Wealth Management

Posted by David Matzko

Wednesday, November 29, 2023

Key Takeaways:

• Consumers are contending with a confounding housing market. New home prices are down over 17% from a year ago but existing home prices continue to increase. This may provide some opportunities for homebuilders to meet demand.
• As prices for durable goods fall, consumers retained an appetite for purchasing major items, but the pace of spending will likely slow in the coming months.
• Economic data often gets revised downward as an economy downshifts, as we saw in the latest Conference Board report and the revised consumer spending estimates from Q3.
• The recent economic data are suppressing yields and stimulating the appetite for risk assets.

Homebuilders Look for Opportunities

One of the confounding experiences for consumers these days is within the housing market. Prospective buyers are reading the tale of two markets when it comes to residential real estate.        After a volatile 2022, the pace of new home sales has stabilized around the pre-pandemic rate. This is good news for homebuilders prepping for 2024, especially for companies such as PulteGroup (PHM) with a diversified portfolio. Median prices for new homes are down roughly 17% from last year as inflation pressures moderate. With supply of existing homes still below 50% of its pre-pandemic level, homebuilders stand ready to take advantage of any increase in demand. Currently, activity is strongest in the Midwest and West, with supply chain issues and inclement weather negatively affecting builds in the Northeast. Both permit issuances and new housing starts saw recent increases and beat their respective forecasts.

Amid low inventory of existing homes on the market, new home sales will likely remain stable to meet the demand. As mortgage rates fall and the Federal Reserve (Fed) pivots away from hiking rates, homebuilders might expect continued growth in business activity.

An Appetite Not Yet Satiated 

Confidence in November rose from last month, but only because of October’s significant downward revision. As prices for durable goods fall, consumers retained an appetite for purchasing major items such as automobiles, big appliances, and homes. Although, more respondents reported jobs were becoming harder to find, meaning a slowdown in spending is likely as the year wraps up.

Investors should remember that economic data often gets revised downward as the economy downshifts, as we saw in the Conference Board report. The three-month average for consumer confidence fell for the third consecutive month, reaching the lowest since August 2022. As we saw in the holiday sales figures, the consumer is still spending but much depends on the job market. All eyes should be on the upcoming jobs report on December 8. As the labor market cools, investors should expect consumer spending to slow down, but so far, it looks like a soft landing. All in, the data supports the Fed’s likely decision to keep rates unchanged at next month’s meeting.

Another Mixed Bag

This morning’s revised estimate for Q3 GDP was full of surprises. Revisions pushed headline growth to 5.2% annualized from 4.9%, but investors must look beneath the headlines.

Consumer spending was revised down to 3.6% annualized from 4.0% but government spending was revised up. Consumer data is often revised downward as the economy downshifts and we see this again in the latest GDP report. Looking ahead, we should expect inventories to subtract from Q4 growth and possibly see less support from consumer spending.

In addition to weaker consumer spending, markets are digesting Fed governor Christopher Waller’s apparent pivot, as he commented yesterday that the Fed could hold rates steady at the upcoming meeting. Investors know that Waller had been the most hawkish of Fed officials, so this is market-moving. Treasury yields and the U.S. dollar fell on the news.

The Bottom Line

The Fed could find themselves in a sweet spot. Inflation is trending lower, the consumer is still spending but at a slower pace, and the Fed could end its rate-hiking campaign without much pain inflicted on the economy. Looking ahead, markets will hotly anticipate the upcoming Beige Book release for anecdotal evidence on the state of the economy, but so far, the economic data are suppressing yields and stimulating the appetite for risk assets.

One additional item to watch is the U.S. dollar. As the Fed started to sound less hawkish, investors saw a decline in the dollar. A weaker dollar is often good for emerging markets, potentially providing an opportunity in the near future. LPL Research currently holds a negative view of emerging market equities but acknowledges valuations are attractive and that certain markets such as India and Brazil are intriguing.

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IMPORTANT DISCLOSURES

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

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

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

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

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

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

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

Posted by Lawrence Gillum, CFA, Chief Fixed Income Strategist

Tuesday, November 28, 2023

November has been a good month for bond bulls with returns for most fixed income categories (so far) posting solid returns. However, despite the solid returns recently, fixed income volatility remains high and longer-term trailing returns are negative for many of the core bond categories. That could raise the question about ongoing demand for bonds. However, with starting yields still among the highest levels in years, investment grade corporate bonds, in particular, are extremely attractive to yield buyers like pension funds and insurance companies.

The investment grade corporate buyer base can generally be broken into three segments: A) domestic institutional investors, B) domestic retail funds and C) foreign investors. According to JPMorgan, those segments are roughly 45%, 26% and 29%, respectively. And within the domestic institutional investor segment resides pension fund investors who have traditionally cared more about total yields than spreads (or the additional compensation for owning riskier debt). And this segment could be a large buyer of corporate bonds for years to come as the funding status of these plans has improved.

The Milliman 100 Pension Funding Index chart below shows pensions, in aggregate, are overfunded (104.2% of target), which means the value of their assets are currently more than their liabilities. Prior to 2022, pension funds were generally underfunded so to help fill those deficits, plans were generally overweight equities. In theory, fully funded pension plans de-risk portfolios by selling equities and buying bonds to lock in a more certain return stream and to lock in higher yields that can be used to offset/cover future liabilities. So now that plans are running surpluses, pension investors have been net sellers of equities and buyers of corporate bonds, which has helped support prices.

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Demand for these higher yields comes at a time when high grade corporate bond issuance remains muted. Many corporations termed out debt in 2020, i.e., they issued a lot of debt at very low interest rates for long maturities. As such, high grade corporations, in general, don’t need to access the capital markets anytime soon (2025 will be a large year for maturities). Thus, supply of new bonds remains below historical averages.

As such, positive demand to go along with muted supply should provide stability for prices within the category. While our preference has been to stay in the short-to-intermediate parts of the corporate credit universe, with the Federal Reserve likely done raising rates, extending duration and locking in high yields for longer may make sense for those investors with longer time horizons.

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 Adam Turnquist, CMT, VP Chief Technical Strategist

Wednesday, November 22, 2023

Key Takeaways:

• Gold is starting to shine again after confirming support off its rising 200-day moving average last week. A meaningful pullback in interest rates and the dollar underpinned the recovery in the yellow metal.
• Momentum indicators point to a bullish trend change, while speculator long positions in gold continue to outpace shorts.
• Central bank demand for gold is building, evidenced by record buying during the first nine months of the year.
• Seasonal tailwinds return next month as gold enters its best two-month seasonal period.
• However, resistance near $2,070 has been problematic for gold over the last several years, so while a retest of this level may be in the cards, a confirmed breakout will be required to keep gold’s upside momentum moving forward.

Gold has regained its luster this month as the narrative surrounding monetary policy changed from tightening to potential rate cuts coming as early as next spring. Interest rates—including real yields— and the dollar all pulled back meaningfully. Ongoing geopolitical tensions in the Middle East have also supported a risk premium in the yellow metal.

As shown in the chart below, gold found support last week off its rising 200-day moving average (dma) at $1,939. Technically, a close above the October highs at $2,009 should pave the way for a retest of the prior highs near $2,070—a major resistance hurdle for the yellow metal to clear.

Momentum indicators are confirming the bullish price action. As shown in the middle panel, the positive directional movement indicator (+DMI) recently crossed back above the negative directional movement indicator (-DMI), signaling a change in trend direction. Managed money net futures positions (typically hedge funds), shown in the bottom panel, are also back in positive territory after briefly turning negative last month, implying long positions among speculators are outpacing short positions. Furthermore, while positioning remains bullish, it has not reached extremes or levels we consider contrarian.

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Gold Demand is Growing

Hedge funds are not the only ones buying gold. According to the World Gold Council, gold demand in the third quarter was 8% above its five-year average, with central banks buying 337 tons (representing nearly 30% of total demand during the quarter). For the year, central banks have now purchased a net 800 tons of gold, marking the highest on record for a nine-month period. The World Gold Council further noted buying has been broad-based, stating, “While there is a nucleus of committed regular buyers, the range of countries whose central banks have added to their reserves over recent quarters is broad-based.”

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Seasonal Tailwinds Return

Gold is coming into a seasonally strong period. Over the past 50 years, gold has gained an average of 1.4% and 1.9% in December and January, respectively, making it the precious metal’s best two-month period over this timeframe.

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SUMMARY

The macro backdrop for gold has improved. Real yields and the dollar have recently pulled back through key support levels as the market looks ahead to a potential shift in monetary policy next year. The anticipation of rate cuts, along with elevated recession odds, ongoing geological tensions, and increased central bank buying in gold should continue to support price action. Seasonal tailwinds also return next month as gold enters its best two-month seasonal stretch. However, resistance near $2,070 has been problematic for gold over the last several years, so while a retest of this level may be in the cards, a confirmed breakout will be required to keep gold’s upside momentum moving forward.  

IMPORTANT DISCLOSURES

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

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

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

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

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

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

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

Posted by Lawrence Gillum, CFA, Chief Fixed Income Strategist

Tuesday, November 21, 2023

There’s no doubt the last few years have been challenging for fixed income investors. And while 2023 was supposed to be the year for bonds, fixed income returns for most core bond categories have only recently turned positive for the year. That said, despite the recent challenges, we think there are several reasons to be thankful (optimistic) about the current set-up within fixed income. As such, below are five things we’re thankful for within the fixed income markets.

• The (potential) end of the Federal Reserve (Fed) rate hiking campaign. The biggest headwind to the fixed income markets over the last few years has unequivocally been the Fed. Over the past 20 months, the Fed increased its fed funds rate by over 5%, including four 0.75% rate hikes over the course of four Fed meetings. However, with inflationary pressures abating (although admittedly still too high to warrant rate cuts), we think the Fed is likely done, which should eliminate the biggest headwind to fixed income markets.
• The asymmetric risk/return profile for core bonds. While not unique to fixed income per se, the asset class has a feature that makes negative price performance increasingly difficult to continue due to rising rates alone. Fixed income returns are a combination of price performance and income so as yields rise, the income component increases as well. The higher income component serves as a “hurdle rate”, or a yield cushion, that will need to be eclipsed before further losses are realized. As such, these higher hurdle rates may decrease the probability of losses due to an increase in interest rates while at the same time these higher starting yields increase the probability of annual gains.

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• The potential for equity-like returns (without equity-like risks). While our base case is for the 10-year Treasury yield to trade between 4.25% and 4.75%, given starting yields, it would not take much of a sustained drop in yields to generate high single digit/low double digit returns over a 12-month horizon for a number of high-quality fixed income sectors. For example, a 0.50% drop in yields could likely generate a 10% return (over 12 months) for AAA-rated agency mortgage-backed securities (MBS). Moreover, if the economy slows and the Fed cuts rates more than we expect next year, these high-quality fixed income sectors could generate 12%–13% type returns (no guarantees of course).

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• The ability for income-oriented investors to generate income again. There are three primary reasons to own fixed income: diversification, liquidity, and income. And with the increase in yields recently, fixed income is providing income again. Right now, investors can build a high-quality fixed income portfolio of U.S. Treasury securities, AAA-rated agency mortgage-backed securities (MBS), and short-maturity investment-grade corporates that can generate attractive income. Investors don’t have to “reach for yield” anymore by taking on a lot of risk to meet their income needs. And for those investors concerned about still higher yields, laddered portfolios and individual bonds held to maturity are ways to take advantage of these higher yields.
• The (historical) after-tax returns for muni investors following Fed rate hikes. While the Fed has stated an additional rate hike may be possible, munis, which can provide additional tax-exempt income in higher-rate environments, have generated attractive after-tax returns at the end of Fed rate hiking campaigns. Over the last four rate hiking cycles, munis averaged a 9.0% after-tax return over the 12-month period after the Fed was finished raising rates. Additionally, muni returns were positive in each of those periods.

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Over the past decade, interest rates were at very low levels by historical standards. Now, the recent sell-off has taken us back to longer term averages. And while the transition out of the low interest rate environment to this more normal range has been a challenging one for fixed income investors, we think the current set up for fixed income investors is a positive one. That’s not to say there won’t be volatility, there will be, but we think the risk/reward for fixed income is as attractive as it’s been in some time, for which we are thankful.

We hope everyone has a happy (and safe) Thanksgiving!

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.

The Bloomberg U.S. Aggregate Bond Index is an index of the U.S. investment-grade fixed-rate bond market, including both government and corporate bonds.

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

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.

Preferred stock dividends are paid at the discretion of the issuing company. Preferred stocks are subject to interest rate and credit risk.

As interest rates rise, the price of the preferred falls (and vice versa). They may be subject to a call feature with changing interest rates or credit ratings.

Mortgage backed securities are subject to credit, default, prepayment, extension, market and interest rate risk.

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

Posted by Jeffrey Buchbinder, CFA, Chief Equity Strategist

Friday, November 17, 2023

Additional content provided by John Lohse, CFA, Analyst

Following its post-summer malaise, the S&P 500 has sternly gained steam, bouncing 9.5% off the October 27 low. Fueled by a softening CPI print, surging performance from top-heavy constituents, and a favorable technical backdrop, the index has its January 2022 all-time highs in sight.

It’s been 471 trading days since the S&P 500 reached its all-time high of 4,796.56 on January 3, 2022. This marks the 11^th time since 1950 that it’s traded below a previous all-time high for over a calendar year on a total return basis; the last time being March 2012, which lasted for 1,128 trading days. The longest streak since 1950 occurred between September 2000 and October 2006 when the index (total return) traded below its previous high for a staggering 1,541 days. The chart below shows the duration of such occurrences.

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To date, this period marks the seventh longest without a new high since 1950 and has experienced the fourth smallest drawdown. Since the January 3, 2022 high, the index met its trough of -25% on October 12, 2022, and we’re still not back at those highs nearly 23 months later! The largest drawdown we saw was a 55% decline during the Great Financial Crisis (GFC). In the year following the recovery from the GFC (April 2012 to April 2013) we saw a 14% total return from the S&P 500, which lands right at the average of these periods. There was only one period in this study in which the total return of the index was negative one year after the recovery, albeit at -1% from July 1976 to July 1977. The chart below shows peak drawdowns of the previous 10 instances and their subsequent one-year returns post recovery.

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As of this writing the index sits just about 6.5% below the January 2022 all-time highs. While LPL Research maintains a year-end fair value of 4,300–4,400 based on an estimated $230 in earnings per share next year, it’s important to note where the market stands relative to history. Technical evaluations show a recent breakout above resistance at 4,400 and a possible re-test of a key 4,600 level. The next six weeks are among the best seasonally for stocks on the calendar. And although breadth remains relatively underwhelming, technology-oriented names continue to be a propellant.

As we get closer to the end of the year and the two-year anniversary of the January 2022 highs, consider what history tells us about the timetable for recovering bear market losses. It suggests that a new record high may not be far off.

IMPORTANT DISCLOSURES

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

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

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

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

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

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

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

Posted by Adam Turnquist, CMT, VP Chief Technical Strategist

Thursday, November 16, 2023

Key Takeaways:

• Benchmark 10-year Treasury yields have plunged over 50 basis points (bps) after briefly surpassing 5% in late October. Reduced longer-term debt auctions, cooling inflation, slowing economic activity, and rising expectations for an end to the Federal Reserve’s (Fed) rate hiking campaign contributed to the pullback.
• Yields are now trading below their 50-day moving average (dma), and a potential head and top shoulders top has formed. Technically, a close below 4.42% would break the neckline and leave 4.35% (prior highs/key Fibonacci retracement level) as the next key area of downside support.
• After forming a negative divergence from yields, the Relative Strength Index (RSI) has dropped back into bearish territory, raising the odds for the highs on the 10-year being set last month.
• Elevated short positions in 10-year Treasuries could trigger a short covering rally and/or increased volatility in the Treasury market.

This week’s cooling inflation data has supported the case for ending the Fed’s rate hiking campaign. October headline Consumer Price Index (CPI) decelerated from 3.7% to 3.2% annually, while core CPI—which excludes the often-volatile food and energy components—eased from 4.1% to 4.0%. Rate hike expectations disappeared following the news, while expectations for a rate cut were pulled forward to May. However, with inflation still running well above the Fed’s 2% target, it is too early for a victory lap, although the “trajectory is encouraging,” according to LPL Chief Economist Dr. Jeffrey Roach, who dug deeper into the CPI report in yesterday’s blog (Yields Plummeted on Benign Inflation Report | LPL Financial Research (lplresearch.com).

Another encouraging trajectory for equity markets can be found on the chart of 10-year Treasury yields, which pulled back through several areas of support following the CPI news. Yields are now trading back below their 50-dma for the first time since May, and a potential head and top shoulders formation has developed. The key word here is ‘potential’ as a close below 4.42% would be required to break the neckline. Additional downside support sets up at 4.35% (prior highs/key Fibonacci retracement level). From our perspective, a completed head and shoulders top formation followed by a break below 4.35% would significantly raise the odds of a top being set for 10-year yields.

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The lower panel of the chart highlights RSI. This momentum oscillator measures the velocity of price action to determine trend strength, overbought and oversold conditions, and divergences. Over the last several weeks, RSI has generated a series of lower highs as yields continued to climb, creating a negative divergence indicative of fading upside momentum. Divergences often—but not always—overlap with major market tops and bottoms.

Short Squeeze Risk

The potential end to the uptrend in 10-year Treasury yields could be a significant problem for short positions (investors who are short Treasuries in anticipation of higher yields). According to the latest Commodity Futures Trading Commission (CFTC) data shown below, leveraged funds (typically hedge funds and other speculative asset managers) reported near-record net short positions in 10-year U.S. Treasuries. Asset managers, including institutional investors such as pension funds, endowments, mutual funds, and insurance companies are on the other side of the spectrum, holding long positions near record highs.

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The Basis Trade

Part of the extremes in short Treasury positions can be explained by the ‘basis trade,’ an arbitrage strategy that profits from pricing discrepancies between the cash bond market and futures market (basically selling expensive bonds in one market to buy cheaper bonds in another market). So, while short positions are running historically high, many are likely hedged with corresponding long positions in the cash market. However, hedged does not mean risk-free, as the basis trade is subject to liquidity and leverage, with financing for these positions typically done via borrowing in the repo market. As shown in the second panel above, Secured Overnight Financing (SOFR) volume has climbed (in tandem with short positions) to record highs, highlighting the jump in overnight Treasury repo activity.

In the event of liquidity drying up, leveraged funds may be forced to unwind their positions, sparking a potential jump in Treasury market volatility that could snowball as funds race to the exit door. According to a recent Bank for International Settlements report on the topic, “The current build-up of leveraged short positions in US Treasury futures is a financial vulnerability worth monitoring because of the margin spirals it could potentially trigger,” while adding that “margin deleveraging, if disorderly, has the potential to dislocate core fixed income markets.” Source: Margin Leverage and Vulnerabilities in US Treasury Futures

SUMMARY

Easing inflation and slowing economic activity have reset expectations for future Fed tightening. Both equity and fixed income markets have welcomed this news with consistent buying pressure this month. Treasury yields have pulled back sharply, and the 10-year has formed a potential head and shoulders top formation. A break below support at 4.35% would complete the formation and also take out support from the October 2022 highs—significantly raising the odds for the highs on the 10-year being set last month. Downside pressure in yields could be accelerated by the covering of historically high short positions among leveraged funds. Furthermore, in a liquidity event, the potential unwind of the basis trade could lead to elevated fixed income and equity market 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. To determine which investment(s) may be appropriate for you, please consult your financial professional prior to investing.

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

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

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

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

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

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

Posted by Jeffrey J. Roach, PhD, Chief Economist

Wednesday, November 15, 2023

Key Takeaways:

• Investor risk appetite could increase in the near-term after the October inflation report, similar to the market reaction after the jobs report from a few weeks ago.
• Headline consumer prices in October were unchanged month over month, pulling the annual rate of inflation down to 3.2% from 3.7% last month.
• Core inflation rose 0.2% from a month ago as housing costs, insurance, and medical care increased in October.
• Hotel prices fell in October, likely on the heels of declining demand for travel.
• Air fares fell in October as fuel costs declined and competition among airlines put downward pressure on tickets.
• Bottom Line: The annual rate of core inflation decelerated to 4%, the smallest rate since mid-2021 and should keep the Federal Reserve (Fed) from raising interest rates at next month’s meeting. Despite the deceleration, the Fed will likely continue to speak hawkishly and will keep warning investors not to be complacent about the Fed’s resolve to get inflation down to its long-run 2% target.

No Inflation in October

The October Consumer Price Index (CPI) showed inflation was unchanged from the previous month, indicating markets may finally get a reprieve from the nagging pressures of inflation. In October, CPI increased by 3.2% from a year ago, a decent deceleration from the 3.7% annual rate registered in September. Following the release, both equity and bond markets responded favorably as the official metrics showed some improvement with inflation.

Digging a Bit Deeper

Energy prices fell 2.5% and was the biggest contributor to the unchanged headline stat. Gas prices fell 5%, the biggest monthly decline since May. Falling energy prices will provide a bit of a reprieve for consumers, especially lower income families more sensitive to gas prices. Other categories are also showing some encouraging signs. Both new and used vehicle prices declined in October. Used vehicle prices have declined now for five consecutive months, although used vehicle prices are up over 30% since the onset of the pandemic.

Airfares also declined in October. In fact, the price index for airline tickets is below 2019 levels and could indicate a cooling off in demand for travel.

Too Early to Declare Victory

The Fed will by no means declare victory since the annual core inflation rate in October was 4.0%, double the long-run target rate set by the Fed. However, the trajectory is encouraging.

View enlarged chart

As shown in the chart above, the annual rate of headline inflation is 3.24% and will likely decline further from here. Despite inflation running above the Fed’s target, the Fed will likely hold rates steady at the next few meetings as policy makers—and investors too, for that matter—remain concerned about the lagged effects of monetary policy. Given the speed of the past rate hikes, many argue the economy and markets have not yet felt the full impact of the policy tightening.

From an investment standpoint, we saw an increase in risk appetite after this report and we could see some encouraging moves in the near-term. Overall, the Strategic and Tactical Asset Allocation Committee (STAAC) remains neutral on equities, maintains a positive bias towards growth stocks, and favors large caps over small caps. High valuations, tight financial conditions, and the potential for a recession (albeit mild) make the STAAC wary of taking on additional risk as investors prepare to enter the New Year. With the Fed likely done hiking rates and yields at attractive levels, bond returns have become increasingly competitive with equities.

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 Lawrence Gillum, CFA, Chief Fixed Income Strategist

Tuesday, November 14, 2023

Late Friday afternoon, rating agency Moody’s announced that it had downgraded is credit rating outlook on U.S. government debt from stable to negative. Moody’s cited wide budget deficits and political polarization as reasons for the downgraded view. Further, Moody’s noted amid higher interest rates, without measures to reduce spending or boost revenue, fiscal deficits will likely “remain very large, significantly weakening debt affordability”.

Moody’s is the last of the three main rating agencies with a top rating on the U.S. debt after Fitch downgraded the U.S. government in August following the latest debt-ceiling battle. S&P Global Ratings was the first to cut the rating for the U.S. in 2011 amid that year’s debt-limit crisis. Since the announcement though, Treasury yields are generally lower (prices higher) across the curve.

In our view, the bond market’s collective shrug for the outlook change affirms that rating agencies are only catching up to the fiscal policy challenges that the bond market has been pricing in for several quarters. In fact, until recently, the market has been trading primarily on the expected increase in Treasury supply to fund budget deficits expected over the next several years. Per the Congressional Budget Office, the U.S. government is expected to run sizable deficits over the next decade in the tune of 5%-7% of GDP each year, which means a lot of Treasury issuance is coming to market.

That is obviously a lot of supply that needs to find demand. However, since we know the U.S. rarely (if ever?) actually pays its debts off, there is also a lot of existing debt that needs to be rolled over as well. Over the next 13 months, the U.S. will need to refinance over $9 trillion of debt with over $3 trillion due this year. The additional supply comes at a time when price-insensitive buyers are stepping back from the Treasury market. The supply/demand imbalance will likely mean interest rates are going to be higher than they otherwise would be absent sizeable deficits.

View enlarged chart

These refinancings will take place with interest rates among the highest in over a decade. So, with the recent announcement that interest expense on existing debt hit $1 trillion, interest expense is likely only headed higher—concerns that were outlined by Moody’s (and Fitch in August). So, frankly, it’s no surprise that rating agencies, in general, have started to sound the alarms that fiscal risk is rising. Importantly though, in our view, the downgrades do not suggest the U.S. will have trouble paying its debts; we think there is currently a very low probability of default. But, until the U.S. government gets its fiscal house in order, we’re likely going to see additional downgrades and likely higher interest rates in the Treasury market.

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.