Wealth Management

Posted by Lawrence Gillum, CFA, Fixed Income Strategist

Thursday, June 30, 2022

Central bankers from the European Central Bank (ECB), Bank of England (BOE) and the Federal Reserve (Fed) met this week in Sintra, Portugal at the ECB’s annual conference to discuss strategies to arrest stubbornly high consumer prices. The combined impact of the COVID-19 pandemic, supply-chain challenges, Russia’s invasion of Ukraine, and a delayed response from central banks has resulted in high inflation, low growth, and increasing recession risks as central banks scramble to tighten financial conditions and slow demand. The inflation shocks across developed markets have delivered an aggressive repricing of monetary policy expectations with virtually all developed market central banks (with the exception of the Bank of Japan) embarking on, or shortly starting, a frontloaded tightening cycle. Policy interest rates were increased a record 80 times in the first six months of 2022. And based on Bloomberg Economics’ forecasts, the GDP-weighted global policy rate is set to rise to 4.6% at end-2022, up from 3% a year earlier.

As such, and as seen in the LPL Chart of the Day, the sudden repricing of higher policy rates has pushed longer-maturity government bond yields higher this year with many countries seeing its interest rates increase by over 1.5%, the largest increase in decades.

View enlarged chart.

Moreover, for Eurozone countries, net buying under an asset-purchase program is also set to end on Friday, which has been a large driver of higher yields over the past few months in the more indebted countries like Greece, Italy and Portugal. However, ECB officials are working on a separate bond buying tool to help prevent “fragmentation” which should help minimize the prospects of another Eurozone debt crisis similar to the one experienced in 2009.

Central bankers in Sintra this week have also stated their concern about inflation expectations becoming unanchored, adding to the urgency to continue to aggressively raise interest rates. Moreover, Jay Powell (Fed) and Christine Lagarde (ECB) both shared their concerns that we may be on the verge of a new higher inflationary regime, which may mean longer-lasting inflation shocks and still higher policy rates. “While some of the aggressive rhetoric may just be jawboning as a way to keep inflation expectations anchored,” noted LPL Financial Fixed Income Strategist Lawrence Gillum. “It’s clear that global central bankers learned from the 70s and 80s and are taking the threat of inflationary challenges seriously and are at least willing to consider pushing economies into a recession to help stave off runaway consumer prices.”

So what do markets think about the prospects of a new higher global inflation regime? Right now, market-implied inflation expectations remain elevated in the near-term but fall decisively over intermediate and longer-term time periods. Central bankers will be watching these markets closely to see how aggressive they actually have to be. Unless, or until, market-implied inflation expectations become unanchored, central bankers may not have to be as aggressive as markets are currently expecting.

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 jkwhitmore123

Tuesday, June 28, 2022

Fixed income’s negative returns have been historic so far in 2022, with the U.S. Aggregate index down roughly 11%. No fixed income sector has been immune to hot inflation prints and rising rates (e.g., 10-year Treasury yield has doubled YTD) as the Federal Reserve quickly shifted to monetary tightening. While the rates market has been historically volatile in 2022, what about the credit markets? Even with double digit negative returns, is there a case to be made that fixed income credit sectors have been resilient during the equity bear market of 2022?

A common metric used to monitor credit markets is option-adjusted spread (OAS), which is the additional yield or compensation investors require for taking on additional risk relative to Treasury securities.  Looking at spreads during previous equity bear markets since 2000, how have credit spreads (as measured by the ICE BofA High Yield Index) behaved? As shown in the LPL Chart of the Day, investors unsurprisingly require additional yield when equities decline meaningfully.  For example, the equity bear market from March 2000 to October 2002 saw high yield spreads peak at over 1100 bps (11%). In the six equity bear markets since 2000, the median peak in spreads is nearly 1000 bps. So far in 2022, high yield spreads have peaked at 538 bps as of 6/23. This indicates that credit has been resilient relative to previous equity bear markets, and roughly in line with the near bear market of 2018. While high yield has returned negative 13% so far in 2022, this poor performance has been primarily driven by a rise in rates, not market participants broadly expecting deteriorations in credit quality and a sharp rise in defaults for high yield bond issuers.

View enlarged chart.

What might explain this resilience in credit in 2022?  Post the Great Financial Crisis, the high yield bond landscape has improved in credit quality. As of 2007, 36% of broad high yield indices were rated BB, one step below investment grade. By the end of 2021, BB-rated high yield bonds represented 53% of the index. Additionally, the COVID-19 pandemic in 2020 resulted in a rise in defaults, peaking at 9%. Removing these bonds from the index left the index in a stronger position to withstand future stress and market volatility. Lastly, the energy sector’s strength has bolstered the broader index. So far in 2022, domestic high yield energy bonds are outperforming the index by approximately 400 bps, with overall spreads for the sector peaking at ~440 bps YTD (versus 2500 bps in March 2020 and over 700 bps in 2018). While we expect spread levels to remain volatile in the near-term with potentially widening if the U.S. enters a recession, the sell-off in 2022 offers an attractive entry point for investors, especially those looking for income as broader high yield indices offer yields above 8%.

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, Quantitative Strategist

Monday, June 27, 2022

With the S&P 500 moving into a bear market and the first half of the year since shaping up as one of the worst ever, many investors are wondering if we have yet seen the bear market low. We first asked, “Was that the low?” in our June 2 Blog and concluded that we were skeptical that the bottoming process was complete due to a lack of panic selling. Today we explore the most recent market data to identify if there are now any more signals to indicate we may have seen the market low.

“Investor sentiment polls have been hitting record lows for some time, but until very recently the market data hadn’t signaled the panic selling and fear we normally see at market lows,” explained LPL Financial Portfolio Strategist George Smith. “However, we are finally seeing some extremes in market data, such as put/call ratios, and improving trends which have typically been found around or after market lows.”

Below are some of the market data signals that we are monitoring and what they are currently telling us (with thanks to our friends from Strategas Research Partners for help with some of the trigger points).

View enlarged chart.

• VIX – The Chicago Board of Options Exchange (CBOE) Volatility Index, commonly known as the VIX, has been relatively subdued so far during this bear market and has not hit extreme levels normally associated with market lows. Typically we have seen this indicator spike over 40 but the highest the VIX has been this bear market is 36. The VIX has been trending upwards since the end of 2021 which is a worrying trend that we are are watching closely.
• VIX and S&P 500 declining significantly – When both the S&P 500 and the VIX decline simultaneously (by 1% and 5% respectively) it can signal that the last panic sellers are capitulating even as market fear, as measured by VIX, is falling. This almost occurred on 6/14 when both VIX and S&P 500 declined but was not quite enough to hit our trigger levels. This signal is rare, occurring just 6 times in the last 10 years, but is one of the most accurate, catching the 2015, 2016 and 2020 lows to the day.

• Put/call ratio – As measured by the CBOE composite put-call ratio 5-day moving average, this indicator tends to signal extreme selling pressure when it exceeds 1.2. After being at fairly benign levels throughout this sell-off, 1.2 was finally hit on June 16 and the ratio has remained above since then signaling extreme levels of fear in the options market.
• NYSE TRIN – This is also known as the arms index and measures the velocity of trading by looking at advancing/declining volumes and advancing/declining stocks. A TRIN score above 2 signals that the velocity of selling is at an extreme. This indicator first showed signs of panic selling at the end of March and has breached the 2 threshold on 6 other occasions since then, the most recent being on June 16.
• Percent of S&P 500 greater than 200-day moving average improvement – The prior four signals were looking for flushed out data that was “so bad it’s good” but here what we look for here is an improvement in price trends of equities from extreme low levels. This tends to occur later than the other signals and is included to try to avoid calling a bottom too early in case of an extended bear market. We look for the percent of S&P 500 stocks above their 200-day moving average to fall to a historically extreme low level (below 20%) and then rise back above 20%, signaling an improvement to the internal trends. This data fell into extreme low territory on June 13 and continued to decline before making a low of 12.6% on June 17. Following the stock market rally on June 24 it broke out back up to 23.8%, meeting the requirement for our trigger.

There is no magic formula that says that these triggers have to occur for the market to bottom but some combination of these have typically occurred, normally in clusters, around market bottoms. As shown in the LPL Chart of the Day and table below, when these triggers occur, especially simultaneously, it tends to be around lows and equity market returns have been well above average moving forwards. In what could be a good signal for stocks two of the triggers hit on June 16 and again on June 24 (especially as the later included the percentage of S&P above its 200-day moving average rising back above 20% trigger); when two triggers have occurred previously in the period studied the average return a year out has been an impressive 19%.

View enlarged chart.

Other market data that we monitor is showing a mixed picture, indicative of the high levels of uncertainty prevalent in the market currently. Some other data supporting the idea that we are further along in the bottoming process include NYSE advancers (10-day moving average) hitting an oversold reading of 0.35, the percent of S&P 500 members with a price above their 50-day moving average getting below 2% (the lowest since March 2020), and that some of the hardest hit parts of the market (speculative technology/biotech, initial public offerings, and Chinese internet stocks, etc.) all managed to hold their May lows in what could be a case of first to top, first to bottom.

Other data we look at still cautions us that the lows may not yet be in. Market momentum, as measured by the number of stocks that had greater than two standard deviation daily advances, has been tepid compared to what we typically see after market bottoms (50%+) with only 7% and 20% hitting that level on the big up days last week (June 21 and 24 – each of which also had relatively high TRIN scores indicating the buying was not panicked). The number of stocks hitting 52-week lows has also been increasing with each market low, this indicator is normally contracting as the bottoming process plays out, as new lows normally peak before the market bottoms. Capitulative selling also tends to see the largest names see high volumes but we have not yet seen that occur as volumes of largest names has been fairly average so far this year. The consumer discretionary vs consumer staples relative price trend, which had been negative since the end of 2021, has also still not moved in favor of discretionary which would be an indicator of a risk on environment. Perhaps the reason to be most cautious is more fundamental: almost all the recoveries from bear markets and corrections over last few decades have occurred with supportive policy shifts from the Federal Reserve (Fed), but this doesn’t seem on the cards while high inflation persists.

Overall we have not seen the levels of market capitulation or fear to believe that all potential sellers have been flushed out, so it’s entirely possible for there to be another wave of selling after this bounce, but we have seen more of the market signals that typically occur around, or after, market lows. While still cautious of Fed policy, we increasingly see the overall risk proposition tilted more to the upside for investors who are able to be patient and withstand a period of heightened market volatility and uncertainty.

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 Scott Brown, CMT, Technical Market Strategist

Thursday, June 23, 2022

As both consumers and the Federal Reserve battle persistent, rising inflation, one of the most prominent inflationary tailwinds has been broad based commodity price increases. But could that tailwind to inflation be turning into a headwind? Today we explore the commodity landscape and why the recent downturn may be a positive for equity investors.

The Bloomberg Commodity Index consists of four major subgroups: Precious Metals, Industrials Metals, Agriculture and Livestock, and Energy. For today’s blog, we’re going set aside precious metals, as gold prices have completely avoided participation in the commodities rally (perhaps a warning sign in hindsight) and have traded sideways for nearly two years.

However, key bellwhethers in each of the other 3 groups all experienced major gains since the March 2020 market bottom, but are now showing signs of breaking down technically.

First up, our representative from the industrial metals group: copper. Copper is often referred to as Dr. Copper for its ability to forecast the economy, and if that is true the doc hasn’t had much positive to say in a while. After rallying more than 125% from the March lows, copper prices traded sideways for much of the past year. However, a 13% loss since June 2 has pushed copper below a key support level and to its lowest level since February 2021.

View enlarged chart.

For US energy investors, the most important commodity is often WTI crude oil, and while this is likely still the healthiest trend we will look at today, recent weakness has occurred at an untimely spot for bulls. After breaking up above $115/barrel., a level that has significance going back to 2011, oil prices failed to get through their March closing highs and have rolled over sharply in recent days. It is hard to bet against one of the few clear uptrends left on earth right now, but for now near-term risk seems skewed to the downside.

View enlarged chart.

Last up, wheat prices. While we could have picked a number of different commodities from the agricultural complex, wheat has been one the most volatile and closely watched due to the Russia-Ukraine conflict. Wheat prices were already up more than 70% in the 2 years prior to the Russia invasion, but spiked an additional 60% in the immediate aftermath due to Ukraine and Russia previously combining to produce more than a quarter of the world’s wheat exports. While the conflict sadly remains unresolved, wheat prices are on the verge of breaking down to their lowest level since the conflict began, as shown in the chart below.

View enlarged chart.

Certainly nobody who has filled up their car with gas recently needs an explanation as to the real world impact of oil and gas prices, but do these potential reversals actually matter to investors’ portfolios? “The Federal Reserve may claim to only focus on inflation ex-food and energy,” explained LPL Financial Technical Market Strategist Scott Brown. “However, market inflation expectations have been highly correlated with commodity prices, especially over the past few years. Not only are we seeing commodity prices correct, but we are seeing a significant repricing of inflation expectations over the past few months.”

To put some hard numbers to those inflation expectations, consider the 2-year breakeven rate. Breakeven rates are the difference between inflation-linked bond yields and nominal bond yields of the same maturity, essentially showing what bond investors believe the inflation rate is likely to be over the holding period. The 2-year breakeven rate was 3.2% at the start of the 2022, but spiked to nearly 5% in late March. As of today it has fallen more than 1.25% to under 3.7% as commodity prices have fallen. If bond investors are seeing things correctly, that could mean less work for the Federal Reserve to do. For now the market is pricing in 7-8 more hikes this year, but any number less than that could be a welcome surprise for 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 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 Ryan Detrick, CMT, Chief Market Strategist

Wednesday, June 22, 2022

Summer is finally here, but 2022 is still shaping up to be one of the worst years for investors ever. That’s the bad news, the good news is the year isn’t over yet and here are three reasons the bulls shouldn’t throw in the towel just yet.

“The S&P 500 Index is down 21% for the year, which would be the worst first half to any year since 1970,” explained LPL Financial Chief Market Strategist Ryan Detrick. “As bad as that has been for investors, the good news is previous years that were down at least 15% at the midway point to the year saw the final six months higher every single time, with an average return of nearly 24%.”

As the table shows below, big drops to start a year tend to see big bounces back. Although most investors probably don’t feel like that is possible in 2022, just remember history says a surprise bullish move is possible.

View enlarged chart.

Next, as shown in the LPL Chart of the Day, a horrible quarter tends to see a nice snapback. Looking at previous quarters to lose at least 15%, the next two quarters stocks were higher 7 out of 7 times with an average return of more than 17%. Things get even better going out a full year, up nearly 30% on average. That is something most investors aren’t expecting right now, but we are guessing they’ll be quite happy should history repeat.

View enlarged chart. 

Lastly, the S&P 500 fell more than 5% back-to-back weeks, another potentially bullish development. In fact, after previous times the S&P 500 fell that much, a year later it was up more than 28% on average and down only once (1987).

View enlarged chart.

For more on what is needed for the bear market to end, the latest on the Fed and economy, please watch our latest LPL Market Signals with Ryan Detrick and Jeff Buchbinder.

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 Scott Brown, CMT, Technical Market Strategist

Friday, June 17, 2022

Undoubtedly the most important story of the past week is the historic move in interest rates. While this is a trend that has been firmly in place for months, it has accelerated even more following last Friday’s higher than expected CPI report. That report prompted the Federal Reserve to hike interest rates by 75 basis points for the first time since 1994 on Wednesday and sent the 2-year yield to its highest level since 2007. Moves on the long-end of the curve have been only slightly less extreme, with the 10-year yield hitting its highest level since 2011 and the 30-year yield briefly tagging 2014 levels.

Today, we want to highlight one of the most prominent groups that higher interest rates put pressure on: homebuilders. As shown in the LPL Chart of the Day, the S&P 500 Homebuilding Index has crashed through a major support level this week and extended its losses from the December highs to more than 40%.

View enlarged chart.

“Expecting homebuilders to underperform amid skyrocketing interest rates isn’t exactly a bold call,” said LPL Financial Technical Market Strategist Scott Brown. “But our takeaway from the recent breakdown is that there is little reason to think this trade is over or the trend is on the verge of reversing.”

To put some numbers to just how dramatic the interest rate move is to potential home affordability, consider this scenario. Someone looking to purchase a $300,000 home, with a 20% down payment and a 30-year fixed rate mortage (using the Bankrate.com National Average) would have faced a monthly payment of $1,047 at the end of last year when the average fixed rate 30 year mortgage was 3.27%. Cut to today, and the 5.91% mortgage rate would increase that monthly payment by 36% to $1,425, and that doesn’t even begin to factor in the other inflationary forces that consumers are battling right now. From a purely technical standpoint, we see little evidence that interest rate moves are done, and would continue to expect homebuilders to underperform the broad market, and potentially work lower in absolute terms as well.

LPL Research’s Strategic and Tactical Asset Allocation Committee (STAAC) remains firmly negative on the Consumer Discretionary sector where homebuilding stocks are categorized. However, weakness is certainly not limited to the homebuilers, as more than 90% of stocks in the sector are below their respective 200-day moving averages and the sector is the worst-performing year-to-date with a more than 30% loss. We will need to see considerable technical improvement from the current situation before we can recommend a change to current positioning.

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

Thursday, June 16, 2022

The Federal Reserve concluded its two day policy meeting yesterday and announced that it was raising its benchmark rate by 0.75% to a range of 1.5 – 1.75%, the first 0.75% move since November 1994. The possibility of a 0.75% hike seemed unlikely even a week ago, but an upside surprise in the latest reading of Consumer Price Index (CPI) index inflation, released on Friday, June 10, changed everything as short-term yields soared and market-implied rate hike expectations climbed higher.

“The Fed still has some leeway to remain credibly committed to bringing down inflation and they’re doing what they need to do,” said LPL Financial Asset Allocation Strategist Barry Gilbert. “But underneath the surface there’s not an easy fit between what they may have to do to bring down inflation and the soft landing they’re trying to achieve. The choices are going to get harder over the second half of the year.”

Here are four observations about yesterday’s rate hike:

• Raising rates helps control inflation by lowering demand, but as important it keeps expectations anchored. The Fed’s main fight right now is against long-term inflation expectations becoming unanchored, because once they are they are difficult to bring back down. As a result, the Fed needs to talk tough, it has been talking tough, and it’s been following it up with action. That’s part of why it thought the 0.75% hike was important. So far, it’s worked. Expectations have not yet become unanchored although there’s been some pressure.
• There is a point for rates where the economy breaks. The Fed is trying to slow growth so demand comes back down toward still constrained supply, but not actually push the economy into recession. We don’t know exactly where that breaking point is and the Fed isn’t necessarily going to get there. In the last cycle a policy rate of about 2.5% began to weigh on the economy, but there was also little inflationary pressure and the Fed was able to bring rates back down and maintain the expansion. The point that pushes the economy into a recession is higher. The median forecasted 2022 year-end rate of 3.4% in the new projections material may already be too much. There isn’t a bright line and the effects of monetary policy take time, but that breaking point is out there.
• With all the tough talk, the Fed isn’t yet facing the really tough decisions. The Fed’s median projected policy rate and projected economic growth rate seem inconsistent. The median forecast for 2022 growth is 1.7%. The average over the last expansion was about 2.3% each year. Those two numbers only sit together well if timing and circumstances are very friendly, which they rarely are. At some point in the second half of the year, the decisions are going to get much harder.
• If the fed funds rate is going to be lower than projected at the end of 2022, the Fed will need some help. Inflation has been the weak spot on the economy and has been stressed repeatedly. Supply chain disruptions. Excess stimulus due to a surprising robust recovery. A tight labor market with many older workers leaving the labor force. And then on top of everything else, high commodity prices due to the war and Ukraine. The easiest path to lifting some inflationary pressure would be supply chains materially improving, which they will eventually, and workforce growth. We do think it’s likely that some help is on the way. The question is whether it will come fast enough. We still tilt yes but uncertainty is rising.

Last Friday’s inflation report was a disappointment, and we believe the Fed’s response was appropriate and will contribute to a better inflation outlook over the medium run. At the same time, the odds of getting a soft landing are probably steadily moving closer to even. We do believe, however, that equity markets have already priced in even deeper skepticism about a soft landing. We have not yet seen the washed out sentiment typical of major market bottoms and we would not deny the added risk. But we think investors should be sticking to their plan and scouting out potential opportunities rather than heading for the exits.

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 Ryan Detrick, CMT, Chief Market Strategist

Wednesday, June 15, 2022

It finally happened. On Monday the S&P 500 Index moved into a bear market, finally closing 20% beneath the January 3 high.

Here are 7 things to know about bear (and bull) markets:

• Since World War II seven bull markets have officially doubled. The recent bull market was the fastest to ever double, but it also ended much quicker than the others at less than two years old.

View enlarged chart.

2)  The bull market that just ended lasted only 21 months from the March 2020 lows until the January 2022 peak, checking in as the shortest bull market since WWII. As noted above though, it was also the quickest to ever double. Wow.

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3)  Here are all the bear (and near bear markets) since 1950. “This bear market is actually already old by recent standards,” explained LPL Financial Chief Market Strategist Ryan Detrick. “At more than five months old, it is already older than six other bear markets going back nearly 40 years. Only the tech bubble and Great Financial Crisis bears lasted longer.”

This could mean the bear market could be closer to a bottom than many expect.

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4)  What could happen next? As we show in the LPL Research Chart of the Day, the good news is a year after the S&P 500 moves into a bear, stocks actually do pretty well, up an average of nearly 15% a year later with a very solid median gain of 23.8%.

The catch, and there’s always a catch, the returns a year later were negative in the 1973-74 recession, the tech bubble, and the Financial Crisis (2008-2009). The good news is we don’t see an economy like that over the next year, so the likelihood of higher prices (maybe significantly higher) is quite strong, in our view.

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5)  How quickly could stocks bottom once a bear starts? The data is all over the map here. It took only 11 days in March 2020 for the lows to form, while it took 18 months after the tech bubble. Bottom line, we think this could play out more like things did in 1987 or the 1950s and 1960s with the ultimate low taking place sooner rather than later.

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6)  Looking at previous bears that took place without a recession (still our base case), showed that stocks tend to bottom at a little more than down 20%. Yes, 1987 is in there, but most of the other times stocks bottomed near where we are now, suggesting potentially limited pain from current levels.

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7)  Investors need to remember that since the S&P 500 Index moved to 500 stocks on March 4, 1957, it has made 1,184 new all-time highs and it has always eventually achieved new highs, even if it doesn’t feel that way today. Wars, sky-high inflation, recessions, bubbles, geopolitical events, policy mistakes, and more have all happened over this time, but stocks have always come back eventually to new highs. We do not think this time will be any different. As long as businesses can grow earnings over the long run, the fundamentals are in place for future stock gains, which means new highs could be coming as well.

They say the stock market is the only place things go on sale and people run out of the store screaming. Please remember that before you make any rash investment decisions.

Lastly, the S&P 500 was just down more than 1% for four consecutive days. This very rare occurrence hasn’t been fun for investors, but be aware the returns after these painful streaks have been very strong, higher a year later 9 out of 9 times, with a solid 26.7% gain on average.

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Jeff Buchbinder and Ryan Detrick discuss the bear market in the latest edition of the LPL Market Signals podcast. They also discuss inflation and the Fed. You can watch the full discussion below.

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, June 14, 2022

To say the bond market didn’t like Friday’s (June 10) consumer inflation report would be an understatement. After the report showed headline inflation at the highest levels since the 1980s, yields across the front end of the yield curve moved sharply higher with the 1-year, 2-year and 3-year maturities moving more than 20 basis points higher for the day. Moreover, the selloff continued into Monday with front end yields up another 30 basis points—the 60 basis point jump over the last two trading sessions for the 2-year Treasury is the largest since the early 1980s and larger than the jump that happened after the Lehman Brothers collapse. Front end yields are more sensitive to changing monetary policy expectations so the move higher in yields is based upon another aggressive repricing of Federal Reserve (Fed) rate hiking expectations. As seen in the LPL Chart of the Day, markets are now expecting an increase of nearly 200 basis points (2.00%) in the Fed funds rate over the next three meetings including the meeting this week. Markets now expect the Fed to take its short-term interest rate above 3.6% by year end. The 360 basis point increase in interest rates would be the most in one year since 1980.

“The selloff in the Treasury market has been historically awful this year,” noted LPL Financial Fixed Income Strategist Lawrence Gillum. “Inflation expectations remain relatively anchored and financial conditions have tightened meaningfully already this year so maybe the Fed won’t have to hike as many times as the markets are expecting. That should help provide a lift to both stock and bond prices.”

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But the question remains does the Fed need to be as aggressive as markets are expecting? Moreover, has the Fed lost control of the inflation narrative? If you were to look at both market-implied inflation expectations as well as the recently released survey data from the Federal Reserve Bank of New York, the answer is maybe not. As seen in the chart below, market-implied inflation expectations remain relatively well anchored. While near term expectations remain elevated, particularly over the five-year horizon, they remain below the peak seen earlier in the year. Also, average five-year inflation expectations beginning five years from now (2027-2032), a metric the Fed relies on to look through current price pressures, remains within historical averages. As for the survey data, one-year ahead inflation expectations as measured by the New York Fed remain elevated but three-year ahead inflation expectations were steady at 3.9%– again elevated but likely not enough to worry the Fed about unanchored inflation expectations.

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 Jeffrey J. Roach, PhD, Chief Economist

Friday, June 10, 2022

Headline Inflation Jumps, Core Inflation Cools

Headline inflation in May rose 8.6% from a year ago, accelerating from April’s 8.3% growth rate. The Consumer Price Index (CPI) rose to the highest year-over-year increase since December 1981. The spike in consumer prices were fairly broad-based but especially noticeable in gas and groceries. “Higher food costs will especially hit lower income consumers with another 1.4% increase in food prices from just one month ago,” warned LPL Chief Economist Jeffrey Roach. Dairy prices rose 2.9% month-over-month, the largest monthly increase since July 2007. A moderation in food prices will not likely come to fruition until geopolitical risks subside and sanctions expire.

Airline tickets jumped another 12.6% after gaining 18.6% last month, as airlines deal with pilot shortages and high fuel costs. As consumers pivot to more services spending, travel-related consumer prices will likely take a longer time to moderate relative to goods prices.

We do see some cooling in prices, particularly in durable goods. As shown in the LPL Chart of the Day, durable goods prices continue to decelerate, supporting the narrative that we are past peak in at least some categories. The core CPI (excluding food and energy) fell to 6.0% from a year ago, down from 6.2% last month and reaching a four-month low.

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Policy Makers More Inclined To Hike More For Longer

Our base case for the Federal Funds target interest rate at the end of this year is 2.50, which roughly matches the estimated neutral rate for the Federal Reserve (Fed). However, the nagging persistence of some consumer prices might change plans for the Fed. The Fed is widely expected to raise rates by 50 basis points next week but now, the odds are increasing that the Fed raises rates another 50 basis points in July. Before today, we expected the Fed to raise by 25 basis points in July but we may update our expectations. Futures markets are now pricing in a 50 basis point hike in September as well.

Investors and policymakers know inflation will likely stay above target for a while but both will focus on the direction of the change. The Federal Reserve’s preferred inflation gauge is the Core Personal Consumption Expenditure (PCE) deflator and we could likely see a more definitive decline in the deflator when released later this month. The Fed prefers the deflator metric because the CPI does not account for product substitutions consumers make when prices change, whereas, the PCE deflator tracks price changes of actual consumer purchases.

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.