Wealth Management

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.

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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

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.

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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.

View enlarged chart

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