Wealth Management

Posted by Adam Turnquist, CMT, VP Chief Technical Strategist

Friday, September 22, 2023

Key Takeaways:

• Stocks are struggling this month against a backdrop of higher interest rates and monetary policy uncertainty. Benchmark 10-year yields have surged around 40-basis points, surpassing resistance off the October 2022 highs. The recent breakout raises the question of how high yields will go—an important question that could continue to weigh on risk sentiment.
• The S&P 500 is down nearly 4% on the month, and technical damage is beginning to mount. The index has broken to the downside of a symmetrical triangle formation after taking out support at the 20- and 50-day moving averages (dma). Additional downside support below 4,330 comes into play in the 4,200 to 4,300 range, followed by the 200-dma at 4,189.
• The recent selling pressure has turned most momentum indicators bearish. Breadth is deteriorating as only 45% of S&P 500 stocks remain above their 200-dma. The two-year cumulative advance-decline (A/D) line for the S&P 500 has also pulled back to an inflection point after violating an uptrend.
• Despite the recent pullback in stocks, there have been no major signs of a sustainable flight to safety. The uptrend on the equal weight consumer discretionary vs. consumer staples ratio chart remains intact.
• Overall, the market is down but not out. Pullbacks are entirely ordinary within the context of a bull market, and while the jump in rates is concerning, the S&P 500 remains in an uptrend and above its rising 200-dma.

While September is living up to its reputation as being a weak month for stocks, seasonality cannot take all the blame for the selling pressure. In addition to a rally in crude oil, a nine-week winning streak in the dollar, and a ‘hawkish pause’ from the Federal Reserve this week, stocks have had to contend with nearly a 40-basis point surge in 10-year yields this month, which are now trading near 4.50%. Once again, the move in rates has proven to be too much too fast for equity markets to handle. And as LPL Research highlighted in August (Yields on the Rise—Too Much Too Fast?), a breakout on the 10-year Treasury yield above the October 2022 highs at 4.34% would be a “warning sign for a potentially deeper pullback in stocks.”

Technical Damage

The S&P 500 is down nearly 4% on the month, and technical damage is beginning to mount. The index has broken to the downside of a symmetrical triangle formation after taking out support at the 20- and 50-dmas. Yesterday’s session-low close at 4,330 landed right at support from the June 2023 lows and August 2022 highs. Additional downside support comes into play at the 4,200 to 4,300 range—a likely spot for a rebound—followed by the 200-dma at 4,189 (also near a key Fibonacci retracement level).

The recent selling pressure has turned most momentum indicators bearish. The Moving Average Convergence/Divergence (MACD) indicator—a trend-following momentum indicator that shows the relationship between two exponential moving averages—recently rolled over into a sell position. Given that the S&P 500’s uptrend is still intact, and price remains above its rising 200-dma, we view the sell signal as a shorter-term signal pointing more toward a pullback than a market top.

View enlarged chart

Market Breadth

Breadth is deteriorating based on the declining percentage of stocks trading above their 200-dma. As of September 21, only 45% of S&P 500 stocks remained above their 200-dma, falling from 76% near the end of July. On a slightly more positive note, the more offensive or cyclical sectors are holding up better than their defensive counterparts. Financials have also bucked the trend of bad breadth this month as 49% of sector stocks are now trading above their 200-dma, as opposed to only 33% one month ago.

View enlarged chart

Advance-Decline Line at an Inflection Point

The two-year cumulative advance-decline (A/D) line for the S&P 500 has pulled back to an inflection point after violating an uptrend. Technically, a break below support off the August lows would check the box for a lower low and suggest a new downtrend is underway. For reference, the A/D line is calculated by taking the difference between the number of advancing and declining stocks on the index for a given trading day and adding that difference to the prior day’s value. A rising A/D line is indicative of positive market breadth as the number of advancing stocks is outpacing the number of declining stocks, and vice versa for a declining A/D line.

View enlarged chart

No Major Flight to Safety…Yet

Despite the recent pullback in stocks, there have been no major signs of a sustainable flight to safety. As shown below, the S&P 500 Equal Weight Consumer Discretionary (SPXEWCD) vs. S&P 500 Equal Weight Consumer Staples (SPXEWCS) ratio chart continues to generate higher highs and higher lows, indicating the equal weight consumer discretionary sector is outperforming the equal weight staples sector. Why is this important? Given the economic implications between discretionary spending on things consumers want vs. spending on things consumers need, relative performance between the two sectors is often used to identify offensive (consumer discretionary outperforming) or defensive (consumer staples outperforming) leadership trends. For now, offense remains on the field.

View enlarged chart

SUMMARY

The S&P 500 is down nearly 4% on the month, and technical damage is beginning to mount. While weak September seasonality is capturing the blame, selling pressure has primarily been driven by a jump in interest rates. Benchmark 10-year Treasury yields have climbed roughly 40 basis points, surpassing resistance off the October 2022 highs. The recent breakout raises the question of how high yields will go—an important question that could continue to weigh on risk sentiment.

Technically, the S&P 500 has broken to the downside of a symmetrical triangle formation. Additional downside support below 4,330 comes into play in the 4,200 to 4,300 range, followed by the 200-dma at 4,189. Momentum has turned bearish, and breadth is also deteriorating. However, despite the recent pullback, there have been no major signs of a sustainable flight to safety. Overall, we believe the market is down but not out. Pullbacks are completely normal within the context of a bull market, and while the jump in rates is concerning, the S&P 500 remains in an uptrend and above its rising 200-dma.

IMPORTANT DISCLOSURES

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

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

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

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

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

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

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

Posted by Jina Yoon, CFA, Chief Alternative Investment Strategist

Thursday, September 21, 2023

‘Normalization’ of Capital Raising Activity

After a record setting year in 2021, capital raising activities in private markets have shown signs of slowing down. Some might wonder if this is just the beginning of a secular cool down of the space. And our answer is, it is not. We believe what we are seeing is a ‘normalization’ back to the long-term private market growth trajectory after the exceptional last couple of years. Also, with a greater number of funds expected to close in the near future and some of the markets and participants’ conditions improving, it is reasonable to expect the capital raising activities to remain healthy, albeit in varying degrees by sector.

In the first half of 2023, $502 billion was raised by global private markets. That is below what had been raised during the same time periods in the past couple of years—$639 billion in H1 2022, $545 billion in H1 2021—but is still above what had been raised during the first half of each year in 2020 and before. In addition, it is worthwhile to note the lighter capital raising activity was not a broad-based phenomenon. Sectors like Private Credit and Secondaries showed resilient and growing investor demand, while Venture Capital within Private Equity continued to see lighter activities. This is not surprising given how Private Credit remains the direct beneficiary of tighter bank lending and higher base rates (related LPL Research blog post here) and Secondaries—a strategy focused on buying and selling of fund shares / assets in existing funds—has gained popularity as it continued to grow with broader coverage of sectors and more buyers/sellers with various motivations flocking in.

View enlarged chart

What Drove the ‘Normalization’ of Capital Raising Activities?

First, we can attribute some of the slow down to the denominator effect. The drop in public markets in 2022 left many investors’ portfolios over-allocated to private markets because they did not re-value lower as much as their public market counterparts. This meant investors had to scale down their future private market commitments, be selective about which sectors and managers they would allocate to, and look to reduce their existing private market holdings, if needed.

Second, some private market sectors faced a more difficult market environment than others, resulting in lighter capital raising activities. After enjoying one of the strongest years in 2021, macro uncertainties, higher funding rates, and banks pulling back from financing large scale levered transactions resulted in Private Equity facing a drought of deals and exit opportunities. This meant investors perceiving the strategy to be relatively less attractive than others as well as them having to wait longer for their locked in capital to come back to their hands to invest in new opportunities. Real Estate was another sector where investors took a more cautious stance as they saw re-valuation slowly taking place since late 2022.

What Are We Seeing Now?

Whether it is economic conditions, policy action, or market performance, divergence remains the keyword for the remainder of 2023, and private markets are no exception. We expect sectors such as Private Credit and Infrastructure to continue to show resilience, while others, such as Venture Capital, wait for more stars to align before re-gaining strength.

That said, we see some constraints easing. With the public equity markets recovering in 2023, investors now have less pressure to rebalance out of their private market positions to bring their portfolios in line with their target allocation between public and private. We see Private Equity and Real Estate valuations stabilizing after the steep re-valuation that took place last year and early this year, closing the gap against their public market counterparts, while providing better entry points for both primary and secondary investors. Especially for secondary markets, we see the market slowly finding better supply/demand balance and narrowing the bid/ask spread, a positive signal for both sellers looking for liquidity and buyers looking to capitalize the discounted pricing in certain sectors that have been beaten down.

View enlarged chart 

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.

Alternative investments may not be suitable for all investors and involve special risks such as leveraging the investment, potential adverse market forces, regulatory changes and potentially illiquidity. The strategies employed in the management of alternative investments may accelerate the velocity of potential losses.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

Asset allocation does not ensure a profit or protect against a loss.
Unless otherwise stated LPL Financial and the third party persons and firms mentioned are not affiliates of each other and make no representation with respect to each other.

Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services.

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

For a list of descriptions of the indexes and economic terms referenced in this publication, please visit our website at lplresearch.com/definitions.
Securities and advisory services offered through LPL Financial, a registered investment advisor and broker-dealer.

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

Posted by Jeffrey Buchbinder, CFA, Chief Equity Strategist

Tuesday, September 19, 2023

Additional content provided by John Lohse, CFA, Analyst

The specter of a U.S. federal government shutdown continues to loom this week as Congress has just 12 days to agree on a budget before the October 1 deadline. House Republicans released a temporary measure on Sunday which could push the deadline out another month, with the hopes of a final solution coming in the interim. However, that proposal has encountered pushback even from within their own ranks, not to mention from across the aisle, and has yet to be voted on. The bad news is it looks like the government is headed for another shutdown; the good news is the stock market has seen this before.

The government has had 20 shutdowns since 1976. The average length of those shutdowns was eight days. The most recent, which started in December 2018, and extended into 2019, was the longest in history and lasted 34 days. The chart below, with data provided by Strategas Research Partners, shows the duration of each shutdown since 1976.

View enlarged chart

As it has a reputation of doing, the stock market has been able to shrug off this gridlock in Washington. In fact, according to Dan Clifton, Policy Strategist at Strategas, during the 34 days of the most recent shutdown the index managed to return a whopping 10.27%. The simple average return of the S&P 500 during those 20 government shutdowns is 0.04%. The chart below shows the performance of the S&P 500 during each period.

View enlarged chart

Not only does the market usually hold up while lawmakers dither, but history also shows it bounces higher shortly after a resolution has been reached. During the one- and three-month periods following a budget being passed the average returns for the S&P 500 are 1.17% and 2.64%, respectively. Investors have been able to look past budget speedbumps as corporate earnings, the overall economic outlook, and other more impactful macroeconomic events took precedent. That said, certain segments of the market that rely on government contracts can be more susceptible to shutdowns. Typically, segments such as defense and life sciences pull back as their revenue sources become less clear; however, they tend to outperform once the spigots are turned back on.

While history has shown the stock market can weather such events, it remains to be determined if other secondary impacts will be felt (barring the unlikely event that a compromise is made before the deadline). Heightened political divisions, a slim majority in The House of Representatives, and intra-party factions could potentially prolong negotiations. An extended shutdown would put economic data aggregation in jeopardy as many government entities responsible for collection and dissemination would be dormant. This would put the data dependent Federal Reserve in an unenviable position as the market awaits its signals. While LPL Research maintains a neutral weight to equities, we view any outsized declines as an opportunity to buy-the-dip, based on the strength of historical patterns.

IMPORTANT DISCLOSURES

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

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

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

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

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

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

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

Posted by Adam Turnquist, CMT, VP Chief Technical Strategist

Friday, September 15, 2023

Key Takeaways:

• The dollar is trading near an inflection point. A breakout above 106 would imply a bottom has been set in the greenback.
• Further upside in the dollar would create additional headwinds for most stocks and commodities. International developed markets could face outsized selling pressure based on their deeply inverse relationship to the greenback. On the commodity side, gold would likely underperform as it is the most negatively correlated commodity to the dollar.
• Despite the recent recovery, investors largely remain bearish on the greenback. Speculative net positioning in the dollar recently fell to over a two-year low, while risk reversals in other major U.S. Dollar Index components are trending higher.
• Next week’s Federal Open Market Committee (FOMC) meeting could be the make-or-break catalyst for the dollar. While the market expects a pause, any incremental hawkish tilt in monetary policy from the Federal Reserve (Fed) would likely propel the dollar out of its bottom formation. A dovish pause would likely lead to a pullback in the dollar, although downside may be limited if the eurozone economy continues to underperform.

The U.S. Dollar Index (DXY)— a basket of six currencies weighted against the dollar—has staged an impressive recovery after hitting year-to-date lows in June. Since then, the greenback has climbed over 5% due primarily to a stronger-than-expected U.S. economy and higher-for-longer monetary policy from the Fed. Of course, with currencies, it is all relative, and the dollar’s gains also came at the expense of euro weakness. (For reference, the euro holds the largest weight within the DXY at 57.6%.)

While the Fed is still battling stubbornly high inflation, they have made more progress against pricing pressures than the European Central Bank (ECB), which, unlike the U.S., is also contending with deteriorating economic conditions. Sticky inflation in the eurozone, including headline and core CPI readings of over 5%, prompted the ECB to raise interest rates for the 10^th consecutive time yesterday. According to the ECB policy statement, “The key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target,” although ECB President Christine Lagarde noted, “We are not saying that we are at peak.” The euro declined on the news and is now trading near its lowest level since May.

Euro weakness has translated into dollar gains. The DXY recently surpassed the May 31 high (104.70) and is now retesting a confluence of overhead resistance in the 105 to 106 range. Momentum remains bullish, although the Relative Strength Index (RSI)— a momentum oscillator used to measure the speed and magnitude of price action—has formed a short-term negative divergence from price action, creating some questions over the sustainability of upside momentum. Technically, a close above 106 would imply a bottom in the dollar has been set and leave the 107 to 108 range as the next resistance hurdle to clear. Support for the greenback sets up at 104.29 (20-dma) and near 103 (March 2020 highs/200-dma).

Dollar Up, Euro Down

View enlarged chart

Positioning Remains Bearish

Investors are positioned for a pullback in the dollar. According to Commodity Futures Trading Commission (CFTC) data, net non-commercial positions (speculators/non-hedging), based on total long vs. total short positions in the greenback, recently fell to their lowest level in over two years. As shown below, major tops and bottoms in non-commercial positioning have often coincided with inflection points in the dollar. However, more recently, positioning and the dollar have deviated, perhaps suggesting dollar bears have yet to capitulate on their trades. We suspect a breakout above 106 could underpin a short-covering rally.

View enlarged chart

Furthermore, risk reversals in the euro, yen, pound, and Canadian dollar—representing over a 90% weight within the U.S. Dollar Index—have been trending higher over the last 12 months. For context, a risk reversal in currency trading refers to the difference in implied volatility levels between out-of-the-money call and put contracts (volatility skew). Generally, a positive risk reversal is considered bullish as implied volatility in call contracts exceeds the implied volatility in puts, and vice versa for a negative risk reversal.

View enlarged chart

What Does This Mean for Investors?

Further upside in the dollar would create additional headwinds for most stocks and commodities. As shown below, the MSCI EAFE Index would likely see the most significant impact based on its deeply inverse relationship to the dollar. Gold could also see additional selling pressure if the greenback continues to climb. Of course, if the dollar pulls back and resumes its downtrend, the MSCI EAFE Index and gold would benefit based on historical correlation data, along with most S&P 500 sectors.

View enlarged chart

SUMMARY

The dollar is close to breaking out from a major bottom formation. A move above 106 would imply a bottom has been set and a new uptrend is underway. Continued strength in the dollar would weigh on most equity markets, including international developed represented by the MSCI EAFE, which has been the most negatively correlated index to the greenback over the past year. Despite the recent recovery, investors largely remain bearish on the greenback, evidenced by speculative net positioning in the dollar recently reaching over a two-year low. Next week’s FOMC meeting could be the make-or-break catalyst for the dollar. While the market expects a pause, any incremental hawkish tilt in monetary policy from the Fed would likely propel the dollar out of its bottom formation. A dovish pause would likely lead to a pullback in the dollar, although downside may be limited if the eurozone economy continues to underperform.

IMPORTANT DISCLOSURES

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

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

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

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

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

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

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

Posted by Jeffrey Buchbinder, CFA, Chief Equity Strategist

Thursday, September 14, 2023

Key Takeaways

• Economic growth is weakening in Europe while inflation remains stubbornly high, leading to waning earnings momentum.
• Meanwhile, European equity markets have a very small allocation to technology, making it difficult for the European stock market benchmarks to keep up with those in the U.S. when the domestic technology sector is rallying.
• Our technical analysis work points to the U.S. and Japan offering better opportunities than Europe, even though European equity valuations look very attractive.

Five Reasons to Be More Cautious on Europe

Here are five reasons LPL Research is becoming more cautious on Europe:

• Weakening Economic Growth. Eurozone GDP in Q2 was revised down to a 0.1% expansion from the previous 0.3% estimate, which pales in comparison to what the U.S. (+2.1% annualized) and Japan (+4.8%) produced during the second quarter.

Meanwhile, more recent data such as the purchasing managers’ index data (see below) and economic surprise indexes, show that the European economy is weakening. In fact, the Eurozone composite PMI in August reflected the deepest contraction in nearly three years, while nearly every economy in the region reported weaker readings, led by Germany. Europe faces energy, labor, and geopolitical headwinds and lacks the innovation engine that can propel stronger growth like the U.S., and to an extent, Japan enjoys.

Bottom line, we believe Eurozone activity will be subdued for the rest of the year and Germany is likely entering recession. Inflation remains stubbornly high, which sparked the European Central Bank’s (ECB) decision to hike rates another quarter point this morning.

View enlarged chart

• Bearish U.S. dollar call tougher to make. As the global economy slows and markets potentially become more volatile, the greenback may get a safe haven bid. Further, the interest rate differential that we had expected to push the euro currency higher against the dollar has not done so, partly due to the U.S. remaining a more attractive investment destination and partly because the ECB may be done hiking rates earlier than we had anticipated. In fact, markets may increasingly start pricing in rate cuts in Europe, removing the interest rate differential with the Federal Reserve as a bearish dollar catalyst. Finally, from a technical analysis perspective, the dollar appears poised for a breakout to the upside through a major level of resistance in the 104-105 area.

The other side of the story is European exporters should garner some support from a weaker currency (making their goods more attractive to U.S. buyers). Regardless, even though the case for USD weakness over the intermediate term looks like a strong one, our conviction in calling a short term dollar decline is low, removing a potential boost for European equities.

View enlarged chart

• Earnings momentum in Europe is waning. Europe’s economy outpaced most expectations in late 2022 and early this year amid fears of an escalating energy crisis as the war in Ukraine continued. Rising earnings expectations coincided with that outperformance, at least until this summer. Since July, earnings estimates have fallen, coinciding with recent ratcheting lower of economic growth expectations in the region. With recession increasingly likely in Europe in the near term, the current consensus expectation for 6% earnings growth from MSCI Europe in 2024 may be too high. We would anticipate the U.S. and Japan delivering stronger earnings growth than Europe over the rest of this year.

View enlarged chart

Europe having a tough time keeping up with big tech. The MSCI Europe Index has just a 6.6% weighting in technology, compared to more than four times that amount (27.7%) in the U.S. Although the technology sector’s 40% year-to-date rally may be a bit overdone, in rising markets it’s tough for European markets with a more defensive sector mix to keep up.

View enlarged chart

• Europe doesn’t look good on the charts. From a technical analysis perspective, Japan and U.S. equity markets look better than Europe right now. The relative strength of the MSCI Europe Index, shown below in local currency, has broken down and has not been able to generate any positive momentum (the Europe index in dollar terms looks very similar). Japan, on the other hand, in yen terms, has been generating some nice outperformance recently against the U.S. and Europe, with higher highs and higher lows. In fact, U.S. investors in Japanese markets that have hedged currency have generally done better than they have done in the U.S. equity markets, based on the S&P 500.

View enlarged chart

Conclusion

LPL Research holds a slightly positive view of developed international equities, due to cheap valuations and the upbeat assessment of Japan. Meanwhile, the European economy is weakening, conviction on a bearish U.S. dollar move is difficult, European earnings momentum is waning, big tech gives the U.S. an advantage, and our technical analysis work suggests the U.S. and Japan are currently more attractive investment destinations than Europe. So for now, we’ll stick with our bullish Japan and neutral U.S. equities positions, but suggest increasing caution toward Europe.

IMPORTANT DISCLOSURES

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

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

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

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

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

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

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

Posted by Lawrence Gillum, CFA, Chief Fixed Income Strategist

Tuesday, September 12, 2023

It’s been another volatile calendar year for municipal (muni) investors. While generally outperforming taxable core bonds so far this year (as proxied by the Bloomberg Aggregate Bond Index), the Bloomberg Muni Index has underperformed what could be expected from coupon payments alone. So with the last few months of 2023 upon us, the following are five things muni investors should be aware of as these last few months of 2023 come into view.

• The muni curve is almost always steeper than the Treasury curve due to uncertainty about future tax rates, as well as strong demand from individuals for bonds maturing within 10 years, and because longer-dated issuance is normally tied to the expected life of an individual project. While this remains the case, for the first time in decades the municipal bond yield curve is inverted, which provides some interesting opportunities. Core fixed income portfolios could use a barbell strategy to capture the cheapest parts of the curve—the very front end and between 10 and 20 years

View enlarged chart

• Many fixed income investors experienced the worst year on record in 2022. And while 2022 wasn’t exactly the worst year ever for muni investors, it was close. So, understandably, last year was the worst outflow cycle for munis in recent memory. And while better than last year, outflows from mutual funds have persisted with over $8 billion withdrawn this year, despite the attraction of higher starting yields. While valuations and fundamentals remain attractive, until outflows slow, returns could be volatile.

View enlarged chart

• That said, new issuance trends remain below averages. With interest rates elevated and many municipalities in good financial health, the need to access the capital market has been muted. Last year was a relatively light year for new supply but because of the record amount of outflows, the positive supply/demand technical didn’t really help investors. This year, while outflows continue (see above), the very light supply has helped (marginally) keep prices well bid and could further support prices once investors re-enter the market.

View enlarged chart

• While many equity investors are familiar with seasonality trends, fixed income investors may not be as versed. Generally, after the summer doldrums, new issuance tends to pick up, which puts downward pressure on prices (upward pressure on yields). However, as mentioned above, new issuance remains muted. And like the other months this year, which 2023 has so far bucked the trend, the typical seasonal patterns may not hold throughout the rest of the year. But if they do hold, muni investors could end the year with a positive tailwind to returns.

View enlarged chart

• Last month, Moody’s, a rating agency, updated its historical default rate analysis between munis and corporates and the story didn’t change. Munis have, by far, better default characteristics. So, while Investment grade munis have underperformed highly rated U.S. corporates so far this year (not tax-adjusted), munis tend to outperform corporate debt during economic slowdowns. Moreover, the default rate for munis is significantly better than corporate borrowers. The cumulative muni default rate for investment grade issuers (between 2013 and 2022) was just above 0 versus 1.9 for taxable corporate bonds. Additionally, the high yield muni credit default rate was around 4.0%, cumulative, versus 32.5% for high yield corporates. With valuations improved relative to corporate bonds, we could see crossover interest return for munis, which could help offset some retail outflows.

View enlarged chart 

Bottom Line: While munis have outperformed a number of taxable fixed income markets this year, after the historically bad year last year, it probably hasn’t been the year (so far) that many muni investors had hoped for. But, with the Federal Reserve close to the end of its rate hiking campaign, we could see a smoother path for munis over the last few months of the year. Despite a slowing economy, fundamentals are still strong compared to history. And while tax revenues may have peaked, high cash balances and reserves should allow most issuers to adapt to an economic slowdown. Total yields remain above longer-term averages and since starting yields are the best predictor of future returns (over longer horizons), we think high quality munis remain 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.

Municipal bonds are subject to availability and change in price. They are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Interest income may be subject to the alternative minimum tax. Municipal bonds are federally tax-free but other state and local taxes may apply.  If sold prior to maturity, capital gains tax could apply.

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, September 8, 2023

Key Takeaways:

• Oil has staged an impressive rally over the last few months. Voluntary production cut extensions from Saudi Arabia and Russia have helped improve the supply side of the equation. U.S. stockpiles of oil have also dropped to year-to-date lows.
• Oil demand is picking up. China has ramped up imports to near-record levels, while the International Energy Agency forecasts fuel consumption likely reached another record-high last month.
• The math is simple—declining supply and rising demand equal higher prices. West Texas Intermediate (WTI) recently wrapped up a nine-day winning streak that lifted oil out from a major bottom. Momentum is confirming the breakout.
• In terms of upside, the next major area of overhead resistance for WTI sets up near the $94 to $97 range, which traces back to the August-November 2022 highs and a key Fibonacci retracement level of last year’s bear market in oil.

Over the last few months, improving supply and demand dynamics have reenergized crude oil. WTI just wrapped up a nine-day winning streak, marking its longest stretch of consecutive gains since 2019. During this period, crude oil amassed a 9.2% gain, an impressive rally, but not sticking out compared to the 12.9% average during previous nine-day winning streaks.

Now that the winning streak is over, what happens next? We looked at the performance of oil after advancing for nine consecutive days. Of the seven other periods that registered nine-day winning streaks since 1983, forward returns over the next 12 months have been impressive, as WTI gained an average of 16.4% and finished higher in all seven periods.

View enlarged chart

Supply & Demand

 Tightening supply has been a significant driver of crude oil’s rally over the last three months. Saudi Arabia, the de facto leader of the Organization of the Petroleum Exporting Countries (OPEC, now more commonly referred to as OPEC+, which includes Russia and other non-OPEC oil-exporting countries), has voluntarily extended its production cut of one million barrels per day until the end of the year. This means the Saudis will hold output at around nine million barrels per day, marking the lowest production quota in several years (blue line in the chart below). Russia also voluntarily extended its export reduction of 300,000 barrels per day over the same period.

In the U.S., crude stockpiles continue to fall. The Energy Information Administration (EIA) reported commercial crude inventories in the U.S. dropped by over six million barrels this week, marking a fourth straight weekly drop that has left inventories at their lowest level since December (dark blue line in the chart below).

On the demand side of the equation, China continues to import more oil (see grey bar chart below). In August, they imported 52.8 million tons of crude oil, or 12.5 million barrels per day, marking a 21% increase compared to July. In the U.S., implied oil demand reached multi-year highs (orange line below) in July before pulling back modestly last month.

View enlarged chart

Simple Math

You don’t need to be an economist to understand that rising demand and falling supply equate to higher prices. As shown below, WTI has broken out from nearly a year-long bottom formation after clearing key resistance at $83.25. Momentum is confirming the breakout, including a recent bullish crossover between the 50- and 200-day moving averages (dma) and a Moving Average Convergence/Divergence (MACD) indicator buy signal.

Tightening oil market conditions have also shown up on the futures curve. WTI time spreads between front-month and second-month futures contracts have been climbing higher in positive territory (technically switching from contango to backwardation in July), pointing to an uptick in near-term demand for oil.

In terms of upside, the next major area of overhead resistance for WTI sets up near the $94 to $97 range, which traces back to the August-November 2022 highs and a key Fibonacci retracement level of last year’s bear market in oil.

View enlarged chart

SUMMARY

Oil has entered a new uptrend after finally breaking out from nearly a year-long bottom formation. Support from OPEC+, notably Saudi Arabia’s one million barrel per day production cut for the remainder of the year, has been a major driver of the rally. Demand is also picking up as imports into China surge. While prices may be overbought short-term, momentum remains bullish, leaving oil’s next major resistance hurdle at the $94 to $97 range. In large part due to the improving technical backdrop for crude oil, LPL Research’s Strategic and Tactical Asset Allocation Committee (STAAC) recently upgraded its view on energy commodities to positive from neutral. Furthermore, in addition to the breakout in oil, improving fundamentals and attractive valuations underpinned STAAC’s recent upgrade of the energy sector to positive from neutral.

IMPORTANT DISCLOSURES

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

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

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

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

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

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

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

Posted by Jeffrey J. Roach, PhD, Chief Economist

Thursday, September 7, 2023

Additional content provided by Kent Cullinane, Analyst

Key Takeaways

• Prices paid by purchasing managers reversed course, reverting to price levels from April.
• Yields on the 10-year Treasury temporarily spiked on the news that inflation could be stubbornly elevated throughout this year, illustrating that investors should expect a bumpy ride in the markets.
• However, business activity has been growing at a slower pace since the end of 2021 as consumers spend down their excess savings.

Bottom Line: The two big challenges facing the Fed right now are the risks that inflation could become entrenched and the possibility that the consumer could falter when excess savings dry up. Given the data, the Federal Reserve (Fed) will most likely deliver a hawkish pause at the next meeting. The hard data is not yet convincing enough to establish strong views about the subsequent meetings. Investors should still find opportunities in the market but it could be a bumpy ride.

The Institute for Supply Management (ISM) released the ISM Services Purchasing Managers’ Index (PMI) report for August, highlighting an increase for the third consecutive month. The Services PMI rose from 52.7 in July to 54.5 in August, beating consensus estimates of 52.5. As a note, a PMI above 50 represents an expansion, while a PMI below 50 represents a contraction. This marked the eighth consecutive month of the index being above 50 or in expansion territory.

While August’s aggregate 1.8 percent increase is impressive, a couple of the underlying sub-components that make up the Services PMI contributed meaningfully to the monthly increase. The New Orders Index expanded in August for the eighth consecutive month, increasing from 55.0 in July to 57.5, with 12 out of 15 industries reporting an increase in new orders. Accommodation & Food Services was the top contributor, as restaurant sales and traffic trends remain positive year over year and when compared to pre-pandemic levels.

Additionally, the Prices Index rose in August to 58.9, up 2.1 percent from the month before and marking the 75^th consecutive month of price increases. Public Administration, Educational Services, and Health Care & Social Assistance were the top contributing industries to the monthly increase.

The relationship between prices and business activity has diverged, however, as the Business Activity Index, another sub-component of the broader Services PMI, added 0.2 percent, increasing less than the aggregate index. Business activity has been growing at a slower pace since the end of 2021 as consumers spend down their excess savings. Below is a chart highlighting the diverging trend between Services pricing and business activity.

View enlarged chart

Following the release of the Services PMI report, Treasury yields spiked, with the 2-year Treasury yield reaching an intraday high above 5%. At the longer end of the yield curve, the benchmark 10-year Treasury yield also increased, although to a lesser degree, reaching an intraday high of 4.30%. The probability of the Fed raising interest rates in November rose to roughly 40%, according to the CME FedWatch Tool. The probability of an interest rate hike at the Fed’s next meeting in September is still very low, with only a 7% chance of the Fed hiking again.

Despite the slowing of business activity in August, it appears companies were able to pass on rising prices to the consumers at least for the first half of this year. Second quarter earnings were much better than we had anticipated relative to consensus expectations, particularly the surprising increase in overall S&P 500 estimates during reporting season. Looking ahead, the historically close relationship between the ISM indexes and earnings suggest that either the economy will pick up (unlikely in our view) or earnings will level off (more likely).

View enlarged chart

LPL Research sees perhaps mid-single-digit earnings gains in 2024 compared to the current consensus expectation of a 12% earnings. So while we may see earnings growth in the second half of this year, analysts appear overly optimistic for 2024. Further, an earnings rebound appears priced in at current valuations and interest rate levels, consistent with the Strategic and Tactical Asset Allocation Committee’s neutral equities 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.

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

Posted by Lawrence Gillum, CFA, Chief Fixed Income Strategist

Wednesday, September 6, 2023

A few months ago we asked the question (blog post here): Has the corporate credit market lost its mind? At the time we were perplexed by the continued resilience and outperformance of the Bloomberg U.S. Corporate High Yield Index despite the increase in downgrades and defaults, which serve to eat away at future returns. Since then, however, downgrades and defaults have continued to increase and yet high yield spreads, or the additional compensation for owning risky debt, continue to tighten. So this week, we’re ready to declare that, yes, the high yield market has in fact lost its mind and we don’t think it properly reflects deteriorating fundamentals and the elevated refinancing risks of the companies most prone to default.

High yield corporate defaults picked up again in August with the high yield default rate at 2.4%, with the expectation that it will increase to 3.25% (per JPMorgan) by the end of next year. Defaults represent companies that are unwilling or unable to pay their debts back in a timely fashion and thus do not pay their debts back at par. And while defaults have started to increase, deteriorating fundamentals will likely continue to pressure lower-rated borrowers, particularly if the Federal Reserve (Fed) keeps interest rates elevated.

Currently, more than half of CCC-rated borrowers have earnings that are lower than their interest payments, making future payments and refinancings potentially problematic. And unfortunately for these borrowers, debt refinancings are set to pick up with nearly 30% of debt issued by CCC-rated companies coming due over the next few years. And the calculus doesn’t look great for these companies. If the Fed keeps interest rates higher for longer, that means newly issued debt by these companies will become more expensive than their existing debt. However, if the Fed has to cut rates due to a hard landing (not our base case), it would likely make debt cheaper, but the souring economic environment would also likely negatively impact earnings for these companies. Neither option looks particularly enticing if you’re a high yield borrower. And yet, spreads for these issuers are only trading around historical averages.

View enlarged chart

So what is keeping spreads contained? Better than expected economic news, low equity volatility, and very little new supply. But as mentioned, the supply/demand dynamics are set to change. And while there’s no doubt the economic data has been favorable for risk assets lately, eventually the lowest-rated cohort within the high yield index will face funding pressures that could lead to more defaults. S&P, a rating agency, has downgraded the outlook for 164 high yield companies this year (versus only 18 upgraded outlooks), which is three times as many as last year and represents the worst upgrade/downgrade ratio in years. So, with valuations continuing to shrug off bad news and with the evidence building that downgrades and defaults are likely going to keep moving higher, we don’t think the risk/reward for owning high yield is very 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.

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.