Wealth Management

Posted by Adam Turnquist, CMT, VP Chief Technical Strategist

Wednesday, May 24, 2023

Key Takeaways:

• Momentum picked up steam for the S&P 500 last week until overhead resistance came into play at 4,200. Stocks have once again struggled to surpass this hurdle, although it shouldn’t be too surprising given the ongoing debt ceiling drama in Washington.
• While last week’s rally wasn’t enough to clear resistance, it was enough to flip the Moving Average Convergence Divergence (MACD) indicator back into a buy position.
• What is the MACD? MACD combines momentum and trend following into a single indicator and, as the name implies, is based on convergences and divergences between a long- and short-term exponential moving average (EMA).
• How does it perform? Historically, MACD buy signals have generated above-average returns, with a relatively high frequency of positive returns occurring across most timeframes over the following year. Returns tend to improve when buy signals occur when the S&P 500 is trading above its 200-day moving average (dma)—as was the case last week.
• Sell signals on the MACD indicator are not as ominous as they sound, as they tend to produce below-average, but still positive, returns when the S&P 500 is trading below its 200-dma.

What is MACD?

This popular technical tool was first introduced by Gerald Appel in 1979 and combines momentum and trend following into a single indicator. As the name implies, the framework of the indicator is based on convergences and divergences between a long- and short-term exponential moving average (EMA)—often a 26-week and 12-week EMA, respectively. The difference between these two EMAs is called the MACD line. A smoothing method is then applied by calculating an EMA of the MACD line, creating the signal line.

How to Interpret?

When the MACD line crosses above the signal line, as it did last week on the S&P 500, it is considered a bullish signal. Conversely, a bearish signal occurs when the MACD line crosses below the signal line. There are also centerline crossover signals based on the MACD line moving above (bullish) or below (bearish) the centerline.

The chart below highlights the S&P 500 along with its MACD indicator. The bottom panel shows recent buy and sell signals. A histogram is also included in the middle panel to better depict the convergence and divergence between the MACD and signal lines.

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As shown above, the MACD indicator flipped back into a buy position last week, marking the third buy signal of this year. The previous two signals proved timely as they coincided with the rallies off of the December and March lows.

How Does MACD Perform?

Since 1950, all MACD buy signals on the S&P 500 have generated average forward three-, six-, and 12-month returns of 2.0%, 4.0%, and 8.3%, respectively. Furthermore, we found buy signals occurring when the S&P 500 was above its 200-dma—as was the case with last week’s signal—historically generated higher returns than buy signals occurring when the index was below its 200-dma.

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Considering the S&P 500’s rolling 12-month average return is 8.9% since 1950, and 73% of those periods produced positive returns, it shouldn’t be a major surprise that MACD sell signals did not generate downside losses, on average. The average S&P 500 returns for all sell signals are shown in the table below.

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Since 1950, all MACD sell signals on the S&P 500 have generated average forward three-, six-, and 12-month returns of 1.8%, 3.7%, and 8.0%, respectively. All three aforementioned timeframes underperformed relative to the MACD buy signal returns. Furthermore, we found that sell signals occurring when the S&P 500 was below its 200-dma historically generated lower returns than sell signals occurring when the index was above its 200-dma.

SUMMARY

The MACD indicator is a useful technical tool to help identify trend direction and momentum. Historically, MACD buy signals have generated above-average returns, with a relatively high frequency of positive returns occurring across most timeframes over the following year. Returns tend to improve when buy signals occur when the S&P 500 is trading above its 200-dma, especially compared to buy signals occurring when the index is below its 200-dma. Sell signals on the MACD indicator are not as ominous as they sound, as they tend to produce below-average, but still positive, returns when the S&P 500 is trading below its 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 Lawrence Gillum, CFA, Chief Fixed Income Strategist

Tuesday, May 23, 2023

• U.S. Treasury yields are generally higher over the past week with the two-year trading around 4.4%. The 0.50% increase in the two-year yield since last Monday is largely due to markets pricing out rate cuts later this year. Our view was that the market was too optimistic for the amount of rate cuts being priced in. Markets now expect one cut this year, which may still be too optimistic, unless financial conditions deteriorate. That said, we think we’re close to the end of the recent rise in Treasury yields.

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• News reports suggested there was “optimism” surrounding the debt ceiling negotiations but still no deal. Treasury market pricing suggests the greatest risk of delayed payment will occur for those securities that mature on or after June 6. Currently, the Treasury Department has around $60 billion in its operating cash account. For context, the Treasury’s cash balance got to around $11 billion in 2011. Our base case remains a deal gets done in time, but the clock is ticking.

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• Moreover, the Treasury Bill (T-bill) market is fairly disjointed currently with T-bills that mature on May 30 yielding 2.89% (the fed funds rate is 5.25%) and those that mature in June 8 yielding 5.81%. The difference in yields between the two securities is at extreme levels as more market participants are avoiding those securities that could be negatively impacted by a delay payment from the Treasury. The longer the negotiations drag out, the more it is likely we’ll continue to see higher yields for the securities maturing in June.

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• Interest rate volatility (as per the MOVE index) remains elevated relative to the last decade but in line with the periods before central banks’ quantitative easing. We think interest rate volatility will remain elevated as long as the Federal Reserve (Fed) remains committed to reducing the size of its balance sheet. The most interest rate sensitive fixed income assets are likely at higher risk of volatility. But buy and hold investors should remember that bonds pay back principal at par regardless of intra-period volatility.

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• After the recent back-up in yields, core fixed income sectors are trading close to levels last seen in early March and above longer-term averages. We think the risk/reward is more favorable for core bond sectors over plus sectors with the exception of the preferred securities market. As such, we think the recent move higher in yields is an attractive opportunity for investors to add to high quality fixed income.

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IMPORTANT DISCLOSURES

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

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

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

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

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

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.

Insurance products are offered through LPL or its licensed affiliates.  To the extent you are receiving investment advice from a separately registered independent investment advisor that is not an LPL affiliate, please note LPL makes no representation with respect to such entity.

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

Posted by Adam Turnquist, CMT, VP Chief Technical Strategist

Friday, May 19, 2023

Key Takeaways:

• The pain trade for the broader market is higher as sentiment and positioning remain extremely bearish.
• Despite all the negativity, risk appetite appears to be building among hedge fund managers, who added exposure to more offensive sectors in the first quarter.
• Continued technical progress and the potential end to the Federal Reserve’s (Fed) rate hiking cycle could spark a change in investor sentiment and pressure speculators to cover historically high short positions.
• What does this mean for the S&P 500? It could be a quick trip toward the August highs near 4,300.

Pain Trade is Higher

The pain trade for the broader market remains higher. Despite the S&P 500’s near double-digit rally this year, sentiment and investor positioning remain historically bearish. As highlighted in yesterday’s blog post—Investor Sentiment Still Depressed by the Wall of Worry—the American Association of Individual Investors (AAII) reported that the spread between the percentage of bullish and bearish investors fell to -17% this week, marking more than one standard deviation below its long-term average of +2%. Fund managers are also bearish. According to the latest Bank of America Global Fund Manager Survey, risk appetite is at its lowest level since November 2022, cash levels are at year-to-date highs, and growth expectations are at their lowest reading of the year.

Actions Speak Louder Than Words

Bearish sentiment has been a well-telegraphed narrative for the last year, and while it did not make a great contrarian indicator in 2022, it seems to be working in 2023. Furthermore, when it comes to investing, actions speak louder than words. We parsed the latest 13F filings to determine what actions asset managers have been taking with their portfolios over the last two quarters. For reference, the Securities and Exchange Commission (SEC) requires institutional investment managers with assets under management of at least $100 million to report their holdings each quarter.

The pie chart below shows the reported first quarter 13F holdings for hedge fund managers. The sector percentages are based on 1,149 SEC filings with an aggregate market value of around $2 trillion.

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At the end of the first quarter, hedge fund holdings were concentrated in the technology, health care, and consumer discretionary sectors. Within the technology sector, the largest increases in aggregate positions based on quarter-over-quarter market value changes were NVIDIA (NVDA), Microsoft (MSFT), and Salesforce (CRM). At the same time, Cisco (CSCO), Accenture (ACN), and Qualcomm (QCOM) had the largest decreases in position sizes among funds.

Given the banking turmoil that overlapped with the first quarter, we also examined what hedge funds bought and sold in the financial sector. The table below breaks down the top and bottom five financial sector stocks based on respective increases and decreases in hedge fund positions during the quarter.

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Hedge funds sold over 20 million shares of both US Bancorp (USB) and Bank of America (BAC) during the first quarter, bringing total hedge fund holdings down by over $1 billion in each company. The largest increase in aggregate positions last quarter was in BlackRock (BLK), as funds added 1.4 million shares, increasing total hedge fund holdings in the company by $860 million.

Despite all of the negative sentiment, hedge fund managers appeared to be more offensive when comparing first-quarter holdings to the previous quarter (4Q22). Fund managers added to technology (+1.5%), communications (+0.9%), consumer discretionary (+0.7%), industrials (+0.4%), and materials (+0.1%). To help fund the increases in the aforementioned cyclical sectors, hedge funds decreased allocations to more defensive sectors, shown below. Fund managers also reduced sector positioning in financials and energy, although energy has been more defensive than offensive over the last year.

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SUMMARY

Despite sizable gains across the major U.S. averages this year, investor sentiment and positioning remain decisively bearish. However, the latest 13F holdings data reveals that risk appetite is coming back into the market among hedge fund managers. This quarter showed a noticeable shift in positioning to more cyclical sectors. Technology remains a heavyweight on hedge fund books, while financial sector holdings have declined in the wake of the latest banking turmoil. Given the continued technical progress for the broader market and the potential end to the Fed’s rate hiking cycle, a change in sentiment may be on the horizon, while pressure to cover historically high short positions builds. What does this mean for the S&P 500? It could be a relatively quick trip toward the August highs near 4,300.

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 George Smith, CFA, CAIA, CIPM, Portfolio Strategist

Thursday, May 18, 2023

The latest weekly data from the American Association of Individual Investors (AAII) showed individual investor sentiment is still at depressed levels. This is perhaps not surprising as investors have built up a “wall of worry” from concerns about lingering inflation, uncertainty over the path of interest rates, recent bank failures, recession fears, and depressed consumer sentiment, not to mention concerns over the debt ceiling and the potential for a U.S. debt default and/or credit downgrade.

The percentage of individual investors who are bullish about short-term market expectations is 23%, down from 29% last week. This marks the lowest level since the end of March and is well below the long-term average of 34%. The percentage of investors who are bearish slightly decreased week-on-week to 40% but was still well above the long-term average of 32%. This puts the spread between the bulls and the bears at -17%, versus a long-term average of +2%.

As shown in chart the below, investor sentiment, as measured by the spread between bulls and bears in the AAII data, is more than one standard deviation below its long-term average. The January rally in the S&P 500 brought some bulls back, with the bull-bear spread getting above zero for a single week, but since then investor sentiment has fallen despite stocks recovering in March and mostly trading sideways since then.

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While the concerns that are feeding into the individual investors’ “wall of worry” are valid, the negative sentiment they have built up is, from a contrarian perspective, a potential catalyst for positive forward returns.  Stock markets are forward looking and if concerns are well known and understood they are also probably largely priced in. Markets typically slump due to surprises and shocks, not known risks. As such, we view the negative sentiment in the AAII data as a contrarian indicator, suggesting support for stocks, as many potential buyers wait in the wings for current worries to subside. Extremes in pessimism in the AAII data are, on average, bullish for near-term stock market returns (and extreme investor optimism tends to be bearish for the near-term outlook). When the bull-bear spread is around where it is now (between 1 and 2 standard deviations below average), we have seen the strongest S&P 500 returns three months and 12 months out, and the second strongest returns six months out.

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Summary

There are many risks out there for markets and the economy that have justifiably built up a significant “wall of worry,” but one remaining asset for stocks, from a contrarian perspective, is all this negative sentiment and positioning. We still maintain a modest overweight to equities funded from cash (where the return profiles of short-term products are very attractive, but reinvestment risk has also risen), as equities may still benefit from falling inflation and the potential end to Federal Reserve rate hikes. We recommend a neutral allocation to fixed income, as valuations have become more attractive relative to equities amid higher interest rates.

IMPORTANT DISCLOSURES

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change.

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

Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities. All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

All index and market data from FactSet and MarketWatch.

This Research material was prepared by LPL Financial, LLC.

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

Insurance products are offered through LPL or its licensed affiliates.  To the extent you are receiving investment advice from a separately registered independent investment advisor that is not an LPL affiliate, please note LPL makes no representation with respect to such entity.

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

Posted by Lawrence Gillum, CFA, Chief Fixed Income Strategist

Tuesday, May 16, 2023

After years of waiting for cash to be a viable asset class again, investors have flocked into money market funds to take advantage of higher Treasury yields. In fact, with over $5 trillion in assets, money market assets under management have never been higher. However, with the ongoing debt ceiling drama in Washington, investors may be concerned about the prospects of delayed payment on Treasury bills (T-bills), which generally make up a sizable allocation within certain money market funds (MMFs). Aggregate data shows that money market fund managers are taking the potential of delayed payment seriously and have been positioning portfolios defensively. Many (not all) managers have been utilizing the Federal Reserve’s (Fed) overnight reverse repo facility (ON RRP) and are selectively adding T-bills that mature outside of the x-date.

The Fed’s ON RRP facility allows certain MMFs to borrow from or lend to the Fed, using government securities as collateral and agreeing to buy or sell back those securities at rates set by the Fed, on an overnight basis. As seen in the chart below, balances at the ON RRP facility remained elevated with over $2 trillion parked there (as of May 15, 2023). Collectively, 95% of the usage of the facility comes from MMFs: Government MMFs made up about 79% of the uptake, prime MMFs close to 16%, and non-MMFs about 5%. With an aggressive rate hiking campaign by the Fed and the ongoing debt ceiling drama in Washington, the Fed’s facility remains an attractive (and comparably risk free) alternative to options in the short end of the Treasury market.

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Additionally, as further precautions, MMFs have been cautious with T-bill allocations by opting for bills that mature outside of the so called x-date. In particular, according to JPMorgan, government MMFs kept investments in T-bills maturing in June through August relatively low as of April-end. Anecdotally, we see this in the nearly 1% difference in yields between bills that mature on May 30 and those bills that mature after June 1^, as investors are demanding additional compensation for the risk of delayed payment.

Our base case remains that Washington will do the right thing and raise the debt ceiling—like it has every single time before. President Biden and House Speaker Kevin McCarthy are scheduled to meet today to continue debt ceiling negotiations, and we’re hopeful further progress will be made. These games of political chicken can introduce volatility to markets in the near term, but we do not think MMFs, in aggregate, are at increased risk of liquidity issues due to a possible technical default of U.S. Treasuries (which again we think is a very low probability). For more information on the debt ceiling, check out our February 27 Weekly Market Commentary.

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.

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 Barry Gilbert, PhD, CFA, Asset Allocation Strategist

Thursday, May 11, 2023

• The Consumer Price Index (CPI) peaked almost a year ago now in June 2022.
• Historically, CPI peaks tend to come around the start of a recession on average. Clearly that wasn’t the case this time
• Stock market risks have been most pronounced as we move toward the CPI peak. Coming off of it, returns have been near the long-term average.
• When the CPI peak is above 9%, as it was this time, the post-peak performance of the S&P 500 Index has been meaningfully stronger, on average.
• The inflation story may not be over, but markets may have already been starting to look past it over the last six months, consistent with post-peak behavior historically.

We are coming up on being a full year removed from the peak in inflation next month, measured by the one-year change in the Consumer Price Index (CPI). CPI peaked in June 2022 at 9.1%. Year-over-year inflation has decline every month since, with the most recent reading for April 2023, released yesterday, at 4.9%. (For some thoughts on yesterday’s CPI report from LPL Chief Economist Jeffrey Roach, see yesterday’s LPL Research blog, “Inflation with a 4 Handle.”)

While every cycle is different, looking at past inflation peaks can provide some insights on both recessions and the outlook for stocks. Perhaps most noteworthy about last June’s inflation peak is that it’s so far behind us while recession risk remains elevated looking forward. When it comes to recessions, peak inflation has on average roughly coincided with the start of a recession but there is a lot of variation. While it’s less common, peak inflation has preceded the start of a recession by a year or more. If the economy were to go into recession in the second half of the year, we could chalk up the more delayed economic downturn to a Federal Reserve (Fed) that was initially behind the curve in fighting inflation along with monetary policy acting with its typical lag. Some economic tailwinds from post-pandemic pent up demand, especially on the services side, might also have contributed to greater economic resilience.

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When it comes to market behavior, it shouldn’t be surprising that S&P 500 Index price returns fared better in the year following peak inflation than in the year prior. Both the median and average returns are negative in the year leading up to the peak. That makes sense: Markets are adjusting to the real time experience of higher inflation and its potential policy impact. By contrast, average returns are positive the year after peak CPI, but just roughly in line with the average overall.

What’s noteworthy is that higher inflation at peak increases the odds of a larger rebound post peak even though inflation generally still remains elevated a year later. Granted it’s a small sample, but the average S&P 500 Index return in the following year when peak inflation has been over 9% has been 20.4%. For markets, it’s been the direction of inflation rather than the level that matters, even though a higher peak meant the economy was still dealing with higher inflation. That might not be all that relevant at this point since the one-year period following the peak looked at in the study is almost behind us. But it does tell us that market risks from higher inflation may be yesterday’s story, even if the full impact of higher interest rates may still be ahead.

The progress already made on inflation is just one of the reasons LPL’s Asset Allocation Committee continues to recommend a modest equity overweight for appropriate investors even as we gauge the potential impact of a recession in the second half of the year.

IMPORTANT DISCLOSURES

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change.

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

Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities. All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

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

All index and market data from FactSet and MarketWatch.

This Research material was prepared by LPL Financial, LLC.

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

Insurance products are offered through LPL or its licensed affiliates.  To the extent you are receiving investment advice from a separately registered independent investment advisor that is not an LPL affiliate, please note LPL makes no representation with respect to such entity.

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

Posted by Jeffrey J. Roach, PhD, Chief Economist

Wednesday, May 10, 2023

Overview

• The monthly consumer inflation rate rose 0.4% in April from 0.1% the previous month, enough to push the annual rate of inflation down to the lowest since mid-2021.
• Shelter costs continue to be the largest contributor to inflation, illustrating the acute pain felt by renters in this country. This component will not likely be a significant driver of inflation by the end of this year as more multi-family units come to market.
• Airline prices in April declined month-to-month but are still higher than earlier this year as consumers release pent-up demand for travel.
• New vehicle prices declined month-to-month for the first time in 12 months as auto dealers work to jumpstart stalled auto sales.
• Bottom Line: April inflation metrics all but confirm expectations that the Federal Reserve (Fed) will not hike rates next month. The Fed could even justify outright rate cuts in coming months as inflation and the economy slow further. Risk assets will likely become more attractive as investors digest this latest inflation report.

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Markets Believe Inflation Moving in Right Direction

As inflation moves in the right direction, investors are right to believe that the Federal Open Market Committee (FOMC) will keep rates unchanged in the upcoming meeting in June. Headline inflation is showing consistent signs of easing but it could take a while for the inflation rate to hit the Fed’s target because services prices may take longer to materially cool down. Rent prices, for example, rose 0.56% in April, hotter than the average monthly rise before the pandemic but lower than last year’s rate. As more multi-family units come to market, we expect rent prices to cool further. According to Apartmentlist, an online apartment advertisement firm, a combination of softer demand and rising supply is “keeping rent growth in check.”[1]

[1] https://www.apartmentlist.com/research/national-rent-data

The Inflation Dashboard below provides a broad snapshot of the inflationary environment.

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Shelter Coming Off the Highs

The annual rate of rent inflation eased slightly in April from the high in March. We may likely see rent prices ease further throughout the year. Strong multi-family construction activity is clearly a good sign that rent costs will eventually ease. The growth in condo and apartment construction means the supply of multi-family units will increase this year as more projects come to market. Industry data already shows declining rent prices, so it’s just a matter of time before the official government statistics reflect that easing. Investors and policy makers alike should expect a softening in housing-related inflation in the coming months.

Food Gets Slightly More Affordable

Overall, the food index remained stable in April. Grocery prices outright declined in April and in March as four of the six major grocery store food group indexes decreased in April. Both the index for fruits and vegetables and the index for meats, poultry, fish, and eggs declined, with drops of 0.5% and 0.3%, respectively. The dairy and related products index also decreased by 0.7%, driven in large part by the milk index’s decline of 2%, the largest decline seen since February 2015. Declining food prices will help the lower income households most sensitive to consumer staples.

What Does It Mean for You?

The outlook for inflation the rest of the year looks promising. The Fed seems to be shifting to a “wait and see” strategy as the banking sector is tenuous and consumers are slowing spending activity. Further, the banking failure of Silicon Valley Bank seems to be contained and the general financial system appears stable. We expect the Fed to keep the target rate unchanged at the next meeting as economic conditions weaken. As inflation convincingly cools closer to the long-run target of 2%, investors will likely take on more risk for their portfolios.

IMPORTANT DISCLOSURES

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

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

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

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

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

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

Posted by Lawrence Gillum, CFA, Chief Fixed Income Strategist

Tuesday, May 9, 2023

The Federal Reserve (Fed) released its quarterly Senior Loan Officer Opinion Survey on Bank Lending Practices yesterday and it continues to show banks are tightening lending standards on commercial and industrial (C&I) loans. C&I loans are an important funding source for companies that can’t (or don’t want to) access capital markets to fund growth initiatives or to just help pay the bills. Moreover, C&I loans are an especially important funding source for lower-rated companies because borrowing (or issuing additional equity shares) can be too restrictive and costs prohibitive at times, whereas C&I loans are short-term loans with variable interest rates that are generally secured by company collateral.

However, with the recent Fed report showing banks are making it harder for some companies to access C&I loans and/or only access them at higher rates, it could mean higher yields and spreads for the high-yield index broadly (Bloomberg U.S. Corporate High Yield Index). Shown below, tighter lending standards (orange line) have historically correlated with higher bond yields and spreads (blue line) for non-investment grade rated companies. This relationship makes sense as C&I loans can provide emergency financing for companies if needed and without that potential lifeline, it could make it harder for some companies to service existing debt.

View enlarged chart

According to the report, the percentage of respondents that reported tightening standards for C&I loans to large and medium firms increased marginally in the past three months, to 46% from 44.8% in the prior survey. However, this report only covers the first quarter, when only SVB (March 10) and Signature Bank (March 12) were thought to be at risk. As the regional banking stresses have continued into the second quarter, it’s likely next quarter’s report will continue to show additional tightening. According to Bloomberg Intelligence, this indicator leads actual lending activity by about 12 months, and has produced an accurate leading signal of recessions in the past. The current value is consistent with a sharper pullback in C&I loans in the second half of the year. C&I lending accounts for 10% of GDP.

And while high-yield companies, in general, did a good job of fortifying balance sheets and terming out debt (i.e., issuing a lot of debt at longer maturities at low interest rates) there will most certainly be companies that will need emergency financing and won’t be able to access it. This in turn will likely lead to defaults, especially if the economy contracts at some point this year. The asset class has been resilient so far though given the ongoing regional banking stresses, debt ceiling debate, and over 5% of Fed rate hikes. But high yield spreads are currently trading around historical averages in a year that feels anything like average. So, while we like high yield from a strategic perspective (for investors with a longer-term time horizon), we remain on the sidelines in tactical portfolios awaiting a better entry point.

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.