Wealth Management

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

Tuesday, December 27, 2022

The 10-year Treasury yield has moved dramatically in 2022. But while the size of the move is in rare territory, it is far from unprecedented. The 10-year Treasury ended 2021 at 1.52%. The closing yield on Friday, December 23 was 3.75%, which would give us a calendar year advance to date of 2.23% (2.23 percentage points). As shown in the LPL Research Chart of the Day, that would make it one of the highest rolling one-year changes, based on data since 1963, but still below the peak one-year change in early November of 2.72 percentage points and well below the peaks seen in 1980 and 1981.

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But most investors don’t want to know where the 10-year Treasury yield has been, as interesting as it might be, but where it’s going. To get our bearings, we looked at a range of historical increases in the 10-year yield over a year and what it’s done in the following year. At a 0.5 percentage point (0.5%) move or higher in the last year, there has not been a clear historical bias toward higher or lower in the next year, but as the prior year move goes up from there, it became increasingly likely the 10-year yield would decrease in the next year, as did the average size of the decrease.

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In the territory where we are now, the 10-year yield has averaged a decline of almost a full 1% over the next year, although about 1/3 of the time it’s actually been higher. Rates aren’t on a strict clock for when extended periods of higher rates will end, but additional moves higher have tended to be muted. It’s also important to recognize that in most prior cases of moves of at least 2% the starting yield was at a much higher starting level, leaving greater scope for the size of a potential decline.

As discussed in our Outlook 2023: Finding Balance, LPL Research expects the 10-year Treasury yield to end 2023 at 3.25–3.75%, which is mostly lower from here and would be consistent with history. The economic fundamentals also likely support a steady to lower 10-year yield. The Federal Reserve (Fed) has moved aggressively to try to tame inflation, keeping inflation expectations well anchored, while pumping the brakes on the economy. On top of that, Fed rate hikes tend to act with a lag, increasing recession risks as the economy continues to try to find balance following soaring prices in 2022. Lower inflation and a slowing economy would both point to a downward bias on yields. If yields do move lower, it would help Treasuries, and higher quality bonds more broadly, rebound from a very rough 2022 and potentially provide positive returns even if the economy enters recession.

IMPORTANT DISCLOSURES

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

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

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

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

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

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

Posted by Adam Turnquist, CMT, VP Chief Technical Strategist

Friday, December 23, 2022

Tis’ the season for the Santa Claus Rally! This unique seasonal pattern was first discovered by Yale Hirsch in 1972. Hirsch, creator of the Stock Trader’s Almanac, defined the period as the last five trading days of the year plus the first two trading days of the new year. This year’s Santa Claus Rally window officially opens on Friday, December 23. Given the challenging year for U.S. equity markets, including what could be one of the worst Decembers for the S&P 500 since 1950, investors are hoping Santa can deliver some positive returns and holiday cheer as we approach year-end.

The Santa Claus Rally usually generates headlines across financial media due to the historically strong market returns during this relatively short timeframe. As shown in the chart below, the S&P 500 has generated average returns of 1.3% during the Santa Claus Rally period, compared to only a 0.2% average return for all rolling seven-day returns.

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Lucky Number 7? If the S&P 500 finishes higher during this year’s Santa Claus Rally, it would mark the seventh consecutive period of positive returns. The longest streak was 10 back in the mid-1960s. However, positive returns during the Santa Claus Rally are relatively common, as the market has advanced 79% of the time during this period. For additional context, all rolling seven-day returns for the S&P 500 since 1950 have a positivity rate of only 58%.

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One of the other primary aspects of the Santa Claus Rally is its application as an indicator for future market returns. As Yale Hirsch stated, “If Santa Claus should fail to call, bears may come to Broad and Wall.” Historical returns, as shown below, give merit to his maxim, as the S&P 500 historically underperforms in January and over the following year when Santa no shows and doesn’t deliver investors a year-end rally.

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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.

Posted by Lawrence Gillum, CFA, Fixed Income Strategist

Tuesday, December 20, 2022

Many financial markets are on pace for their worst year in quite some time, or in the case of core bonds, the worst year since inception of the Bloomberg Aggregate Bond Index, which is the main core bond index. With inflationary pressures running much hotter than central bank targets, many central banks were forced to respond by raising policy rates at a speed and magnitude unlike any other year, which was a decided headwind to many financial assets this year.

As mentioned in this week’s Weekly Market Commentary (found here), the Fed’s 0.50% rate hike last week capped a year in which the Federal Reserve (Fed) raised short-term interest rates at the fastest clip in four decades. Moreover, the magnitude of rate hikes brought the fed funds rate to its highest levels in over a decade. However, we think most of the rate increases have either already taken place or (mostly) priced into market’s expectations at this point. And since we’re starting to see positive signs of inflationary pressures easing, it is likely the Fed can step down the pace and magnitude of rate hikes in 2023 and perhaps even pause rate hikes, which could be welcome news for core bonds.

Historically, core bonds have performed well during Fed rate hike pauses. Since 1984, core bonds were able to generate average 6-month and 1-year returns of 8% and 13%, respectively, after the Fed stopped raising rates. Moreover, all periods generated positive returns over the 6-month, 1-year and 3-year horizons.

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While we don’t think monetary policy will become accommodative anytime soon—absent a financial crisis or deep recession, which isn’t our base case—the central bank headwind that took place in 2022 may not be as strong in 2023, which could help many financial markets in 2023. This year will most certainly be the worst year for core bonds on record and it will take time to recover the price declines experienced this year. However, while there is certainly no guarantees that history will repeat or even rhyme this time, the back-up in yields, for many fixed income markets, provides an attractive opportunity, in our view.

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

Friday, December 16, 2022

It has been a painful week for those investors hoping for a shift toward dovish monetary policy. The Federal Open Market Committee (FOMC) raised rates by an expected 50 basis points (bps) on Wednesday. The surprise factor came from the updated Summary of Economic Projections (SEP), which showed policymakers moving their 2023 federal funds rate forecasts from 4.6% in September to 5.1% this month. Furthermore, several FOMC members penciled in a peak terminal rate of 5.25% or higher for next year. The SEP also showed upgraded forecasts for inflation and downgraded growth estimates for 2023 and 2024.

Outside of the U.S., the European Central Bank (ECB) also raised interest rates by 50 bps yesterday, as expected. Similar to the FOMC, forecasts for future rate hikes and commentary leaned hawkish. The accompanying policy statement noted, “We decided to raise interest rates today, and expect to raise them significantly further, because inflation remains far too high and is projected to stay above our target for too long.”

Finally, the Bank of England raised rates by 50 bps yesterday, although based on the 1.9% drop in the British pound, and reduced implied rate hike probabilities for next year, the market appeared to digest the outcome with a dovish tilt.

A notable divergence has developed in the aftermath of this week’s FOMC meeting. The Federal Reserve’s (Fed) projected federal funds rate and the implied terminal rate based on the federal funds futures market remain divided. The chart below compares the current fed funds target rate projections (orange) to the September SEP projections (grey). In addition, the fed funds futures implied rate is shown in blue. For 2023, futures are pricing in a federal funds rate of 4.4% for December 2023, compared to the actual Fed forecast of 5.1%. In addition, the futures market is also pricing in rate cuts starting as early as November 2023. From our perspective, this variance equates to elevated market uncertainty, and until market expectations and Fed forecasts align more closely, we suspect volatility could remain elevated. According to LPL Chief Economist Jeffrey Roach, “The Fed has demonstrated a penchant for forecast revisions, so we should not be surprised if the Fed revises the expected peak fed funds rate as inflation, including the sticky components, starts to moderate.”

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In terms of price action, U.S. equity markets extended their post-FOMC decline yesterday and erased intraweek gains. An unexpected drop in weekly jobless claims from 231,000 to 211,000 (estimates: 232,000) further exacerbated concerns over a tight labor market, a key risk factor for a higher-for-longer policy path. The S&P 500 dropped 2.5% on the day and closed just below key support at 3,900.

Given the negative reaction to this week’s FOMC meeting, we also researched if market performance on the day of a rate hike has any implications for future equity market returns. We identified 100 rate hikes going back to 1970, filtered for rate increases occurring at least three weeks apart (there were several intra-month adjustments made back in the 1970s and 1980s that were filtered out).

As shown in the bar chart below, S&P 500 returns have been mixed immediately following a rate hike, although returns tend to improve over the following four-week period. On a more positive note, when the S&P 500 traded lower on the day of a rate hike announcement, returns over the following eight weeks averaged 0.6%, compared to only 0.1% when the index traded higher on the day of a rate hike announcement.

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Overall, risk for continued volatility appears elevated until there is greater alignment between Fed policy and market expectations. Continued signs of abating inflation pressure, especially in the non-housing core services sector could help bridge the gap and reduce the degree of FOMC hawkishness.

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, December 15, 2022

Slower Growth and Higher Inflation

As expected, the Federal Open Market Committee (FOMC) increased the fed funds rate yesterday by 0.50% and made upward revisions to both inflation forecasts and interest rate forecasts in the next few years. The target range is now 4.25–4.50%. This meeting signaled the beginning of a downshift in the pace of rate hikes, as the previous four meetings concluded with a 0.75% increase to the target rate. The Committee delivered a well-telegraphed move, barely changing any verbiage from the previous statement, and unlike the recent rate decision in the U.K., the FOMC was unanimous.

The FOMC released an updated Summary of Economic Projections (SEP) after this meeting and from all appearances, the Committee is more pessimistic about growth and inflation than they were in the September edition of the SEP.

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The Committee downwardly revised growth forecasts for both 2023 and 2024 as high inflation is expected to weigh heavily on consumer spending. As inflation is expected to erode purchasing power, growth will likely stall next year. Short-term interest rates will likely be higher next year, as the Committee believes inflation will not come down as fast as projected in September. The Committee did not change the long-run estimate of the fed funds rate but the Committee revised up projections for fed funds in 2023 and 2024. A healthy minority of committee members are forecasting fed funds above 5.25%, creating a hawkish tilt to the overall forecast. In the press conference, Chairman Powell focused on the imbalances in the labor market, indicating that the job market is the linchpin for economic growth in the coming year.

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Conclusion

The Fed is uncertain about the future path for inflation and therefore, has remained decidedly hawkish on short-term rates. However, the Fed has demonstrated a penchant for forecast revisions, so we should not be surprised if the Fed revises the expected peak fed funds rate as inflation, including the sticky components, starts to moderate. Looking ahead, investors need to watch the inflation path for non-housing core services, which is closely tied to labor market conditions.

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, December 14, 2022

Equity markets responded to yesterday’s cooler than expected inflation data in similar, but eventually much more muted, fashion to how they responded earlier in this rate hiking cycle. November’s core Consumer Price Index (CPI), which excludes food and energy, came in at 6.0% year over year, below estimates of 6.1%. So far in this rate hiking cycle, cooler inflation data has boosted markets, and especially rate sensitive sectors, based on market participants’ belief that slowing inflation data could give cover for the Federal Reserve (Fed) to slow the pace of interest rate hikes sooner rather than later.

The S&P 500 has posted average returns of 2.4% when core CPI surprised to the downside, as it did yesterday, so initially it was little surprise when markets surged around 2.7% shortly after the open. What is perhaps telling, in the way that the narrative has shifted from worries over inflation to concerns over the strength of the economy and recession risks, is that the early gains largely evaporated as the day wore on with the S&P 500 closing just off its worst levels on the day, and up only around 0.75%. This is a very different market response to last month when the softer October CPI data spurred a daily jump of 5.5% in the S&P 500, a record gain on a CPI release date, closing at the daily high.

The bar chart highlights the average daily return of the S&P 500 and its sectors for all CPI release dates since the Fed began raising rates in March 2022. The returns are bifurcated between days when year-over-year core CPI came in above or below estimates.

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At a sector level, yesterday’s market returns followed a similar pattern to earlier in the rate hiking cycling but with some undercurrents exhibiting a shifting narrative in the markets. Consistent with this rate hiking cycle so far, consumer staples was the worst performing sector and the only sector down on the day (-0.17%). Healthcare has also been a laggard if inflation has surprised to the downside and it was a similar story yesterday. The biggest surprise was consumer discretionary, which has averaged a return of around 3.9% if inflation has printed lower than expected, but was the second worst performing sector on the day, only seeing a modest pickup of 0.2%. This is a further manifestation of the waning importance of the inflation data and of increasing concerns over the economy and the ability for consumers to keep spending at the current pace if there is a recession.

Real estate (2%) continued its strong performance on days when CPI surprised to the downside and was the top sector of the day, albeit with much more muted daily returns than the average (3.2%) seen earlier this rate hiking cycle. Energy (1.8%) and communication services (1.7%) were the only other sectors that saw daily increases of at least half of the average we have seen earlier in the rate hiking cycle when inflation came in cooler than expected.

Equity market reaction to inflation data so far this rate hiking cycle has really been a reaction to how markets expect the Fed will respond to inflation data, hence all eyes will be on the Fed today to see if the last two inflation data releases have been enough to sway their actions at all. Today the Federal Open Market Committee will release their updated forecasts for economic growth, inflation, and interest rates. We expect for the Fed to push back on some of the more aggressive market expectations for a pause or pivot in the near-term.

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
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• Not Bank/Credit Union Deposits or Obligations
• May Lose Value

Posted by Lawrence Gillum, CFA, Fixed Income Strategist

Tuesday, December 13, 2022

The Federal Reserve (Fed) is meeting this week and will likely increase short-term interest rates by 0.50% to bring the fed funds rate to 4.50% (upper bound). The 0.50% increase represents a step-down in the pace of hikes, though the cumulative increase to date ranks amongst the most aggressive increases since the 1980s. Along with the expected increase in interest rates, the Fed will also release updated forecasts for economic growth, inflation and interest rates. The “dot plot”, which is the individual committee member’s expectation of the appropriate fed funds rate each year, will likely show a terminal rate of around 5%, or potentially higher. While markets believe the Fed will hike rates to 5%, given the aggressive rate hikes already this year and the long and variable lag associated with said hikes, markets do not believe the Fed will hold rates at elevated levels for very long.

Despite assurances of an unwavering commitment to bring down inflationary pressures, markets continue to think the Fed will “pivot” or “pause” and cut rates in 2023 and into 2024. As such, markets have a very different view of monetary policy over the next few years, which the Fed may think is premature. The chart below shows market expectations for where the fed funds rate will end each year (orange line) versus the dot plot expectations with a pronounced divergence in 2024. While markets and Fed officials seemingly agree on the near term trajectory of the fed funds rate, markets expect the Fed to reduce interest rates by nearly 0.50% in 2023 and another 1.0% in 2024.

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Historically, markets have done a pretty good job of predicting rate cuts, but with inflationary pressures still significantly above the Fed’s target, Powell may need to reset market expectations—again. Markets have rallied three times this year on the expectation of a more accommodative Fed. These three rallies ended when expectations for Fed moderation proved too early. This time the Fed has signaled it is on board with the market’s consensus for a 0.50% hike this week, but a hawkish press conference by Chair Powell could be a catalyst for some retracement. Moreover, if there is forceful pushback, similar to the type of pushback Powell provided at the Jackson Hole Symposium in August, we could see another leg up in yields. However, with the second softer-than-expected CPI release today, maybe the market is right. Could be an interesting Fed meeting tomorrow.

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

Friday, December 9, 2022

Selling pressure over the last several weeks has left the U.S. Dollar Index near an inflection point. Falling interest rates have primarily been responsible for the recent decline. Prior to last month’s 5% drop (the largest since 2010), the dollar was trending sharply higher and outperforming most other assets with a +15% year-to-date (YTD) return at the end of October. The dollar’s outsized gain was attributable to outsized tightening as the Federal Reserve (Fed) raised the federal funds rate by 4% this year, essentially ‘out-hawking’ most other foreign central banks. However, recent signs of cooling inflation pressure have sparked speculation for an eventual end to the Fed’s rate hike cycle next year, pouring some cold water on the dollar’s bullish narrative.

Technical Setup: As shown in the LPL Financial Chart of the Day, the U.S. Dollar Index has dropped back near key support at the 105 area, which lines up close to the rising 200-day moving average (dma), prior highs and lows, and the 38.2% Fibonacci retracement level of this year’s advance, another level that technical analysts watch for potential support. A further breakdown in the dollar would leave 103 (March 2020 highs) and 102 (50% retracement level) as the next levels of downside support. As shown in panel 2, the Relative Strength Index, a technical indicator used to measure the strength of a trend, is near oversold levels. A rebound off support would leave 108.50 (July highs) and 109.25 (declining 50-dma) as the next key levels of overhead resistance.

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Given the negative correlation between the S&P 500 and U.S. Dollar Index, a breakdown or rebound in the dollar would likely have a meaningful impact on equity markets. Next week could also be a major catalyst for dollar volatility. The Fed is expected to raise rates by 50 basis points (bps) on Wednesday, marking a slowdown from the last three 75 bps increases.

The European Central Bank (ECB) is also expected to slow the pace of tightening from 75 bps to 50 bps on Thursday. Similar to the U.S., there have been recent signs of abating inflation pressure within the Eurozone. The euro also holds around a 58% weight within the U.S. Dollar Index, meaning changes in the euro’s relative value can have a big impact on the dollar.

Finally, the U.S. Consumer Price Index data will be released on Tuesday. Headline inflation is expected to decelerate in November from 7.7% to 7.3% based on year-over-year comparisons. Core CPI is also forecasted to recede from 6.3% to 6.1%. For context on price action surrounding recent CPI reports, the dollar has moved -2.2%, -0.8%, +1.4%, and -1.1% during the last four CPI release days. The lesson? Expect volatility next week.

What could a breakdown or rebound in the dollar mean for equity markets? The matrix below highlights the correlation between the U.S. Dollar Index, the S&P 500, and its sector ETFs. The correlation data was calculated from weekly returns over the last year.

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Key takeaways: The S&P 500 and all of its sectors have been exhibiting a negative correlation to the dollar, not surprising given that the dollar is up and equity markets are down, but it’s not unusual for the dollar to show some strength during an equity downturn. In the event of a further breakdown in the dollar, financials and materials could capture tailwinds based on their relatively large negative correlations. If the dollar does rebound, consumer staples, energy, and utilities could see a pickup in relative strength as they have the least negative correlation to the dollar.

Taking it one step further, we also found the top and bottom five S&P 500 industry groups based on their correlation to the dollar. Health Care Technology was the only industry group with a positive correlation to the dollar based on weekly returns over the last year.

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We ran a similar analysis for commodity markets and unsurprisingly found several metals with the largest negative correlation. Title Transfer Facility (TTF) Natural Gas, essentially Dutch natural gas futures, was the most positively correlated at +0.31, while several grain commodities also made the list.

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In summary, the dollar has dropped to an inflection point. Further selling pressure in the greenback below key support at 105 should benefit the broader equity market. Financials and materials could see a lift in relative strength, as they are the most negatively correlated to the dollar. The metals complex would likely also benefit from a further breakdown in the dollar.

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.