Wealth Management

Posted by Adam Turnquist, CMT, VP Chief Technical Strategist

Friday, May 5, 2023

Key Takeaways:

• Time is running out for Congress to raise the debt ceiling. Treasury Secretary Janet Yellen has warned lawmakers that the government may not be able to service its debt by June 1.
• The fixed income market continues to show signs of concern over a potential technical default. Credit default swap (CDS) rates for U.S. government debt have roughly doubled over the last month, while four-week Treasury bills auctioned at their highest discount on record this week.
• While we view a default as a very low probability event, headline risk over the next few weeks could weigh on risk sentiment.
• What does this mean for stocks? In the event of a prolonged debt ceiling battle similar to 2011, watch for large caps to outperform small caps, growth to outperform value, and defensive sectors to outperform more cyclical sectors.

Backdrop

As if rate hikes, rising recession risk, and another bank rescue were not enough to deal with, the market is now gearing up for a battle inside the Beltway as Democrats and Republicans spar over solutions to avoid a default on the nation’s debt. According to Treasury Secretary Janet Yellen, time is running out for Congress to raise the debt ceiling as she warned lawmakers earlier this week that, while the actual date is unclear, the government may not be able to service its debt as early as June 1, the so called X-date.

A failure by the government to reach a deal by the X-date could trigger a technical default with potentially catastrophic economic consequences. Chair Powell commented on the severity of the situation during this week’s Federal Open Market Committee press conference: “It’s essential that the debt ceiling be raised in a timely way so that the U.S. government can pay all of its bills when they’re due. A failure to do that would be unprecedented. We’d be in uncharted territory, and the consequences to the US economy would be highly uncertain and could be quite averse.”

While we view a default as a very low probability event, headline risk over the next few weeks will likely weigh on risk sentiment.

The fixed income market continues to show signs of concern over a potential technical default, resulting in a delayed payment for bond holders. Credit default swap (CDS) rates for U.S. government debt have roughly doubled over the last month as investors demand a higher premium for the potential default risk. For context, CDS rates reached only 0.80% during the 2011 debt ceiling crisis, about half of where rates are today. Furthermore, four-week Treasury bills auctioned at their highest discount on record this week, yielding 5.84%.

The message from the fixed income market is concerning, although the risk lies more in the government’s willingness versus its ability to service its debt. According to LPL Fixed Income Strategist Lawrence Gillum, “U.S. bond market investors have taken for granted the government’s ability and willingness to pay its debt. While its ability to repay its obligations is not in question, the debt ceiling debate complicates the country’s willingness to pay its debts.” Read more from his April blog titled The Treasury Market is Starting to Show Signs of Worry Over Debt Ceiling.

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Flashback to 2011

While we view a default as a very low probability event, headline risk over the next few weeks could weigh on risk sentiment. Unfortunately, the market has also seen this film before, with the most recent edition playing out in 2011. As a quick backdrop, a debt ceiling spring showdown in Washington resulted in the government hitting its debt limit on May 16, 2011. However, the Treasury pulled off some accounting maneuvers to narrowly avert a crisis and fund the government until August 2, exactly how long it took Congress to get a deal done. The damage during this period included a sizable sell-off across equity markets, lower yields underpinned by a flight to safety, and a credit downgrade of U.S. debt to AA+ from AAA by Standard & Poor’s.

While there are many economic differences between now and then, the 2011 analog at least provides a potential roadmap for stocks if the debt ceiling drama continues. The chart below shows how several major indices performed during this period, encapsulated by the market’s April high to the October low.

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At the market cap level, small cap stocks clearly underperformed during this period, evidenced by sizable drawdowns on the Russell 2000 and S&P Small Cap 600 Index. Large caps and growth outperformed but still posted double-digit declines.

The following chart breaks down the S&P sector performance during the 2011 debt ceiling crisis.

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Defensive leadership was a major theme during this period as utilities and consumer staples topped the sector leaderboard with minimal relative losses compared to peers. The more offensive cyclical sectors widely underperformed, led by financials. Under a prolonged kick-the-can down the road scenario similar to 2011, we suspect defensive sectors could be in a similar position this year.

Summary

We believe the odds of the government defaulting on its debt obligations remain low. However, without a debt ceiling deal, the probabilities of a technical default are not zero and headline risk will remain elevated until a resolution is passed. The fixed income market continues to price in increased credit risk in U.S. Treasuries as the X-date approaches. In the event of a prolonged debt ceiling battle similar to 2011, watch for large caps to outperform small caps, growth to outperform value, and defensive sectors to outperform more cyclical sectors.

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, May 4, 2023

Overview

• The Federal Reserve (Fed) increased its policy rate for the tenth consecutive time, pushing the upper bound of the fed funds rate to 5.25%, the highest since August 2007.
• In the press conference, Chairman Powell was careful to strike a balance between the committee’s commitment to fight inflation and the committee’s view that policy is sufficiently tight.
• So far, the labor market has been a bright spot for the committee, giving them reason to increase rates yesterday, despite uncertainty within the banking sector.
• It takes time for the real economy to react to tighter financial conditions so we can legitimately infer that the Fed can pause in June, especially since investors are still waiting for the cumulative impact of the last 10 hikes.
• Looking ahead, the Fed will release its updated Summary of Economic Projections at the next meeting, likely providing greater guidance for monetary policy over the balance of 2023.
• As inflation further decelerates, and the job market cools, investors should anticipate some rate cuts in the latter half of the year. We will not likely see a negative jobs report this coming Friday, but by summer, investors should expect a weaker labor market, giving support for those expecting rate cuts by the end of this year.

Softer Language

The Fed raised rates for the tenth consecutive time, pushing the upper bound of the fed funds rate to 5.25%, the highest since August 2007. Markets were not surprised by that decision but many took note of the conspicuous removal of the key word, “anticipates.”

Investors should note the evolution within the Federal Open Market Committee’s (FOMC) statements over the past several meetings. Let’s go back in time. In January, the “committee anticipates ongoing increases in the target range will be appropriate” and then in March, they thought “additional policy firming may be appropriate” and in May, they no longer anticipate additional tightening, but rather remain focused on economic and financial developments [emphasis added].

A key takeaway is the Fed has set themselves up for keeping their target rate unchanged in June. We already know the Fed is monitoring the long and variable lags to monetary policy, which is just another way of saying it takes time for the real economy to react to tighter financial conditions. So, if the Fed is concerned about the time it takes for tighter credit conditions to slow down the economy, we can infer the Fed will be inclined to pause at the next meeting and wait and see. The good news for market watchers is that the Committee will publish an updated Summary of Economic Projections at that June meeting, likely providing greater guidance on monetary policy for the balance of 2023.

Looking Ahead

Now this begs the question: what about July? That meeting is in late July and we expect that by then we will have slower inflation and weaker job growth.

During the press conference, Chairman Powell referenced the tight labor market as a reason to remain hawkish in the near term. As the Federal Reserve moves to restore price stability, they rely on a host of statistics to gauge risks to their outlook. One metric is the openings-to-unemployed ratio. This metric seeks to provide a concise reading of the supply and demand of the American labor market by measuring how many job openings exist per unemployed individual. In the fight against inflation, the Federal Reserve has regularly relied on labor figures when marking their progress. In comments from a November 2022 press conference, Powell remarked the labor market is “especially important” when looking at inflation. This ratio must fall further to convince the Fed that the labor market will not create inflationary headwinds.

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Conclusions and Market Implications

The U.S. is poised to slip into recession later this year, which has implications for future rate decisions. Markets are convinced the Fed will cut rates and we agree but perhaps not in the magnitude of cuts. How will markets react? Although 2023 has its fair share of risks, we do not think markets will retest last year’s lows, despite the likelihood of a recession later this year. Perhaps the relationship between the equity markets and the 1990-91 recession is most informative for today’s most likely scenario as shown in the chart below. As recession risks rise, we think the Fed will eventually cut rates later this year, which may provide some added support for markets.

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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.

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 2, 2023

In this week’s Weekly Market Commentary, we noted the seasonal stock market pattern in which stocks generally produce the best returns from November through April and the worst returns from May through October (although we note this pattern hasn’t been true recently). But most investors may not be as familiar with the seasonal patterns in fixed income markets. Because of the seasonal pattern in equity markets, changing investor sentiment has translated into a strong demand tailwind for fixed income markets and the summer months have generated, on average, some of the best monthly returns of the year.

As seen in the chart below, some months appear more or less favorable for core fixed income, as measured by the Bloomberg U.S. Aggregate Bond Index, with August generally being the best performing month. However, May through August has, historically, represented the best stretch of average returns for the index over the last 20 years. Moreover, that stretch has also seen the highest median returns (averages can be misleading when you’re dealing with smaller numbers) and, except June, have seen the fewest negative monthly returns.  All this suggests the preferred destination for the “sell in May” crowd may be the fixed income markets.

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Now, we would certainly not advocate repositioning portfolios due to these popular patterns because, again, average returns can be misleading, especially during a year that feels anything but average. So, whether the seasonal patterns in the equity or fixed income markets persist this year or not, we think owning core bonds in a diversified portfolio makes sense. The fact that fixed income markets have performed best over the summer months, when equity market volatility has tended to increase, is no coincidence. Core bonds have historically been the best diversifier to equity market risk and despite that lack of protection last year, we think the back up in yields now allows bonds to regain that role in 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.

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 lplresearch

Monday, May 1, 2023

Top Bidder for First Republic Bank

In the early hours of Monday morning (May 1, 2023), JP Morgan Chase (JPM), as announced by the Federal Deposit Insurance Corporation (FDIC), outbid other large U.S. banking institutions for the rights to acquire the failing First Republic Bank (FRC).  Indeed, the FDIC took control of the bank on Sunday and brokered the bidding process. JPM will assume all deposits of FRC and substantially all the assets. JPM received a waiver from the FDIC to acquire FRC because JPM already holds more than 10% of U.S. deposits. The FDIC provided $50 billion in financing for JPM to facilitate the transaction. On Monday morning (May 1), FRC offices will reopen as JP Morgan Chase. JPM has stated it expects the FRC deal to be modestly accretive to EPS.

The failure of FRC marks the third bank failure this year. FRC, a commercial bank and provider of wealth management services, was the 14^th largest U.S. bank by assets, with $229 billion, and the largest U.S. bank to fail since Washington Mutual in 2008. The bank was headquartered in San Francisco, CA and operated 93 offices in 11 states. The offices were primarily in California, Massachusetts, Florida, and New York.

How Will Regulators Handle The Issue?

The FDIC took an extended step to insure all deposits of the previous two bank failures this year—Silicon Valley Bank (SVB) and Signature Bank of New York (SBNY). To potentially forestall further bank runs, the FDIC stood ready to insure deposits above its official $250,000 deposit threshold. In the case of FRC, the FDIC will not have to make any special extension of its deposit insurance. As stated above, JPM has assumed all bank deposits and it is the full owner of FRC. According to JPM, customers are expected to have uninterrupted access to deposits and banking services.

LPL Research View

LPL’s view of the markets and economy is guided by The Strategic and Tactical Asset Allocation Committee (STAAC) and the senior LPL Research members within. The Committee meets weekly to analyze and discuss capital market conditions and to adjust our market views accordingly. The Committee has been monitoring bank developments since the SVB collapse and has remained cautious on bank stocks as a result. As it relates to FRC, we believe investors should react to the developments with some caution, as sentiment around bank conditions continues to be fragile.

The Committee remains “equal weight” to the financials sector relative to its weight in the S&P 500 Index. The inverted yield curve, higher deposit costs, falling earnings estimates, and the possibility of further bank failures, offset valuations in the sector, which are very low.

More broadly, we believe tactical investors should be maintaining their multi-asset allocations at or near benchmark levels. Bank sentiment headwinds and signs of an economic slowdown are near-term negatives, but we believe these developments are partially offset by the possibility that the Federal Reserve’s interest rate tightening could be near its end as inflation pressures ease.

Notably for investors looking for a potential unique opportunity, we are suggesting a tactical overweight to preferred stocks (a 3-4% position for some investors. Please consult with your financial advisor for allocations specific to your needs.). The universe for preferred stocks does include material exposure to financial institutions, and we believe it is a tactically favorable way to potentially take advantage of the bank sector distress.

For longer-term, strategic investors we believe no changes to well-balanced allocations need to be made.

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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 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 Bloomberg.

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 Adam Turnquist, CMT, VP Chief Technical Strategist

Friday, April 21, 2023

Key Takeaways:

• Despite the S&P 500’s technical progress this year, investor sentiment and positioning remain significantly bearish.
• The lack of respect for the market’s recovery and continued investor angst are evident in S&P 500 futures positioning. Non-commercial net futures positioning (speculative trades) reached its lowest level since August 2011. The decline was due to a combination of long S&P 500 futures positions falling to their lowest level since 2006 and short S&P 500 futures positions climbing to their highest level since September 2022.
• Extremes in both short and long S&P 500 futures positioning are often found at major turning points for the market. The key word here is often, but not always.
• We found that on a one- to three-month basis, major peaks in long positioning (extreme bullishness) historically produced above-average returns that outpaced returns of major positioning lows (extreme bearishness) during this time window.
• When looking out to 12-month returns, major lows in futures positioning have historically produced respective average and median returns of 12.2% and 13.4%, outpacing the 12-month returns of major positioning highs.

No Respect

The market and Rodney Dangerfield have a lot in common these days – they both get no respect!

Despite the S&P 500’s technical progress powered by a 7.5% gain this year, investor sentiment and positioning remain significantly bearish. Cash in both retail and institutional money market funds are at record highs—aided by yields north of 4%—and recent fund manager data collected by Bank of America shows investors are the most underweight equities relative to bonds since the Great Financial Crisis.

There are plenty of reasons to question the current recovery. Valuations are running relatively high as first-quarter S&P 500 earnings are expected to decline for a second consecutive quarter, triggering a potential earnings recession. And speaking of recessions, the odds of a recession in the U.S. occurring over the next 12 months rose to 65% in March, according to a Bloomberg survey of economists. Uncertainty over the Federal Reserve’s (Fed) monetary policy path, tightening credit conditions due to the fallout from last month’s banking turmoil, interest rate volatility, declining leading economic indicators, contracting manufacturing data, and debt ceiling drama are just a few of the factors behind the increased recession probabilities and investor pessimism.

The lack of respect for the market’s recovery and continued investor angst are also becoming evident in S&P 500 futures positioning. As shown in the bottom panel of the chart below, the Commodity Futures Trading Commission (CFTC) recently reported that non-commercial net futures positioning (speculative trades) reached its lowest level since August 2011. The decline was due to a combination of long S&P 500 futures positions falling to their lowest level since 2006 and short S&P 500 futures positions climbing to their highest level since September 2022.

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Futures positioning provides useful insight into investor conviction on both sides of the trade, making the CFTC data an applicable sentiment tool. And with most sentiment indicators, they typically work best at extremes. As you may notice in the chart above, extremes in both short and long S&P 500 futures positioning are often found at major turning points for the market.

The key word here is often, but not always, as we analyzed S&P 500 returns after all of the major peaks and troughs across long and short futures positioning since 2003. The average and median forward returns for each major futures positioning high (bullish extreme) and low (bearish extreme) are shown below.

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On a one- to three-month basis, major peaks in long positioning historically produced above-average returns that outpaced returns of the major positioning lows during this time window. When looking out to 12-month returns, major lows in futures positioning have historically produced respective average and median returns of 12.2% and 13.4%, outpacing the 12-month returns of major positioning highs.

Finally, for illustrative purposes, we created a simple trading model that 1) enters long S&P 500 trades when net futures positioning crosses two standard deviations below the mean (extreme bearishness) and 2) enters short S&P 500 trades when net futures positioning crosses two standard deviations above the mean (extreme bullishness). Based on this framework, the model is always long or short depending on the crossover signals.

Since 2003:

• The model generated a total return of 87% for an annualized rate of return of 3.2%. For comparison, a buy and hold S&P 500 strategy returned 326% during the same period for an annualized return of 6.2%.
• Of the 17 trades generated in the model, the average return for each trade was 5.1% with eight trades producing positive results.
• The maximum drawdown of the model was 31%, occurring over a 69 weeks. For comparison, a buy and hold strategy during the same timeframe had a maximum drawdown of 56%, occurring over 73 weeks.
• Overall, the model showed positive absolute returns but significantly underperformed a simple buy-and-hold strategy. The underwhelming performance stresses the importance of using the weight of the collective technical evidence for forecasting price trends instead of a single indicator or sentiment gauge.

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Summary

The market remains resilient as investors meaningfully repriced risk during last year’s +20% drawdown. Low expectations along with the potential end to the Federal Reserve’s rate hike cycle have helped the S&P 500 climb the wall of worry. Given the extremes in futures positioning, a breakout above resistance at 4,200 could spark a short-covering rally that drives the index back to the August highs at 4,300. Historically, we have also found that major lows in futures positioning have produced above-average returns over the following 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. 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, August 20, 2023

Implied volatility, as measured by the Chicago Board Options Exchange (CBOE) Volatility Index (VIX), closed yesterday at 16.46, its lowest closing level since mid-November 2021. Today we take a look at possible reasons for the decline in the VIX and what it could mean for short-term stock market returns.

The VIX provides a real-time update of expectations for volatility on the S&P 500 over the next 30 days. The VIX represents implied volatility derived from the aggregate values of a weighted basket of S&P 500 put and call options over a range of strike prices. The VIX is often referred to as the “fear gauge” because generally, a rising VIX is associated with increased fear in the marketplace and falling stock prices, while a declining VIX is associated with decreased investor fear and rising stock prices. In addition to speculative positioning, the VIX is commonly used to hedge long positions.

This new multi-year low for the VIX may be surprising to many investors as they access a wall of economic worry consisting of recent bank failures, uncertainty in the path of interest rates, rising recession concerns, still lingering inflation, and a looming debt ceiling standoff. As highlighted in the chart below the VIX has been making lower highs since closing at 36.45 in March 2022. During the whole bear market the VIX has actually been fairly subdued compared to history. Typically it spikes to at least 40 in times of major market stress. Both the 1-month and 12-month moving averages are now in downtrends, with the next technical resistance level around 15, a support level that has held since the very early days of the COVID-19 outbreak.

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Why is the VIX trending lower?

There are a couple of possible structural reasons for the VIX to be hitting multi-year lows amidst such an uncertain economic and market environment. One could be the increased popularity of zero days to expiration option contracts, or what many investors call “0DTE.” As the name implies, these are call or put options with less than one day until expiration. For the S&P 500, the CBOE’s recent addition of Tuesday and Thursday weekly expirations to already listed Monday, Wednesday, and Friday contracts meant investors could trade 0DTE contracts daily on the index, providing a clean way for investors to hedge daily event risk without buying VIX options. Volume has climbed steadily since last April and May when the new contracts were added

Another reason why VIX upside has been relatively subdued could simply be due to fewer positions to hedge. With short-term rates surging over the last year and economic uncertainty running high, money market funds have been taking in record inflows. According to the Investment Company Institute (ICI), assets in money market funds are now over $5 trillion, surpassing the peak pandemic levels.

What could new lows in the VIX suggest for future stock returns?

Like many other measures of market sentiment that we monitor, extreme relative levels of volatility have historically had the potential to be contrarian signals when it comes to predicting stocks prices over the short term. As we looked at here last year, extreme highs in the VIX tend the lead to above average future returns for stocks and, as shown in the table below, new one-year lows in the VIX tend to have an opposite, and more muted, effect of below average returns. Based on 40 occurrences of new one year lows in the VIX (that happened at least 90 days from the prior occurrence) the 3-month to 12-month returns for the S&P 500 Index were all below average, and each period studied, including 1-month returns, had a significantly lower percentage of positive returns than average. Possible reasons for this are markets catching their breath, or running out of steam, after hitting new one-year lows in the VIX (following on from the faster/larger stock market increases that tend to follow extreme high spikes in the VIX that occur around market lows).

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A more positive sign for near term stock market returns would be if we were to see a continued sharp decrease in the VIX. Looking back at periods when the VIX was fairly subdued as it is now (which we defined as having a one-month moving average below 20) and it closed at least 20% lower than the one-month average, the S&P 500 Index saw above-average returns and percentage of positive returns across all time periods studied. The latest VIX close was about 15% below the one-month moving average so we are not at this level yet. Caution should be taken with the small sample size and the concentration of the occurrences in the 2013 to 2019 period in the middle of the last bull market.

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Summary

While the VIX data suggests a cautious approach in the short term, generally periods of falling volatility have been associated with rising stock markets. We still maintain a modest overweight to equities funded from cash (where the return profiles of short term products are attractive but reinvestment risk has risen), as equities may benefit from falling inflation and a prompt 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 Deposits or Obligations |Not Bank/Credit Union Guaranteed | May Lose Value

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

Posted by Lawrence Gillum, CFA, Chief Fixed Income Strategist

Wednesday, April 19, 2023

With tax season (mostly) behind us, the U.S. Treasury Department will have a better sense of how much cash it has on hand and when it will run through the extraordinary measures it is currently employing to pay its bills. The Treasury is unable to issue net new debt (it can issue debt to replace maturing debt), so it is currently relying on accounting gimmicks to ensure continued payments. However, that can only work for so long. Right now, estimates for the so-called x-date, or the drop-dead date when Congress has to act, range from early summer to the fall, but the first key hurdle comes around June when there’s an additional influx of tax money and when it can also tap some additional accounting measures to continue to honor its debts. We will likely hear from Treasury over the next week or so on an updated x-date, but the conventional wisdom is that if Treasury can make it past that mid-June horizon, the debt ceiling likely won’t have to be raised until the end of July or August.

If the debt ceiling isn’t resolved in time though, the U.S. Government would technically default on its contractual obligations and the Treasury market is starting to price in, however remote, a chance of delayed payment. Treasury bills (t-bills) that mature in May are yielding around 1.2% less than t-bills that mature one month later (around June) and a record 1.49% less than t-bills that mature in July. As Treasury is likely able to make the May payment, investors have bid up the price of these securities seemingly at the expense of debt that matures around the expected x-date(s). While changing monetary policy expectations and a record amount of money in money market funds are also playing a role in the distortions, investors are likely demanding more to hold those securities at risk of delayed payment.

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U.S. bond market investors have taken for granted the government’s ability and willingness to pay its debt. While its ability to repay its obligations is not in question, the debt ceiling debate complicates the country’s willingness to pay its debts. In 2011, Congress waited until the very last minute to fix the debt ceiling issues and S&P downgraded the country’s debt rating to AA+ from AAA because of the questions surrounding that willingness to pay its obligations. Now, another rating agency, Fitch, has threatened to do something similar if Congress fails to act soon. Another debt downgrade would likely be disruptive to financial markets. While we think Congress will act in time and get a deal done, these games of political chicken can introduce volatility to markets in the interim. 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.

Tracking # 1-05367813

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, April 18, 2023

Overview

• Small businesses, considered the backbone of the economy, are shrinking hiring plans. Hiring intentions among small businesses declined in March, implying that upcoming job reports will likely be lackluster.
• Firms are hunkering down as virtually no firms have plans to expand business operations. In fact, the number of firms reporting any expansion plans is the lowest since early 2009 when the economy was in the depths of the Great Financial Crisis.
• Small businesses are reporting more difficult access to credit. The percent reporting tighter credit is the highest since 2012 as lending institutions tighten up under the uncertainty of the macro landscape.
• Now, some good news. Inflation was less of a problem in March as firms are more concerned about the overall business environment as the economy slows under tighter financial conditions.

The Backbone of the Economy

Small businesses are often considered the backbone of the economy because of the amount of economic activity generated by the sector, and it looks like a backache has emerged.

Small businesses have an incredible impact on both the national and local economy. Small businesses make up the majority of all businesses by count while also employing over 46% of the private sector workforce.[1] It’s not a stretch to say “as goes the small and independent business, so goes the national economy.” They provide their communities with the goods and services their customers have grown to enjoy, in addition to supporting local causes and charities. With this supporting role in local economies comes the need for expansion, a need that is typically fulfilled by community banks. Small businesses tend to prefer banks when in need of credit, more regularly turning to them when compared to larger corporations, who often seek their funding from the capital markets. Approximately 44% of small business financing comes from banks, completely outsizing the next two points of origin, online lenders at 22% and credit unions at 6%.[2]

As shown in the chart below, firms are hunkering down as few have expansionary plans in the near future. No doubt, tighter credit conditions impacted those decisions.

[1] What’s New with Small Business?

[2] FDIC Community Banking Study 2020 – Chapter 4

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Tighter Credit Constricts Expansion Plans

Small and independent businesses rely on credit and as the Federal Reserve (Fed) tightened monetary policy and overall financial conditions worsened after the Silicon Valley Bank fiasco, these firms had less availability of credit for financing operations. When analyzing growth and changes in banks’ small business loans, it is important to rely on Call Reports. As evident from Call Report data dating back a little over a decade, small business loans grew from $599 billion at year-end 2011 to $645 billion at year-end 2019, for an average annual rate of loan growth of less than 1%, which while positive, was outperformed by the average annual business loan growth rate of roughly 7%. This growth in small business loans rests solely on the shoulders of small C&I loans, as other small business loans fell from during the same period. Despite the lower growth trends, the small business-community bank relationship is vital as community banks hold 36% of total small business loans while their share of total loans across the industry is only 15%.[3]

Perhaps there are additional risks within the community and regional banking sectors that the markets need to address but nonetheless, tighter conditions will likely constrict expansion plans for smaller businesses and thus, crimp overall economic growth in the U.S.

3 FDIC Community Banking Study 2020 – Chapter 4

What Does It Mean for You?

Businesses appeared to hunker down under the weight of tighter credit conditions and weaker economic growth. If small businesses are an accurate barometer, recession risks are rising and the labor market will likely cool in the coming months. Although the economy is slowing, the Fed continues its fight with inflation and will likely hike rates at the next meeting on May 2-3. However, if the economy becomes more unstable, the Fed could pivot to rate cuts by the end 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. 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.

For Public Use  Tracking # – 1-05367813

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

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

Posted by Adam Turnquist, CMT, VP Chief Technical Strategist

Friday, April 14, 2023

Key Takeaways:

• Earnings season officially kicked off today with the major money center banks reporting first quarter (Q1) results. Expectations are running low as earnings estimates have been continuously revised down into the quarter.
• The downward revisions have failed to stop the broader market’s recovery. While the fundamental bar may be set low, the rally into earnings season may raise the technical bar for stocks, especially with the S&P 500 now contending with key resistance at 4,200.
• Short-term rallies ahead of earnings season have historically led to continued upside momentum for the S&P 500 during the reporting period, albeit at a moderated pace.
• Outsized contributions from mega cap stocks this year have raised concerns over market breadth. While around 60% of S&P 500 stocks are trading above their 200-day moving average, only 32% are outperforming the market this year.

Earnings season officially kicked off today with the major money center banks reporting first quarter (Q1) results. Expectations into the quarter are running low as S&P 500 earnings per share (EPS) estimates are at -6.8%, according to FactSet. This marks a sizable drop from the -0.3% Q1 estimate at the start of the year and potentially the largest quarter-over-quarter earnings decline since Q2 2020.

The downward revisions this quarter have failed to stop the broader market’s recovery. The S&P 500 has amassed a total year to date return of 8.9% as of April 13, with most of those gains generated over the last four weeks. While the fundamental bar may be set low, the rally into earnings season may raise the technical bar for stocks, especially with the S&P 500 now contending with key resistance at 4,200.

Coming in Hot

With the S&P 500 trading up 5% over the last four weeks, we analyzed S&P 500 price action for pre-earnings season outlier performance going back to 2000. Outlier performance was defined as four-week price returns of +/-3% into earnings season. The start of earnings season was based on the first major money center banks’ earnings dates. (We also included Alcoa earnings dates as the company historically kicked off the reporting period until it left the Dow Jones Industrial Average and eventually split into two companies in 2016.)

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Since 2000, we found 27 other quarters when the S&P 500 rallied at least 3% four weeks before the start of earnings season. As shown above, these outlier returns historically point to continued upside momentum for the index after the kickoff of earnings season, albeit at a moderated pace. The average and median seven-week (encompasses most earnings seasons) forward returns during the reporting period were 1.4% and 3.1%, respectively.

During sell-offs into earnings season, the index still advanced by an average of 1.4% during the seven-week reporting period, although median returns came in at only 0.4%. For additional context, the average S&P 500 four- and seven-week returns since 2000 have been 0.5% and 0.8%, respectively.

The Generals Lead

As noted previously, the S&P 500 has generated a total return of over 8% this year. Most of the gains have been driven by a select number of mega cap names (aka the “Generals”). Shares of AAPL, MSFT, NVDA, META, GOOG/L, TSLA, and AMZN have contributed to nearly 3/4 of the index’s overall year-to-date gain. These stocks collectively represent around a 22% weighting within the S&P 500.

The outsized mega cap contributions have raised concerns over narrow market breadth. While around 60% of S&P 500 stocks are trading above their 200-day moving average, only 32% are outperforming the market this year. On a more positive note, the technology, communication services, and consumer discretionary sectors have the highest percentage of stocks outperforming. We view this as a constructive sign for the broader equity market, given their offensive tilt and 53% collective weighting within the S&P 500.

View enlarged chart

Bottom line, while the fundamental bar for Q1 earnings season may be low, the rally into earnings season raises the technical bar for stocks, especially with the S&P 500 contending with key resistance at 4,200. History suggests S&P 500 price momentum into earnings season could continue, as the broader market has posted above-average gains during the reporting season after sizable pre-earnings rallies.

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.

https://www.youtube.com/watch?v=T2WiP1yS_-U&t=10s