Stocks fell in September as the month lived up to its reputation as a difficult one for stocks. The S&P 500 Index lost 3.6% for the month, lowering its year-to-date gain to 11.7% (excluding dividends). Losses came as interest rates broke through to new 16-year highs. As October began, improving seasonals, dysfunction in Washington, D.C., and economic impact of higher interest rates garnered significant attention from investors.
Despite inflationary pressures falling and the Federal Reserve (Fed) maintaining its current interest rate policy, core bonds, as measured by the Bloomberg Aggregate Bond Index, were lower in September by over 2.5%. The surprising resilience of the U.S. economy is causing the bond market to price out expected rate cuts causing longer term yields to rise. Higher yields may mean another opportunity for investors to add to high quality fixed income.
As discussed in our Midyear Outlook 2023: The Path Toward Stability, the LPL Research Strategic and Tactical Asset Allocation Committee (STAAC) sees them risk-reward trade-off between equities and fixed income as roughly balanced given elevated equity valuations and higher yields.
INVESTMENT TAKEAWAYS:
- The STAAC maintains its recommended neutral equities allocation based on the Committee’s assessment that the risk-reward trade-off between equities and fixed income is roughly balanced. Stock valuations are not attractive at such high yield levels in the bond market.
- The Committee favors large cap stocks over their smaller brethren ahead of a likely economic slowdown toward the end of the year.
- Style views remain neutral overall. Our technical analysis work points toward growth, but valuations support value.
- The STAAC’s regional preference remains developed international stocks over the U.S. and emerging markets (EM) due largely to valuations and better corporate governance in Japan, though recent economic weakness and waning relative strength in Europe are concerning.
- The bond market is coming to grips with the Fed’s higher for longer narrative so expected rate cuts continue to get priced out, which has put upward pressure on longer maturity Treasury yields. Moreover, Treasury supply is expected to increase in the coming quarters, which will likely also keep pressure on yields. As such, our updated year-end 2023 target for the 10-year Treasury yield is 4.25% to 4.75%.
- The selloff in the banking sector has provided an attractive opportunity in preferred securities, however the risk/reward for core bond sectors (U.S. Treasury, Agency mortgage-backed securities (MBS), investment-grade corporates) is more attractive than plus sectors, in our view.
BROAD ASSET CLASS VIEWS
LPL Research’s Views on Stocks, Bonds, and Cash
OUR ASSET CLASS & SECTOR CHOICES
2023 MARKET FORECASTS
Expect Yields to Pullback and Stocks to Be Choppy Through Year-End
Source: LPL Research, FactSet, Bloomberg
All indexes are unmanaged and cannot be invested into directly. The economic forecasts may not develop as predicted.
*Our year-end 2023 forecast for the U.S. 10-year Treasury yield has been updated and is now 4.25% to 4.75%. The Fed’s higher for longer narrative and the poor supply/demand technicals for Treasury securities will likely keep interest rates at these elevated levels until the economic data weakens and/or inflation falls back in line with the Fed’s longer term 2% target.
**Our year-end 2023 fair-value target range for the S&P 500 of 4,300-4,400 is based on a price- to-earnings ratio (PE) near 19 and our S&P 500 earnings per share (EPS) forecast of $230 in 2024.
Any forward-looking statements including economic forecasts may not develop as predicted and are subject to change.
2023 ECONOMIC FORECASTS
Downshift in Global Growth
Source: LPL Research, Bloomberg
The economic forecasts may not develop as predicted.
All data, views, and forecasts herein are as of 10/06/23.
LPL RESEARCH STRATEGIC AND TACTICAL ASSET ALLOCATION COMMITTEE
For investors who have their own benchmarks, we would recommend emphasizing underweights or overweights relative to the individual benchmark at the most similar overall risk level.
Equity benchmark style weights are equally distributed across growth, core, and value. Cap weights are based on the underlying holdings of the domestic benchmark indexes. Bond benchmark sector allocations are based on a look-through analysis of the major sector components of the Bloomberg US Aggregate Bond Index.
Treasuries include other government related debt. MBS includes other securitized debt.
Abbreviations: TAA – tactical asset allocation; MBS – mortgage-backed securities; IG corporates – investment-grade corporates; TIPS – Treasury inflation-protected securities.
EQUITY ASSET CLASSES
Favor Large Caps, Staying Neutral on Style, with Slight Preference for Developed International for Now
The STAAC maintains its recommended neutral equities allocation based on the Committee’s assessment that the risk-reward trade-off between equities and fixed income is roughly balanced. Stock valuations are not attractive at such high yield levels in the bond market. The Committee favors large cap stocks over their smaller brethren due to potentially slower economic growth and tighter credit conditions, though valuations remain attractive for high-quality small caps. Technical analysis points to growth over value, but valuations remain elevated for growth stocks broadly. The Committee continues to slightly favor developed international stocks over U.S. due mostly to valuations and increasingly more shareholder friendly management teams in Japan, but currencies have not been helping and Europe has clearly weakened. Key risks to equities include overtightening by the Fed, broader military conflict in Europe, and escalation in U.S-China tensions.
Relative trend is an assessment of the intermediate term price trend and performance between various asset classes and sectors. For regions and styles the relative trends are compared to each other.
EQUITY SECTORS
Favor Energy and Industrials for Cyclical Value Tilt
Because of its narrow focus, specialty sector investing, such as healthcare, financials, or energy, will be subject to greater volatility than investing more broadly across many sectors and companies. Relative trend is an assessment of the intermediate term price trend and performance between various asset classes and sectors. For sectors each sector’s relative trend is versus the S&P 500.
FIXED INCOME
Favor Up-In-Quality Approach with a (Small) Allocation to Preferreds
Longer-maturity Treasuries were higher in September as the market continues to reprice expectations for the Fed’s policy path, pricing out some of the anticipated rate cuts throughout 2024 while also shifting the expected “neutral” rate higher. Yields on high quality fixed income sectors moved higher as well, offering investors another opportunity to take advantage of attractive valuations. Importantly, starting yields are the best predictor of long-term returns and with starting yields at levels last seen over a decade ago, the return prospects for fixed income have improved as well. That said, aside from preferred securities, valuations for riskier fixed income sectors remain rich relative to core sectors, in our view.
We favor municipal bonds as a high-quality option for taxable accounts with tax-equivalent yields as attractive as they’ve been in over a decade. Additionally, for appropriate investors, we believe high-yield municipal bonds offer an attractive tax-equivalent yield; however, we would expect additional volatility as economic growth concerns increase. Fundamentals in both markets may have peaked but remain solid.
Yield spread is the difference between yields on differing debt instruments, calculated by deducting the yield of one instrument from another. The higher the yield spread, the greater the difference between the yields offered by each instrument. The spread can be measured between debt instruments of differing maturities, credit ratings, and risk. Bank loans are loans issued by below investment- grade companies for short-term funding purposes with higher yield than short-term debt and involve risk. For the purposes of this publication, intermediate-term bonds have maturities between three and 10 years, and short-term bonds are those with maturities of less than three years
All bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and are subject to availability and change in price. Corporate bonds are considered higher risk than government bonds but normally offer a higher yield and are subject to market, interest rate, and credit risk, as well as additional risks based on the quality of issuer, coupon rate price, yield, maturity, and redemption features. Investing in foreign and emerging market debt (EMD) securities involves special additional risks. These risks include, but are not limited to, currency risk, geopolitical and regulatory risk, and risk associated with varying settlement standards. High-yield/junk bonds are not investment-grade securities, involve substantial risks, and generally should be part of the diversified portfolio of sophisticated investors. Municipal bonds are subject to availability, price, and market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Interest income may be subject to the alternative minimum tax. Federally tax-free but other state and local taxes may apply. Mortgage-backed securities (MBS) are subject to credit, default, prepayment risk that acts much like call risk when you get your principal back sooner than the stated maturity, extension risk, the opposite of prepayment risk, market, and interest rate risk.
Municipal bonds are subject to availability and change in price. They are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Interest income may be subject to the alternative minimum tax. Municipal bonds are federally tax-free but other state and local taxes may apply. If sold prior to maturity, capital gains tax could apply.
COMMODITIES
Dollar Headwinds Persist
The broad commodity sector declined in September after facing a relentless rally in the U.S. Dollar Index. The greenback climbed 2.5% last month amid an ongoing 11-week winning streak underpinned by surging interest rates and the repricing of expectations for higherfor-longer monetary policy. The Bloomberg Commodity Index (BCOM) slid 1.2% after failing at the neckline (109) of a potential head and shoulders bottom formation.
It wasn’t all bad news across the commodities complex. Energy was once again the standout, posting a 3.9% gain. The energy commodity sector has been up for four consecutive months, amassing a 30% price gain over this period. Crude oil has captured most of the headlines after its recent breakout from a bottom formation. While oil has since pulled back from overbought levels, the improving technical and supply and demand backdrop suggests the path of least resistance remains higher. Natural gas is following suit after posting back-to-back 5% rallies in August and September. Prices have now recaptured the 50- and 200-day moving averages, leaving $3 as the last hurdle to clear before a breakout from a bottom formation can be confirmed. We maintain our positive view on the energy commodity sector.
Metals declined in September after being dragged down by weakness in gold and silver. Both precious metals suffered sizable technical damage after they broke below support from their summer lows. Oversold conditions have developed, raising the odds for a potential relief rally on a near-term horizon; however, there is limited technical evidence pointing toward any imminent capitulation. Industrials metals advanced, although copper failed at an important downtrend. An underwhelming economic recovery in China and signs of increased supply continue to weigh on copper prices. We maintain our neutral view on both the industrial and precious metals group.
Ag and livestock markets declined last month. Grains underperformed within the space as selling pressure continued in wheat and soybeans. Record Russian supplies of wheat hitting the market and weak demand from China have largely underpinned the declines. Softs were flat, with sugar sticking out with a 4% rally that lifted prices out from a four-month consolidation range. Livestock also finished near the flatline, buoyed by a 2.5% rally in live cattle.
Any futures referenced are being presented as a proxy, not as a recommendation. The fast price swings in commodities will result in significant volatility in an investor’s holdings. Commodities include increased risks, such as political, economic, and currency instability, and may not be suitable for all investors.
ALTERNATIVE INVESTMENTS
Macro and Managed Futures Providing Uncorrelated Returns and Portfolio Diversification in Times of Volatility
The alternative investment strategies posted mixed results in September based on the preliminary data from Hedge Fund Research (HFR).
Improving Bottom Up Stock Picking Environment
Equity L/S strategies posted mixed results in September. With the steep sell-off in equity markets, long biased Equity L/S strategies underperformed while low-net/market neutral Equity L/S were able to positive results. The stock dispersion has risen meaningfully in recent months, lending improved trading environment for low-net/market neutral Equity L/S strategies focused on bottom up stock picking. Event Driven strategies posted small gains as Merger Arbitrage and Special Situations strategies gained from the marginal pick up in global M&A deal volume and some of the catalyst events. Lastly, Relative Value strategies were generally down, with the Covertible Arbitrage strategies detracting the most due to the rise in volatility.
Remain constructive on Global Macro, Managed Futures and Multi-Strategy
Tactical Trading Strategies, namely Global Macro and Managed Futures, were the leading performers, helping to provide uncorrelated returns and portfolio diversification for investors. Global Macro was the major beneficiary of the US rates curve dis-inversion which was brought by the strong US economic data that has pushed recession expectations out and brought back “higher for longer” rates expectations. They also gained from other tactical themes in commodities, currencies and equities as well. Looking forward, we expect Global Macro managers to continue to find ample trading opportunities, with heavier focus on inter regional relative value opportunities that arise from the divergence in economic conditions and central bank policies. Within Managed Futures, both trend followers and short-term strategies posted gains. Many of them were able to profit from the sell-off in rates and rally in crude oil prices. With respect to equities, some of the short-term models were able to profit from the sharp sell-off of the market that came with the rise of volatility while trend followers focused on further reducing their equity beta. Given the continued uncertainties around the economy and fiscal and monetary policy, we expect the volatility to transition higher and remain constructive on both Global Macro and Managed Futures strategies that tend to perform in such regimes and provide uncorrelated returns and portfolio diversification for investors.
Multi-strategy funds posted muted returns, reflecting the mixed performance across the underlying strategies. Multi-strategy remains a core focus of ours as we believe they can supply additional sources of uncorrelated returns and help dampen portfolio volatility in an environment where interest rates are expected to remain persistently elevated.
Please see https://www.hfr.com/indices for further information on the indices
Definition: The HFRI 400 (US) Hedge Fund Indices are global, equal-weighted indices comprised of the largest hedge funds that report to the HFR Hedge Fund Research Alternative investments may not be suitable for all investors and should be considered as an investment for the risk capital portion of the investor’s portfolio. The strategies employed in the management of alternative investments may accelerate the velocity of potential losses.
IMPORTANT DISCLOSURES
This material has been prepared for informational purposes only, and is not intended as specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors and they do not take into account the particular needs, investment objectives, tax and financial condition of any specific person. To determine which investment(s) may be appropriate for you, please consult your financial professional prior to investing. Any economic forecasts set forth may not develop as predicted and are subject to change.
Stock investing involves risk including loss of principal. Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies. Value investments can perform differently from the market as a whole and can remain undervalued by the market for long periods of time. The prices of small and mid-cap stocks are generally more volatile than large cap stocks. Bonds are subject to market and interest rate risk if sold prior to maturity.
Bond values will decline as interest rates rise and bonds are subject to availability and change in price. Corporate bonds are considered higher risk than government bonds. Municipal bonds are subject to availability and change in price. Interest income may be subject to the alternative minimum tax. Municipal bonds are federally tax-free but other state and local taxes may apply. If sold prior to maturity, capital gains tax could apply. U.S. Treasuries may be considered “safe haven” investments but do carry some degree of risk including interest rate, credit, and market risk. Bond yields are subject to change. Certain call or special redemption features may exist which could impact yield. Mortgagebacked securities are subject to credit, default, prepayment, extension, market and interest rate risk.
Municipal bonds are subject to availability and change in price. They are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Interest income may be subject to the alternative minimum tax. Municipal bonds are federally tax-free but other state and local taxes may apply. If sold prior to maturity, capital gains tax could apply.
High yield/junk bonds (grade BB or below) are not investment grade securities, and are subject to higher interest rate, credit, and liquidity risks than those graded BBB and above. They generally should be part of a diversified portfolio for sophisticated investors.
Floating rate bank loans are loans issues by below investment grade companies for short term funding purposes with higher yield than short term debt and involve risk.
Credit Quality is one of the principal criteria for judging the investment quality of a bond or bond mutual fund. Credit ratings are published rankings based on detailed financial analyses by a credit bureau specifically as it relates to the bond issue’s ability to meet debt obligations. The highest rating is AAA, and the lowest is D. Securities with credit ratings of BBB and above are considered investment grade. Duration is a measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. It is expressed as a number of years.
Preferred stock dividends are paid at the discretion of the issuing company. Preferred stocks are subject to interest rate and credit risk. As interest rates rise, the price of the preferred falls (and vice versa). They may be subject to a call feature with changing interest rates or credit ratings.
Alternative investments may not be suitable for all investors and should be considered as an investment for the risk capital portion of the investor’s portfolio. The strategies employed in the management of alternative investments may accelerate the velocity of potential losses.
Event driven strategies, such as merger arbitrage, consist of buying shares of the target company in a proposed merger and fully or partially hedging the exposure to the acquirer by shorting the stock of the acquiring company or other means. This strategy involves significant risk as events may not occur as planned and disruptions to a planned merger may result in significant loss to a hedged position.
Commodity-linked investments may be more volatile and less liquid than the underlying instruments or measures, and their value may be affected by the performance of the overall commodities baskets as well as weather, geopolitical events, and regulatory developments. The fast price swings in commodities and currencies will result in significant volatility in an investor’s holdings.
Investing in foreign and emerging markets securities involves special additional risks. These risks include, but are not limited to, currency risk, geopolitical risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks. All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.
Earnings per share (EPS) is the portion of a company’s profit allocated to each outstanding share of common stock. EPS serves as an indicator of a company’s profitability. Earnings per share is generally considered to be the single most important variable in determining a share’s price. It is also a major component used to calculate the price-toearnings valuation ratio.
Gross Domestic Product (GDP) is the monetary value of all the finished goods and services produced within a country’s borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory.
All index data from FactSet.
For a list of descriptions of the indexes referenced in this publication, please visit our website at lplresearch.com/definitions.
Managed futures are speculative, use significant leverage, may carry substantial charges, and should only be considered suitable for the risk capital portion of an investor’s portfolio.
The Strategic and Tactical Asset Allocation Committee (STAAC) is a division of LPL Research.
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 Financial affiliate, please note LPL Financial makes no representation with respect to such entity.
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