak fed funds rate as inflation, including the sticky components, starts to moderate. Looking ahead, investors need to watch the inflation path for non-housing core services, which is closely tied to labor market conditions.
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.
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