Wealth Management

Posted by Adam Turnquist, CMT, VP Chief Technical Strategist

Friday, August 11, 2023

Key Takeaways:

• While there is strong support for stocks being in a bull market, overbought conditions, weak seasonality, rising interest rate volatility, and ongoing uncertainty over monetary policy suggest a shorter-term pullback in this rally could be underway.
• In terms of downside, support for the S&P 500 sets up at 4,450 (June highs), 4,432 (50-day moving average), and near the 4,200-4,300 range (uptrend/prior highs). We believe the latter support range is the most likely spot for a bounce given the confluence of support in this area, the degree of record-high cash sitting in money market assets, and the fact many investors missed the first half rally.
• Don’t panic—pullbacks are normal, even during years with above-average returns. History suggests a 5-10% drawdown between now and year-end is not uncommon, even during years with strong rallies into August. However, even with a drawdown, the S&P 500 has still historically generated positive average returns into year-end.

Stocks have pulled back modestly this month as overbought conditions met overhead resistance. Interest rate volatility spurred by Fitch’s downgrade of the U.S. credit rating, monetary policy uncertainty, stretched valuations, and underwhelming economic data in China have also weighed on risk appetite. The S&P 500 is down 2.6% month to date (as of August 10) after struggling to surpass the 4,600 area. While this is hardly a drawdown by most standards, it is enough to raise the question of where potential support sets up if the selling pressure continues.

As shown below, the S&P 500 began its pullback at 4,600 with a bearish engulfing candlestick on Thursday, July 27. (For reference, bearish engulfing candlesticks are often found after upward price moves and suggest a shift to supply overwhelming demand.) At that time, the index was trading at around a 12% premium to its 200-day moving average (dma), marking over two standard deviations above average, while nearly 20% of index constituents were also overbought based on their Relative Strength Index (RSI). While overbought does not mean over, we suspect this could be a logical spot for a pause or a pullback in this rally, especially as the market enters a weak seasonal period.

View enlarged chart

In terms of downside, support for the S&P 500 sets up at 4,450 (June highs), 4,432 (50-dma), and near the 4,200-4,300 range (uptrend/prior highs). We suspect the latter support range to be the most likely spot for a bounce given the confluence of support in this area, the degree of record-high cash sitting in money market assets, and the fact many investors missed the first half rally. We view the 200-dma as a worst-case scenario for a drawdown.

Bull Markets are not Linear

While there is overwhelming technical evidence supporting the case for a sustainable bull market, expect some pullbacks along the way. The table below compares annual price performance and maximum drawdowns for the S&P 500. At a high level, the chart shows that even years with double-digit gains often experience double-digit drawdowns.

To break down the data, we decile ranked annual price returns of the S&P 500 going back to 1950. The top or first decile represents the top 10% of all years based on price gains, while the bottom or tenth decile reflects the bottom 10% of all years for the index. The percentage thresholds for each decile group are also labeled for reference. After ranking each year by performance, we calculated each decile group’s peak-to-trough average maximum drawdown. We found that the average maximum drawdown for all years going back to 1950 is -13.8%. Furthermore, even years with well above-average price gains are not immune to sizable pullbacks, as the top decile groups reported drawdowns of around 10% on average.

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With the S&P 500 up 16.4% year to date (as of August 10), this year stands out as a top quintile year for performance thus far. Despite the strong momentum, we found other years with above-average gains during this stretch still experience sizable drawdowns into year-end.

The table below breaks down the S&P 500 based on decile-ranked performance from December 31 to August 11. The subsequent average returns and maximum drawdowns for each decile group are also highlighted for the August 11 to December 31 timeframe. In short, history suggests a 5-10% drawdown between now and year-end is not uncommon, even during solid rallies into August. However, even after a drawdown, the S&P 500 has still historically generated positive average returns into year-end.

View enlarged chart

SUMMARY

Stocks have pulled back modestly this month as overbought conditions met overhead resistance. Interest rate volatility, monetary policy uncertainty, stretched valuations, and underwhelming economic data in China have also weighed on risk appetite. While there is still strong support for stocks being in a sustainable bull market, we suspect odds for a pullback in this rally are increasing. However, don’t panic, pullbacks are normal, even during years with above-average returns. History suggests a 5-10% drawdown between now and year-end is not uncommon. And even with a drawdown, the S&P 500 has still historically generated positive average returns into year-end.

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, August 10, 2023

Additional content provided by Colby Hesson

Highlights:

• Consumer prices rose 0.2% in July, pulling the annual rate of inflation up to 3.2% from 3.0% last month.
• Not surprising, the largest contributor to the monthly increase in prices was shelter costs.
• Monthly core inflation, which excludes food and energy, rose 0.2% for the second consecutive time, as core inflation has downshifted in recent months.
• Inflation is still considerably above the 2% level where the Federal Reserve (Fed) would like to see it but the trajectory is encouraging.
• So far, the data suggest the Fed will likely pause at the next meeting but no guarantees about the meeting after that.

Bottom Line: Core inflation is getting less sticky, but for the Fed to declare victory on inflation, it is imperative it unwinds at a faster and more decisive pace. The Fed’s dove versus hawk tug-of-war appears now to be predicated on an ‘insurance’ rate hike later this year, which according to the hawks will help keep inflation expectations anchored. Although the CPI is moving in the right direction, it doesn’t mean another rate hike this year is out of the question, especially with gasoline prices rising. The probability of a rate hike in September is merely 10%, over 8 percentage points lower than this time last week according to the futures market.

The July Consumer Price Index (CPI) data provides an updated view of the inflation situation in the United States. While certain components of the report indicate inflation is slowing, there are underlying variables that continue to influence the total rate. According to the July CPI report, consumer prices rose by 3.2% year over year, a minor increase from the 3.0% annual rate recorded in June. Although this is a reduction from the high levels seen in 2022, it is crucial to remember that inflation remains considerably above the Fed’s 2% target.

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The core CPI, which includes volatile food and energy costs, also slowed slightly, with a 12-month rate of 4.7%, down from 4.8% the previous month. This decrease in core inflation shows some stabilization, but it is critical to understand the variables that are contributing.

Shelter expenses rose by 0.4% in July, accounting for a large share of the overall increase in consumer prices. Notably, shelter expenses increased by 7.7% year over year, underscoring the housing sector’s continuous pressure. This factor is critical in the inflation equation because housing costs influence the consumer price index and thus the total inflation rate. Rent prices continue to rise but at a decreasing rate.

Despite a spike in crude oil prices and increased gas prices during the month, energy prices rose by only 0.1% in July. Used vehicle prices decreased by 1.3%, while medical care services decreased by 0.4%. Airline fares, which had fluctuated significantly owing to the pandemic, declined by 8.1% in July, continuing the trend begun in June.

The CPI report illustrates the continuous dynamics of consumer demand, with a shift away from goods and toward services. Restaurant prices have continued to climb at a rapid pace, showing robust consumer demand in that industry. This is consistent with a broader trend seen in recent months, in which customers have indicated a preference for experiential spending, which has influenced price dynamics in a variety of service industries.

The report also sheds light on the possible influence of housing on inflation. While housing costs have been a key contributor to the growth in consumer prices, there are signs the housing sector may cool. Increased multi-family development activity, driven by an increase in condo and apartment building projects, may result in an increase in the supply of multi-family apartments. This increase in supply may help lower rents, thereby slowing housing-related inflation.

Market reactions to the July CPI figure were overall favorable, with Dow Jones Industrial Average futures up more than 200 points and Treasury yields mostly lower. These replies indicate market participants perceive the report as showing inflation is on the rise, which may give the Fed the leeway to maintain current interest rates in the short term.

The rising level of inflation, particularly in housing expenses, presents a challenging problem as the Fed contemplates its next measures. While the overall trend in inflation appears to be positive, the Fed is likely to stay cautious. The dual mandate of the central bank of price stability and maximum employment requires careful analysis of the changing economic landscape.

When the August CPI report is released, it will be closely analyzed to see if the patterns seen in the July report continue. It will give useful information about whether the current decrease in inflation rates is sustainable or if there are new events that could influence the Fed’s policy decisions.

Conclusion

While the July CPI report indicates a good trend in inflation, it is important to note inflation remains above the Fed’s objective and the central bank faces a delicate balancing act. Continuous monitoring of inflation is required, and the Fed’s choices in the next few months will be critical in navigating the complicated economic situation. Although the CPI is moving in the right direction, it doesn’t mean another rate hike this year is out of the question, especially with gasoline prices rising. However, we think the Fed will pause during its September meeting but keep everything on the table for the November meeting. Investors should find plenty of opportunities in this market despite the disproportionate easing in inflation pressures. Cyclical sectors performed well today as inflation is easing and so far, without creating any obvious cracks in the economy.

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 Josh Whitmore, CFA, Senior Analyst

Wednesday, August 9, 2023

Many investors labelled 2023 as the “Year of the Bond” following 2022’s historic bond rout (the Bloomberg U.S. Aggregate Index (Agg) declined 12%). Broadly, fixed income returns are positive across the board in 2023. However, high quality core bond returns (proxied by the Agg) have materially lagged the returns of riskier plus sectors like high yield bonds, bank loans, and emerging market debt, countering many market participants‘ expectations at the start of the year. While returns in core bonds have lagged expectations in 2023, retail flows have seen a sharp reversal after investors fled taxable bond funds in 2022 (~$200 billion per Morningstar data). Why are core bond fund flows particularly important in 2023?  What’s more surprising, high yield funds have seen outflows and have still managed to generate over 6% return YTD. How is this possible?

Per Morningstar data, the chart below shows open-ended intermediate core and core plus bond funds (mutual funds and ETFs) have had strong inflows of over $100 billion during the first half of 2023, representing roughly 80% of total 2023 inflows for taxable bond categories. These inflows come at an opportune time, allowing money managers to support the bond market as two important buyers step back—the Federal Reserve (Fed) and banks. As the Fed continues to run quantitative tightening (QT), it has actively stepped back from Treasury and mortgage-backed securities (MBS) markets. Additionally, elevated front-end rates incentivize investors to pull cash out of bank deposits and allocate to products like money market funds and other cash-like alternatives. Declining deposits equates to lower reserves needed by banks, which equates to banks stepping away from high quality bond markets as well. As two key market participants and their natural bid step back from the market, money managers need to fill in this demand gap. So far in 2023, that hasn’t been a problem given the positive inflows, providing a bid to high quality core bond sectors.

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As the chart above shows, high yield credit funds (bonds and bank loans) have seen outflows over the last 18 months. The resilience of high yield credit returns despite investor outflows is a good example of the technical aspects of the bond market. In simplest terms, high yield supply slowed in 2022 and has continued to do so in 2023. According to JPMorgan Market data, 2023 high yield supply is 42% lower than the four year average (excluding 2020). This lower supply helps to offset investor outflows as the market avoids becoming over saturated with high yield debt, which would push yields higher and returns lower for investors. This recent lack of supply of high yield credit is partly explained by the war chest of liquidity high yield issuers built during the ultra-low rate environments of 2020 and 2021. However, roughly $785 billion of high yield bonds are set to mature between 2024 and 2026. This may lead to high yield supply closer to historical averages as issuers re-tap the market, and this supply may become a technical headwind if supply outpaces demand, particularly if economic growth slows.

We expect high quality bond fund inflows to continue as yields have reached levels not seen since 2008 (the Agg recently reached a yield-to-worst of roughly 5%). High quality core bond funds with yields in the 4–6% range are reasonable alternatives to other asset classes, particularly for investors fearful of an economic slowdown. Starting yields are the best predictor of long-term returns. We also expect core bond fund inflows to outpace sectors like high yield bonds over the near-term given materially lower credit risk. These inflows will provide stability to the bond market as the Fed and banks take a step back. We continue to favor core bonds over high yield credit broadly as investors no longer have to reach for yield.

IMPORTANT DISCLOSURES

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

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

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

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

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

For a list of descriptions of the indexes and economic terms referenced in this publication, please visit our website at lplresearch.com/definitions.

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

Posted by Jeffrey J. Roach, PhD, Chief Economist

Tuesday, August 8, 2023

KEY TAKEAWAYS

• This morning, the National Federation of Independent Business (NFIB) released their latest insights from their July survey and hiring plans have trended lower since mid-2021.
• We are starting to see this softer trend show up in the jobs report. Headline payrolls rose by 187,000 in July, with the prior month’s gain revised down from 209,000 to 185,000.
• The high correlation between this survey and job growth implies the labor market should loosen in the coming months and provide leeway for the Federal Reserve (Fed) to pause at their next meeting.
• Markets should respond favorably to softer job growth if it translates into easing inflation pressures.

OVERVIEW

The Bureau of Labor Statistics (BLS) reported nonfarm payrolls grew by 187,000 in July, just shy of consensus. This, however, marks a slight uptick from the revised June figure of 185,000. The healthcare sector was the biggest contributor, adding 63,000 jobs, followed by social assistance (24,000) and financial activities (19,000). Labor force participation came in at 62.6% for the fifth straight month, while the unemployment rate ticked down to 3.5%, from a previous 3.6%.

Although July’s BLS report showed a steady pace of hiring, the longer-term path in hiring has displayed signs of slowing over the past year. The chart below highlights the overall trend since July 2022.

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July’s report shows we haven’t yet seen the marked slowdown in hiring, which usually accompanies an economic downturn. This data lends itself to the soft landing narrative which is taking hold. If we continue to see consumer demand, then companies will continue to hire in order to meet their needs. However, consumer debt as measured by credit card balances, has now reached warning-sign levels. Credit card interest rates were 20.86% as of the last reading in May, which marks the highest level since the data series began in 1972. It’s important to note that elevated balances and record-level borrowing rates cannot be sustained.

LOOKING AHEAD

Leading indicators of job growth show signs of further softness. This morning, the NFIB released their latest insights from their July survey and hiring plans have trended lower since mid-2021. We are starting to see this softer trend show up in the jobs report. As shown in this second chart below, the NFIB survey and the monthly jobs report are highly correlated, and according to the latest report from business owners, investors should expect hiring to slow as we enter the latter months of 2023. Investors should expect the markets to respond favorably to softer job growth if that growth remains positive. So far, we aren’t seeing signals of contraction yet, so as long as inflation decelerates further, the Fed should pause its tightening cycle at the next meeting.

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.

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, August 4, 2023

Key Takeaways:

• A busy earnings calendar for equities has largely been overshadowed by volatility in the fixed income market this week.
• Treasuries stole the spotlight after Fitch downgraded the U.S. credit rating from AAA to AA+, putting added upward pressure on yields. Longer duration Treasuries lagged and a bear steepener curve developed, creating a potential double bottom formation in the closely watched 10-year minus 2-year Treasury curve spread.
• Historically, curve spreads have bottomed before five of the last six recessions since 1980, although it took an average of 187 trading days after the bottom for the official recession to start.
• Equity market returns following a major bottom in the 10-year minus 2-year Treasury curve spread have historically been positive over the following 12 months. Smaller caps tend to underperform during this period.

Treasuries Steal the Show

While it has been a busy week of S&P 500 earnings, the fixed income market stole the show. Fitch’s downgrade of the U.S. credit rating from AAA to AA+ put Treasuries in the spotlight and exacerbated upward pressure on yields that are already facing increased supply, quantitative tightening, relatively resilient economic data, higher-for-longer monetary policy, and the Bank of Japan’s recent tweak to their yield curve control program.

Longer duration Treasuries are underperforming on the week, including the 10-year, whose yield is up over 20 basis points (bps) since last Friday. The jump in 10-year yields triggered a breakout above the March highs at 4.09%, leaving the 4.24%-4.34% range (October/November 2022 highs) as the next major area of overhead resistance. Momentum is also confirming the breakout, including a recent Moving Average Convergence/Divergence (MACD) buy signal and bullish crossover between the 50-day and 200-day moving average (dma).

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Volatility on the front end of the curve has been less pronounced, as shorter duration Treasuries are more directly tethered to monetary policy—which remains a higher-for-longer theme. With benchmark 2-year Treasury yields trading nearly unchanged since last Friday, a bear steepener curve has formed as longer-term rates are rising faster than shorter-term rates. As shown on the right below, the recent steepening or dis-inversion of the curve occurred right at support from the March lows, forming a potential double-bottom in the 10-year minus 2-year Treasury curve spread. Technically, a breakout above the declining 200-dma would add to the evidence of the lows being set.

View enlarged chart

However, on a longer-term basis, and as you can see on the left side of the chart above, dis-inversions of the 10-year minus 2-year Treasury curve spread often precede recessions (and provide an even more timely indicator for recessions than the actual inversion). Curve spreads have bottomed before five of the last six recessions since 1980, although it took an average of 187 trading days after the bottom for the official recession to start. Only in March 1980 did curve spreads bottom during a recession.

View enlarged chart

How Do Stocks Perform After Curve Spreads Bottom?

Finally, we also looked at how the S&P 500, Nasdaq Composite, and Russell 2000 performed after a major bottom was set in the 10-year minus 2-year Treasury curve spread. While acknowledging the data is limited, returns over the subsequent 12 months have historically been positive for each index, although most returns track toward modest underperformance relative to historical 12-month returns during this timeframe. In terms of relative performance, the Russell 2000 has historically lagged its index peers, a common theme for small caps before the onset of a recession.

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SUMMARY

Curve spreads have recently steepened after finding support off the March lows, forming a potential double bottom on the closely watched 10-year minus 2-year Treasury curve spread. Technically, a breakout above the declining 200-dma would add to the evidence of the lows being set. While a dis-inversion of the curve often precedes a recession, the lag time between when curve spreads bottom and the start of a recession has averaged 187 trading days. Stocks have also posted positive returns over the following 12 months after a bottom in curve spreads.

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, August 3, 2023

Additional content provided by John Lohse, CFA.

• The energy sector has recently re-emerged into the spotlight as a confluence of events have driven a shake-up in prices and profitability.
• The S&P 500 Energy Sector posted a 7.4% gain in July and outperformed all sector peers.
• Major integrated oil and gas companies are posting sharp declines in year-over-year profits.

Company Profits and Fundamentals

Major oil companies have recently reported plunging second quarter profits. Weaker fossil fuel prices compared to a year ago have significantly eaten into bottom lines. Despite these second quarter results, stock prices have not faltered in a commensurate manner. In July, the energy sector of the S&P 500 posted its highest monthly return of the year. The 7.4% return was top among all S&P sectors.

Companies have emphasized returning shareholder value by raising dividends and implementing share buybacks. Additionally, a renewed focus on stricter cost measures has begun to shore up balance sheets and improve fundamentals. We’ve seen both free cash flow yield and cash flow return on invested capital, measures of valuation and profitability, turn positive this year as industry management teams—with pressure from Wall Street—have focused less on production volumes and more on profitability.

Global Supplies Have Been Shocked

Crude oil prices (as measured by West Texas Intermediate, or WTI) leapt higher and finished July at $81.80/bbl, up almost 16% from the previous month. This was due, in part, to voluntary production cuts by OPEC+ members in April, along with an additional 1 million barrel-per-day cut by Saudi Arabia starting in July.

Meanwhile, in the U.S., stocks of crude oil fell by 17.05 million barrels for the week ended July 28. That marks the largest single-week decrease since 1982 when the Energy Information Administration (EIA) started reporting data. The week’s drawdown was entirely from private reserves, as the Strategic Petroleum Reserve remained static, albeit at a 40-year low of 347 million barrels.

The chart below shows the decline in U.S. ending stocks of crude oil, including both the private and strategic petroleum reserves.

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The Demand Picture is Muddied

While supply is being constrained, the outlook on demand is less clear. The waning of summer-heightened demand will shift the seasonality factor, the U.S. economy may contract slightly later this year or early next, Europe is currently teetering on the edge of recession, and higher oil prices could curb demand and limit the industry’s profit potential. On the other hand, Chinese economic officials have recently pledged to “restore and expand” consumption which could further spur demand from the world’s second-largest economy. However, the effects and success of these policies are yet to be seen.

Conclusion

LPL Research holds a ‘neutral’ view on the energy sector but maintains a positive bias. Current fundamentals are showing signs of strength and valuations are attractive, but the geopolitical backdrop and recession fears amid an expected slowdown in growth, are creating cause for concern. We continue to maintain a watchful eye on the sector and assess the landscape through a technical and fundamental lens.

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, August 2, 2023

Yesterday, one of the three main rating agencies (Fitch) downgraded U.S. government debt to its second highest rating, AA+. The agency cited “the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to ‘AA’ and ‘AAA’ rated peers over the last two decades” as the reasons for the downgrade. The rating agency warned two months ago that a downgrade was an option and, frankly, has been warning of a downgrade for years. The two other major rating agencies have not changed existing ratings: Moody’s still has the U.S. at Aaa while S&P remains at AA+.

While not necessarily wrong in its assessment, the rating downgrade will likely not have an impact on U.S. government debt or markets broadly. The U.S. remains the safe haven during times of market stress and the downgrade will likely not change that. That was further evidenced by the (non) reaction from the bond market after the announcement. And this isn’t the first time the U.S. has been downgraded. In August 2011, S&P, which arguably carries more weight than Fitch, cut the U.S. rating from AAA to AA+, which is the current rating. At the time S&P noted that the downgrade “reflects our opinion that the … plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics”. And while that came as an initial surprise to markets, markets recovered in short order with the S&P 500 Index rebounding and finishing up the year nearly 20% off those lows.

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A potential reason why it could matter to investors is likely only administrative. The U.S. is officially split-rated so accounts that have minimum AAA-rating requirements may have to change account documentation, but it will not likely result in forced selling. That said, continued fiscal expansion/deficits could result in additional downgrades from rating agencies. So, until the U.S. government gets its fiscal house in order, we’re likely going to see additional downgrades.

In a related announcement this week, the Treasury department seeks to borrow an additional $1 trillion in the third quarter alone (and nearly $2 trillion over the rest of the year). This is on top of the $1 trillion of new debt that has been issued since the debt ceiling was removed in June. With budget deficits expected to continue, we’re likely going to see elevated Treasury issuance as well. While historically there has been very little relationship between supply and prices, given the amount of Treasury debt coming to market over the next few quarters/years, we could see upward pressure on yields. However, we think the 10-year Treasury yield ends the year between 3.25% and 3.75%.

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.

Tracking # 1-05376752

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

Tuesday, August 1, 2023

Key Takeaways:

• Credit card debt hit a new high in the first quarter of this year, just shy of a trillion dollars and rates on card debt also hit a new high since the data series began in 1972.
• The average credit card debt at the end of last year was over $7,200 and half of those individuals say it would take over a year to pay off that balance.
• The trajectory for consumer spending will likely downshift when credit card bills come due.

What’s the Latest Trend with Credit Card Usage?

Total credit card balances are getting close to a trillion dollars. As of Q1 of this year, the Federal Reserve (Fed) reported card balances were $986 billion, roughly $60 billion higher than the previous record set in 2019.

Typically, card balances fall in first quarters, but sometimes consumers present an anomaly. This year along with 2000 and 2001 were the only years where Q1 balances did not fall. Balances are growing amid higher credit card rates. At the end of last year, the average debt for card holders who had unpaid balances was over $7,200, and the most concerning part is survey respondents confess that it would take over a year to pay off those balances.

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What Can Credit Card Usage Tell Us About the Future?

The growth of credit card debt accelerated into the recession of 2001 and 2008. So, the increasing rate of card debt could be a harbinger of things to come. As shown in the chart above, when an economy is slowing and going into recession, consumer spending slows and card balances grow to offset factors such as slowing real wage growth.

The increase in card balances foreshadows a weakening consumer, and as the consumer goes, so goes the economy.

Conclusion

Investors should pay close attention to unpaid credit card balances for signs of any cracking within the consumer sector. Stubborn inflation is one reason credit card debt has spiked this past year. In Q1 of this year, credit card debt reached a record $986 billion, roughly $60 billion higher than the previous peak in 2019. Amid rising balances, credit card rates reached an all-time high since the data series began in 1972, putting additional pressure on consumers.

As the economy searches for stability, we think the inflation dynamic will continue to improve throughout the year as consumer spending slows and the Fed likely pauses in September.

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, July 28, 2023

Key Takeaways:

• Broadening participation in this year’s rally has changed the narrow leadership narrative.
• The average stock is doing quite well, evidenced by continued technical progress on the S&P 500 Equal Weight Index.
• The S&P 500’s advance/decline line has broken out to new 52-week highs after diverging from the broader market this spring. The breakout provides additional confirmation of the S&P 500’s rally to year-to-date highs.
• The percentage of stocks trading above their 200-day moving average has notably improved this year. Furthermore, the composition of breadth leadership remains heavily tilted toward cyclical stocks.
• Global stocks are also participating in this rally. The MSCI All Country World Index ex-USA has recently reached a new 52-week high.

A New Chapter

The narrative of this year’s rally has changed as this bull market is no longer just a mega-cap story. A new chapter of broadening participation has developed. Relatively resilient economic data in the U.S., receding inflation pressures, and expectations for the end of the Federal Reserve’s (Fed) rate-hiking campaign have underpinned a notable expansion in market breadth since early June.

The following four charts highlight why this rally is no longer just a mega-cap story.

• Equal Weights Getting Even

After lagging behind the S&P 500 (SPX) for most of the year, the S&P 500 Equal Weight Index (SPW) kicked back into gear last month and staged an impressive comeback. As the name implies, each stock within the index is equally weighted, unlike the market-cap-weighted SPX. The equal weighting eliminates the distortion of the mega-cap components and significantly changes several sector weightings, including technology, which drops from around 29% on the SPX to only 13% on the SPW. The industrials sector has the biggest increase in weight, jumping from 9% on the SPX to 16% on the SPW.

Technically, the SPW has cleared resistance off the August highs after confirming support off an uptrend. The rising 20-day moving average (dma) is above the rising 50-dma, which is also above the 200-dma (20-dma > 50-dma > 200-dma). This moving average alignment provides additional confirmation of the SPW’s uptrend.

Relative strength is improving for the average stock. The SPW vs. SPX ratio chart recently inflected higher off support from the 2021 lows. While it’s too early to make the call for an uptrend on the ratio chart, the recent higher lows near support provide a constructive sign for the SPW. Furthermore, a pullback or consolidation within the mega-cap space, coupled with a soft landing economic scenario, could serve as a catalyst for a confirmed relative uptrend of SPW outperformance.

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• Advancers > Decliners

The chart below shows the two-year cumulative advance-decline (A/D) line for the SPX. The 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.

Earlier this spring, the A/D line (bottom panel) was trending lower as the SPX (top panel) continued to climb higher. This negative divergence resulted from narrow participation pushing the broader market higher, a concerning technical sign for the sustainability and strength of the rally. However, the tables have turned as participation in the rally began to broaden last month. As a result, the A/D line reversed course and surpassed resistance from the August 2022 highs. The breakout on the A/D line provides additional confirmation of the SPX’s rally to year-to-date highs.

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• From Bad Breadth to Good Breadth

The percentage of stocks on an index trading above their longer-term 200-day moving average (dma) is another important way to quantify and compare market breadth. As a general rule, if a security is trading above its 200-dma, it is considered to be in an uptrend, and vice versa if price is below the 200-dma. Furthermore, the higher the percentage of stocks above their 200-dma implies buying pressure is more widespread—suggesting the market’s advance is likely sustainable.

As shown in the chart below, 73% of stocks within the S&P 500 are trading above their 200-dma as of July 27. This compares to only 48% at the end of 2022. In addition, the composition of breadth leadership has turned increasingly bullish. The highest sector readings include technology, industrials, energy, and consumer discretionary. So not only is breadth on the index robust, but cyclical stocks are also leading.

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• Participation is Global

The U.S. equity market is not the only place to find a bull market. Global stocks are also doing relatively well, with several major indices recently hitting new 52-week highs, including the MSCI All Country World Index ex-USA. This index, comprised of over 2,300 constituents, tracks mid and large cap companies operating across 22 of 23 developed markets (excludes the USA) and 24 emerging market countries. As shown below, the index has recently broken out from an ascending triangle formation and registered a new 52-week high.

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SUMMARY

Technical evidence suggests this year’s rally is no longer just a mega-cap story as broadening participation has changed the narrative. The relative performance of the average stock is building, while the market’s A/D line trades at new 52-week highs. Nearly 75% of S&P 500 stocks are back above their 200-dma, with cyclical sectors posting the highest percentages among sector peers. International stocks are also participating in this year’s rally as most major global benchmarks are in bull market territory. Overall, we view the expansion in market breadth as a constructive sign for the sustainability of this bull market.

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