China Weighs on Emerging Markets Indexes

Market Blog Posted by lplresearch

Friday, July 30, 2021

China’s stock exchanges have been hit hard in response to several sudden regulatory actions that have dismayed investors. First came the crackdown on ride sharing service DiDi, which has about a 90% market share in China. Regulators had announced a cybersecurity review soon after its initial public offering on the New York Stock Exchange, eventually ordering the removal of DiDi from app stores. Then there were fines against tech giants Alibaba and Tencent. Next came an announcement that for-profit tutoring services would no longer be able to charge for certain core classes. The rapid sequence of government action against publicly traded companies has shaken market participants, with Chinese indexes and related stocks down significantly.

The issues in China also mean problems for investors in diversified emerging market equities. China has by far the largest weight in the MSCI Emerging Markets Index, at 35%, down from more than 40% prior to the recent sell-off. MSCI and other index providers have steadily increased their exposure to Chinese equities in emerging market indexes in recent years, a seemingly active decision that may surprise so-called passive investors.

As shown in the LPL Chart of the Day, China weighing down broad emerging markets is not exactly a new trend. While China outperformed other emerging markets (EM) amid the early stages of the COVID-19 pandemic, as global markets have recovered, a basket of emerging market equities that excludes China has strongly outperformed the MSCI China Index going back to last year.

See enlarged chart.

“Chinese officials have more recently taken a conciliatory tone to try and settle markets back down,” said LPL Financial Chief Market Strategist Ryan Detrick. “However, broken trust is not easily restored and technical damage will take time to repair. How China continues to respond will be important for investors to watch in August.”

We preview more things investors should know heading into August in next week’s Weekly Market Commentary. For now, we recommend that investors recognize that while China could bounce, alpha opportunities might lie elsewhere in 2021. In addition, we believe traditional active management makes the most sense for EM exposure, allowing experts to assess risk and reward for regions and companies rather than defaulting to market cap-weighted indexes.

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

Services Consumption Lifts GDP Growth

Economic Blog Posted by lplresearch

Thursday, July 29, 2021

Lofty expectations for second quarter gross domestic product (GDP) growth were left somewhat wanting as a decent headline number fell short of expectations. Peering under the hood, though, we think this is still a fairly solid report.

The Bureau of Economic Analysis released its preliminary estimate for second quarter GDP this morning, showing the U.S. economy grew at a 6.5% annualized pace against the Bloomberg median forecast for 8.4%. While this represented a small acceleration from the first quarter’s 6.3% pace, investors viewed the headline number as a mild disappointment in light of the heightened expectations. The composition of the growth, though, largely reinforces the prevailing narratives of a strong consumer juxtaposed with supply chain bottlenecks, restricting growth.

“The positive takeaway from today’s report is that we are clearly seeing a rebound in the in-person consumption of services,” said LPL Financial Chief Investment Strategist Ryan Detrick. “This indicates a confidence by consumers to reengage with the parts of the economy beaten down most by COVID, and continued momentum here will be key if we are to see the consumer continue to power overall growth.”

As seen in the LPL Chart of the day, the US consumer continued to do the heavy lifting, offsetting weakness in most other major GDP components.

View enlarged chart.

Business fixed investment came in strong and demonstrated business’ attempts to ramp up output to meet surging demand. Residential investment had a more predictable decline, as well-documented labor shortages and high materials costs are restricting new projects. The volatile inventory components, though, did represent a drag.

Looking forward, we expect continued growth in the third quarter but with a different composition. Consumer spending should still be respectable, but likely will recede a bit due to the fading impact of past government transfer payments. New momentum in services as in-person commerce picks up should continue under the hood. Picking up the slack; though, business investment should continue to recover, and net exports may improve as the rest of the world plays catch-up to the U.S. in their recoveries, consuming more of our goods and services. Government spending and inventories also both have favorable outlooks.

The Delta variant of COVID-19 presents a risk to the outlook, but we see strong reason to remain optimistic. The U.S. is lagging the U.K. in its exposure to the Delta variant, and if we model our trajectory after theirs, which obviously is an imperfect comparison, we expect to see a peak in cases in the coming weeks. In fact, the U.K. is already on a strong path to recovery despite doomsday headlines. Domestically, COVID-19 cases are spiking in areas with the lowest vaccination rates. But, there is evidence that these are also the states experiencing the highest uptick in new vaccinations, which should help self-correct the trends. Positivity rates can be thought of as the fastest-twitch indicator, with hospitalization trends following in the ensuing weeks. Through that lens we see that some of the hardest hit states may have already seen their positivity rates peak.

We upgraded our 2021 forecast for U.S. real GDP growth earlier this year from 5–5.5% to 6.25–6.75%, and while there are sure to be bumps along the way, we expect to see the economy continue growing at a strong pace as activity further normalizes over the course of the year.

For further analysis on our outlook for the economy and financial markets, please check out our Midyear Outlook 2021: Picking Up Speed.

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

Federal Reserve Meeting Preview

Market Blog Posted by lplresearch

Tuesday, July 27, 2021

The Federal Reserve (Fed) meets this week to discuss its ongoing support for the U.S. economy. During its regularly scheduled two-day meeting, the nineteen-member committee is expected to discuss if and when the Fed should start to remove the emergency level monetary accommodation that it has provided since the beginning of last year’s COVID-19 shutdowns. Last month’s meeting sparked some market volatility as some of the comments, along with the data releases, were interpreted as a shift in tone to be slightly less accommodative. While we won’t be getting the same type of data releases at the conclusion of this meeting, that doesn’t mean the market can’t (over)react to what is and isn’t said. Below are some of the things we’ll be watching for.

“We’re not expecting fireworks at this Fed meeting,” noted LPL Financial Fixed Income Strategist Lawrence Gillum. “But we are expecting the committee to go further down the road in discussing the when and how to start removing the emergency level monetary accommodation it has been providing markets.”

  • Any changes in the language in the post-meeting statement. At the conclusion of Federal Open Market Committee (FOMC) meetings, the Fed releases its post-meeting statement summarizing the outcome of the meeting. Generally included is the committee’s assessment of the economy and potential risks to its recovery. Notably, the committee downgraded the COVID-19 risk last month. However, the committee may reinsert that language given the uptick in cases due to the Delta variant. An acknowledgement would likely indicate the committee’s hawkish shift last month may have been premature.
  • More discussion around reducing the bond buying programs. The Fed currently purchases $120 billion of debt securities every month ($80 billion of Treasury and $40 billion of agency mortgage securities) to help provide liquidity and to support financial markets. In previous meetings, Fed Chair Jerome Powell has said that it’s too early to talk about reducing that support. While we don’t think the Fed is ready to announce the start of the tapering process, we do expect the committee to announce that those discussions are taking place with a formal tapering plan coming in the next few months.
  • Still too early to talk about raising short term interest rates. The Fed has said that it would like to reduce its bond buying programs before it starts to increase interest rates. At the end of the day, the market is more concerned about rising interest rates than the tapering of bond purchases. Historically, when the Fed starts to raise interest rates, economic growth tends to slow. The market will be looking for any hint of when that process will start. Markets don’t expect that to take place for another year or so. Any suggestions otherwise will likely increase market volatility.

As seen in the LPL Research Chart of the Day, market expectations for when the Fed will start to raise short-term interest rates have changed over the past month. Largely due to the expected slowdown in economic growth due to the COVID-19 delta variant, the market now thinks the Fed will wait until the first part of 2023 to hike rates. Moreover, the expected path of interest rates over time has come down slightly with the market only pricing in four 25 basis point (0.25%) interest rate hikes over the course of the next five years.

See 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 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

Leading Indicators Forecasting Continued Growth

Economic Blog Posted by lplresearch

Friday, July 23, 2021

On Thursday, July 22, the Conference Board released its June 2021 report detailing the latest reading for the Leading Economic Index (LEI), a composite of ten data series that tend to lead changes in economic activity. Many economic data points are backward looking, but we pay special attention to the LEI, as it has a forward-looking tilt to it and spans many segments of the economy. The index grew 0.7% month over month, a bit slower than the previous three months but still squarely in positive territory.

“The market’s upward momentum is contending with a few bearish narratives at the moment, one of which is second derivative economic growth concerns,” said LPL Financial Chief Investment Strategist Ryan Detrick. “And while June’s LEI growth certainly did come in below the elevated levels of the past few months, we continue to see plenty of strong economic growth ahead of us.”

As seen in the LPL Chart of the Day, the LEI’s growth rate came off its hot run rate from the last three months, but it is still growing at a healthy clip by historical standards.

View enlarged chart.

Eight of the ten components grew in June, while two fell. Average weekly initial claims for unemployment insurance, the Institute for Supply Management (ISM) New Orders Index, and the Leading Credit Index represented the three largest positive contributors. Building permits and average weekly manufacturing hours detracted from the overall index’s performance.

We noted in last month’s coverage of the May LEI report that the trailing three months had all seen monthly gains in excess of 1%, which is a historicaly rare feat. Perhaps, then, some giveback was to be expected this month as the LEI can be a volatile series. Through this lens, we caution against interpreting the deceleration as a sign that the economic outlook is deteriorating. The broader trend remains definitively positive, we remain in the early stages of a new economic expansion, which can be accompanied by occassional jitters, and continued strong breadth among underlying components should act as support for the overall index. We continue to see plenty of reasons for optimism as we move into the second half of 2021 where we expect labor supply to come back online and bottlenecks to begin to resolve themselves, allowing for increased output.

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

LPL Market Signals: Mr. Powell Goes to Washington

Market Blog Posted by lplresearch

Friday, July 23, 2021

Inflation is soaring and Jerome Powell still isn’t overly worried about it. In fact, he was grilled by Congress last week and held his ground on his inflation views. This week in the LPL Market Signals podcast Chief Market Strategist Ryan Detrick and Equity Strategist Jeff Buchbinder breakdown that, along with a preview of first quarter earnings.

Earnings season is here.

First quarter earnings season officially kicked off and is already off to a great start. Jeff noted that just last week we thought earnings could be up in the mid-70% range year over year, now it could hit 80%. Ryan noted last quarter earnings came in way above expectations and wouldn’t be shocked to see that one again. Jeff noted that the majority of the gains should come from reopening areas, as the economy continues to surprise to the upside.

See enlarged chart.

Jerome Powell goes to Washington

Last week was Federal Reserve (Fed) Chairman’s biannual meeting with Congress and overall he remained steadfast that the spike in inflation the past three months is indeed transitory. Ryan pointed out this is also our base case as well, that inflation will be higher, but we don’t see runaway 1970s style inflation. Jeff then noted that the majority of the jump in prices can be found in areas like new cars, used cars, airfare, and hotels. In other words, these areas are all about the reopening and the other parts of the economy are seeing prices remain more tame.

The start of something more?

Ryan and Jeff end the conversation discussing Monday’s big market drop. Ryan noted after a 90% rally, some type of pullback would be perfectly normal. Also, we aren’t quite seeing the amount of breadth we saw last year and earlier this year, so this is indeed a potential warning sign of a well-deserved break. Jeff pointed out that the S&P 500 hasn’t had a 5% correction since October, which is a very long time. In fact, you tend to see three separate 5% corrections a year on average, so to not have one the full first half of this year only increases the odds of a 5% pullback in our views.

Tune In Now

Listen to the entire podcast to get the LPL strategists’ views and insights on current market trends in the US and global economies. To listen to previous podcasts go to Market Signals podcast. You can subscribe to Market Signals on iTunesGoogle Podcasts, or Spotify and find us on the LPL Research YouTube channel.

You can watch the full video below and directly on our YouTube channel. Please be sure to subscribe to the LPL Research YouTube channel so you don’t miss anything! Also, if you like our channel, please give us a positive review—it helps more than you know!

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.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

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

U.S. Housing Starts Continue to Ramp Up

Economic Blog Posted by lplresearch

Thursday, July 22, 2021

In data we received on Tuesday, July 20, U.S. Housing Starts increased 6.3% in June to 1.64 million units, a 3-month high. By region, housing starts rose in the South and West, and in the Northeast, single-family home construction soared more than 34% from the prior month. The data suggested residential construction continued its sharp post-COVID rebound despite the difficulties builders are having in finding labor and materials.

As seen in the LPL chart of the day, Housing Starts are now hovering in the same territory as the highs reached prior to the Great Recession; an economic instance spurred by excess housing activity and high home prices. While recent housing activity has been decidedly robust, efforts to ramp up supply have still not offset demand. The chart illustrates that the Months’ Supply of Home inventory continues to dwindle (only 2.5 months of inventory as of May).  This has kept upward pressure on housing prices and reduced housing affordability.

“U.S. residential construction activity continues to be robust, but builders, faced with labor shortages and high materials costs, can’t seem to catch up with demand. The supply of home inventory continues to shrink suggesting today’s U.S. housing market may be even tighter than prior to the Great Recession,” explained LPL Financial Director of Research Marc Zabicki.

We believe the tight supply condition is not expected to dissipate anytime soon. Why? A key reason is that home building activity may be showing signs of slowing. Building Permits, a proxy for future housing construction (also released on Tuesday), fell 5.1% in June which followed a 2.9% drop in May. That’s the lowest permit activity since October 2020 and it suggests a more moderate pace of homebuilding in coming months. High materials costs and shortages of land and labor are stifling efforts to ramp up supply to meet demand.

See enlarged chart.

Should current conditions persist, we believe high housing prices could begin to negatively impact consumer spending and become a net drag on economic growth in the coming quarters.  We believe high prices may lead to higher mortgage payments and higher rental cost.  According to the S&P CoreLogic Case Shiller Home Price Index, house prices rose 14.9% year-over-year in April (the latest data available). This same index has risen by double-digit percentages since December, a pace that is likely not sustainable for long.

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 data from Bloomberg.

This Research material was prepared by LPL Financial, LLC.

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

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

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

Is It Time For A 5% Pullback?

Market Blog Posted by lplresearch

Wednesday, July 21, 2021

Monday’s big down day was a harsh reminder of how markets actually can produce volatility. It was the worst day of the year for the Dow and only the second drop of 1% or more for the S&P 500 Index in just over two months.

As we noted recently in Three Things That Worry Us, there are many reasons to think that after more than a 90% rally (and virtually a double on a total return basis), the S&P 500 could finally be ready for a break. From less stocks participating, to weak seasonality, to a lack of bears, to typical choppiness during year two of a bull market, the summer months could be ripe for an eventual pullback (down 5-9%) or even a 10% correction.

See enlarged chart.

“The truth is investors have been very spoiled by the recent stock market performance,” explained LPL Financial Chief Market Strategist Ryan Detrick. “Incredibly, we haven’t seen as much as a 5% pullback since October. Although we firmly think this bull market is alive and well, let’s not fool ourselves into thinking trees grow forever. Risk is no doubt increasing as we head into the troublesome August and September months.”

As shown in the LPL Chart of the Day, the average year sees three separate 5% or more pullbacks for the S&P 500 with not a single one happening yet in 2021. This doesn’t mean a 5% correction is directly around the corner, but note that most stocks are actually already down as much as 10% off their recent highs, suggesting the internals of the market are a tad weak and risk is higher than normal.

See enlarged chart.

Looking at 10% corrections, the S&P 500 has averaged exactly one a year since 1950. Of course, with the historic volatility last year we saw four separate 10% corrections, though there hasn’t been a 10% correction since March 2020. Again, this could be getting long in the tooth after the 90% plus rally from the lows.

See enlarged chart.

Overall, worries over inflation, yields, the Delta COVID-19 variant, peaking economic data, or something else will get the headlines for any market weakness. We know that year two of bull markets can be choppy and frustrating, but the truth is earnings remain extremely strong, justifying stocks at current levels. It is just that sometimes stocks need to catch their breath, and we wouldn’t be surprised at all if that happened over the coming months.

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

The Recession Is Over, So What Happens Next?

Market Blog Posted by lplresearch

Tuesday, July 20, 2021

The National Bureau of Economic Research (NBER) announced yesterday that the COVID-19 recession is over. If things don’t feel all that different, it’s because they announced the recession ended in April 2020. Yes, that’s last year. We are now in the 15th month of the new expansion. This delay is perfectly normal. NBER doesn’t change a recession call once it’s made, so they need to have a high degree of confidence in the supporting data. Waiting until 15 months after the recession is over is actually the average since they started making recession calls in real time in the 1970s.

“Stock markets gave us an early signal on the end of the recession back in March 2020,” said LPL Research Chief Market Strategist Ryan Detrick. “The S&P 500 tends to bottom before a recession ends and it did this time as well, despite the narrow window of the shortest recession ever. It just took a while for the economic data to catch up.”

As shown in the LPL Chart of the Day, the recession lasted only two months, the shortest on record, but also one of the steepest, the economy contracting more in just two months than any other recession back to 1948.

See enlarged chart.

So what happens now?

Based on history, we are likely in for several more years of economic expansion. Expansions are on no particular timetable but the average length of an expansion does tell us something about how long it usually takes for the kind of economic excesses to build up that usually cause recessions. While post-World War II expansions have lasted as little as 12 months, the average is more than five years and the last four expansions have averaged over eight years.

See enlarged chart.

Absent an unexpected shock, we would not be on the lookout for a recession until the Federal Reserve (Fed) raises its policy rate several times. Recessions are usually accompanied by an inverted yield curve, where short-term interests are higher than long-term rates, not the normal situation. Since the Fed has a lot of influence over short-term interest rates, they often play some role in the yield curve inverting. The Fed usually won’t start to raise rates until the economy starts to strengthen and will continue to raise rates as it heats up. Raising rates several times is a signal that excesses have started to build that make the economy more vulnerable to a recession. Raising rates also adds to that vulnerability by pushing up short-term borrowing costs.

While rate hike expectations have come forward, they still put a recession several years away. In the Fed policy committee’s latest economic projections, the consensus view was for no rate hikes in 2021 or 2022, and two rate hikes in 2023. While those projections will change based on what’s actually happening in the economy, if it held true it likely would not be enough to signal increased danger of a recession.

But just because we don’t see a recession on the horizon does not mean it’s an all clear for markets. As discussed in our Midyear Outlook 2021: Picking Up Speed, we do still view the overall economic backdrop as supportive. But we are also in the second year of a bull market, which tends to be choppier than the first year, although the S&P 500 Index does typically still see gains.

NBER’s announcement is something to celebrate, but it does not signal smooth sailing ahead. Still, most bear markets are associated with recessions, and with plenty of fiscal stimulus still in play, the Fed’s policy rate still near zero, and the labor market continuing to see strong improvement, even if slower than expected, absent a shock we are not expecting a recession any time soon, and that’s usually good news for markets.

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
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A Check-In on Inflation

Economic Blog Posted by lplresearch

Friday, July 16, 2021

This week has provided investors with a fresh batch of data carrying the potential to heavily affect the inflation debate. Tuesday brought us the Consumer Price Index (CPI) for June, while Wednesday saw the release of the Producer Price Index (PPI) for June as well as the start of Federal Reserve (Fed) Chair Jerome Powell’s two-day testimony to Congress providing an update on the economy.

So has any of this materially changed our view (or the Fed’s) on the great inflation debate? Not really.

This may surprise some given CPI’s and PPI’s large beats relative to expectations, but at least for the next few months we believe that the composition of the inflationary increases is more important than the headline numbers. Headline CPI jumped 0.9% month over month vs. estimates of 0.5%, while core CPI jumped 0.9% month over month vs. estimates of 0.4%. Base effects from rolling off weak numbers a year earlier meant the year-over-year numbers were even more eye-popping. Meanwhile, headline and core PPI both rose 1.0% month over month vs. expectations for 0.5%. Under the hood, though, the theme of both reports is quicker-than-anticipated reopenings are stretching supply chains. The good news there is that those supply chain dynamics have the potential to improve quickly to meet demand and mitigate the lasting effects.

This is especially true in the auto, travel, hospitality, and food industries. Semiconductor shortages, which are already showing signs of subsiding, are driving shortages in both the new and used car marketplaces. As rental car companies increase their fleets to meet demand, they are increasingly being forced to bid up a limited amount of existing supply. Similarly, labor supply shortages in the leisure and hospitality sector, as well as airline travel, are restricting supply and causing prices to skyrocket. These components all tend to be relatively small parts of the overall CPI basket, but at the moment they are driving an outsized degree of the volatility.

All of these phenomena can be described as supply chain bottlenecks, which should eventually resolve themselves. For example, the elimination of supplemental unemployment benefits in September should help increase the supply of labor. Rent prices, though, have a greater impact on overall CPI as they account for 41% of the basket, and increases tend to have greater staying power. While they have risen slightly, they are still under control by historical standards, and play a major part in informing our view that inflation will eventually prove to be transitory.

Fed Chair Powell’s testimony did not break any new ground on the debate either. While the market did perk its ears up when Powell mentioned that the committee is in “active consideration” over when to begin tapering asset purchases, his characterization of inflation as being mainly transitory and affected by supply chain bottlenecks remained steadfast.

“The composition of recent data suggests that inflation will largely prove transitory as the Fed has stated,” said LPL Financial Chief Market Strategist Ryan Detrick. “Just how long ‘transitory’ will prove to be is the big question. We are in the middle of the season when we expected to see some hot prints, so this week has not necessarily been a surprise. But with each passing report market participants will be increasingly anxious to see those numbers start to moderate.”

What is market pricing telling us about inflation? As seen in the LPL Chart of the Day, the market seems to be largely buying into the Fed’s narrative of transitory elevated inflation so far.

View enlarged chart.

Breakeven inflation rates, market-based measures of inflation expectations over given timeframes, rose steadily until roughly the release of the April CPI report when we started hearing about peak inflation concerns. Though that report beat consensus estimates, the subsequent drop in both 5- and 10-year breakevens suggests the market accepted the Fed’s characterization of inflation as transitory.

And while the levels of these series can be volatile, we believe the divergence that began around the New Year is telling. 5-year breakevens began outpacing 10-year breakevens, suggesting that inflation may run hotter in the near-to-intermediate term, but that the market still has faith in the Fed to keep long-term inflation under control. 5-years making a new local high in the last week without 10-years following suit suggests that while the market is slightly concerned that transitory may prove to be longer than originally thought, it does not believe it will cause concerns on a longer horizon.

Rents and wages continue to be areas we monitor as tells on whether inflation may be “stickier” than the market anticipates. Our next good look into wage pressure comes on July 30 when we will receive the second quarter Employment Cost Index (ECI) from the Bureau of Labor Statistics. This report is important because it keeps the jobs mix it looks at constant. If there is wage pressure it may not show up in average earnings data if the job mix is shifting to lower wage jobs, as we likely have now, but the ECI would capture it.

For further analysis on our outlook for the economy and financial markets, please check out our Midyear Outlook 2021: Picking Up Speed.

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.

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.

If your representative is located at a bank or credit union, please note that the bank/credit union is not registered as a broker-dealer or investment advisor. Registered representatives of LPL may also be employees of the bank/credit union.

These products and services are being offered through LPL or its affiliates, which are separate entities from, and not affiliates of, the bank/credit union. Securities and insurance offered through LPL or its affiliates are:

  • 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

Main Street Sentiment Remains Strong Despite Risks from Speedy Recovery

Economic Blog Posted by lplresearch

Friday, July 16, 2021

Sentiment on Main Street remains strong as the U.S. economy continues to move towards normalcy, but concerns about the impact of a strong but uneven recovery are rising as higher prices, supply chain bottlenecks, and trouble finding qualified workers weigh on businesses’ ability to expand.

As shown in the LPL Chart of the Day, Main Street sentiment is at its second highest level in over a decade according to LPL Research’s proprietary Beige Book Barometer (BBB), topped only by the June 2021 BBB reading. The result is based on our analysis of the Federal Reserve’s (Fed) Beige Book, a publication released two weeks before each Fed policy meeting that captures qualitative observations made by community bankers and business owners—what we like to think of as “Main Street” rather than “Wall Street.” The BBB gauges sentiment by looking at how frequently key words and phrases appear in the text.

In the most recent Beige Book, “strong” words had declined slightly while “weak” words fell to their lowest level since the BBB’s inception in 2005. However, expressions of uncertainty had increased and the report did note broad-based pricing pressures. Our sub-index of inflation-related words in the Beige Book remained at its highest level since we created the inflation sub-index in 2015.

“The economy is picking up speed but has not yet returned to pre-pandemic levels,” said LPL Financial Chief Market Strategist Ryan Detrick. “We expect the return to normalcy to continue to support economic growth, but the speed of the recovery also comes with some hazards.” (For more on LPL Research’s economic outlook and its potential impact on markets, see its recently released Midyear Outlook 2021: Picking Up Speed ).

See enlarged chart.

Mentions of COVID-related words (virus, COVID, pandemic) continued to fall in the most recent Beige Book, as they have in every Beige Book since January, even falling below the level of their initial appearance in March 2020. More concerning, in addition to the persistence of inflation-related words, supply chains also received frequent mention and mentions of shortages remained elevated. The downside of the economy’s rapid acceleration has been a mismatch between demand, which can ramp up quickly, and supply, which comes on line more slowly, while labor markets have also been slow to keep pace with reopening.

Nevertheless, the fundamental backdrop for the economy remains positive. Upside risks from inflation and disruptions from the Delta COVID variant are on-going risks, but we continue to expect inflation to start to subside as the economy normalizes. Global vaccine distribution will help limit the impact of the Delta variant, although it has led to some new restrictions. US economic acceleration will probably peak in the second quarter, but there’s still plenty of scope for growth to moderate and still remain above average. Much of the positive news is already priced in for equity markets, which are forward looking, and gains may not come as easily, but we still see solid potential for upside as the economy continues to rebound and potentially gains additional support from an improving global economy.

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