A lot has changed in the past few weeks, both in terms of expectations for interest rates and lost confidence in the health of the banking system as a result of the sharp rise in interest rates that has led to some things “breaking,” as we wrote about here last week. Here we share some thoughts on who’s to blame for the ongoing banking crisis and reiterate how we are telling investors to adjust, or not adjust, their asset allocations in light of ongoing market volatility.  

Markets On Alert

It’s difficult to grasp that just a few weeks ago, the fed funds futures market had priced the terminal rate at nearly 6%. The market’s hawkish outlook was predicated on the Federal Reserve (Fed) raising rates amid a still solid economy underpinned by a tight labor market and consumer spending, but with inflation still above the 2% level that reflects price stability.

Now, with continued pressure on both domestic and global banks, markets are expecting the Fed will be forced to cut rates towards the end of this year as loan growth slows and businesses, particularly small businesses, and consumers find it more difficult to secure loans. As a result, the broader economy is expected to be negatively affected.

The rapid collapse of Silicon Valley Bank (SVB), followed by continued pressure on regional banks, along with headlines surrounding the struggle to shore up confidence in First Republic Bank (FRC), has the market on alert for other potentially vulnerable banks. The banking stress of the past couple of weeks has put some heavy pressure on the bank-heavy small cap Russell 2000 Index (Figure 1).

chart 1

The swift crash of Signature Bank, the third largest bank failure in U.S. history, following the demise of SVB, which held $160 billion in deposits, along with Silvergate Bank, has investors and depositors questioning if the banking system is as “sound and resilient with strong capital and liquidity” as suggested recently by both Fed Chair Jerome Powell and Secretary of the Treasury Janet Yellen.

To be sure, the Fed’s emergency bank lending facility, the Bank Term Funding Program, which was quickly put in place to help strengthen the banks, also served to restore confidence as banks grapple with depositors who are seeking higher rates elsewhere, and who are also increasingly concerned about the viability of the banks themselves.

Finger pointing: Who’s to blame?

No sooner had news regarding the run on SVB hit the media, generalized fear and panic spread quickly. Depositors mounted a modern-day run on the bank using their smart phones, and over the course of 36 hours, the bank was forced to sell $21 billion of long duration bonds at a loss of $1.8 billion.

The blame was quickly focused on venture capitalists who sent out immediate warnings to their start-up companies to withdraw their funds at once. SVB’s large client base was broadly made up of fledgling technology companies backed by venture capital. It didn’t take long for depositors to exit.

A widely followed newsletter that covers the venture capital world, “The Diff,” has also been considered the spark that led to the mass exodus of deposits, when in late February the report indicated that SVB’s debt-to-asset ratio was 185 to 1, implying that the bank was virtually insolvent. The underlying culture of the tech world has also come under scrutiny as to how rapidly conclusions were drawn and how instantaneously they were acted upon.

Mismanagement and regulatory failures

The deficit of a functioning risk management team has been the most enduring criticism of SVB, while criticism has similarly been leveled at the supervisory team at the San Francisco Fed, which is supposed to monitor the operations of the banks within its regulatory jurisdiction. The lack of communication from the bank’s senior leadership didn’t help matters.

Silvergate Bank, with $12 billion in deposits, is most closely associated with crypto activities, but suffered a swift run on its holdings around the same time as the SVB failure. Despite early warnings of fragility in the wider crypto world, and with risks climbing, there was apparently, according to media reports, little contact with supervisors from the San Francisco Fed.

At the Federal Open Market Committee (FOMC) meeting press conference on March 22, Powell addressed criticism that there wasn’t any supervision of operations at SVB. He stressed that there were red flags raised months ago by examiners from the San Francisco Fed, but he couldn’t say whether the warnings were escalated. “We’re doing the review of supervision and regulation,” Powell said, and “My only interest is that we identify what went wrong here.”

Senator Elizabeth Warren, the leading Democrat on the Senate Banking Committee, blamed Powell for the banking crisis in no uncertain terms, saying that he was an integral part of the process that weakened regulatory oversight of regional banks, “Fed Chair Powell’s actions contributed to these bank failures.”

Monetary and fiscal policy

Moving up the blame chain leads directly to the monetary and fiscal policies that flooded the banking system with government transfers to consumers and small businesses, coupled with interest rates that stayed near zero for too long, which allowed risk to intensify across the investing spectrum.

With the Fed’s insistence that the inflationary effect was “transitory” and primarily due to COVID-19-related supply chain challenges, the central bank was slow to begin raising interest rates. With financial conditions remaining loose, risk taking was elevated in venture capital, private equity, and real estate, especially commercial real estate. But as the Fed finally launched its aggressive rate hiking campaign, the dynamic changed.

The collapse of SVB, followed by the other banks that were victims of the immediate panic that ensued, is emblematic of the changing landscape. When all is said and done, the blame falls on all of the above for failing to recognize the risks associated with policies that allowed risk taking but then quickly turned off the spigots.

Asset Allocation Views

In the current environment of elevated volatility and concerns about banks, LPL Research believes tactical investors should still maintain multi-asset allocations at or near benchmark levels with an emphasis on diversification.

Within fixed income, LPL Research continues to like the preferred sector to take advantage of attractive valuations with less risk than equities.

Within equities, the technology sector looks better to us here, which, along with the Strategic and Tactical Asset Allocation Committee’s (STAAC) recent decision to downgrade healthcare to neutral, suggests limiting the size of any style tilts toward value. The Committee continues to take a wait and see approach on the banks while closely watching the latest developments. Finally, precious metals-related investments warrant consideration on the long side, in our view.

Quincy Krosby, PhD, Chief Global Strategist, LPL Financial

Jeffrey Buchbinder, CFA, Chief Equity Strategist, LPL Financial

The Federal Reserve (Fed) has a history of raising short-term interest rates until something “breaks.” Considering the Fed has raised rates from a near-zero level to 4.75% (upper bound) over the course of only one year, it was almost a near certainty this time would be no different. Recent bank failures suggest things are indeed starting to break. However, we don’t think we’re on the brink of a full-blown crisis, as market indicators we follow suggest contagion risks are still currently low. And while we don’t think a full-blown crisis is imminent, financial stability risks have clearly increased, which makes a prudent asset allocation plan a must.  


The aftermath of the Silicon Valley Bank (SVB) and other bank failures in the U.S. rippled into Europe last week as Credit Suisse’s (CS) troubles moved firmly into the spotlight. The Swiss bank’s shares slid to an all-time low on Wednesday after the Saudi National Bank (which owns almost 10% of CS) stated it would not provide additional financial support after CS earlier acknowledged “material weakness” in its financial reporting. This followed a series of missteps and compliance issues that have hindered the bank’s global standing in recent years.

Then, on Thursday, the Swiss National Bank (SNB) issued a note aiming to regain confidence in CS, saying they “will provide liquidity to the global active bank if necessary”. Hours later CS announced it had taken the SNB up on this offer and would borrow up to $54 billion (50 billion Swiss Francs) in what the bank called a “decisive action to pre-emptively strengthen its liquidity.” After a week of such high drama, which culminated in UBS’ takeover of Credit Suisse over the weekend, we look at a few key indicators to gauge how various market indicators we watch are reacting to the turmoil in the banking sector.

The word at a the top of everyone’s mind at the moment is “contagion”: Will the troubles at SVB, CS, and others spread to the wider banking sector and lead to a 2008-like banking crisis? Credit Default Swaps (CDS), a derivative financial instrument that market participants can use to insure against default, on European banks so far don’t seem to be indicating contagion in the European banking sector (Figure 1). Prior to the UBS tie-up, the CDS on CS may have reached deep distressed levels not seen at a major global bank since the financial crisis, but European bank sector CDS are still below levels seen as recently as fall 2022. 

chart 1

Back to domestic equity markets, the CBOE (Chicago Board Options Exchange) Volatility Index, commonly referred to as the VIX, is sometimes known as the “fear gauge”. Based on the VIX, the response to banking troubles from equity markets has been fairly subdued and certainly hasn’t indicated a wider panic is taking hold in the markets. The VIX is near 25, up around 6 points, or 30%, since the middle of last week, but this level only places it in the top 39% of readings over the last year (although the last year has been abnormally volatile and over the last 10 years the current reading would be in the top 13%) (Figure 2).

A market sentiment indicator we watch to assess stock selling pressure is the New York Stock Exchange (NYSE) Short Term Trading Index (TRIN), also known as the ARMS index. It is a technical indicator that measures the velocity of trading by looking at advancing/declining volumes and advancing/declining stocks. A TRIN score above 2 can be interpreted as a signal that the velocity of selling is at an extreme, while around 1 is considered neutral. The velocity of selling did spike on Thursday last week, indicating some panic sellers, but since then the TRIN has been at very average levels (Figure 3).

chart 3

A more extreme signal is coming from the bond markets where the MOVE Index (Merrill Lynch Option Volatility Estimate) is hitting levels not seen since 2008. The MOVE Index tracks the expected volatility of U.S. Treasury yields implied by option prices (much like the VIX does for equities). Generally, the MOVE and VIX tend to be correlated but do diverge significantly at times, as they are now.

Volatility in Treasuries has been rising since the start of 2021 when the bond markets started sniffing out that the Fed may need to take action to tackle rising inflation and has been extremely elevated since the start of 2022. What was already an important rate decision this week has taken on epic proportions since the banking turmoil. Fed Chair Jerome Powell seemed to have opened the door to a 50 basis point (0.5%) hike during his congressional testimony (pre-SVB) and now he is caught in a tough spot between sticking with even a 25 basis point (0.25%) hike or pausing and not hiking at all to help ease stress on the banks. All of this uncertainty has sent the MOVE index skyrocketing (Figure 4).

chart 4

Other Financial Indicators

The financial indicators listed above are just some of the metrics we use to measure financial market stress. Other, more traditional metrics, such as U.S. high yield corporate credit spreads and the health of the short-term funding markets, also suggest the recent banking challenges are contained. Certainly, this is a highly fluid situation, and we know confidence in the banking system is key in preventing these isolated events from turning into something more systemic, but from our seats, we do not think a banking crisis is imminent.

Asst Allocation Views

It’s easy to forget about long-term investment objectives when markets are fluctuating widely, but it is those moments when sticking to a well thought out plan is most critical. It’s also a reminder why a diversified asset allocation plan is important.

In response to ongoing market volatility, we would consider adding preferred securities exposure to fixed income allocations. At this point, we are taking a wait and see approach on the banks while closely watching the latest developments. The technology sector looks better to us here, while precious metals warrant consideration on the long side.

Our updated thoughts on asset allocation are outlined below.

Equities vs. Fixed Income. LPL Research’s Strategic and Tactical Asset Allocation Committee (STAAC) remains slightly overweight equities after the Committee reduced its suggested equity exposure and moved higher in quality in fixed income about three weeks ago. While we believe investors should react to recent developments in the banking sector with some caution due to ongoing risk of deposit flight, the backstops provided by central banks and bank regulators over the past week have given us confidence the crisis will be contained. But sentiment remains fragile and technical indicators we follow suggest some caution is prudent.

Value vs. Growth. The recent dip in interest rates and our technical analysis work suggest it makes sense to shift some toward growth and get closer to neutral despite above-average valuation discounts on the value side. The Committee now recommends benchmark technology sector exposure.

Small Caps vs. Large Caps. The near-term outlook for small cap stocks is challenged given larger financial sector weights, but the asset class offers compelling valuations, in our view, to support attractive returns over the next 9 to 12 months—our targeted tactical asset allocation time horizon.

Developed International vs. Emerging Markets. European bank stress and a potential flight-to-safety rally in the U.S. dollar create near-term headwinds for developed international equities. The STAAC remains comfortable with its neutral stance, its underweight position in emerging markets equities, and slight overweight for U.S.

Financials Sector. The ongoing fragility of the banking system, coupled with the negative impact on bank profits from these recent events, leaves us neutral on financials for now with a strong preference for high quality. Fundamentals and valuations suggest the insurance industry looks ripe for opportunities.

Commodities. We consider precious metals an attractive opportunity, particularly gold, in this macro environment. Rising recession risks have weighed more heavily on industrial metals and energy, offsetting catalysts from China’s ongoing economic reopening. The technical setup for West Texas Intermediate (WTI) has deteriorated, and we are waiting for more evidence of price stability before making a bullish call on oil.  

Fixed Income Positioning. On the fixed income side, the Committee continues to believe a mostly up-in-quality approach makes sense. Core bond sectors (U.S. Treasuries, Agency mortgage-backed securities [MBS], investment grade corporates) offer income potential and provide diversification to equity market stresses. Preferred securities are the only “plus” sector we believe is worth a small allocation due to valuation discounts offered by the ongoing bank health concerns. The STAAC continues to view high-quality core bonds as good diversifiers offering attractive yields in the current environment.

Bottom line, we believe tactical investors should be maintaining their multi-asset allocations at or near benchmark levels with an emphasis on diversification. We continue to monitor bank industry and macro conditions and will communicate any changes to our tactical views as they occur.

George Smith, CFA, Portfolio Strategist, LPL Financial

Jeffrey Buchbinder, CFA, Chief Equity Strategist, LPL Financial

Lawrence Gillum, CFA, Fixed Income Strategist, LPL Financial

Last week did not play out how we anticipated. Coming into the week, it was all about Federal Reserve (Fed) Chair Jerome Powell’s congressional testimony and the February jobs report. Instead, we got a shockingly fast collapse of a financial institution with over $200 billion in assets, which turned the market’s focus toward the stability of the banking system and what systemic risks banks might be facing. This commentary is focused on our asset allocation views, but no doubt the Silicon Valley Bank saga will require more attention from investors in the days ahead.

Maintaining Recommended Equity Allocations Despite Latest Developments

A tough environment for asset allocators just got tougher with the events of the past few days. For the “no landing” crowd thinking strong consumer spending and low unemployment would keep this economy growing until the inflation fight is won, they now have to consider signs of stress in the banking system after the failure of SVB Financial (commonly known as Silicon Valley Bank). See the LPL Research blog for our latest thoughts on that situation.  

The stock market bulls also had to absorb hawkish testimony from Fed Chair Powell that led the bond market to increase the chances of a 50 basis point rate hike on March 22 (though those expectations unwound following the SVB news). Add to that a troublesome last round of inflation data and the most inverted yield curve in four decades, based on 2- and 10-year Treasury bonds, and the bulls don’t have the firmest ground to stand on.

But this market has also made it tough for the bears to get it right. The cyclical, so-called “high beta” stocks have been outperforming—the late-week selloff in the banks notwithstanding. Double-digit gains from the October lows were accompanied by strong breadth—a sign of a healthy bull market with a broad range of stocks participating in the rally. Recent economic data has pointed to continued growth—giving rise to the “no landing” narrative. Earnings estimates have held up better than many expected. We’re in a very strong seasonal period for stocks, based on the four-year presidential cycle (year three has an average gain of 16.8%, higher 89% of the time since 1950). Fed pauses—likely coming fairly soon—have historically been followed by double-digit returns one year later, on average.

So the case for gains this year seems strong based on history, enough for the LPL Research Strategic and Tactical Asset Allocation Committee (STAAC) to continue to recommend an overweight equities position. However, the pressure on valuations from higher interest rates, which have made bonds attractive alternatives, led to the Committee’s recent decision to reduce the size of the overweight from 5 points to 3.

Not Enough Evidence to Switch Back to Growth

Growth stocks have come storming back in 2023 after significantly underperforming their value counterparts in 2022. The Russell 1000 Growth Index has returned 4.6% year to date, compared to the 2.3% decline for the value index. The question now is have growth stocks shown enough to reclaim leadership and sustain the outperformance.

Starting with the technical analysis picture, the improving relative strength has pushed the Russell 1000 Growth (RLG)/Russell 1000 Value (RLV) ratio chart back above its declining 200-day moving average. However, technically, the ratio chart has yet to recapture the lower end of its prior range and until that area of overhead resistance is cleared, we believe the sustainability of growth outperformance remains questionable (Figure 1).

chart 1

From a fundamental perspective, the near-term outlook for the value style has gotten much tougher following the banking selloff last week. Financials are the biggest value sector, composing 20% of the Russell 1000 Value Index, compared with just 3% of the Growth Index.

But valuations strongly favor value over growth. Despite the strong 2022 for value in which the Russell 1000 Value Index outperformed the Growth Index by more than 20 percentage points, the Value Index still trades at a 38% discount to growth compared with the respective 10- and 20-year average discounts of 28% and 25%.

Other reasons the STAAC maintains a slight preference for value include the Committee’s favorable view of energy, which is the second biggest value sector, and value’s record of outperformance during rising interest rate and high inflation periods.

Small Cap Valuations Offer Some Cushion for Business Cycle Risks

Small caps would typically not be one that asset allocators would recommend when some of the most prescient leading economic indicators are sending strong recession signals. They tend to do better early in economic cycles once the economy emerges from recession. If the common—though not quite unanimous—view that recession may come in 2023 or early 2024 turns out to be right, then the sweet spot for small caps may be a year or more away.

But small caps have performed relatively well this year, despite the economic uncertainty. The S&P 600 small cap index has returned about 1.5% year to date, while the Russell 2000 Index is up 0.9%, after both lost more than 7.5% last week.

We would cite valuations as the primary reason small caps have held up amid concerns about stress in the banking system (which we do not see as systemic). The small cap indexes carry more financials than large caps, (about 8% more based on the Russell 2000 and S&P 500 indexes) and generally companies’ balance sheets are not as strong.

Small caps look cheap enough to us here to favor despite these risks. As shown in Figure 2, the S&P 600 Small Cap Index trades at a 13.6 price-to-earnings ratio (P/E), well below its 10-year average at 17.2. For comparison, the S&P 500 Index trades at a 17.2 P/E, right in line with its 10-year average.

The technical setup for large caps versus small caps, based on the ratio chart for the S&P indexes, remains in a downtrend and below its declining 200-day moving average, implying the trend still favors small cap outperformance ahead.

Developed International A Worthy Alternative to The United States

LPL Research’s outlook for developed international equities has improved in recent months. Based on the combination of improving technical analysis trends, attractive valuations, and resilient performance by European economies thanks to falling energy prices, the STAAC’s allocation to international has been increased to near that of U.S. equities. Specifically, the Committee recommends a neutral allocation to international and a 3-4% overweight to U.S. equities.

The earnings growth picture suggests a similar outlook for developed international and U.S. equities, as shown in Figure 3. These are just estimates, but consensus currently reflects 1.8% growth in earnings for the S&P 500 and MSCI EAFE indexes. The outlier is emerging markets (EM)—the MSCI EM Index is expected to see a 3.4% decline in earnings in 2023.

chart 3

Not only is EM expected to see earnings fall this year, the momentum in those estimates is clearly negative (Figure 4). The U.S. earnings estimate trend is starting to inch higher, recent strength in international estimates has begun to roll over, and EM estimates have drifted lower over most of the past year. These earnings trends generally match our views on these three regions. Ongoing U.S.-China tensions and regulatory uncertainty add to our EM concerns.

chart 4

From a technical perspective, international developed continues to outperform U.S. equity markets. The MSCI EAFE Index vs S&P 500 ratio chart has been climbing higher since October, with no signs of a trend change on the horizon. Emerging markets are beginning to look more constructive on a technical basis; however, there is insufficient technical evidence to make the call for a trend change at this time. Based on this backdrop, we prefer international developed markets over emerging markets. The STAAC’s next move is more likely to be upping developed international equities rather than emerging markets.


In conclusion, LPL Research maintains a slight preference for equities over fixed income, value over growth, small caps over large caps, and U.S. and developed international over emerging markets. The STAAC continues to watch for more clarity as to how long the inflation problem will persist, how far the Fed will have to go to tame it, and whether the U.S. economy can prove its skeptics wrong, muddle through, and avoid a recession. The failure of Silicon Valley Bank doesn’t make the road ahead for the economy any easier, but it may offer a silver lining for markets by slowing the Fed down.

Jeffrey Buchbinder, CFA, Chief Equity Strategist, LPL Financial

Adam Turnquist, CMT, Chief Technical Strategist, LPL Financial

Suggesting an economy makes “no landing” makes no sense. Analogies eventually break down, especially this one. Economic activity does not stop like an airplane eventually does, but rather the economy will settle into a steady state where growth is consistent with factors such as population and productivity. Here we take a look at some factors that illustrate how the economy is struggling to find a stable growth path.

Why the “Landing” Analogy?

We need to go back a few years to recall when investors began using the “landing” analogy. During the hot summer of the mid-1990s, the Honorable Alan Greenspan spoke to the Economic Club of New York, where he was introduced as “the pilot we are all counting on for that very smooth and we hope very soft landing.”

Perhaps that was not the first time market watchers used the term, but the conversations at the Economic Club of New York were prescient. The hope for a soft landing came to fruition. The economy started overheating in 1994, so the former chairman of the Federal Reserve (Fed) raised rates, cooled the overheated economy, and the country escaped a second recession that decade (Figure 1).

chart 1

What is A Soft or Hard Landing?

A soft landing is when economic growth slows but remains positive as the economy sets up for a long-term sustainable growth path. In contrast, a hard landing means the country falls into recession to break the overheated economic machine. One assumption behind the analogy is an overheated economy is not on a sustainable growth path, so policy makers ought to tighten financial conditions to improve the economy’s chances of reaching a stable growth rate.

Why A “No Landing” Makes No Sense

Suggesting an economy makes “no landing” makes no sense. Analogies eventually break down, especially this one. Economic activity does not stop like an airplane eventually does, but rather the economy will settle into a steady state where growth is consistent with factors such as population and productivity.

So perhaps it’s time to rethink the use of the “landing” analogy and use one related to that of a runner. Runners often talk about the various phases of the race. One important phase is when runners transition from the acceleration phase, when they focus on increasing stride length and frequency, to a steady state, when runners focus on maintaining stride length and frequency over time. Central bankers are looking for ways to get the economy “hitting its stride” with a consistent, sustainable growth path and stable prices.

Factors Keeping the Economy Off-Stride

The conundrum is investors are regularly receiving a mix of both good and bad news. One example is the slow recalibration of goods and services spending. During those early years of the pandemic, consumers reallocated more on goods and less on services. The return to “normal” has been slow as the share of services spending is still roughly 2.5 percentage points below pre-pandemic share as of the latest report (Figure 2).

Investors should take note on the composition of spending to understand the underlying inflationary trends. This differential means consumers could allocate roughly $450 billion in services as the composition of spending normalizes throughout the year. Investors and policy makers must accept that inflation metrics will be skewed until consumers recalibrate their composition of spending. Watch for renewed demand for health care, communication services, retail, and financial services.

Another conundrum is the divergence of construction activity between single-family versus multi-family dwellings, but growing multi-family construction activity is clearly a good sign for renters in this country (Figure 3).

chart 3

The growth in condo and apartment construction means the supply of multi-family units will increase this year as more projects come to market. New multi-family projects will likely dampen rents as more properties come online, so we should expect rent prices to decline this year as supply of units grows. Industry data already show declining rent prices, so it’s just a matter of time before the official government statistics reflect that easing. Investors and policy makers alike should expect a softening in housing-related inflation in the coming months.

What Does This Mean For You?

The Fed wants to tighten financial conditions so the economy can smoothly transition from the post-pandemic reopening phase—when the economy grew 5.9% in 2021 and 2.1% in 2022—to a more sustainable rate that neither stokes inflation nor stalls economic growth.

If the economy can break the back of inflation without a deep and prolonged recession, investors will likely experience markets that could return to lower volatility and improved conditions for both bond and equity investors. We think the economy will eventually hit its stride, notwithstanding unforeseen global shocks. Hitting that stride may not come until the Fed’s rate hiking campaign is closer to its end, but we expect stock investors to benefit once it does.

Higher interest rates are challenging stock valuations and perhaps pushing the gains further out in 2023, but we still see solid potential for double-digit returns for stocks this year. The LPL Research Strategic and Tactical Asset Allocation Committee (STAAC) recommends a slight overweight allocation to equities, favors value over growth, small caps over large caps, and the energy, healthcare, and industrials sectors.

Jeffrey Roach, PhD, Chief Economist, LPL Financial

While concerns about the debt ceiling have been increasing, markets, businesses, and the economy are likely to see only minimal impact until we are days, or maybe a few weeks, from the “x date,” the date on which the federal government will no longer be able to meet all its obligations, likely in the summer or early fall. We continue to believe the chances that Congress will fail to raise the debt ceiling before the x date remain extremely low, but current political dynamics have likely increased the risk and there are some negative consequences to even an eleventh-hour agreement, as we saw in 2011.

Debt ceiling drama is once again increasing, but the build-up will be slow. The Department of the Treasury (Treasury) has been using “extraordinary measures” to cover debt payments since January 19, but that has not been an unusual course of action and does not impact the government’s ability to function smoothly. Markets, businesses, and the economy are likely to see only minimal impact from the debt ceiling debate until we are days, or maybe a few weeks, from the “x date,” the date on which the federal government will no longer be able to meet all its obligations. That date will likely be in the summer or early fall, depending on tax receipts and other factors.

We continue to believe the likelihood the debt ceiling won’t be raised in time remains extremely low. Nevertheless, uncertainty about whether it will be raised can have its cost. We believe those costs are currently near negligible and will build slowly. Risks will increase more quickly if we are several weeks away from the x date and still appear to be at a deep political impasse. The mere appearance of Democrats and Republicans playing politics near the deadline can weigh on markets and force businesses to start preparing for the very unlikely, but still possible, outcome of a government default. The current political dynamics, with a split Congress and a thin majority in both the House and Senate, have likely increased the overall risk and there are some negative consequences to even an eleventh-hour agreement, as we saw in 2011.

U.S. Debt Ceiling Questions Answered

1. What is the debt ceiling?

The debt ceiling is the limit on how much the federal government can borrow. Unlike every other democratic country (except Denmark), a limit on borrowing is set by statute in the U.S., which means Congress must raise the debt ceiling for additional borrowing to take place.

2. Why does the U.S. do it differently?

The debt ceiling was originally created to make borrowing easier by unifying a sprawling process for issuing debt to help fund U.S. participation in World War I. The process was further streamlined to help fund participation in World War II, creating the debt ceiling process that is in use today. According to the Constitution, Congress is responsible for authorizing debt issuance, but there are many potential mechanisms that could make the process smoother.

3. Why is it important to raise the debt ceiling?

The government uses a combination of revenue, mostly through taxes, and additional borrowing to pay its current bills—including Social Security, Medicare, and military salaries—as well as the interest and principal on outstanding debt. If the debt ceiling isn’t raised, the government will not meet all its current obligations and could default.

4. Has Congress always raised the debt ceiling?

Yes, whenever needed. According to the Treasury, since 1960 Congress has raised the debt ceiling in some form 78 times, 49 times under Republican presidents and 29 times under Democratic presidents. As shown in Figure 1, Congress has regularly raised the debt ceiling as needed. In fact, every president since Herbert Hoover has seen the debt ceiling raised or suspended during their administration.

chart 1

5. Is the debt ceiling being raised to cover potential new spending programs?

No. Lifting the debt ceiling does not authorize any new spending. The debt ceiling needs to be raised to meet current obligations already authorized by Congress. Theoretically, not raising the debt ceiling would limit spending in the future, but only by deeply undermining the basic ability of the government to function, including funding the military, mailing out Social Security payments, and making interest and principal payments on its current debt.

While perhaps symbolic of excessive spending, the debt ceiling is not the appropriate instrument to limit spending. Spending responsibility sits with Congress and the president, but Democrats and Republicans have both favored deficit-financed spending once in power. Bill Clinton’s presidency, much of it with a Republican Congress, was the only one that saw the publicly held national debt decline since Calvin Coolidge in the 1920s.

6. When was the debt ceiling last raised?

The debt ceiling was last raised in December 2021. No Republicans voted for that increase, but some Republicans did vote to suspend the Senate filibuster so the increase could be passed with a simple majority.

7. If we were at the debt ceiling on January 19 and nothing happened, why is there a problem?

When we hit the debt ceiling, the Treasury is authorized to use “extraordinary measures” that allow the government to continue to temporarily meet its obligations, including suspending Treasury reinvestment in some retirement-related funds for government employees. But the additional funding available through these measures is limited.

8. What’s the actual deadline?

The real deadline, also called the “x date” is hard to pinpoint because it depends on revenue and payments that are variable as we approach the date. The level of tax revenue around the federal income tax filing date is particularly important. The window right now is wide, probably summer to early fall, but that does mean there are circumstances where the actual x date could be early summer.

9. Who typically wins debt ceiling battles?

Independent of anyone’s view on the level of government spending, a timely increase in the debt ceiling eliminates the risk of unnecessary turmoil for markets, businesses, and the economy. As for who wins the battle politically, we leave that for voters to decide for themselves.

10. What would the Treasury have to do if Congress failed to act in time?

Without the ability to issue new debt to pay existing claims, the Treasury would have to rely on current cash on hand (and incoming cash) to make its payments. So, the Treasury would be able to make some payments—just not all of them.  As such, the Treasury department would likely have to prioritize its payments. Moreover, the longer the delay in raising/suspending the debt ceiling, the harder it may be for Treasury to make its payments.

In 2011 and again in 2013, Federal Reserve and Treasury officials developed a plan in case the debt ceiling wasn’t addressed in time. At that time, they determined the “best” course of action would be to prioritize debt payments over payments to households, businesses, and state governments. By prioritizing Treasury debt obligations it was assumed the financial repercussions would be minimized. However, given comments by rating agencies (more on this below), there’s no guarantee that prioritizing debt payments would stave off severe, longer-term consequences like a debt downgrade or higher borrowing costs. Nonetheless, in order to adhere to the full faith and credit clause within the Constitution, debt servicing costs would likely be prioritized.

There is the possibility that prioritizing debt service would be challenged in court. Even if there’s a strong case to be made, we think debt service prioritization would be allowed to continue while the case works its way through the courts, since the potential economic damage would be too great otherwise. Even in the very unlikely event that Congress fails to raise the debt ceiling, the political and economic fallout would potentially be so swift that we would expect it to be raised in days rather than weeks or months, making the question of whether debt payments could be prioritized a moot point.

11. U.S. Treasury debt was downgraded in August 2011 because Congress waited until the last minute to raise the debt ceiling. Could we see additional rating changes this time?

In 2011, even though Congress acted before the x date, one of the three main rating agencies, S&P, downgraded U.S. Treasury debt one notch from AAA to AA+. While the other two main rating agencies retained the U.S. AAA rating, they both downgraded the outlook to negative. S&P has maintained that AA+ rating since 2011.

Now, all three rating agencies have publicly stated that they are confident a deal will get done. However, one of the three, Fitch, has threatened to downgrade U.S. debt if the debt ceiling isn’t raised or suspended in time. Further, Fitch has stated that prioritization of debt payments would lead to non-payment or delayed payment of other obligations and “that would not be consistent with an AAA rating.” So even if Treasury made debt payments on time, missing other payments would likely result in a rating downgrade. It is likely other rating agencies would follow suit as well. Another rating downgrade by a major rating agency would likely call into question use of Treasury securities as risk-free assets, which would have major financial implications globally.

12. Could failure to address the debt ceiling push the economy into a recession?

It would depend on how long Treasury would have to prioritize payments. If the delay is only a day or two, then it is unlikely the economy would slow enough to actually enter into a recession. Payments that were deferred would be repaid in arrears so the economic impact would likely be minimal.

However, in the very unlikely event that payment prioritization is necessary over a prolonged period of time—say a month or longer—this could indeed cause economic activity to contract. Since the government is running a fiscal deficit, and since Treasury cannot issue debt to cover that deficit, spending cuts would need to take place. The spending cuts, if prolonged, would likely push the U.S. economy into recession. Moreover, the unknown knock-on effects such as the impact on business confidence would also likely slow economic growth. Since the situation would be unprecedented, it’s very difficult to estimate the impact. Moody’s has said that based on their modeling, “the economic downturn ensuing from a political impasse lasting even a few weeks would be comparable to that suffered during the global financial crisis” (Moody’s Analytics, “Debt Limit Brinksmanship,” 6).

13. How would a technical default impact the financial markets?

In 2011, the S&P 500 fell by over 16% in the span of 21 days due to the debt ceiling debate and subsequent rating downgrade. The equity market ended the year roughly flat so investors who were able to invest after that large drawdown were rewarded. However, that large drawdown was due solely to the policy mistake of not raising the debt ceiling in a timely manner. It’s likely that if Congress were to wait until the last minute in raising/suspending the debt ceiling, equity markets would react similarly.

Perhaps counterintuitively, despite the prospects of delayed payments and the debt downgrade, intermediate and longer-term Treasury yields fell/prices increased as they are generally considered to be a “safe-haven” asset. And while that may have been the market reaction in 2011, there is no guarantee that in the event of a technical default and further rating downgrades Treasury securities would have a positive return this time around, particularly if Treasury securities lose their status as the risk-free rate.


Given the experience from 2011, we think it would be prudent for Congress to raise the debt ceiling reasonably in advance of the date when the government would no longer be able to meet all its obligations. Political brinksmanship with the debt ceiling is a dangerous game, with likely relatively little to gain and much to lose. At the same time, we don’t think that should hinder conversations about controlling spending. The debt ceiling simply isn’t the place for that conversation to take place.

Barry Gilbert, PhD, CFA, Asset Allocation Strategist, LPL Financial

Lawrence Gillum, CFA, Fixed Income Strategist, LPL Financial

Markets have adjusted to several changes this year. The pace at which inflation has cooled is slowing. The market has started to believe the Federal Reserve’s (Fed) “higher for longer” message. The bar for earnings has been lowered. Market relationships to interest rates have been turned upside down. And many of last year’s losers are this year’s winners and vice versa. Here we take a look at some of the biggest changes in the market environment so far in 2023 and what those changes could mean for investors over the balance of the year.

The Fed’s Message Is Getting Through As Markets Recalibrate

Coming into 2023, markets had been pricing in two 25 basis point (0.25%) interest rate hikes, one in February and the second one at the next Fed meeting on March 21-22. In addition, there were expectations of an interest rate cut at the end of the year. All macro-economic indications suggested that with inflationary pressures easing, the Fed would be moving closer to its final “terminal” rate by the second half of the year. The only question was would the Fed stay on hold throughout 2023 before lowering rates in 2024, as suggested by a consensus of Fed members.

However, recent data releases, including the Consumer Price Index (CPI), Producer Price Index (PPI), and retail sales, showed inflation inching higher and a consumer still spending at a healthy pace. Even amid weak housing data for January, homebuilder sentiment improved nicely and exceeded expectations. Factoring in all of the data releases, including disappointing industrial production figures, the Atlanta Fed’s GDPNow real-time tracker of gross domestic product inched higher to a solid 2.5% for the first quarter.

The fed funds futures market quickly adjusted probabilities as well, pricing in a potential third interest rate hike at the Fed’s June meeting. What has caught the market’s attention, however, is the slight probability for a 50 basis point rate hike at the March meeting has been climbing higher, as two non-voting members of the Federal Open Market Committee (FOMC), Loretta Mester and James Bullard, made comments suggesting a 50 basis point rate hike in March may be necessary to help tackle inflation. Markets are listening, which you can clearly see in the change in market-implied Fed rate targets for this year (Figure 1).

chart 1

Important data releases before the March 21-22 meeting will help underpin the Fed’s monetary policy trajectory. The February 24 release of the Fed’s preferred inflation index, the Personal Consumption Expenditures Price Index (PCE), will be especially important in forecasting the Fed’s next policy decision.

Similarly, comments from Fed officials will also help guide markets regarding the Fed’s thinking regarding its rate hike campaign.

Earnings Bar Has Been Lowered Substantially

A difficult fourth quarter earnings season is entering the home stretch, and overall the numbers have been lackluster. S&P 500 earnings per share (EPS) for the quarter are tracking to a roughly 4% year-over-year decline, slightly below estimates at year end. Slower economic growth, cost pressures from higher inflation, and ongoing adjustments from excess pandemic-related spending have combined to create an especially challenging earnings environment. The end result will be the first year-over-year earnings decline since the third quarter of 2020.

Despite lackluster overall results, we see a silver lining amid the sea of red numbers. Earnings estimates for 2023 have been widely considered to be too high based on historical earnings declines in recessions. The consensus estimate for S&P 500 earnings this year has come down 3% since the year began, lowering the bar. Earnings estimates have not collapsed, but corporate America has sure brought expectations down (Figure 2). Cautious guidance has made estimates more realistic.

Chart 2

It’s difficult for stocks to sustain moves higher as estimates are coming down. However, we believe lowering the bar sets up potential gains for stocks later this year as estimates stabilize, or potentially even start moving higher, and earnings growth resumes.

Shifting Relationship Between Stocks and Interest Rates

Much has been written about how the laggards of 2022 have been the winners of 2023. Value stocks held up much better than growth stocks last year, and this year growth is leading. Last year’s worst performing sectors, consumer discretionary, communication services, and technology, are this year’s top performers, each with double-digit year-to-date-percentage gains. At the individual stock level, the reversal is stark. The 50 worst performing stocks of 2022 have gained an average of 21.8% year to date.

Here we focus on the interest rate relationship. Last year, stocks and yields moved mostly in opposite directions. When inflation expectations and interest rates moved higher, stocks tended to sell off and vice versa. But we have seen this relationship change recently, as stocks and yields have risen together. Specifically, since January 25, the 10-year Treasury yield has risen roughly 50 basis points while the S&P 500 has gained 2%. That’s not much, but as Figure 3 shows, it suggests a more resilient equity market in the face of higher-than-expected inflation data. Last year, the market response to pricing in more Fed rate hikes would have been much more negative.

We don’t know if this dynamic will be sustained, but we view it as a positive step toward exiting the bear market that increases the chances of a rewarding 2023 for investors.

chart 3

What does it mean?

We see several implications from these changes in the economic and market environment:

  • More volatility in the near term. First, though this may be obvious, markets may be bumpy in the coming weeks and months because it will take more time to fully price in the end of the Fed rate hiking cycle. Market-based interest rates, such as the 10-year Treasury, may go higher than we anticipated when the year began, potentially putting pressure on stock valuations. That makes our bull case for stocks (S&P 500 to 5,100) in Outlook 2023: Finding Balanceless likely than our original odds of 25% and increases the chances that stocks miss our base case scenario target (4,320) from that publication.
  • Possible barbell year. The lowered bar for earnings should help stocks over the balance of the year, though that benefit may not come until the fall. We could envision a scenario where estimates dip below our forecast before upside late in the year gives earnings—and stock prices—a lift. That means we could see a solid start for stocks and a solid finish, with weakness in between.
  • Don’t chase high growth. We would be careful not to chase the most growth-oriented sectors of the market after such a strong start to the year. Near-term risk of higher interest rates is increasing, and these areas do tend to be interest rate sensitive. Value-style stocks are trading at well above-average valuation discounts to their growth counterparts despite the strong 2022 and have historically performed better in inflationary, higher interest rate environments (a topic we discussed here). Energy and industrials look like particularly fertile ground to find investment opportunities.

In conclusion, while these takeaways may not sound particularly bullish at the moment, we would not discount the chances of a soft landing (as we wrote about here last week). The elevated producer price index (PPI) reading last week was disappointing, but it was paired with a solid retail sales report and low jobless claims numbers that tell us the outlook for consumer spending remains healthy. The path to low double-digit gains for stocks this year has narrowed some, but it still looks passable.

Jeffrey Buchbinder, CFA, Chief Equity Strategist, LPL Financial

Quincy Krosby, PhD, Chief Global Strategist, LPL Financial

Soft landing or no soft landing, that is the question, with all due respect to William Shakespeare. But while this may be the most commonly asked question these days, it may not be the most important or the toughest. That honor goes to what’s priced in. Good market forecasts are not just about the economy and earnings—they are about what the market is pricing in. Below we share our thoughts on the potential for a soft landing, the possible role China might play in that, and whether markets are pricing in too much good news.

Strong Job Market Supports Case for Soft Landing

Recent economic and market data have reignited conversations about a potential soft landing. As we wrote in Midyear Outlook 2022: Navigating Turbulence, the ongoing economic recovery from the global pandemic required businesses and consumers to pilot the economy into a soft landing but that path would go through turbulence. As we subsequently developed Outlook 2023: Finding Balance, we thought the markets would be choppy as the world found its balance, while we waited for inflation to decelerate and central banks to ease up on their rate hiking campaigns.

So where are we in the business cycle? If you focus on jobs, the U.S. economy is headed toward a soft landing. Excluding the blowout report for January, average job gains were on a smooth downward trajectory (Figure 1). Minimal turbulence in the trend line is consistent with a pathway to a smooth landing. In fact, the blowout jobs report did not alter the Federal Reserve’s (Fed) playbook.

chart 1

The unemployment rate was 3.4% as the labor market is still very tight—too tight for central bankers. But more importantly, wage pressures are abating. Growth in average hourly earnings continues to slow, easing down to 4.4% year-over-year in January.

Low participation rates continue to weigh on the minds of economists and investors, but it’s important to remember that business formation stats are consistently growing above pre-pandemic levels, revealing many workers’ interests in alternative employment and one reason why some of the workers remain out of the official labor force.

So bottom line here is the labor market is still solid, offsetting some risk of slower consumer spending. Additionally, the slowdown in average hourly earnings should ease inflationary pressures in the near term as wage growth comes back in line. No doubt the Fed will continue to increase rates at the next meeting to slow the demand side of the economy.

Consumers’ Debt Load Remains Manageable

As Figure 2 illustrates, consumers hold much less debt now relative to previous cycles. After the Great Financial Crisis, consumers started aggressively deleveraging. Overall debt payments as a percent of disposable income declined and remained steady until the emergence of COVID-19 and most recently, the debt service burden on the American household moved back up to pre-pandemic levels but still relatively low. The job market is tight, which means personal income growth is supporting consumer spending along with the accumulated excess savings. To further pad personal spending, consumers will likely tap into consumer credit. We expect revolving credit demand to increase in the first part of this year, but we don’t expect debt service payments to approach rates last seen in 2007 and 2008. This manageable debt load is a key component of the case for a possible soft landing.

Chart 2

China Reopening May Help

As the world’s second largest economy, China’s economy reopening could help prospects for the U.S. in 2023. The International Monetary Fund (IMF), which recently upgraded its global growth forecast for 2023 to 2.9%, listed China and India as economic “bright spots” contributing to nearly half of global growth for 2023. China is expected to expand by 5.2% as the stringent Zero-COVID-19 measures that hampered its economy during the pandemic have been lifted.

Similarly, global ratings agency Fitch recently revised its 2023 forecast for China’s economic growth to 5.0% from 4.1%, noting that “consumption and activity” are recovering at a faster pace than initially expected. The Purchasing Managers Index (PMI), an important indicator for growth, has already begun to reflect a sharp rebound in activity, with a jump from 41.6 in December 2022 to 54.4 in January 2023.

According to official government announcements and reports, consumer spending and support for private businesses are a top priority to help stabilize the sputtering Chinese economy. China’s debt-laden real estate sector is also a major area of the economy that is scheduled to be helped by government support, including lower interest rates to help property developers.

Chinese officials have embarked on a campaign to revive its longstanding trading relationships, with high level visits and talks with Europe and Australia. Despite difficult bilateral relations with the U.S., there are indications both countries seek to continue trade ties, as China remains an integral part of the global supply chain. In addition, U.S. companies have continued operations in China and expect their earnings to increase as the economy gains momentum.

For the global economy, China’s recovery and resilience should help underpin the broader worldwide recovery. The healing of remaining supply chain challenges will be an important factor in the normalization in global economic growth, as will the normalization of overall trade relations. If the U.S. is going to achieve a soft landing, China’s impact on global growth will likely be a meaningful part of it.

Is a Soft Landing Priced In?

The outlook for economic growth and corporate profits is always a good place to start when forming a view of the equity market, but that’s only the first step. Next we ask perhaps the tougher question—what’s priced in?

The simple way to answer this question is with a basic price-to-earnings ratio (P/E). On a trailing four quarter basis, the S&P 500 Index is trading at a P/E of 19, in line with the 30-year average. That suggests valuations are fair and that a soft landing, or short-lived, mild recession, is probably priced in. Earnings are a bit depressed, supporting higher valuations, but the challenging near-term economic outlook with still-high inflation and more Fed rate hikes forthcoming, perhaps argue against that. Upside risk to interest rates may also argue against that, though LPL Research sees manageable upside to yields this year from current levels at a 3.7% 10-year Treasury.

Interest rates are a powerful force in equity valuations as a lower risk alternative. Factoring in rates and calculating an equity risk premium (ERP, earnings / price vs. 10-Treasury yields) gives us a below-average valuation (Figure 3). The ERP of 1.6% is currently above (more attractive) the long-term average ERP of 0.9%, though it is one of the more expensive readings of the past decade, given the big jump in yields since summer 2020. 

chart 3

So, do these higher valuations mean more downside risk for stocks? Not necessarily. The average bear market decline in a recession is about 29%. That includes all recessionary bear markets, including the really bad ones such as 2000–2002 and 2008–2009. Even if we get a recession this year, we simply do not expect it to be as deep as those two instances, suggesting the 25% peak-to-trough decline in the S&P 500 last year may have been sufficient to price in the risk of the current economic environment.

Another way to assess downside risk is to apply more of a typical recessionary haircut to valuations and earnings. Instead of 18–19 times $240 in 2024 (LPL Research base case assumptions), 16 times $230 in 2024 puts the S&P 500 at around 3,680 at year end (the index closed at 4,090 on Friday, February 10), seemingly a reasonable bear case scenario as laid out in our Outlook 2023: Finding Balance publication.

Evidence Investors Are Strongly Embracing Risk

Another way to assess what the market is pricing in is by looking at the strength in high-beta stocks year to date relative to their low beta (or low volatility) counterparts. Better returns for high-beta, or higher volatility, stocks indicate investor risk taking and, presumably, increasing odds of a soft landing. The strength of high beta stocks in January was the ninth best month out of the past 30 years (360 months), or higher than the third percentile. This suggests maybe the soft landing is priced in and any disappointment could result in some downside to stocks.

Bottom line, while we acknowledge downside risk to earnings in a recession scenario, the risk to valuations from further increases in interest rates, and the market’s increasing optimism based on where the biggest 2023 gains are so far, we expect the October lows to hold and see solid, double-digit gains for stocks in 2023.


The 14% move for the S&P 500 off the lows last October, despite the weakening earnings outlook, clearly tells us the market is pricing in a more optimistic outlook for the economy and corporate profits. But perhaps much of that move may be justified based on rising odds of a soft landing. Recent strength in the jobs market, while worrisome for the Fed, along with healthy consumer balance sheets and manageable debt loads, position the U.S. economy to potentially muddle through.

Valuations are fair by our assessment, not rich, and enable some upside potential as the market gains additional visibility into the potential resumption of earnings growth later this year and into 2024. LPL Research’s Strategic and Tactical Asset Allocation Committee (STAAC) maintains its overweight recommendation on equities and 2023 year-end fair value target of 4,400 to 4,500, based on 18.5 times 2024 earnings per share of $240.

Jeffrey Buchbinder, CFA, Chief Equity Strategist, LPL Financial

Quincy Krosby, PhD, Chief Global Strategist, LPL Financial

Jeffrey Roach, PhD, Chief Economist, LPL Financial

Investors got more excited about international investing late last year. Some of that was chasing better returns, as developed international equities solidly beat the U.S. over the last three months of 2022. Some was the increased popularity of value investing as mega-cap U.S. technology stocks became less in favor. The surprising resilience of core European economies and a weaker U.S. dollar added to the market’s excitement. After such strong performance in international benchmarks recently, is there enough good news still yet to come for these markets to continue to outpace the U.S.?

International Earnings Outlook Is Improving

Earnings are, of course, the bottom line, so when looking at an equity investment we certainly can’t ignore earnings. The U.S. has been the clear earnings leader relative to international for the past decade, but the tide has recently turned. International earnings slightly outgrew U.S. earnings in 2022, (7.7% vs. 5.4% based on the latest estimates) and we believe international earnings may hold up slightly better in 2023 than the U.S.—it may be a 1-0 game, (a pitcher’s duel for you baseball fans) but the U.S. is no longer the place to go for earnings growth.

As shown in Figure 1, international earnings have also been exhibiting better momentum recently. Estimates have risen steadily over the past three months, while earnings estimates in the U.S. have edged lower and are likely to come down further. A weaker U.S. dollar translating into more non-U.S. earnings is a big part of the story, but there are other factors at work here. More on that below.

Emerging market (EM) earnings tumbled early in 2022 after Russia’s invasion of Ukraine and the subsequent removal of Russian companies from the index, and have stalled since. EM companies have had a difficult time translating economic growth into profits over the past decade for a number of reasons, largely China-related, a situation that does not appear likely to change in 2023.

chart 1

International Valuations Remain Attractive

Turning to valuations, that slightly better (perhaps “less weak”) near-term earnings outlook does not come at a steeper price. International stock valuations have been lower than those in the U.S. for much of the past three decades. Despite recent outperformance, that gap between price-to-earnings ratios for the MSCI EAFE Index and the S&P 500 Index is still quite large (Figure 2). Developed international stocks are trading at a 28% discount to the S&P 500 on a forward price-to-earnings (PE) basis. That discount is the largest in at least 30 years, and larger than the average discount over the past 10 years of 16%. The valuation discount for international has grown so large that it is actually in line with EM.

Chart 2

Absolute valuations relative to history also make international valuations look attractive. The current forward P/E of 13 for the MSCI EAFE is 10% below its 10-year average, while the U.S. and EM are 0.9 points and 0.5 points above average by the same measure.

Even if we adjust international for its different sector mix, it’s only 8% more expensive (so still a 20% discount to the U.S. on an apples-to-apples basis). After many headfakes since the 2008-2009 global financial crisis, where short rallies in international evaporated and the long-term downtrend in relative performance resumed, this time could potentially be more sustainable.

Resilient European Economies

Europe’s surprising resilience has undoubtedly been part of the improving international story. European markets have demonstrated solid resilience despite mounting concerns over the ongoing Russia/Ukraine conflict, natural gas supplies, interest rates climbing higher as the European Central Bank (ECB) continues to raise rates, and a slow start to China’s reopening.

Recent official Eurostat data releases suggest the Eurozone expanded by 0.1% in the fourth quarter of 2022 compared with the third quarter. Moreover, the most recent Purchasing Managers’ Index, which includes both manufacturing and services, indicated a modest expansion for the first time in six months. In addition, the International Monetary Fund (IMF) upgraded its 2023 economic forecast for the Eurozone to 0.7%, from an initial projection of 0.5% made in October.

Natural gas prices, which had climbed higher at the onset of the military conflict, turned considerably lower as supplies were restored and moderate weather helped restrain demand. Also bolstering economic and market expectations is China’s reopening, which is expected to restore China’s historically strong trade relationships with Eurozone nations, particularly Germany, France, and Italy.

Although concerns remain that the very modest recovery could edge lower, the widely followed ZEW index that serves as a barometer for German investor sentiment moved into positive territory in February, reflecting a marked shift in expectations. The index had remained negative since before the onset of the Russia/Ukraine conflict. Christine Lagarde, president of the ECB, commented in late January that “the news has become much more positive in the last few weeks.” That can be seen in the Eurozone economic surprise index, shown in Figure 3.

chart 3

We don’t know how long this better news will last, and downsize risks clearly remain, but international investors seem to be using a glimmer of sun to make some hay.

U.S. Dollar Shifting from Headwind to Tailwind

During 2022, as the Federal Reserve (Fed) launched its aggressive interest rate hiking campaign, the U.S. dollar began a near-parabolic climb above developed market currencies (Figure 4). S&P 500 multinational companies felt the sting of the escalating dollar, and in earnings reports the strong dollar was mentioned as a significant headwind as their foreign earnings were reduced as they were converted into dollars. Approximately 40% of S&P 500 earnings originate in non-U.S. markets.

chart 4

As it became apparent the Fed was planning to move towards smaller hikes, the dollar began to ease considerably in the fall of 2022. Also, whenever Fed Chair Jerome Powell mentioned there was a possibility for a soft economic landing, the dollar softened even more.

In early 2023, the dollar transitioned from being a headwind to a tailwind that could help underpin multinational earnings and U.S. investor returns in non-U.S. investments. Companies with a strong input from foreign earnings are seeing more interest from investors than companies that are more domestically focused. The currency translation to dollars is now helping earnings rather than hurting them.

Currency movements are notoriously hard to forecast, but we believe the odds favor a lower rather than higher dollar over the balance of this year.


As we weigh the pros and cons of international equities relative to the U.S., the ledger is looking more balanced. Earnings are soft everywhere, but maybe international delivers slightly better earnings growth in 2023. International equities are cheap, but they’ve been cheap for a while and adjusting for sector exposures (much less high valuation technology/digital media/eCommerce exposure than the U.S.), valuations aren’t as compelling.

The weight of the evidence based on technical analysis may point to international, but the last couple of weeks show us why we may not want to count the U.S. out. Especially with economic risks in Europe high in the intermediate term and no guarantee of further U.S. dollar weakness.

So while the international outlook is improved, we also believe investors should hold at least benchmark level exposure to U.S. equities, if not slightly more, at the expense of fixed income. The U.S. is where the innovation is, which won’t stop because of still-elevated inflation or fears of recession. And the end of the Fed rate hiking campaign is approaching as inflation comes down, despite Friday’s strong jobs number.

Jeffrey Buchbinder, CFA, Chief Equity Strategist, LPL Financial

Quincy Krosby, PhD, Chief Global Strategist, LPL Financial

The script has been flipped in 2023. Last year’s underperformers have turned into outperformers this year, driving the S&P 500 Index up over 5% this month. The pace and composition of the rally have left many investors skeptical over its sustainability, especially amid a lackluster earnings season thus far. Of course, the market is also forward-looking, with expectations for falling inflation and a less hawkish Federal Reserve (Fed) as we progress into 2023. And although the trajectory of the rally will likely slow, seasonal indicators point to a path higher for U.S. equity markets by year-end.

For background, market seasonality is premised on the adage of ‘history doesn’t repeat, but it often rhymes.’ The embedded assumption is the market exhibits seasonal patterns or cycles that ‘rhyme’ throughout history, or more specifically when prices move in a recognizable pattern that occurs with some degree of consistency over a specific timeframe. These patterns can last anywhere from several days to several years, each having its own tendencies unique to that period. For example, we are now in year three of the presidential cycle, historically the best-performing year for stocks across the four-year cycle. By no means is seasonality flawless, as pricing patterns are historical tendencies and not a guarantee of future results. Within LPL Research, we view seasonal data as one input, among many, into our decision-making process.

When various seasonal indicators tell the same story, the message becomes more powerful. The market is now on the cusp of receiving one of these ‘messages’ by potentially hitting a trifecta of seasonal indicators this month.

What are the components of the trifecta?

  1. Santa Claus Rally: This seasonal pattern was first discovered by Yale Hirsch in 1972. Hirsch, the creator of the popular Stock Trader’s Almanac, defined the period as the last five trading days of the year plus the first two trading days of the new year. A positive Santa Claus rally signal occurs when the S&P 500 posts a positive return during this timeframe. For 2023, the S&P 500 was up 0.8% during this period, checking the box for a positive signal.
  2. First Five Days: Hirsch also created the First Five Days indicator. This indicator is considered a warning system for the year ahead when the first five days of the year are negative. The S&P 500 finished the first five days of 2023 up 1.4%, checking the box for a positive First Five Days signal.  
  3. January Barometer: Last but not least, Hirsch also created the January Barometer indicator and its popular tagline of ‘As goes January, so goes this year’ (positive January returns are historically associated with positive annual returns). A positive January Barometer indicator occurs when the S&P 500 posts a positive return in January. With the S&P 500 up over 5% this month as of Friday, January 27, a positive signal is expected.

When all three of these indicators are positive, such as this year, the January Trifecta has been hit (credit for the Trifecta indicator goes to Jeff Hirsch, Yale’s son who has continued his Stock Trader’s Almanac work).

Figure 1 highlights various return metrics for years when the trifecta indicator was hit for the S&P 500. For additional context, we also included year-over-year earnings growth for the index, along with whether or not the year included a recession.

chart 1

Key Takeaways:

As you can see in the chart, the trifecta accomplished this month has historically led to some very strong returns. The S&P 500 has on average added 12.3% to a 4.6% January gain between February and December, bringing the average gain for these years to over 17%. This sounds like a big gain, and it is, but keep in mind the average gain in the third year of the four-year presidential cycle is 16.8%, and the average year following a down year is up 15%.

It also worth noting that with the broad market slipping nearly 20% last year, this gain still would not get the market back to the 2022 high set on January 3, 2022. Stocks enter 2023 much more attractively valued than a year ago—roughly 18 times forward (2023) earnings as compared to over 21 times forward (2022) earnings a year ago, based on FactSet estimates.

Steady Path to Gains

Finally, we also compared the monthly seasonality for trifecta years and non-trifecta years. Figure 2 highlights the returns across each scenario. While the strong January average returns during trifecta years decelerate in February, they do not historically turn negative. In fact, of the 31 trifecta years observed, all 12 months produced positive average monthly returns.

Chart 2


Stocks continue to climb the wall of worry despite mixed messages between technicals and fundamentals. Seasonality indicators, including the trifecta indicator, suggest the path of least resistance for the broader market is likely higher for the year ahead. And while the seasonality message is clear, the market still needs catalysts to climb higher. LPL Research believes the end of the Fed’s monetary policy tightening will be a key driver for stocks this year. Cooling inflation data will not only underpin a policy change, but also reduce headwinds for companies battling ongoing pricing pressures. The end of a rate hike cycle could also mean interest rate stabilization or even lower interest rates, another potential driver of equity market gains. Finally, while we believe recession risk remains high, there is the chance the U.S. economy is only facing a growth scare and muddles through on the back of a resilient consumer who is flush with cash. 

Adam Turnquist, CMT, Chief Technical Strategist, LPL Financial

Jeffrey Buchbinder, CFA, Chief Equity Strategist, LPL Financial

The latest episode of the debate between stock market bulls and bears has gotten more interesting. For every valid point from one side, there’s an equally compelling argument on the other side. Perhaps the best reason for the debate is the uniqueness of this environment. The pandemic and its aftermath don’t come with a historical playbook. We haven’t been here before. So we’ll just recognize that the outlook is uncertain, weigh the pros and cons, glean what we can from the past, and give it our best shot. Call us cautious bulls.

Topic 1: Economy

Bull case: Consumer is resilient, the labor market is strong, wages are rising, and inflation is coming down steadily.

Bear case: Inflation is still high, leading indicators are signaling recession, manufacturing activity and housing market have slowed significantly.

Background: The global economy will likely slow from the upper-2% range in 2022 down to slightly above zero in 2023 (Figure 1). Much depends on China’s growth path now that it has largely abandoned its overzealous Zero-COVID-19 policy. 

chart 1

If the U.S. falls into recession, the chances are it would occur during the first half of 2023 and will not likely be as deep as the 2008 recession, which was initiated by a fundamentally flawed financial market.

One reason we’re currently seeing a healthy debate on the likelihood of a recession is that most metrics that typically precede recessions are flashing warning signs. Business activity and consumer spending are contracting. However, recent data, including a stable labor market and decelerating inflation, suggest a soft landing may still be possible. As supply chains improve in the months ahead and Federal Reserve (Fed) tools become more impactful, we could see the rate of inflation decelerate more in 2023. So far, producer prices, wages, and survey data clearly point to improvement with inflation.

If the economy does fall into a recession, the cause will likely be from the consumer sector retrenching after years of inflationary pressures, high housing costs, and slow real wage growth.

Our take: The U.S. economy either narrowly avoids recession or enters a mild and short-lived recession in the early-to-middle portion of 2023. Easing inflation pressures and a stable job market with only modest additional tightening from the Fed are keys to limiting the severity of an economic downturn.

Topic 2: The Fed

Bull case: Pricing pressures continue to recede and the Fed ends its rate hike campaign this spring, essentially declaring victory on inflation and opening the door for potential rate cuts in the back half of the year. Interest rates continue to fall and/or stabilize, re-steepening the yield curve. Dollar weakness continues.

Bear case: Inflation proves sticky, prompting either further Fed tightening or a higher-for-longer policy path and raising the odds of recession. Interest rates move higher along with the dollar, weighing on risk assets.

Background: The market maxim of ‘Don’t fight the Fed’ has proven prescient once again. Since the Fed embarked on its historic rate hike cycle last March, the S&P 500 Index entered a bear market and witnessed a 25% peak-to-trough drawdown in 2022. However, according to the futures market, the probability of the Fed reaching its last interest rate hike is inching closer. Forecasts suggest the Fed’s aggressive campaign to tackle inflation could be completed this spring. Moreover, and in stark contrast with Fed rhetoric, the futures market is indicating the Fed could cut interest rates toward the latter half of the year.

These projections are predicated on the assumption that inflation will continue to edge lower at a faster pace than initially expected. Recent inflation-related data, especially the Consumer Price Index (CPI) and the Personal Consumption Expenditures Index (PCE), both underscore that inflation has plateaued and is easing in key areas of the economy.

Figure 2 provides a visual of the contrasting interest rate projections between the Fed and futures market. The blue line depicts the implied policy rate based on probabilities from the fed funds futures market. As you may notice, a potential peak in the terminal rate is expected sometime this spring, which aligns with LPL Research’s 2023 outlook. Furthermore, the market has priced in rate cuts later this year, with the federal funds rate forecasted to reach the 4.25%–4.50% range by year-end. The dotted grey line highlights the latest Summary of Economic Projections (SEP) from the Fed, which shows policymakers’ forecast for a fed funds rate of 5.1% for the end of 2023 with no rate cuts penciled in for this year.

Chart 2

Our take: How the diverging policy expectations between the market and Fed get resolved boils down to the rhetorical glass half-full or glass half-empty question. Our expectation is the Fed will stop hiking rates in March after two more 25 basis point (0.25%) hikes and will be a positive catalyst for stock market performance in the coming year.

Topic 3: earnings

Bull case: Earnings fall less in inflationary environments because of revenue strength. Expectations are already very low. Companies have had plenty of time to prepare for the slowdown. U.S. dollar headwinds turning to tailwinds as the greenback heads lower.

Bear case: Margin pressures intensifying. Estimates likely still too high for a potential recession in 2023 when historically earnings have typically fallen about 10%. Contributions from energy are dwindling.

Background: As we discussed in our Q4 earnings season preview, expectations for earnings season for the quarter and 2023 are quite low. As supply chain pressures ease, growth in China picks up, inflation (likely) falls further, and the dollar potentially moves lower, companies will be in a better position to generate earnings growth in late 2023 and early 2024. Consumers still have money to spend. Margins will deteriorate further in the short-term but companies are taking steps to manage costs after preparing for recession for months now—especially the big banks as we have heard during their earnings reports. A return to prior decade norms is unlikely given the new higher profitability regime, backed by technology advances.

Estimates remain too high but are already coming down, as shown in Figure 3. The reduction in estimates for S&P 500 earnings this year from the 2022 peak is already in line with the long-term average of 10%. Estimates will come down further, but the pace of those reductions will likely slow after the bar is lowered again during the current earnings season.

chart 3

Our take: Markets may be pleasantly surprised by a modest, rather than significant, earnings decline in 2023 supported by strong revenue, cost controls, and a healthy U.S. consumer.  LPL Research expects earnings resilience to be supportive of stocks later this year.

Topic 4: China’s Reopening

Bull case: China’s reopening will help unsnarl global supply chains, driving global growth and helping ease inflation pressures. Stimulus measures will be supportive.

Bear case: China’s re-opening will be uneven and inflationary pressures will continue.

Background: After nearly three years of a stringent policy that closed down large and important parts of China, in what was called Zero-COVID-19 policy, Beijing has ordered the reopening. Although the COVID-19 virus continues to spread across the country, leading to a self-imposed voluntary lockdown, expectations are that by the second half of the year, the economy could begin to emerge from the serious economic decline wrought by strict lockdown measures. Supporting the economy, which is the world’s second largest, has become an important message from top Chinese leadership.

In addition, the government is enacting policies to help the beleaguered and debt-laden property development market. The totality of the property market accounts for nearly 25% of China’s economy. Comments regarding support for the private sector are of particular interest as that could help generate stronger growth for the overall economy, even if only marginally.

Moreover, government officials have stressed they want to ensure personal consumption, or personal spending, gains momentum following years of pent-up demand as fears of lockdowns dominated consumer activity.

Trade with China’s Asian partners is expected to improve, as is trade with traditional partners in Europe, particularly Germany, France, and Italy. With central banks continuing to raise rates in order to tackle inflation, and growing concerns about a slowing global economy, China’s emergence as a dominant presence in world trade would certainly help bolster prospects for a stronger global economic landscape.

Our take: China’s reopening is more bullish than bearish, but geopolitical tensions will remain a risk. We believe China-heavy emerging market equities are more of a trade than a long-term investment at this point.


LPL Research remains reluctant bulls but wary of the risks of further equity market volatility. Mild recession and modest earnings declines are likely already baked in the cake. Should the Fed pause after a March interest rate hike, the stage may be set for a nice stock market rebound on the back of falling inflation, reasonable valuations, and stable interest rates. Earnings may not be much of a catalyst this earnings season, but we see some of the pessimism turning into optimism as 2023 progresses.

The hotly contested bull-bear debate will continue early in 2023 and likely keep volatility elevated in the near term, but we expect these key risks to stocks to be largely resolved mid-year, setting the stage for stocks to make a run at our year-end fair value S&P 500 target of 4,400–4,500 by year-end.

Jeffrey Buchbinder, CFA, Chief Equity Strategist, LPL Financial

Quincy Krosby,PhD, Chief Global Strategist, LPL Financial

Jeffrey Roach, PhD, Chief Economist, LPL Financial

Adam Turnquist, CMT, Chief Technical Strategist