Wealth Management

Posted by qukrosby

Wednesday, September 28, 2022

Oil prices are rising today as hurricanes in North America introduce concerns over possible disruptions of supply, coupled with an easing of the U.S. dollar.  But despite this respite, unease among Organization of the Petroleum Exporting Countries Plus (OPEC+) member countries continues over slower global demand and recession fears given weaker economic forecasts.,.

“The stronger dollar has exacerbated worries within the OPEC+ cartel” explained LPL Financial Chief Global Strategist Quincy Krosby “and it’s looking increasingly likely that they are going to try to defend higher oil prices”

The OPEC+ policy meeting next week, on October 5, should be of particular interest for markets as members continue to suggest that the possibility of production cuts will be considered. Small production cuts for October, amounting to a modest 100,000 barrels a day, were announced at the September meeting as the oil cartel tries to maintain the higher prices it has recently enjoyed.

The “+” part of OPEC+ was formed in 2016 consisting of ten non-OPEC oil producing nations, including Russia and Mexico. Russia is expected to propose production cuts of 1 million barrels of oil per day for November’s production schedule, and according to industry reports it is seriously being considered as $90 per barrel appears to be the price target OPEC+ wants to sustain.

View enlarged chart.

With weaker global macro-economic headwinds factored in, there are also important structural and supply side issues that present a more favorable situation for oil prices. There are expectations for demand from China, the world’s largest importer of oil, to resume imports, as the country emerges from the strict zero COVID measures that nearly closed down the economy. A stimulus package is also expected to be announced at the upcoming Chinese Communist Party plenum in mid-October that could spur Chinese demand for oil.  In addition, investment in oil exploration and production has slowed dramatically with inventories and capacity sitting at depressed levels which will likely not be able to keep up if demand does pick up.

Volatility in the energy markets will likely continue as commodity markets overall cope with rising interest rates globally, a stronger dollar, and recession worries hindering demand.  OPEC+, however, seems determined to preserve its dominance in a transitioning environment.

IMPORTANT DISCLOSURES

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

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

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

All index and market data from FactSet and MarketWatch.

This Research material was prepared by LPL Financial, LLC.

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

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

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

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

Friday, September 23, 2022

It’s hard not to call what we’re experiencing stagflation at this point, if there are any holdouts left. With growth flat for the first half of the year, growth expectations for the rest of the year muted, inflation continuing to run very hot, and the Federal Reserve (Fed) aggressively raising rates, we clearly have the combination of economic weakness with high inflation that gave “stagflation” its name.

But this is not your 1970s style stagflation and the ultimate consequences of this stagflationary period are likely to be more benign. As shown in the LPL Chart of the Day, while inflation has been high, the unemployment rate has remained very low. The low unemployment rate is keeping the “Misery Index” (the unemployment rate + inflation) muted compared to the 70s and likely to decline further as inflation falls quickly relative to rising unemployment..

“With the workforce as healthy as it is, call it lunch box stagflation. Inflation is high but people are working” said LPL Financial Asset Allocation Strategist Barry Gilbert. “The average unemployment rate during the stagflationary years was 6.7%, and here we sit at 3.7%. That will move higher but it’s likely to remain low by comparison.”

View enlarged chart.

That’s not the only difference. The 10-year Treasury yield has moved dramatically higher but still looks low from the perspective of the 1970s and early 1980s. And the Fed’s rate hikes are a shock after years of the fed funds rate sitting near zero and policy is tight, but from the perspective of the 1970s and early 1980s, rates remain extraordinarily low and are unlikely to hit the extremes of the earlier period.

High inflation and higher rates do come with considerable economic pain and economic growth is certainly anemic. But labor market strength, even if it weakens from here as the Fed tightens, should contribute to economic resiliency. This may create a challenge for businesses, but also is likely to support demand. The unemployment rate is often the last casualty of an economic slowdown and the odds of a recession are increasing, but if we do get a recession, relatively supportive labor markets point to it likely being a shallow one.

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, September 22, 2022

A Bit More Pessimistic, A Lot More Realistic

The Federal Open Market Committee (FOMC) increased the target rate by 75 basis points (bp) to a 3.25% upper bound and delivered a more pessimistic outlook in their published Summary of Economic Projections.

The Committee hiked rates at this magnitude for the third consecutive time and Federal Reserve (Fed) Chairman Powell signaled “ongoing increases…will be appropriate.” So at this point, we expect a 50 bp hike at the next meeting in November with additional hikes in the following meetings. If the economy shows resiliency and headline inflation does not ease as much as policymakers prefer, the Fed funds rate could reach 4.50% by mid-2023.

As shown in the LPL Chart of the Day, the Fed has a lot more work to do in slowing aggregate demand and thereby slowing the rate of inflation. “The Fed tightening cycle does not always induce a recession, but since the Fed is acting particularly aggressively to combat nagging inflation, we see rising recession risks in 2023,” warned LPL Financial Chief Economist Jeffrey Roach.

View enlarged chart.

Recession Risks Rising

The Fed is willing to sacrifice growth for lower inflation. Growth expectations were revised materially lower for this year and the next. The Fed’s new forecast for 2023 GDP growth is 1.2% with an unemployment rate of 4.4%. The unemployment rate could increase because the Fed pushes the economy into recession. Or, unemployment could rise because the millions of individuals still on the sidelines finally re-enter the workforce during an unfortunate time when the plethora of job openings dissipate.

The new unemployment rate forecast of 4.4% for both 2023 and 2024 seems reasonable. The economy will be better off the sooner the unemployment rate reaches the so-called “natural rate of unemployment”, which is the rate that is neither too low and inflationary nor too high and recessionary. The Fed is now more aligned with the Congressional Budget Office (CBO) estimate of the natural rate of unemployment.

Overall, the economy is on unsure footing. Chairman Powell warned that “no one knows whether this process will lead to a recession, or, if so, how significant that recession would be.”

Conclusion

Inflation may be rolling over. We are already seeing August rents decline in some markets across the U.S. and imported food prices decline, so the upcoming inflation reports could be surprisingly better than expected.[1]

The impacts from recent Fed rate hikes are being quickly passed through to the mortgage market and other credit markets. Variables to watch are auto sales, credit card usage, residential real estate and personal loan demand. Unfortunately, other areas of the real economy have yet to feel the full impact of these aggressive rate hikes. So far, recession indicators are holding up so our base case is still a soft landing but risks are to the downside, especially in Q1 of next year.

IMPORTANT DISCLOSURES

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

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

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

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

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

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

Posted by Tom Shipp, CFA, Sr. Equity Analyst

Friday, September 16, 2022

As the focus for US equities continues to be on the macro environment, and how hawkish the Fed will act to tame inflation, we think it’s a useful time to check in on the year-to-date style performance of value and growth, from a quantitative style factor lens. Factor performance is typically measured based on a long/short portfolio of long stocks (“buys”) in the top quintile of factor scores and short stocks (“sells”) in the bottom quintile. However, in order to compare factor returns to an index such as the S&P 500, a long-only approach is required.  Leveraging Bloomberg’s factors, we analyzed Growth and Value factor performance based on a long-only portfolio of the top quintile of stocks in the S&P 500 over 3 different periods.

Period 1: Start of year to the S&P 500’s bottom on June 16, 2022

View enlarged chart.

Stocks with strong value characteristics such as high earnings yields strongly outperformed both the broader market, measured by the S&P 500, and stocks with high growth characteristics (sales/earnings growth). The value factor’s outperformance was driven largely by investors fleeing to the perceived safety of higher yielding stocks amidst four–decade-high inflation and a rising rate environment, as well as the high concentration of energy and other commodity producer stocks in the top quintile of value factor scores amid the run-up in commodity prices due to the Russia-Ukraine conflict.

Period 2: Summer Equity Rally (mid-June to mid-August)

View enlarged chart.

Over the summer the mood in the market shifted, as the “Fed pivot” narrative took hold, i.e., that the Federal Reserve would soon stop hiking rates to fight inflation and focus on supporting economic growth. The market experienced a two month rally that saw a reversal of the factor trends seen in the first half of the year. With expectations of a more dovish Fed and a ceiling on rates, equity investors bid up growth stocks given valuations are driven in large part by on the present value of future cash flows (growth stocks are expected to have higher future cash flows), and many growth stocks’ sensitivity to the business cycle.

Period 3: Post Jackson Hole Economic Symposium to Current (mid-August to Current)

View enlarged chart.

Fed Chairman Jerome Powell poured cold water on equity markets (and risk assets broadly) in Jackson Hole, WY, stating that the Fed would “use our tools forcefully” to tamp down inflation, raising rates in a way that will cause “some pain” to the US economy. Subsequent economic reports showing continued strong jobs and retail activity, and a disappointing August inflation report reinforced the market view that rate hikes will continue and the Fed will need to remain hawkish for longer. While the sample period is short, the factor performance trend follows a similar path as the first half of the year, with value outpacing the S&P 500, and growth slightly trailing the broader market.

One interesting takeaway from our analysis is that while many may perceive the flight to value as analogous to a flight to quality, our analysis showed otherwise. The performance of a “quality” composite factor, composed of high profitability and low leverage factors, actually tracked much closer to the year-to date performance of the growth factor, on both a long-only and long/short basis.

What does this mean going forward? In the very near-term, we would expect the current trend of value factor outperformance to continue, given the lack of expected catalysts to change the estimated path of rate hikes. Longer term, growth factor outperformance will likely require stronger conviction that core inflation is on a steady downward trajectory, providing clarity on the timing of a Fed pause or pivot.

IMPORTANT DISCLOSURES

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

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

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

All index and market data from Bloomberg.

This Research material was prepared by LPL Financial, LLC.

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

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

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

Posted by Lawrence Gillum, CFA, Fixed Income Strategist

Thursday, September 15, 2022

Tuesday’s Consumer Price Index (CPI) release surprised to the upside with core inflation remaining stubbornly high. (For more details on Tuesday’s release, please see our blog post here.) Moreover, the breadth of inflationary pressures broadened in August so alternative measures of inflation that, for example, strip out higher and lower outliers continued to move higher. And while there were some categories that eased, August saw the largest recorded year-over-year price increases in food (since 1979) and electricity (since 1981). So, clearly, inflationary pressures continue to run hotter than the Federal Reserve (Fed) is comfortable with.

As a result, the Fed will likely increase interest rates by at least 75 basis points (bp) at its meeting next week to take its short-term interest rate to 3.25% (upper bound). Assuming the Fed does raise rates by 75 bp next week it would be the third time this year. Over the previous 30 years, the Fed only raised rates by 75 bp one other time. So, the Fed is taking the inflation problem seriously with these jumbo-sized rate hikes. However, according to a recent study from the Federal Reserve Bank of San Francisco, about half of the elevated inflation levels are caused by supply-driven factors and not due to excess demand. And Fed Chairman Jerome Powell has admitted that the Fed’s tools don’t work on supply-related challenges. So why, then, is the Fed continuing to push interest rates higher in an attempt to slow the economy? Frankly, it’s to make sure inflation expectations don’t become unanchored.

Inflation expectations are simply the rate at which consumers and/or businesses expect prices to rise in the future. They matter because actual inflation depends, in part, on what consumers expect it to be. If consumers expect prices to continue to move higher, then they will likely change behaviors and inflation then becomes a self-fulfilling problem. There are three primary ways to track inflation expectations: surveys of consumers and businesses, economists’ forecasts, and market-implied inflation-related instruments. And as seen in the LPL Chart of the Day, market-implied inflation expectations are seemingly well anchored. After spiking earlier in the year, market-implied inflation expectations have fallen back to levels seen earlier in the last decade. Moreover, markets expect inflation to average 2.25% over the five year period, five years from now (2027-2032), which is the Fed’s preferred way to measure long-term market-implied inflation expectations. So by one measure at least, inflation expectations remain anchored.

View enlarged chart.

So, while the Fed is potentially hamstrung in its ability to fully fight current inflationary pressures, it will likely have to stay committed to increasing interest rates to make sure consumers and businesses don’t expect higher prices to continue. “Not taking current inflationary pressures seriously, would likely cause a repeat of the 1970s and 80s,” noted LPL Financial Fixed Income Strategist Lawrence Gillum. “Inflation expectations became unanchored in the 1970s and it took three years and two recessions to bring inflation expectations back to more normal levels. That is not something the Fed would like to repeat.”

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 David Matzko

Wednesday, September 14, 2022

Tuesday (September 13^th) turned out to be a very bad day for global stocks, as a hotter than expected US inflation report spooked market participants. The CPI report pushed back on some of the peak inflation narratives and all but confirmed that the Federal Reserve (Fed) will hike rates at least 75 basis points at their September Federal Open Market Committee (FOMC) meeting next week (September 20-21).

“To say the market reacted badly to the inflation report would be an understatement” explained LPL Financial Portfolio Strategist George Smith “The S&P 500 and Nasdaq indices posted their worst days since 2020 but based on history such steep daily declines have proven to be buying opportunities for patient investors willing to wait out volatility”

The S&P 500 index slid 4.3%, the worst single day return since June 2020, and at the close was down 17.5% year-to-date. The more growth oriented Nasdaq 100 saw a daily drop of 5.5%, its worst day since March 2020, leaving it staring down a -27% return year-to-date . As shown in the LPL Research chart of the day, big daily declines over 4% occur, on average, almost twice a year but cluster around recessionary periods.

View enlarged chart.

Investors looking for some good news can take solace from the fact that following big daily drops, like those that occurred this week, medium-term returns tend to be well above average. The lower proportion of positive returns after such drops does lead to extra caution when interpreting this data.

View enlarged chart.

A warning sign that the market was getting ahead of itself, among some other speculative signs, was that on Monday both stocks, as measured by the S&P 500 index, and the Volatility Index (VIX) were significantly up, by 1.1% and almost 5% respectively. This is an unusual occurrence as normally the VIX, or the fear gauge as it is sometimes known, and stocks have an inverse relationship. When this inverse relationship breaks down and both move significantly in the same direction it can be a sign that the recent trend is about to turn. Both the VIX and stocks moving down can be an indicator of a trough, while both moving up can be an indicator of a, at least a short term, peak.

Analyzing returns back to 2000, both stocks and the VIX simultaneously rising significantly has only occurred 12 times. Half of these occurrences happened at, or close to, short team peaks and as such tends to be a headwind for ultra-short term returns. Only twice has the following day been even marginally positive, and a week out the historic average and median returns are firmly in the red. Looking at 12 month forward returns doesn’t make pretty reading either, unless the returns are segregated into two groups: the average for recessionary periods is -12% (all negative) versus +22% (all positive) in non-recessionary periods.

View enlarged chart.

The LPL Research Strategic and Tactical Asset Allocation Committee (STAAC) continues to believe stocks are overly discounting the risk of recession in the near term and that economic and earnings growth in the second half of 2022 can still push stocks higher, consistent with historical strong rebounds from shallow bear markets and midterm election year lows. Investors who are willing, and able, to ride out some volatility may be rewarded with above average returns. Stubbornly high inflation, a potentially overly aggressive Federal Reserve, possible broader military conflict in Europe, and U.S-China tensions still present significant risks, despite not being our base case.

IMPORTANT DISCLOSURES

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

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

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

All index and market data from FactSet and MarketWatch.

This Research material was prepared by LPL Financial, LLC.

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

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

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

Posted by Jeffrey J. Roach, PhD, Chief Economist

Tuesday, September 13, 2022

Inflation Cools But Not Enough

The August Consumer Price Index (CPI) rose 8.3% year-over-year (YoY) from 8.5% in July. Excluding food and energy, the core CPI rose 6.3% (YoY), accelerating from last month. Inflation pressures continue to ease in a few categories such as gasoline, airfare, and used vehicles. However, several categories are still running hot. Food prices rose 11.4% from a year ago, the largest year-over-year increase since 1979, and electricity prices increased 1.5% month-over-month, the fourth consecutive increase. Yearly electricity prices rose the largest since August 1981. As shown in the LPL Chart of the Day, the latest inflation report is sending mixed messages. “Headline inflation is slowly easing, but rising food and shelter costs put acute pressure on U.S. consumers,” explained Jeffrey Roach, Chief Economist for LPL Financial. The Personal Consumption Expenditure (PCE) price deflator, the Federal Reserve’s (Fed) preferred inflation gauge, will likely show a slower rate of inflation since imputed housing costs have a smaller impact. The August PCE deflator will be released on September 30.

View enlarged chart.

Impacts on Consumers Are Uncertain

Declining prices at the pump could support consumer confidence in the near term, but rising electricity and natural gas prices will put a damper on the consumer outlook as we move into the winter season. The U.S. does not have an energy crisis like Europe; however, the impact of higher energy bills will likely affect consumer spending in the upcoming cooler months.

Rising food costs are a growing concern. Inflation pressures are especially hurting lower income households who spend a greater percentage of income on food.

Rising Rents Continue

Rents will likely continue to rise as long as a tight housing market keeps would-be buyers away. Recent pricing trends for rent of primary residence is alarming. Rent prices are up 6.7% (YoY), the fastest rate since the early 1980s. The booming 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.

Fed Will Probably Hike 75

Headline inflation is likely past its peak, but the Fed still has work to do. The Fed will likely increase rates again by 75 basis points later this month as core inflation is not cooling as fast as expected.

As import prices and producer prices ease, the inflation outlook should improve. As policy makers have publicly 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 growth rate of 2%.

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. To determine which investment(s) may be appropriate for you, please consult your financial professional prior to investing.

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

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

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

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

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

Posted by Lawrence Gillum, CFA, Fixed Income Strategist

Tuesday, August 30, 2022

Like most financial markets, preferred securities have generated negative returns so far this year, however the value proposition remains. Preferreds offer generous yields, both absolute and after-tax, with their high income stream serving as a total return buffer against future spread volatility. “Preferred securities can be higher yielding alternatives to traditional core fixed income options. They are concentrated in the financial sector but since the global financial crisis, many financial institutions have emerged with stronger balance sheets, which should limit downgrades and defaults,” noted LPL Financial Fixed Income Strategist Lawrence Gillum.

Following are five things investors should know before allocating to preferred securities.

1. Hybrid securities. Preferred securities are “hybrid” securities that can be classified as either equity or debt within a company’s capital structure. They are senior to common equity but junior to traditional debt. As such, they don’t have the same capital appreciation potential of common equity nor do they possess the same capital preservation benefits of traditional debt. Preferred securities, then, tend to offer higher coupon payments to attract investors.
2. Financial focus. The majority of issuance comes from financial institutions. Preferred securities are highly correlated with the health of the financial system and a shock to the financial system would adversely impact these securities.
3. Credit risk. The securities tend to be BBB- or BB-rated, which means they carry higher levels of credit and default risks than the senior debt issued by the same issuer. However, since the issuers of preferred securities tend to be higher quality companies, default rates have been lower than similarly rated non-financial corporate bonds.
4. Multiple markets. As seen in the LPL Chart of the Day, preferred securities trade in different markets and while the issuer could be the same, the individual security characteristics can be different. The $25 retail market (ICE Core Plus Fixed Rate index) is an exchange-traded market where the securities generally have longer durations and lower yields, whereas the $1000 institutional market (ICE US Capital Securities index) is an over-the-counter traded market where the securities pay dividends semi-annually. Finally, non-US issuers trade primarily in yet a different market (ICE USD Contingent Capital index) with different characteristics and different risk premium.

View enlarged chart.

5. Diversification benefits. Given the hybrid nature of preferred securities, there are diversification benefits to adding preferreds to a portfolio. While these securities tend to “act” like equity and high-yield fixed income securities across a full market cycle, since the financial crisis in 2009, these securities have generally held up better than both during equity market sell-offs (as measured by the S&P 500 Index).

Despite the lower earnings environment for financials this year (75% are issued by banks and insurance companies), the fundamental health of the financial system remains intact. In fact, with June’s release of the Fed’s 2022 “stress test” results, banks proved able to absorb more than $600 billion in losses while maintaining minimum common equity capital requirements. Bottom line, these financial institutions can likely weather any potential recessionary storm while continuing to pay dividends on their preferred securities. So, for those income-oriented investors willing to take on some additional credit risk, preferred securities might be an attractive investment to consider.

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.