Wealth Management

Posted by Lawrence Gillum, CFA, Fixed Income Strategist

Thursday, July 28, 2022

The Federal Reserve (Fed) ended its two-day Federal Open Market Committee (FOMC) meeting yesterday and the outcome was broadly in line with market expectations. As expected, the Committee raised short-term interest rates by 75 basis points (0.75%) to take the fed funds rate to 2.5% (upper bound). The 2.5% level is the level, by the Fed’s estimate, to be neutral in the long run; that is the level where monetary policy is neither contractionary nor expansionary. As inflationary pressures continue to run much higher than the Fed’s 2% target, the fed funds rate will need to get above the neutral level to help balance aggregate supply and demand. Finally, the Committee maintained balance sheet normalization with initial reinvestment caps at $47.5 billion until fully reducing Treasury and mortgage securities by $95 billion per month beginning in September.

“Market volatility will likely remain elevated until the Fed starts to slow the pace of rate hikes,” noted LPL Financial Fixed Income Strategist Lawrence Gillum. “However, until inflationary pressures start to significantly recede, the Fed has to continue to tighten. If they pivot before inflation starts to definitively fall, we could be in that dreaded stagflationary environment that characterized the ‘70s and ‘80s. Hopefully the Fed has studied up on its history.”

During the press conference, which took place immediately after the conclusion of the FOMC meeting, Chairman Jerome Powell seemingly indicated a willingness to slow the pace of rate hikes. First, Powell acknowledged that the economy is slowing (which is what the Fed wants) and the full effect of the rate hikes has not yet been felt. Moreover, he said the Committee would react to growth, labor market and inflation data, versus only focusing on inflation data. Finally, Powell commented that 75 basis point hikes are “unusually large”. As such, and as shown in the LPL Chart of the Day, market expectations for future rate hikes have come down. Now, the market expects a peak fed funds rate around 3.3%, down from a nearly 4% rate that was priced in last month.

View enlarged chart.

We continue to think the Fed will likely increase rates this year up to approximately 3.5% if the labor market remains stable but could begin cutting again in late 2023 if the economy shows significant weakness. The next FOMC meeting is not until September and the Fed will have two more inflation prints to mull over when deciding the next rate hike (which we think may be 50 basis points but that will be very dependent on the economic data over the next two months). However, this morning’s negative -0.9% annualized 2Q GDP print certainly puts the Fed in a difficult position and may make a softish landing that much more difficult to achieve.

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

Wednesday, July 27, 2022

Investors love to chase returns. In the near term it can potentially be a successful strategy that has some strong academic and industry research behind it. But nothing lasts forever and markets move in cycles. One reason is the more a segment of the equity market outperforms, the greater the potential for it to become mispriced as sentiment runs ahead of fundamentals. Sentiment can run hot for a long time, and there’s no rules for how long these cycles may last, but at some point there’s typically a comeuppance. Historically a decade has often been long enough to see some meaningful reversals. Our basic conclusion: based on history, outperformers over the last 10 years tend to be underperformers over the next 10 and vice versa.

“Once a segment of the market has underperformed for a decade, it is often so hated many investors actively avoid it,” said LPL Asset Allocation Strategist Barry Gilbert. “As a result, that’s often when that segment becomes statistically favored to outperform.”

As shown in the LPL Chart of the Day, looking at 22 major segments of the equity market, outperformers in one decade became underperformers over the next decade over every rolling period, starting with the comparison of 1990-1999 and 2000-2020. In fact, an average of 6.0% of outperformance from the winners in the starting decade became an average of 2.8% of outperformance from the prior losers in the next.

View enlarged chart.

The study suggests that the right thing to do when positioning tactically may not be the same as the right thing to do when positioning strategically, but taking advantage of that difference takes patience. So what were the underperformers from 2012-2021 that may be potential outperformers over the next decade? The Russell 1000 Value, Russell Mid-Cap Value, Russell 2000, Russell 2000 Value, MSCI EAFE, MSCI Emerging Markets, and the S&P Dow Jones Select Sector indexes for energy, materials, consumer staples, communication services, and utilities. It looks like an awful list judging from the last decade—but that’s the point. For long-term investors, these areas may be worth considering for mean reversion opportunities.

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, Fixed Income Strategist

Tuesday, July 26, 2022

In this year’s midyear outlook, entitled Navigating Turbulence, the LPL Research team outlines the reasons why the second half of the year is likely to experience better investment returns across both equity and fixed income markets. But volatility is likely to remain. For fixed income markets, as shown in the LPL Chart of the Day, this year is off to the worst start ever for core bonds (as defined by the Bloomberg Aggregate index), so an improved return environment would be a welcome reprieve from the deep drawdowns investors have already experienced this year.

View enlarged chart.

“The large drawdowns that we’ve seen in fixed income markets the first half of the year may represent the majority of negative returns as inflationary and monetary expectations were quickly digested by the market,” noted LPL Financial Fixed Income Strategist Lawrence Gillum. “Looking ahead, we think better days are expected for some areas of the fixed income market (no guarantees of course).” In this month’s Rate and Credit View, we take a more granular look at fixed income sectors that the Strategic and Tactical Asset Allocation Committee find favorable and areas that we think could remain stressed in the near term. Following are high level thoughts on the U.S core bond sectors.

For the US Treasury market, the direction of yields going forward will likely be determined by the continued tug-of-war between fears of outsized inflationary pressures and increasing recession risks. 10-year Treasury yields have more than doubled this year after increasing around 100 basis points off its lows in 2020. The 300 basis point move higher that has already taken place this cycle is the biggest move higher in yields since 1986/87, when rates moved higher by 320 basis points. We expect 10-year Treasury yields to end the year between 2.75 to 3.25% as slowing growth fears really get priced in.

For the mortgage-backed securities market (MBS), performance is largely impacted by interest rate volatility as these securities are AAA-rated and government guaranteed. MBS have an embedded optionality with regard to the timing of principal and interest payments, so higher interest rate volatility equates to higher uncertainty around refinancing and mortgage prepayments. Interest rate volatility, as defined by the MOVE index, has been near historically high levels, however, we expect interest rate volatility to subside as the Fed slows down its aggressive interest rate hiking campaign.

For the corporate credit market, returns have been painful through the first half of 2022. Returns, as measured by broad indices, were down meaningfully with the investment grade (IG) corporate bond index down 14%. Corporate credit is not immune to rising rates and elevated inflation that negatively impact bonds overall, and that has been reflected in returns for corporate bonds that have meaningfully underperformed this year. The steep sell off in corporate credit in 2022 offers more compelling valuations and may be a better entry point for investors.

To get additional details on the U.S. investment grade fixed income market along with additional content on the high yield, bank loan, non-US developed and emerging market debt markets, be sure to check out the most recent edition of the Rate and Credit 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.

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

Posted by Jeffrey J. Roach, PhD, Chief Economist

Friday, July 22, 2022

From Heavy Highway Congestion to Eerily Empty Roadways

Not to play up too much on the data from the National Association of Home Builders (NAHB) but the NAHB gives insights on the traffic of prospective buyers, a leading indicator of future activity. Not surprising but definitely troubling, traffic fell to the lowest level since May 2020 and suggests that the housing market has more downside to go as interest rates trek higher and inflation chisels away consumer purchasing power. Since mid-2020 until recently, we saw heavy congestion as housing traffic was too high and extraordinary demand pushed up selling prices to unstable levels, a consequence of ultra-loose monetary policy. Now, as the Federal Reserve (Fed) tightened policy and mortgage rates rose, traffic cleared up. But, is the decline in prospective buyers too ominous? Not likely in our view. Rather, the market is returning to levels reached in 2019.

View enlarged chart.

As shown in the LPL Chart of the Day, the current pace of home sales has reverted to the pre-pandemic pace. “We have not likely reached the bottom in the housing market but as of now, we are not making the apocalyptic case that housing is going to crash,” explained Jeffrey Roach, Chief Economist for LPL Financial. Although the outlook seems bleak, a vast majority of existing homes sold in June were on the market for less than a month. This indicates some lingering demand for home buying in the midst of a slowing economy and rising rates. Overall, the residential real estate market is slowing, not likely heading into an outright collapse, but some of this outlook hinges on the duration of historic inflationary pressures on home builders from high raw material prices and a tight labor market.

All-Cash Deals Increase as Borrowing Costs Rise

High borrowing costs will likely squelch loan demand as shown in the weekly mortgage data. Mortgage applications are now the lowest since early 2000, so it’s not surprising that all-cash offers will likely stay elevated as mortgage rates spiked this year.

Some cash buyers are most likely investors but also buyers who are moving from higher-priced areas such as the West Coast to lower-priced areas such as the Southeast. The real estate market is still adjusting to the hybrid work environment, giving workers greater flexibility in living arrangements and locations. Regional variations within the NAHB housing metric confirm the suspicion as the West region continues to feel the impact of waning housing demand as workers benefit from flexible working arrangements. As of July, the South region is twelve points ahead of the West, the highest gap since the beginning of the regional index.

Given the time required for residential real estate markets to adjust, we may see this housing slowdown phase continue throughout the rest of this year.

Good News for the Federal Reserve

The good news is that various economic metrics show enough stability to handle the Fed’s front-loading tightening cycle.  The Conference Board’s index of leading economic indicators for June fell to 117.1. The current index value still stands 4.2 points above June 2019. The economy will most likely take the upcoming Fed rate hike in stride but as the economy becomes more vulnerable, the probability of the Fed breaking something increases as the economy moves into 2023.

For more on the current environment, be sure to watch our latest Econ Market Minute, where LPL Financial Chief Economist discusses more about the current state of affairs.

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, Equity Strategist

Thursday, July 21, 2022

With earnings season underway, in addition to following beats, misses, and growth rates as second quarter reports stream in, we are also assessing the potential future path of earnings. That’s tricky right now given the uncertainty.

“Some expect steady mid-to-high single digit earnings gains for the foreseeable future while others see double-digit earnings contraction as soon as 2023,” according to LPL Financial Equity Strategist Jeffrey Buchbinder. “We believe the revenue environment and corporate productivity are in too good of shape for earnings to contract anytime soon.”

History shows that it takes a pretty rough economic environment to knock earnings meaningfully off track. As shown in the LPL Chart of the Day, in the more mild recessions, earnings recover within a year or two typically, with declines in the low-to-mid teens. That includes the early 1970s, which saw operating earnings decline only 13% peak to trough (on a rolling four quarters basis), the mid-1970s when earnings dipped about 15%, and 2020, which saw earnings slip 13% before a quick snapback.

View enlarged chart.

In a bear case scenario, say a garden variety type recession, a 10-15% decline in earnings is a reasonable expectation. But our economic forecast still calls for no recession this year and a 50% chance next year. A soft landing will still be very difficult for the Federal Reserve to achieve, but it’s possible. And a recession could be very mild, resulting in a smaller hit to earnings.

Our base case for earnings, as laid out in Midyear Outlook 2022: Navigating Turbulence, is that modest economic growth, effective cost management, and healthy revenue growth, bolstered by pricing power, will enable corporate America to grow earnings near double-digits this year (to $225 per share in S&P 500 earnings per share) and another 4-5% next year (to $235). As the chart above illustrates, in the absence of recession, earnings tend to keep chugging higher at a mid-to-high single digit pace over the long term.

So, don’t completely dismiss the possibility that trend continues despite so many market pundits telling us otherwise. It’s very early in earnings season with results from just 88 S&P 500 companies, but a 72% beat rate is solid, while corporate America is well on track to grow earnings north of 5% year over year. The consensus estimate for 2022 earnings has barely budged in July. Bottom line, the pessimism may be overdone.

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 Scott Brown, CMT, Technical Market Strategist

Wednesday, July 20, 2022

As the bear market continues on, investors are anxiously awaiting an answer to the most critical question: is it over? It isn’t unreasonable to ask, as the S&P 500 is actually higher by about 6% since June 16 despite a significant amount of bad news during that time. This is good news because it follows some real capitulation that we saw in June, as we discussed at the time.

The next stage we would like to see would be some real signs of investor enthusiasm for buying stocks. For the most part over the past month, the data there has been lackluster. The best performing areas of the market have been oversold growth sectors, such as discretionary and technology, but defensives are close behind and cyclical value has been flat to lower over the time. In fact, 25% of stocks in the S&P 500 are actually lower than they were a month ago, and the percent of stocks up above their respective 200-day moving average has only nudged up slightly, from 13% then to 18% as of Monday. Not exactly impressive.

However, over the past few days we are seeing some signs of life from breadth.

“Tuesday was the best day for breadth on the NYSE since January 4, 2019,” reported LPL Financial Technical Market Strategist Scott Brown. “While breadth has been rather unimpressive during the market’s rally since the June lows, days like Tuesday are exactly what we are looking for, and can go a long way towards changing the character of this market.”

The Tuesday reading saw advancers outnumber decliners by more than 14:1 on the NYSE, and that comes on the heels of a nearly 8:1 reading on Friday, which at the time was the best reading since May of this year. Data on the S&P 500 was similar, with 98% of stocks advancing, the most since December 26, 2018, the first trading day after the market bottom that occurred on December 24, 2018.

To be clear, the S&P 500 is not out of the woods yet. As shown in our Chart of the Day, the strong advance on Tuesday finally pushed the index to a close above the 50-day moving average for the first time since April 20, but it remained just short of the late-June intraday highs.

View enlarged chart.

The real test for the S&P 500 will come in the range just below 4200, which represents arguably the major breakdown point for the index. In our view, support levels like this become resistance once they break down and we saw a textbook example of this in May when the index reversed higher, only to be rejected at that level.

This is clearly an area where sellers have overwhelmed buyers this year, so if it is to be eclipsed we think it will take strong momentum and continued broad-based buying of equities in the days leading up to it. The trend is still firmly against stocks this year, and the onus is still on the bulls, but we are happy to report a clear positive and will continue to monitor for further signs of strength that could signal a major market low.

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, Fixed Income Strategist

Tuesday, July 19, 2022

Fixed income markets have been hit hard this year by changing monetary expectations due to stubbornly high inflationary pressures. For investors allocated to a core bond strategy (as defined by the Bloomberg Aggregate index), returns have been the worst ever to start a year. And within these core bond sectors, there’s been no place to hide—even the traditionally defensive mortgage-backed securities (MBS) sector is down 8% this year (although the broader index is down nearly 10%). So what can investors expect going forward? While near term uncertainty is certainly high, we think the sector is in a good position to outperform.

Agency MBS performance is largely impacted by interest rate volatility as these securities are AAA-rated and government guaranteed. MBS have an embedded optionality with regard to the timing of principal and interest payments, so higher interest rate volatility equates to higher uncertainty around refinancing and mortgage prepayments. This is the primary fundamental risk for MBS. As seen on the LPL Chart of the Day, interest rate volatility, as defined by the MOVE index, has been near historically high levels and has seen a recent divergence from implied equity volatility (as defined by the VIX index). “MBS may have been disproportionally penalized given the rate volatility and uncertainty surrounding Federal Reserve (Fed) rate hikes,” noted LPL Financial Fixed Income Strategist Lawrence Gillum. “As interest rate volatility decreases, however, which we think will happen as the Fed gets through its rate hiking campaign, MBS may be poised to outperform.”

View enlarged chart.

Another key risks for the MBS market in 2022 and 2023 is the potential for outright sales of securities by the Fed as it shrinks its balance sheet. Currently, the Fed is allowing securities to naturally roll off as they mature; however, the Fed has stated that it would like to aggressively shrink its balance sheet and primarily hold Treasury securities. However, given the maturity profile of the Fed’s MBS holdings and the repricing higher of mortgage rates recently, natural roll-off through prepayments seems unlikely at this point. As such, the Fed will likely be a seller of MBS in 2023, if not earlier. And while this would seemingly put upward pressure on yields and spreads, its likely we’ll see traditional MBS investors (mutual funds, banks, foreign investors) re-enter the market as they were crowded out due to Fed purchases. Moreover, the relative attractiveness of MBS versus high-grade corporates may improve to the point that investors may choose the AAA-rated paper with lower prepayment risks over the BBB-rated corporate paper that may experience elevated risks during an economic slowdown. That said, a continued weakening of the housing market could cause the Fed to reevaluate its plans to exit the MBS market completely. As such, we continue to think the risk/reward profile for owning MBS is attractive.

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.

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