Wealth Management

Posted by Barry Gilbert, PhD, CFA, Asset Allocation Strategist

Thursday, April 13, 2023

Yesterday, the Federal Reserve (Fed) released the minutes from its March 21-22 Federal Open Market Committee (FOMC) meeting. In the section summarizing staff projections, to the surprise of some, the staff explicitly forecasted a recession:

“Given their assessment of the potential economic effects of the recent banking-sector developments, the staff’s projection at the time of the March meeting included a mild recession starting later this year, with a recovery over the subsequent two years.”

Three important things to keep in mind with this:

• A projection is only a base case scenario. The consensus base case for Bloomberg-surveyed economists has also been that a recession is more likely than not in the next year for some time, so the call by the Fed’s staff should be no surprise.
• Having a recession as a base case is by no means saying it is a “lock.”
• The staff play an important role in supporting policymakers, but they are not the policymakers themselves.

As for Fed policymakers, they have been more careful about how they talk about the likelihood of a recession. But without saying it directly, even their projections imply a recession may be more likely than not over the rest of the year. FOMC participants’ median forecasts for 2023 economic growth and changes in the unemployment rate, last updated in March, both remain consistent with a recession in the second half of the year (although the dot plot is not).

With recession risks getting more attention in the wake of the FOMC minutes’ release, today we highlight some important characteristics of market behavior around recessions and some unusual features of the current market if a recession were to be on the horizon. Most of these points can be seen in the table below, which summarizes some key historical S&P 500 behavior around recessions.

• As has been widely reported, S&P 500 lows have always occurred after the start of a recession, going back to 1937. This has led to rising concerns that the increased likelihood of a recession is also increasing the risk of a new bear market low.
• But it’s important to keep in mind that recession declines are not always all that steep. We have seen a bias toward reporting only the size of recession declines during bear markets, but this is deceptive, even if we’re already in a bear market. Typical market behavior during recessions needs to include ALL recessions. The median decline in the price index of the S&P 500 during recessions has been 23.9%.
• The current 25.4% maximum decline of the bear market to date from the January 3, 2022 all-time high is already greater than the median decline for all recessions in our study.
• If we get a recession in the second half of the year, the S&P 500 would have peaked earlier compared to the start of the recession than for any recession in the lookback period. It has been 465 days since the last S&P 500 Index all-time price high on January 3, 2022. By the start of the second half of the year, it will have been 544 days. No other recession has seen the index peak more than 400 days before the recession began.
• Combining the two points above, if we have a recession at this point it would have been the most anticipated recession going back to 1937, by a solid margin, primarily from the perspective of the time since the last peak but reasonably also based on the price decline. That’s not surprising given the primary cause of this recession, were it to occur, would likely be the Fed’s well telegraphed efforts to control inflation. From that perspective, getting a new S&P 500 low, even if we were to have a recession, would be more surprising than expected.
• If we used the rough (but inaccurate) definition of a recession as two consecutive quarters of economic contraction and stipulate, for argument’s sake, that we had a recession in the first half of 2022, the bear market would have looked entirely consistent with history. February 2022 would probably have been called the peak of the expansion, putting the start of the first full recessionary month at March 1, 2022. The market low on October 12, 2022 would have taken place 225 days after the start of the recession, which would already be a little longer than average, but entirely within the realm of normal. And the S&P 500 decline would be almost exactly the same as the median for a recession. In other words, you could view last year’s declines as a typical recessionary bear market.

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We are wisely often warned that the most dangerous words in the industry are “this time it’s different.” In the current context, that phrase has often been used to caution a recession would likely come with a new market low. The problem with this argument is that this time has already been different. Saying we may not hit a new bear market low, even if we get a (mild) recession, is simply paying attention to those differences.

The risk of a new bear market low certainly increases if we get a recession and economic uncertainty remains elevated. But for now, our Asset Allocation Committee’s base case is that well telegraphed recession risk has already been meaningfully priced into markets and market participants may look past a mild recession as inflation continues to fall. We have recently reduced our recommended equity overweight on the combination of market gains and increasing risk, but still remain overweight overall.

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).

Certain call or special redemption features may exist which could impact yield

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

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

Posted by Jeffrey Buchbinder, CFA, Chief Equity Strategist

Wednesday, April 12, 2023

Today marks the six-month anniversary from the October 12, 2022 low in the S&P 500. Since the 25.4% drop in the index from January 3, 2022 through that day in October (is it me or do bear markets often end in October), the S&P 500 has rallied 15.1%, as shown in the accompanying table. That sounds pretty good, right? Well, it’s not, based on history.

The table below shows the average gain for the S&P 500 six months off the bear market low is 25%. So this bull market, which isn’t officially a bull market because the index has not yet achieved a 20% gain, would be one of the weakest. In fact, of the 17 bear markets since WWII, just three were followed by a smaller gain than 15% in the first six months of the subsequent bull market, and only one of those occurred within the last 60 years—the bull that started on October 9, 2002, after the 2001 recession and accounting scandals involving WorldCom and Enron.

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Another way to look at what we would call underperformance of the (possible) new bull market is by comparing the average return progression for all of the new bull markets during their first year, and plotting that against the current rally since the October 2022 lows. As you can see in the chart below, the gains over the past six months have lagged well behind the average advance.

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The logical question to ask here is what does this mean for stocks going forward? We hope it means stocks will play some catch-up, propelling the index to a new bull market more than 20% above the October lows. That level, which is 4,292, is just 4.5% from Tuesday’s close at 4,109—not too far away.

A less appealing scenario is one where a second half recession hits earnings and drags stocks down below the October 2022 lows before a new bull market begins. Then we’d start the clock over. Though not our base case, if new lows are established later this year, perhaps the bounce off of those new lows would be stronger than what we’ve seen in the past six months.

We believe the first of these two scenarios is more likely given inflation pressures are easing, interest rate volatility has moderated, and a recession, if we have one, is likely to be short-lived and mild, in our view. Also consider no bear market has bottomed before a recession takes place, though several bear markets were not accompanied by recessions at all, such as the 1987 bear, making this at least a plausible scenario. The close call in 1998, when the S&P 500 lost just shy of 20%, may be another reasonable historical analogue.

Bottom line, LPL Research believes a new bull market will be established before the next bear begins. However, this bull—if it is one—ranks near the bottom in terms of early-stage performance and may not be set up for the type of surge seen in past rebounds. Time will tell whether slow and steady ends up winning this race.

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 Lawrence Gillum, CFA, Fixed Income Strategist

Tuesday, April 11, 2023

The Federal Reserve (Fed) has raised short-term interest rates at the most aggressive pace since the 1980s in an effort to bring down the highest inflationary pressures in more than 40 years. Certainly, the main motivation behind these aggressive rate hikes is to realign the supply/demand imbalances that create inflationary pressures. But, the Fed is also trying to ensure that inflation expectations don’t become problematic as well. Inflation expectations are simply the rate at which consumers and/or businesses expect prices to rise in the future. They matter because actual inflation depends, in part, on what consumers expect it to be. If consumers expect prices to continue to move higher, then they will likely change behaviors and inflation then becomes a self-fulfilling problem. There are three primary ways to track inflation expectations: surveys of consumers and businesses, economists’ forecasts, and market-implied inflation-related instruments.

And as seen below, market-implied inflation expectations, or what the bond market thinks inflation will average over time, have remained, more or less, in a normal range for the last six months and are seemingly well anchored. After spiking earlier last year, market-implied inflation expectations have fallen back to levels seen earlier in the last decade. Moreover, markets expect inflation to average 2.2% over the five year period, beginning five years from now (2028-2032), which is the Fed’s preferred way to measure long-term market-implied inflation expectations. So despite surprise production cuts from OPEC+ and bank stresses that many thought would prompt the Fed to abandon its inflation fight, markets continue to think the Fed will get inflation back to its 2% target.

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And while we get additional CPI data on Wednesday that will likely show positive (albeit slow) progress, the bond market continues to believe the Fed will win its fight against inflation… one way or another. Markets are generally expecting one more rate hike in May but then rate cuts later this year. Expected rate cuts, still calm credit markets, and market-implied expectations drifting to 2% all suggest the Fed can win the fight. Can markets be wrong? Of course. And if investors think markets are too sanguine on the inflation fight, we would suggest a small allocation to TIPS strategies as a hedge.

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.

Certain call or special redemption features may exist which could impact yield

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

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

Posted by Barry Gilbert, PhD, CFA, Asset Allocation Strategist

Monday, April 10, 2023

There deservedly was a lot of hand-wringing about the death of the 60/40 portfolio in 2022, a portfolio of 60% stocks and 40% bonds. As we stated back in June, the call for the demise of the 60/40 had likely come too late. Even at that time, we believed the challenges the markets were facing were likely already contributing to the prospect of better times ahead.

What was most surprising for the 60/40 in 2022, or course, was how spectacularly bonds failed to play their traditional role as a portfolio diversifier in a down market for equities. Equity volatility is unnerving, but many investors understand the path to potential longer-term stock gains is rarely smooth. But we are less accustomed to bond volatility and we had plenty of it (although still less than stocks). In fact, the first three quarters of 2022 were all among the 5 worst quarters for the Bloomberg U.S. Aggregate Bond Index since its inception in 1976.

But the tide does seem to be turning. While the fourth quarter of 2022 and the first quarter of 2023 weren’t spectacular for the 60/40, using the total return for the S&P 500 Index and the Bloomberg U.S. Aggregate Bond Index as our proxy for stocks and bonds, the 60/40 has been on solid footing the last two quarters, as seen in the chart below. Both stocks and bonds were up both quarters with the 60/40 for each quarter in the top 30% of historical values.

View enlarged chart

But that’s looking backward. What about looking forward? LPL Research’s Asset Allocation Committee sees reason to be bullish on the 60/40 over both a tactical and a strategic time frame.

Looking at bonds from a tactical perspective, with higher starting yields, a Federal Reserve (Fed) likely near the end of its rate hiking campaign, and inflation coming back down, not only do return prospects look brighter for bonds, we believe they have become more likely to return to their historical role of a portfolio diversifier in the event of an economic downturn.

On the equity side, there is still economic uncertainty ahead to work through, but we think some of the same factors that may support bonds (lower inflation, a steadier rate environment) may also provide a lift for stocks. The economy is still on shaky ground as Fed policy tends to act with a lag and we have not yet felt the full impact of higher rates. However, we believe the kind of economic excesses that have contributed to steeper downturns in the past are not currently a threat and markets may look past a modest economic downturn relatively quickly.

Turning to the strategic perspective, we base our outlook on our long-term capital market assumptions, which look ahead 10 years and are based on the long-term drivers of returns. For stocks, that’s largely the outlook for earnings growth together with some expectation that valuations will move toward historical norms. For bonds, the main driver is yields, which are generally solid predictors of returns 5–10 years out. (Stock forecasts, by contrast, are subject to greater variability even over a 10-year time horizon.)

As seen in the table below, our long-term forecasts for stocks and bonds, again using the S&P 500 Index and the Bloomberg Aggregate as proxies, improved substantially from 2022 to 2023. While stock valuations remain somewhat elevated relative to history, giving us a below-historical return expectation, they did see some improvement during the downturn, with prices coming down more quickly than forward earnings expectations. The jump in bond returns is even more meaningful as the downside from higher yields (falling bond prices) turns into upside looking forward. Between the two, our forecast for a 60/40 portfolio improved 2.3 percentage points, which over the course of a 10-year investing cycle would make a profound difference to returns.

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While our outlook for the 60/40 portfolio has improved and we believe many investors remain overly cautious—on fixed income markets in particular—we shouldn’t forget the lessons learned in 2022. Bonds are risky assets, even if core bonds are generally not as risky as stocks, and are vulnerable to downturns. And while high quality bonds have historically acted as an effective portfolio diversifier much of the time, they will not necessarily all the time. There were also some effective hedges against losses in 2022 that investors can sometimes forget when the 60/40 is on a roll, especially in alternative investments. We do believe that there are ways in which a portfolio can be better diversified beyond the traditional 60/40, but we think the 60/40 remains a sound foundation for a diversified portfolio, both tactically and strategically, something that is easy to forget after the challenges of 2022.

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.

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

Certain call or special redemption features may exist which could impact yield.

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

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.

Posted by Jeffrey Buchbinder, CFA, Chief Equity Strategist

Wednesday, April 5, 2023

An eventful first quarter wrapped up last week. In today’s blog, we make seven market observations from first quarter performance and share our thoughts on what these performance trends could mean for our outlook.

• Growth Dominated Value

Growth soundly beat value on technology’s strength, with an additional boost from consumer discretionary outperformance and financials underperformance (based on the Russell 1000 style indexes). Lower interest rates and lower inflation supported the growth style. LPL Research has reduced its value tilt and now recommends a roughly balanced approach to style.

Looking ahead, the key question is whether the macroeconomic environment will remain supportive for growth stocks. We’re in no rush to declare the value run is over, but with more evidence this week of easing inflation pressures (soft ISM manufacturing, dip in ISM prices paid (<50), fewer job openings in the JOLTS report, ADP jobs shortfall, etc.), macro conditions are moving in the direction of growth stocks despite premium valuations.

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• The Return of Tech

After a nearly 30% decline in 2022, technology has come storming back in early 2023. LPL Research has upgraded the sector to neutral, partly in response to recent technical strength. Nothing about technology’s fundamentals points to outperformance. Earnings growth doesn’t stand out, nor do estimate revisions. Even valuations look a bit stretched at a more than 35% premium to the S&P 500 on a forward price-to-earnings ratio (P/E) basis. But the sector is clearly in favor right now, our technical analysis work is pointing to further potential gains ahead, and macroeconomic conditions are becoming more favorable for growth stocks, as we noted above.

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Communication services was the second-best performing sector in the quarter with its 20.2% gain. Communication services, with its greater than 50% weighting in digital media, has benefited from more spending discipline among its top constituents, which helped buoy profit margin expectations and lift earnings estimates. The sector’s social media heavy names also got a boost from the possibility of a TikTok ban.

• Concentrated Leadership

The biggest individual stock contributors to the S&P 500’s solid first quarter gain were Apple (AAPL), Microsoft (MSFT), NVIDIA (NVDA), Tesla (TSLA), Meta/Facebook (META), Alphabet/Google (GOOG/GOOGL), Amazon (AMZN), Salesforce (CRM), AMD (AMD) and Broadcom (AVGO). Those companies, which are all technology-oriented, drove 88% of the S&P 500’s first quarter gain, which has sparked questions about whether this market is too top-heavy. Narrow leadership, in general, reflects a less healthy rally than one with broader participation. Importantly, about 60% of S&P 500 stocks are trading above their 200-day moving averages, suggesting healthy breadth. Bottom line, breadth should not be a concern at this point.

• Last Year’s Losers Became This Year’s Winners

Technology underperformed by quite a bit last year before turning around in a big way in 2023. But the trend of last year’s losers becoming this year’s winners, and vice versa, is much broader. If we categorize stocks into quintiles based on 2022 price returns, as shown in the chart below, we see the quintile of the worst performing stocks in 2022 have meaningfully outperformed with a 7.9% first quarter gain, compared with the 2.2% decline for the quintile of the best 2022 performers.

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Now the key question is will these oversold bounces turn into sustainable rallies. LPL Research sees enough of a possibility of that occurring that the Strategic and Tactical Asset Allocation Committee (STAAC) has upgraded the communication services and technology sectors (2022 losers), and downgraded energy and healthcare (2022 winners), bringing all four sectors to neutral. The team’s top sector pick is industrials.

• Small Caps Worked…Until They Didn’t

Bank stress in financials weighed on small caps in March, but for the quarter, strength in large cap technology was actually the biggest contributor to large cap outperformance. The Russell 2000 small cap benchmark returned 2.7% in the first quarter, compared to the more than 7% advance for the large cap S&P 500 and Russell 1000 indexes. Small caps tend to underperform large caps when banks underperform because of the bigger weighting in that segment of the financials sector. But more broadly, small caps often struggle with tightening financial conditions, which is indeed what we have seen since the bank failures about four weeks ago.

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LPL Research’s STAAC has downgraded small caps to neutral due primarily to the technical deterioration evident in the charts. As markets continue to debate if another shoe must drop and how much more work the Federal Reserve (Fed) has to do to combat inflation, the macroeconomic environment may be more supportive for large caps. This may be a short-term stay on the sidelines because of how attractive small cap valuations are currently, particularly profitable, “high quality” small caps.

• Financials Drag

It’s not a surprise that the banking crisis weighed on financials stocks, to the point of trimming 0.45 percentage points off of the S&P 500‘s first quarter return. What might be a surprise is that healthcare was a bigger drag (-0.65 percentage points), but technology’s more than 5 percentage point contribution more than offset the drags from all of the other sectors. The biggest quarterly declines came from energy, financials, and healthcare.

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The STAAC is maintaining a neutral view of the sector, as attractive valuations and the backstops by the Fed and Treasury Department appear to have contained the crisis for now. However, the Committee recognizes the pressure on bank profits from the difficult yield curve environment and higher deposit costs. Meanwhile, more regulations are likely coming that might make banks look more like utilities.

• Developed Markets Continue to Outpace Their Emerging Brethren

One of the biggest stories not just of the first quarter but of late 2022 has been the resilience of European markets. France and Germany have been the biggest drivers of MSCI EAFE Index gains this year, while losses in India and modest gains in China drove most of the MSCI Emerging Markets underperformance. During the first quarter, the MSCI EAFE Index gained 7.6% (8.7% total return), slightly outpacing the large cap U.S. benchmarks. Meanwhile, the MSCI Emerging Markets (EM) Index gained a respectable 3.5% (4% total return), but fell well short of its developed market competition.

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The STAAC continues to favor developed international markets over EM. Valuations are similar, but fundamentals and valuations tilt the scales in favor of developed. Europe’s economic resilience remains impressive. When comparing U.S. equities to developed international, the Committee still gives the U.S. a slight nod. As long as growth stocks are working, it will be difficult for international markets to outperform, despite more attractive valuations.

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 Jeffrey J. Roach, PhD, Chief Economist

Tuesday, April 4, 2023

Overview

• Manufacturing activity last month fell to its lowest since May 2020, as recession fears loom in front of businesses and consumers alike.
• Employment shrunk for the second month as firms cut workers in response to weaker demand. The decline in jobs is a harbinger of a weaker job market in the months ahead.
• Prices paid by factories declined in March and align with the latest reading from the Federal Reserve’s (Fed) preferred inflation gauge released last week.
• Bottom Line: The main takeaway from this report is the job market is slowing so investors should prepare for a weaker job market, higher unemployment, and cooling wage growth in the months ahead. A cooler job market should release some of the inflationary pressure the Fed is working hard to conquer.

All Components Below 50—A First Since 2009

The manufacturing business report reveals the weakness within the manufacturing sector as the economy reacts to high inflation, tighter financial conditions, and uncertainty within the banking sector. For the first time since 2009, all components of the ISM Manufacturing Index were below 50 (levels below 50 signify contraction.)  The headline index was the lowest since May 2020, as recession fears loom large in front of businesses and consumers alike. Looking into the details of this report, we can build expectations for Friday’s employment report and those expectations are not great. Factory employment activity shrunk in March as firms cut workers as demand slows. Of course, our modern economy is a services-oriented economy and the manufacturing industry does not impact us as much as it did in earlier periods. However, the deterioration in factory activity is likely a harbinger of broader weakness ahead. In this period of recalibration, the consumer seems to be adjusting the composition of spending and showing persistent demand for services. We could call this the “demand for experiences” and so the ISM Services Index will likely hold up better than the ISM Manufacturing Index.

Manufacturing activity is negatively correlated to the real trade-weighted dollar index. As shown in the chart below, in most years after the Great Financial Crisis, U.S. manufacturing activity declined when the dollar appreciated. Part of the story is the dollar is a safe haven asset, so when the economy slows and domestic manufacturing declines, investors increase appetite for the dollar. Another factor is a stronger dollar allows firms to shift away from domestic manufacturing and use the leverage of a stronger dollar to increase demand for foreign labor and capital.

Indexes are unmanaged and cannot be invested into directly. All performance referenced is historical and is no guarantee of future results.

View enlarged chart

Inflation Outlook Will Likely Improve

The inflation outlook will likely improve from a weaker job market, higher unemployment, and cooling wage growth in the months ahead. Already, other metrics show inflation has eased. In the inflation dashboard below, the pipeline is clearing as import prices and producer prices are off their peak from last year. March prices paid in the manufacturing sector fell below 50, signaling an outright decline in prices and align with the latest reading from the Fed’s preferred inflation gauge released last week.

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What Does It Mean for You?

The main takeaway from this report is the job market is slowing so investors should prepare for a weaker job market, higher unemployment, and cooling wage growth in the months ahead. A cooler job market should release some of the inflationary pressure the Fed is working hard to conquer. The inflation fight is not without its challenges in the near term. Recent news out of OPEC+ producers incited a jump in crude oil prices. The interest for lower oil production is in response to an anticipated global slowdown in demand from tighter financial conditions and weaker consumers. The surprised cut in output makes sense if you believe financial risks are high and a recession is coming soon. In the more immediate term, high oil prices create a conundrum for central bankers on the fight with inflation. However, the modern domestic economy is less reliant on crude and the pass-through effects from higher energy prices are not as pronounced today as they were in previous decades. Obviously, the transportation sector is most sensitive to changes in energy prices in today’s economy, but investors should remember that, in general, a modern services-oriented economy will be less affected by oil price volatility than the historic manufacturing-oriented economy.

We do believe recession risks are elevated and as Chair Powell hinted previously, the economy may endure some pain (of a recession) before inflation is fully conquered.

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 Adam Turnquist, CMT, VP Chief Technical Strategist

Friday, March 31, 2023

Key Takeaways:

• March was a volatile month, but seasonality patterns prevailed, as stocks stuck to the script of back half outperformance.
• April seasonality trends suggest the melt up could continue. Since 1950, the S&P 500 has posted average and median April returns of 1.5% and 1.2%, respectively.
• Historical return progressions for April show a strong first half of the month. During the first 12 trading days, the S&P 500 has historically climbed 1.4%, capturing the majority of the gains for the month.
• The market avoided breaking below the December lows this quarter, triggering a bullish signal on the December Low indicator.

“In the spring, I have counted 136 different kinds of weather inside of 24 hours” — Mark Twain

While maybe not all in 24 hours, stocks faced several different kinds of ‘weather’ this month; however, the one thing that did not change was the market’s resiliency. The S&P 500 is coming into month-end with a gain of 2.0%, as of March 30. Perhaps some of the spring optimism helped the index recover from nearly a 5% drawdown from intra-month highs. Two of the largest bank failures since 2008, the collapse of Credit Suisse, another 25 basis point rate hike from the Federal Reserve, and interest rate volatility were high hurdles for stocks to clear this month.

This backdrop created a lot of volatility and headlines but seasonality patterns prevailed, as stocks stuck to the script of back half outperformance.

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Can the Spring Melt Up Continue?

April seasonality trends suggest buying pressure could continue next month. Since 1950, the S&P 500 has posted average and median April returns of 1.5% and 1.2%, respectively. In addition, the index has finished positive during the month 71% of the time, marking the second-highest positivity rate on the calendar.

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Unlike March, historical return progressions for April show a strong first half of the month. During the first 12 trading days, the S&P 500 has historically climbed 1.4%, capturing the majority of the gains for the month.

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December Low Indicator

The end of March also means the S&P 500 has finished the first quarter (Q1) of the year. As of March 30, the index is up over 5%, and perhaps most importantly, price has not violated the December closing low of 3,783—triggering a bullish signal on the December Low indicator. This indicator was created by analyst and Forbes writer Lucien Hooper back in the 1970s. He observed that whenever the market violated its December low within Q1 of the following year, it was an ominous sign for stocks for the remainder of the year. In contrast, if the market held above the December low in Q1 as it did this year, it was a bullish sign for the market.

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As shown in the table above, the December Low indicator has an impressive track record. For years when the S&P 500 held above the December low in Q1, the average annual return has been 18.5%, with 94% of years also finishing positive. When the S&P 500 violated the December low in Q1, the index only generated a modest average annual return of 0.4%, with only 53% of years producing a positive return.

IMPORTANT DISCLOSURES

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

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

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

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

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

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

Posted by Lawrence Gillum, CFA, Fixed Income Strategist

Wednesday, March 29, 2023

After one of the weakest February’s on record, the municipal market is on track for its strongest March performance since 2008, as it benefits from a flight to safety amid turmoil in the banking industry. The Bloomberg Municipal Index is up nearly 2% (so far) this month bucking the historical trend of March being the worst month for muni investors. Since 2011, the Bloomberg Municipal Index has lost -0.39%, on average, in March, making it the worst month for the index. The good news for muni investors? The next two months have been good months for muni investors with April and May generating, on average, monthly returns of 0.25% and 0.97%, respectively.

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That said, the ongoing banking sector stress could bleed into the municipal market. U.S. depository institutions hold $580 billion of municipal debt—14% of total municipal debt outstanding—according to Federal Reserve (Fed) Flow of Funds data as of year-end 2022. Moreover, according to FDIC Q4 2022 call report data, approximately 57% of bank muni holdings were available for sale. So, there remains a chance that banks could sell municipal holdings and use the cash to shore up balance sheets and/or potentially raise liquidity to meet customers’ withdrawal demands. With the Fed’s new lending facility though (which we wrote about here), the need to quickly sell securities in times of stress has been reduced, in our view.

A further wildcard remains how investors will react going forward. While flows into muni mutual funds have generally been positive this year, the last six weeks have seen outflows (according to the Investment Company Institute). If demand stabilizes, along with what is expected to be a light month (April) of new issuance, the supply/demand picture could be a favorable one for munis over the next few months. Nonetheless, with starting index yields still above longer term averages, and with the fundamental story still a positive one, we would see any municipal sell off as a potential buying opportunity.

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.

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

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

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

Posted by Jeffrey J. Roach, PhD, Chief Economist

Thursday, March 23, 2023

Overview

• As we expected, the Federal Reserve (Fed) raised the fed funds rate by 0.25%, pushing the upper bound to 5.00%.
• Financial conditions were stable enough for the Federal Open Market Committee (FOMC) to release updated projections, unlike the Fed’s decision back in March 2020 to delay updated projections due to financial instability.
• Yesterday, the Committee was unanimous in their decision, creating an aura of calm for markets.
• Financial stability is clearly a vital factor in future decisions, but as of now, the Fed will likely hike at least one more time at the May meeting.
• Tighter credit conditions translate into equivalent rate hikes. Therefore, the Fed can rightly soften their language that additional policy firming may (or may not) be appropriate.
• Prices in non-housing services have yet to ease and are the top concern for the Committee.
• The Fed sees Silicon Valley Bank as an outlier, not a harbinger of more banking failures. Therefore, the Fed will stay vigilant, but fighting inflation is still the main focus for monetary policy.
• Bottom Line: Investors’ wishes may come true: contagion risks are low enough for the Fed to hike rates and inflation pressures are soft enough for the Fed to be near the end of the rate hiking campaign. Inflation should ease further in the latter half of this year and investors will likely be interested in taking on more market exposure in portfolios.

First, a Pause was Discussed but Eventually Dismissed

In days prior to the meeting, committee members considered pausing the rate hiking campaign due to uncertainty with some regional banks. The run on deposits at some banks in the U.S. created a bit of a scare, but as the days passed, participants believed conditions were favorable for increasing rates and markets were stable enough for participants to publish updated Summary of Economic Projections (SEP). Uncertainty in the banking sector created some division among committee members; however, the median rate forecast for 2023 was unchanged from December at 5.1%, but the path for the rest of the year is muddied. Some forecast no more rate hikes, while others forecast quite a bit more tightening.

As risks of contagion seem to diminish, investors should expect the FOMC to focus on the inflation portion of the dual Congressional mandate for price stability and full employment, i.e., the growth component of the mandate. Unlike the Great Financial Crisis, larger banks are currently well-capitalized and hedged against broader economic risks, giving the Fed room to hike rates amid the volatility.

Second, Tighter Financial Conditions are Equivalent to a Hike in Rates

The Fed may not have to raise rates as much as they expect if financial conditions tighten, since tighter conditions translate into equivalent rate hikes. Although broader financial conditions are tighter now, the Fed will likely stay vigilant with fighting inflation. Given the recent deceleration of prices across much of the economy, the Fed can rightly soften their language about future rate increases from a commitment to a possibility.

As shown in the chart below, financial stress spiked from the uncertainty in the banking sector, and will likely put a damper on the economy, and as the economy slows, consumers pull back spending, and aggregate demand falls, the Fed may not have to hike as much as they anticipated just a few weeks ago.

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Third, Fed Officials do not Expect to Cut Rates this Year.

The markets are at odds with Chairman Powell and his colleagues. The FOMC does not plan on cutting rates this year, but the markets seem convinced the committee will indeed cut rates. Who is right? The markets are probably right because the impact of tighter financial conditions, softening consumer demand, and a slowing economy will release some of the inflationary pressure. Our view is that inflation will be in the mid- to upper-3% range by end of year and will likely slow further next year.

Inflation fighting is still the Fed’s main focus and therefore, it behooves the committee not to pencil in any rate cuts at this point of the cycle. But both markets and the FOMC can agree on at least one thing—the outlook for inflation the rest of the year looks promising.

Supporting the “higher for longer” view is that the banking failure of Silicon Valley Bank seems to be contained and the general financial system appears stable. Although we expect a final 0.25% increase in the Fed’s target rate at the next meeting, the economy is weakening so conditions look like our baseline forecast this year will come to fruition. That is, the Fed pauses by the summertime and the economy ekes out slightly positive growth for 2023.

What Does It Mean for You?

Policy makers view the banking sector as sound. And further, during the press conference, Chair Powell emphatically communicated that the crisis within Silicon Valley Bank was an outlier, not a harbinger of more banking failures. Contagion risks are dissipating but still, the localized crisis has tightened financial conditions and increased recession risks this year. If the economy slows, the Fed may not have to raise rates as much as they had anticipated. In the near term, markets should respond favorably to the updated outlook and the latest decision. Investors’ wishes may come true—contagion risks are low enough for the Fed to hike rates and inflation pressures are soft enough for the Fed to be near the end of the rate hiking campaign. LPL Research remains cautiously constructive on equities, though gains for this year may be more back-end loaded.

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 Adam Turnquist, CMT, VP Chief Technical Strategist

Tuesday, March 21, 2023

Key Takeaways:

• Equity market uncertainty is running high as investors assess the fallout from the latest banking failures. However, implied volatility measured by the Chicago Board Options Exchange (CBOE) Volatility Index (VIX) has been relatively subdued.
• The lack of upside in implied volatility has been surprising, especially considering the S&P 500 traded down as much as 23% after the VIX reached its high watermark last year. Even the recent bank failures barely pushed the VIX above 30 last week on an intraday basis.
• The proliferation of zero days to expiration option activity over the last year has likely limited VIX demand. These options provide an alternative to the VIX for hedging known event risk.
• Record-high money market fund assets are also likely limiting demand for the VIX as there are fewer positions to hedge. Money market funds recently topped $5 trillion, surpassing the pandemic-era highs.

Volatility has increased this month as banking sector turmoil shook investor sentiment. The sequential failures of Silicon Valley Bank (SVB) and Signature Bank (SBNY), along with the recent bailout of Credit Suisse (CS), have elevated uncertainty over contagion risk—and with increased uncertainty comes increased fear.

One way to measure fear in equity markets is through the CBOE VIX, or as some call it, the ‘fear gauge,’ which 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 puts and calls over a range of strike prices. 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.

The chart below highlights the spot VIX and the difference between 1-month and 3-month VIX futures. For reference, spot VIX refers to the real-time calculation of the VIX, as the actual index is not traded—only VIX futures.

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As highlighted, the VIX has been making lower highs since its January 24, 2022 intraday high of 38.94. The lack of upside in implied volatility has been surprising, especially considering the S&P 500 traded down as much as 23% after the VIX reached its high watermark last year. Even the recent bank failures barely pushed the VIX above 30 last week on an intraday basis.

Underwhelming VIX demand is evident when comparing the VIX futures curve to other periods when near-term market uncertainty was elevated. Last week, the VIX curve went into backwardation, meaning shorter-term VIX contracts became more expensive than longer-term contracts. While this represents an increase in near-term demand for hedging, the backwardation period last week was brief compared to other backwardation periods. In addition, the VIX only closed around 26 during each day of backwardation last week, well below the average closing VIX price of 31.8 on previous days when the curve was in backwardation (since May 2004).

The muted VIX response to equity market selling pressure becomes even more apparent when comparing last year’s drawdown on the S&P 500 to other comparable drawdown periods. We analyzed VIX levels for all trading days when the S&P 500 was in a drawdown ranging from 18.5% to 28.5% (range based on +/- 5% levels from last year’s 23.5% drawdown from January to June). The bar chart below is bifurcated between all periods from 1990-2021 and 2022.

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Why does the VIX Appear Less Fearful?

One potential driver of limited upside in the VIX is 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. It is important to note, a 0DTE option could be a longer-term option that has reached its final day of expiration or it could be a specific option only listed for a single trading day.

Outside of speculative positioning, the Monday through Friday 0DTE option menu allows investors to hedge known event risk. For example, if an investor was worried about short-term downside risk following tomorrow’s March 22 Federal Open Market Committee announcement, they could buy a 0DTE S&P 500 put contract to hedge long positions instead of hedging with the VIX.

Based on option volume, the addition of the Tuesday and Thursday expirations helped underpin trading activity last year. The chart below shows the 50-day moving average of put and call volumes for S&P 500 options over the last several years.

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Volume has climbed steadily since last April and May when the new Tuesday and Thursday contracts were added to the market. Most of the increase in volume was due to 0DTE trading activity. According to the CBOE, the average daily volume for S&P 500 options with zero days to expiration jumped 83% in 2022 and comprised 43% of overall S&P 500 option volumes in December alone.

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 took in record inflows. According to the Investment Company Institute (ICI), assets in money market funds are now over $5 trillion, recently surpassing the peak pandemic levels.

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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.