Wealth Management

Posted by Jeffrey J. Roach, PhD, Chief Economist

Thursday, November 3, 2022

The Federal Reserve (Fed) ended its two-day Federal Open Market Committee (FOMC) meeting yesterday and the outcome was broadly in line with market expectations. As expected, the Committee raised short-term interest rates by 0.75% to take the fed funds rate to 4.0% (upper bound). The 0.75% increase was the fourth in a row and only the fifth over the past thirty years. The Fed reiterated its desire to continue to hike rates to a “sufficiently restrictive” level and keep rates there until there is compelling evidence that inflation is on course to return to its 2% target. Importantly though, the Committee included language in its statement that may indicate that the most recent string of 0.75% rate hikes could transition to smaller hikes at subsequent meetings.

The Committee specifically called out the lags with which policy affects the economy, building the case for eventually slowing down the pace of future increases. While the Fed has been hiking rates aggressively, the Committee only started hiking rates by 0.75% in June and has raised rates by 3.75%, cumulatively, since the start of the rate hiking campaign in March. Thus, the long and variable lags associated with rate hikes likely haven’t made their way through the real economy. That said, the economic “pain” necessary to bring inflation down may not be as acute as originally feared, as the Fed likely slows the pace of future hikes. As inflation becomes more demand-driven rather than the supply-driven pressures experienced after the COVID reopening, Fed tools will be more efficacious in the inflation fight.

Looking ahead, the December Fed meeting will include an updated Summary of Economic Projections, the official forecast of the Fed including the now-infamous “dot plot,” representing the individual views of the committee members. As of the most recent release of the dot plot, Fed officials broadly assumed fed funds could peak at 5% by mid-2023 but fall to 4.5% by end of 2023. However, during the press conference, Powell suggested he sees rates higher than expected at the last forecast round in September, indicating a terminal rate above 5%. As seen on the chart below, bond markets have priced in a terminal rate slightly above 5% by the May 2023 meeting and then marginal cuts throughout the year.

View enlarged chart

Bottom Line: These recent hikes will likely dampen the housing market, corporate activity, and consumer spending in the coming quarters and tighter financial conditions put the economy on unsure footing for 2023. It all boils down to the stability of the consumer. A silver lining is markets may have possibly priced in much of the near-term recession risks.

IMPORTANT DISCLOSURES

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

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

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

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

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

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

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

Posted by Jeffrey J. Roach, PhD, Chief Economist

Wednesday, November 2, 2022

Awaiting the Federal Reserve Decision

While awaiting the Federal Reserve’s (Fed) interest rate decision, investors received a few pieces of relevant news this week that could likely be topics of conversation among Fed officials. Most expect the Fed to aggressively hike the federal funds target rate for the fourth consecutive time at this November meeting so the real interesting part will be the press conference after the Federal Open Market Committee (FOMC) announces the decision. A tight labor market amid signs of easing inflation will likely be discussion topics for the foreseeable future.

Some Good News and Some Bad News

We’ve previously highlighted the areas where we see easing pricing pressures. Rents in some areas, shipping costs, and used car prices have come down. The point of contention for some members of the FOMC is if the deceleration is convincing or not.

Recently, investors received some good news about prices. The Institute for Supply Management issued a report on October manufacturing activity, which is still expanding but has consistently decelerated since March 2021 as global economies slow down. Imports are still growing, in contrast to exports which have contracted for three consecutive months. Order backlogs fell the lowest since mid-2020 when economic activity ground to a halt. Supply chains have improved dramatically, releasing some of the inflationary pressures of this year. But the highlight of the report is that input prices fell from a month ago, the first month-to-month decrease since May 2020, and should add convincing evidence for the Federal Reserve that inflation is past peak. (Index levels below 50 imply contraction and above 50 imply expansion.)

Two main themes are developing from this report. First, international economies are under greater economic stress than the U.S. and second, prices are finally declining after an extended period of extreme inflationary pressures.

View enlarged chart

Investors also had some bad news to digest this week. According to the September Job Openings and Labor Turnover Survey (JOLTS), the job market is still tight as firms struggle to find workers. The labor market could slowly loosen as workers re-enter the workforce. Quit rates were unchanged in September and stayed below the all-time highs earlier this year. However, the number of job openings increased up to 10.7 million but below the high of 11.9 million in March. Quit rates are a more stable metric than openings and give a snapshot into the optimism of individuals as they move from one job to another or take a modified “gap year” off from employment.

Elevated inflation pressures should lower the quit rates in the coming months as individuals become less inclined to quit their jobs. The Federal Reserve will likely continue hiking interest rates to slow aggregate demand and attempt to bring demand and supply back into balance. Rising unemployment should fix some of the imbalances between the number of individuals looking for work and firms with open positions. But nonetheless, the imbalance in the labor market could likely be a hot topic in upcoming Fed press conferences.

View enlarged chart

Conclusion

In the near term, the Federal Reserve is concerned about the tightness of the labor market and how that might impact the inflationary environment. However, investors are seeing more evidence that inflation is easing and in some cases, prices are outright declining. Nagging inflation, a tight labor market, and an aggressive Federal Reserve puts the economy on unsure footing for 2023. A silver lining is markets may have possibly priced in much of the near-term recession risks.

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 Barry Gilbert, PhD, CFA, Asset Allocation Strategist

Tuesday, November 1, 2022

Wednesday last week, the three-month Treasury yield moved above the 10-year Treasury yield, a condition known as yield curve inversion and historically an important warning flag of elevated recession risk. But has it also been a warning flag for market returns? Historically, that depends on the risks that have already been priced into markets.

An inverted yield curve is usually a sign that the Federal Reserve (Fed) is responding aggressively to an overheated economy and/or inflation. Right now, we certainly don’t have an overheated economy, despite a strong labor market, but we are struggling with high inflation.

As shown in the LPL Chart of the Day, yield curve inversion independent of other factors has historically implied tepid forward-looking returns for the S&P 500 Index, giving us just a 2% price return over the next year, on average. But what has happened over the previous year makes a difference.

View enlarged chart.

A positive return in the prior year when the yield curve inverted has historically provided a near flat return in the next. A negative return in the prior year has provided a below-average but respectable 7.3% forward year return, although not without some added volatility in the interim. If you include only the prior year double digit declines (which we had last week), the average historical return over the next year jumps to 13.5%. Granted, that’s only four cases, a very small sample, but it’s what’s most similar to where we are now.

If you look at inversion accompanied by a mid-term election year, the historical numbers look even a little better: 1966, 1974, 1978, 1992, 1998, and 2006 were all mid-term election years, as is this year. The only negative return a year later was an inversion that took place in early 1966 when the calendar effects for mid-term years are still typically negative.

Yield curve inversion implies potential risks ahead that shouldn’t be ignored. It does usually mean continued volatility. But if we do get a recession in the next year, it will be one of the least surprising recessions over the last fifty years, and that may potentially be good for markets.

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 Jeffrey J. Roach, PhD, Chief Economist

Thursday, October 27, 2022

What a Rebound

After two consecutive quarters of negative growth, the U.S. economy grew at a 2.6% annualized rate in the third quarter, driven by a resilient consumer sector. Real personal spending, roughly 70% of the economy, grew 1.4% annualized, slightly slower than the previous quarter.

Net exports were a large contributor to Q3 growth from a narrowing trade deficit. One big driver behind the lower trade deficit was the massive decline in crude oil prices. Crude prices fell over 26% in Q3 as risks of a global slowdown intensified which cut the cost of oil imports into the U.S. during this period. Looking ahead, the trade deficit will likely widen from here as international economies weaken, restricting U.S. exports amid a very strong U.S. dollar. Therefore, net exports will likely detract from Q4 growth and could further impede growth in 2023.

Consumer spending on services was another contributor to Q3 growth. A strong labor market and a stockpile of savings have supported consumer spending so far this year but we do not know how long this can last. Eventually, consumers will retrench as they draw down savings and tap into credit or pull back on spending.

Not surprising, residential investment subtracted from growth as borrowing costs spiked and housing demand plummeted. Outside of the pandemic, residential investment contracted the most since 2010. As housing normalizes in the coming quarters, this category will continue to be a drag on growth for the next few quarters.

View enlarged chart.

Removing the Noise

Trade and inventories are two volatile categories in Gross Domestic Product (GDP), the general metric used to track the economy. In order to get a better view on the trajectory of growth, investors should pay special attention to the inflation-adjusted “final sales to domestic purchaser,” a line item in the GDP report. This combined category of consumer spending and fixed investment spending was roughly flat relative to the previous quarter, putting the run-rate significantly below pre-COVID averages and illustrating the weakening trend in growth.

Conclusion

The U.S. is not currently in recession, given the strength of the consumer sector. However, excluding the more volatile categories, the trajectory for growth looks weak. Therefore, the Federal Reserve may shift to a 0.50% increase in December after a likely 0.75% increase next week. Consumers will be the linchpin for the likelihood of a soft or hard landing. A deteriorating housing market, nagging inflation, and an aggressive Federal Reserve put the economy on unsure footing for 2023. A silver lining is markets may have priced in much of the near-term recession risks.

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 George Smith, CFA, CAIA, CIPM, Portfolio Strategist

Wednesday, October 26, 2022

British bond markets and the British pound received a boost on Tuesday as Rishi Sunak, a former chancellor of the Exchequer and Chief Secretary to the Treasury, was named the new Prime Minister (PM) of the United Kingdom (UK). Mr Sunak is expected to provide more financial stability to the volatile UK economy than it has experienced so far in 2022.

It was 1964 when former PM Harold Wilson was said to have mentioned that “A week is a long time in politics” but never has this been truer than the last few weeks in the UK. It has been a tumultuous time for UK politics with three different PMs being in power during the past seven weeks alone (for comparison there were only three PMs within 28 years from the Margaret Thatcher to Tony Blair eras).

The unfortunate chain of events kicked off when Boris Johnson resigned as PM in July, following the “partygate” scandals in which Mr. Johnson appeared to break COVID lockdown rules for social get-togethers, including his birthday, with government staff. He eventually left office in September when Liz Truss was named his successor following a vote of conservative party grassroots members. This was where it all started to unravel for the UK as Ms.Truss and her chancellor, Kwasi Kwarteng, unveiled a largely unfunded round of tax cuts, labelled locally as “Trussomics”.

Markets panicked as the government appeared to be stoking inflating just as the Bank of England (BoE) was trying to stem it, causing the sterling to briefly fall to its lowest ever level against the US dollar and for UK government borrowing costs to soar. This, in turn, caused huge losses for UK pension funds that were heavily exposed to gilt (UK government debt) yield fluctuations, forcing the BoE to step in with billions of pounds of gilt purchases to shore up the market.

Mr. Kwarteng resigned initially but it wasn’t enough for the House of Commons (the UK equivalent of the Senate/House of Representatives) and Ms. Truss soon followed, resigning after only 44 days in office – becoming the shortest ever serving PM in UK history.

There had been speculation that former Prime Minister Boris Johnson was going to run again for PM but he withdrew from the race over the weekend as it became clear that Sunak had significant internal support from the Conservative party. As shown in the LPL Chart of the Day, the 10-year British gilt yield declined as the appointment of Rishi Sunak as the new UK Prime Minister was received positively by the market.

View enlarged chart.

Mr. Sunak has a tough job ahead of him. Even aside from the ill-fated “Trussonomics” mini-budget, the British pound had been weakening for some time amid a backdrop of dollar strength and a poor outlook for the UK economy wracked by rising energy costs and a cost-of-living crisis. LPL Research’s Strategic and Tactical Asset Allocation Committee maintains a overall negative view on developed international equity markets, including the UK, given the energy and currency headwinds that are hampering the post COVID-19 recoveries of most European economies.

IMPORTANT DISCLOSURES

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

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

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

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

All index and market data from FactSet and MarketWatch.

This Research material was prepared by LPL Financial, LLC.

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

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

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

Posted by Lawrence Gillum, CFA, Fixed Income Strategist

Tuesday, October 25, 2022

With the aggressive front loading of rate hikes we’ve already seen from the Federal Reserve (Fed) this year, yields on Treasury securities are at multi-year highs. Moreover, since Treasury yields are generally used as the base rate for consumer and corporate borrowers, the increase in Treasury yields this year pushed borrowing costs for many borrowers to levels not seen in years. Consumer loans such as mortgage rates have already repriced higher and have been a big reason affordability has fallen in the housing market. And for corporate borrowers, after years of borrowing at ultra-low rates, the backup in yields we’ve seen this year has pushed corporate borrowing rates back above 6%, which is the highest levels since 2009. As higher borrowing costs have reduced the affordability and activity we’ve seen in the housing market, could higher borrowing costs for corporates reduce profitability and potential growth opportunities as well?

View enlarged chart.

Perhaps, but over the last two years in particular, corporate borrowers have increased the amount of new debt issued seemingly to prepare for the rising rate environment we’re currently in. In fact, new corporate debt issuance for investment grade companies hit record highs in 2020 and 2021 when over $3 trillion of new debt was issued. As such, corporate entities were able to term out debt by issuing a lot of debt at longer maturities and at lower rates. And now that interest rates have moved higher this year, 2022 new debt issuance is on pace for the lowest levels in years. With still elevated cash levels for larger cap companies, it seems corporations don’t need to access the capital markets as much as they have in years past.

View enlarged chart.

Also and importantly, because companies were able to refinance existing debts over the last few years and push out maturities, only about 1% of existing debt needs to be refinanced in 2023, and less than 10% needs to be refinanced before 2025. Again, the need for companies to refinance existing debt at these higher levels seems to be muted currently.

View enlarged chart.

The move higher in Treasury yields this year has been swift and unrelenting and has pushed borrowing costs for countries, consumers, and companies to multiyear highs. While higher consumer loans have no doubt hit the housing market hard, reducing affordability for potential buyers, the impact on corporate borrowers is still mixed. Yes, new issuance by companies will be at these higher rates but companies, in aggregate, did a good job of taking advantage of the low rate environment over the past few years and locked in lower rates. With cash balances still relatively elevated and without the pressing need to refinance existing debt, we don’t think potential growth opportunities or corporate profitability will be negatively impacted in the near term. That said, if the Fed is able to keep rates at these elevated levels and as the need for corporate borrowers to access the capital markets increases, no doubt corporate profitability will be negatively impacted by higher interest expenses. We don’t think it happens in the near term though.

IMPORTANT DISCLOSURES

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

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

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

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

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

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

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

Posted by George Smith, CFA, CAIA, CIPM, Portfolio Strategist

Wednesday, October 19, 2022

Investors who feel like there have not been many good days to cheer so far this year are correct to think that way. As shown in the LPL Research Chart of the Day, the year-to-date percentage of days that the S&P 500 has seen a positive daily return is just 43.5%. This is the lowest value since 1974 when the market ended the year down almost 30%. Years with such low percentages of up days unsurprisingly normally do end underwater, with only 1982 managing a positive return after so few up days. The good news from this data is that the year following on from one with such few up days tends to see well above average returns, with an average and median return of 12% and 17% respectively. Caution though must be paid to the small sample size and the very wide range of returns from +44.1% to -29.7%.

View enlarged chart.

Market volatility in major stock markets, including the S&P 500, has continued to be elevated this year as markets gyrate up and, mainly, down, with wild swings occurring in both directions. Rising recession risks, stubbornly high inflation and elevated geopolitical risk and uncertainty are all adding to the volatility on the bearish side, with oversold conditions, extremely pessimistic market positioning, and somewhat resilient earnings still providing some fodder for more bullish market participants

The most common measure of market volatility, the Volatility Index (VIX) has been elevated, and above 30 for much of the past few weeks, but has not reached the 40+ levels that we have normally seen in prior market dislocations. Some other measures of volatility however are showing levels that are consistent with prior market dislocations.

So far this year we have seen an elevated number of instances of daily returns (positive or negative) greater than 2%. There have been 39 occurrences year to date, with 7 of these occurring in the last 14 trading days. Thursday, Friday of last week and Monday of this week all saw daily moves greater than 2% in magnitude. This was the first time this had occurred on three consecutive days since July, and only the 7^th time since the Great Financial Crisis (GFC). Interestingly, despite the market being down sharply this year, the number of big up days has been approximately equal to the number of big down days, which is consistent with long run averages, even in bear markets.

View enlarged chart.

Markets have also seen elevated intraday volatility, with Thursday of last week marking a huge intraday reversal. A large gain at the close, of over 2.6%, obscuring an intraday range of over 5.5%, as stocks initially reacted negatively to the hotter-than-expected CPI report before bouncing back strongly later in the session. The last time there was such a large intraday swing was right around the 2020 market low, and it would be unusual to see a bear market low without at least a few more of these occurring.

View enlarged chart.

Much of this market data, along with sentiment data from the American Association of Individual Investors and the Bank of America fund manager survey, appears to suggest that many market participants are approaching levels of pessimism similar to major market events such as the GFC, Dot Com Bubble, or even Great Depression. At present we do not believe this level of pessimism is warranted, and while we believe that the risk of a mild recession has probably risen to more likely than not, the S&P 500 still has the potential to see gains from here to year-end, even if it’s against a continued backdrop of above average volatility.

IMPORTANT DISCLOSURES

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

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

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

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

All index and market data from FactSet and MarketWatch.

This Research material was prepared by LPL Financial, LLC.

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

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

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

Posted by Lawrence Gillum, CFA, Fixed Income Strategist

Tuesday, October 18, 2022

The start of the 2000s was a trying time for equity investors. After the dot-com bubble burst that saw equity prices fall nearly 50% from peak to trough, it took the better part of the decade to recover those losses. It took patience, but the equity market did eventually recover. Now, the core bond index (as defined by the Bloomberg Aggregate Bond index) is seeing losses unlike any year since inception of the index. Core bonds are down nearly 16% this year and this year’s losses have wiped out five years of gains for the index. So, with the decade of low interest rates seemingly coming to an end, bond market investors may be in a similar position. However, within the fixed income markets, because bonds are not only financial instruments, but also financial obligations that pay coupons and principal repayments at par at maturity, the potential for recovery is a bit more certain than in the equity markets that relies primarily on price appreciation. So how long will it take to recover this year’s losses?

View enlarged chart.

The table below provides some expectations for various fixed income markets under different interest rate scenarios. If interest rates don’t change at all, the best expectation for performance over the next year would be the index’s starting yield (dark blue highlighted section). However, if interest rates decline by 0.5%, the Bloomberg Aggregate Bond index could return over 9% over the next 12 months. Moreover, if interest rates move back into the low 3’s, the core bond index could return around 12% over the next year. Also, importantly, given where starting yields are, if interest rates increase by another 1% from current levels, only the Bloomberg Treasury index is expected to generate further negative returns. Given the move higher in yields we have already experienced this year, we think the risk/reward for owning core bonds has improved.

View enlarged chart.

While it may be tempting to hide out in cash or other short-term financial instruments, we think the potential for price appreciation within core fixed income could help offset the earlier losses faster than collecting income alone. There is no doubt that this year has been a challenging year for core bond investors but we do think the worst is behind us. Like the equity markets at the beginning of the 2000s, it will take patience to fully recover this year’s losses, but we think the best way to do that is to stay invested lest you may miss out on the recovery in the fixed income markets that will eventually occur.

IMPORTANT DISCLOSURES

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

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

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

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

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

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

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

Posted by George Smith, CFA, CAIA, CIPM, Portfolio Strategist

Friday, October 14, 2022

The latest weekly data from the American Association of Individual Investors (AAII) showed the percentage of individual investors who are bullish about short-term market expectations at very depressed levels (20.4%), and continued the trend of an extremely elevated proportion of bearish investors (55.9%). This puts the spread between the bulls and the bears at -35.5%, only the 21^st time in the survey’s 35 year history the reading has been this pessimistic.

As shown in the LPL Chart of the Day, investor sentiment, as measured by the spread between bulls and bears in the AAII data, is still in extreme territory, more than two standard deviations below its long-term average. The mid-summer stock market bounce had brought some bulls back, with the bull-bear spread getting close to zero by mid-August, but since then investor sentiment has fallen along with the stock markets, with the spread reaching a low of -43 in mid-September (the fourth most pessimistic ever).

View enlarged chart.

We continue to view the AAII as a contrarian indicator with extremes in negative sentiment tending, on average, bullish for near-term stock market returns and extreme investor optimism tending to be bearish for the near-term outlook. The more extreme the pessimism (or optimism) the greater the outperformance (or underperformance) over the next year. When the spread has been as low as it is now (-35.5 or approximately 2.5 standard deviations below average), the returns a year out have been even stronger, with average returns of 7%, 16% and 18% over 3, 6, and 12 month periods.

View enlarged chart.

IMPORTANT DISCLOSURES

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors 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.

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• May Lose Value

Posted by Jeffrey J. Roach, PhD, Chief Economist

Thursday, October 13, 2022

Disappointing

The core Consumer Price Index (CPI), which excludes food and energy, rose to a multi-decade high in September, disappointing both investors and policy makers. The CPI is one, but not the only metric for inflation.

September headline inflation eased slightly to 8.2% year-over year from 8.3% in August. Energy commodity prices outright declined for the last three months, offsetting the accelerating price increases in other areas such as food and rent. Core inflation, which excludes food and energy, rose 6.6% from a year ago, the highest rate since 1982. The nagging pressure on core inflation will likely put pressure on the Federal Reserve (Fed) to stay aggressive in its fight.

Inflation is Unevenly Distributed

Not all categories experienced price increases. Gasoline and fuel prices fell for the third consecutive month and used car prices fell six out of the last eight months.

But other categories show persistent and potentially entrenched inflation pressures. Shelter costs were the largest contributor to headline inflation, adding 2.2 percentage points in September. Rent prices rose 18 out of the past 19 months, creating acute pain for those who didn’t participate in the recent home-buying surge.

Inflation continues to be driven by services such as medical care, insurance, and housing in contrast to the decelerating inflation in goods, especially durable goods as shown in the chart below.

View enlarged chart.

Impacts on Consumers Are Mixed

Higher prices and slow wage growth will likely put pressure on consumers as purchasing power declines. We expect to see growing demand for credit and a drawdown in savings to support spending habits. Prices at the pump fell during the first half of September but reversed course and continued to increase into October, adding to the risk that the October CPI report will also disappoint.

Rising food and rent costs are a growing concern. These pressures are especially hurting lower income households where food and rent are a larger share of total spending.

Rising Rents Continue

Rents will likely continue to rise as the housing market rebalances after the post-COVID boom. Recent pricing trends for rent of primary residence is alarming. Rent prices are up 7.2% from a year ago, the fastest rate since the early 1980s. The massive reshuffling in the housing market explains most of the rise in rental costs. During the recent period of unusually low mortgage rates, housing demand skyrocketed and home price appreciation reached new levels. High housing costs pushed many homes out of reach for would-be millennial buyers and for first-time buyers with no pre-existing home equity. High demand for homes and low supply created insurmountable hurdles and pushed many to be renters instead of home buyers so it may be a while before rent prices cool.

Conclusion

Headline inflation is likely past its peak, but the Fed still has work to do. The Fed will likely increase rates again by 0.75% in November as core inflation is not cooling as fast as expected. A big risk for the Fed is inflation becoming entrenched in some sectors such as services as inflation cools in other sectors. Another risk is the unknown impacts of a strong dollar in the international currency markets. The US dollar will likely strengthen as the Fed keeps tightening in this uneven inflationary environment.

As import prices and producer prices ease, the inflation outlook should improve. As policy makers have publically indicated, inflation is the primary concern and for now, the Fed is willing to sacrifice economic growth in the near term to get inflation back to the long-run rate of 2%. The path to a soft landing for the Fed continues to narrow. While avoiding a deep recession remains possible if the labor market holds up, the odds of recession continue to rise as the inflation fight gets more challenging.

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.