The LPL Research team provides in-depth analyses, insights, and perspectives on the second half of 2023.

At LPL Research, our 2023 investing outlook started with a theme of returning to normalcy. Considering 2022’s market volatility and the aftereffects of the pandemic, the idea of finding balance was certainly a welcomed change. It’s a theme we could all embrace six months ago and what we will continue to rally around through year-end.

That’s not to say that 2023 hasn’t come with its own set of challenges. We saw two regional banks fail in rapid-fire succession in March—and another closed its doors in May. Collectively representing over $530 billion in assets, the trio ranks as the second, third, and fourth largest bank failures to date.

We also held our breath as a last minute deal to raise the debt limit came together as the clock ticked closer to default. Despite the market gyrations these events caused and a banking sector still on tenterhooks, the overall financial system seems stable. Counterbalancing the challenges, some bright spots include:

• Inflation is under 5% at home, significantly lower than its 8.3% level this time last year
• The fed funds rate is approaching its apex as the Federal Reserve grapples with the unknown impacts yet to emerge from its aggressive tightening cycle
• Global inflation has ticked down from its 8.7% high in 2022, and is following a slow descent to a projected 6.5% for 2023

As the economy is likely downshifting, investors should take heed that the Federal Reserve’s (Fed) current stance is eerily similar to early 2007.  During that time, the Fed held a tightening bias since they believed the housing market was stabilizing, the economy would continue to expand, and inflation risks remained. Clearly, their expectations were not met as the economy soon fell into recession. That’s not suggesting another 2008 is coming, but rather highlights how fast the economic environment can change. 

Overview

Forecasting regime shifts are difficult for both public policymakers and private investors. The macro-environment will likely experience a shift in the coming months as consumers retrench and businesses slow hiring. Despite emerging signs of slowing, the Fed recently communicated a hawkish stance on the path of interest rates going forward and the markets seemed to take it all in stride.

At the conclusion of the June 13-14 meeting, the Federal Open Market Committee (FOMC) kept rates unchanged but communicated a hawkish bias toward future interest rate decisions. Committee members were intent on further tightening but expressed concerns over unknown risks yet to emerge from the cumulative tightening over the past year. During the post-meeting press conference, Fed Chairman Jerome Powell indicated the Committee has not made a decision about next month, but if economic conditions hold steady, investors should pencil in a 0.25% increase to the Fed funds rate.

Along with the statement, the Committee updated the Summary of Economic Projections (SEP), which is arguably more important than the brief monetary policy statement. Within the most recent SEP, most policymakers believe further tightening is needed unless conditions materially weaken.

Inflation is going in the right direction

We think the Fed should consider the improving inflation outlook in addition to the other variables and concerns they’ve already stated. The latest Consumer Price Index (CPI) print decelerated toward the lower end of expectations, with overall headline inflation falling to the lowest level since April 2021. The encouraging trend in consumer prices will provide the Fed some leeway throughout the balance of 2023. Investors seem to believe the latest CPI report shows inflation is heading in the right direction and likely reinforced the Fed’s decision to skip a June rate hike or even pause for a longer period. As shown in Figure 1, headline inflation is below the fed funds upper bound, although core inflation is not decelerating as fast as headline inflation.

And perhaps that’s why equity markets added to recent gains over recent trading days, despite the disappointment that no Fed official thought conditions would warrant an outright cut in rates.

Fed should anticipate further easing in rents

The housing sector is currently a significant factor impacting inflation in 2023. Shelter costs, which hold a significant weight in the CPI, are expected to ease. There is evidence rent costs will eventually decrease, as can be seen in the robust multi-family construction activity. As more projects hit the market this year due to the increase in condo and apartment units under construction, the supply of multi-family housing will rise, which should help bring down rent prices. As such, we don’t think it will be long before official government numbers reflect the decrease in rent prices. In the upcoming months, investors and policymakers alike should anticipate a slowing of housing-related inflation.

We have updated our Inflation Dashboard (Figure 2), designed to provide a snapshot of the inflationary environment, with the latest CPI data. The CPI rent of primary residence is the only one of our dashboard indicators that remains at an elevated level, and even that has fallen from an extreme level since April.

A lot can change in a few quarters

So, why bring up a Fed statement from 2007? Because it’s a good example of how radically the economy can change in just a few quarters. In the January 2007 statement, the Fed communicated a “hawkish pause” because they anticipated a stabilizing housing market, a growing economy, and nagging inflation risks. A lot changed over the course of 2007 and 2008 as the economy fell into the Great Financial Crisis.

The current SEP revised up GDP growth forecasts and softened the deterioration in unemployment, and it seems the Fed is reticent to forecast a recession. However, our most likely scenarios put the economy in a mild recession by the end of the year as consumers retrench and businesses slow hiring as surveys suggest.

The release of the dot plot, which is the individual Committee member’s expectation of the appropriate fed funds rate each year, was the hawkish surprise markets were worried about. Despite raising rates by 5% over the past 15 months, the majority of the Committee, not just the median policymaker, sees at least two more 0.25% rate hikes this year, which would take the fed funds rate to 5.625%—the highest level since 2001. Moreover, the Committee thinks the fed funds rate should end 2024 at 4.625%, which reflects the potential for some rate cuts, but not as many as markets are expecting, which could put upward pressure on bond yields if those forecasts are accurate.

The Fed’s crystal ball is no better than the market’s and we know from history that the dot plot is not a good forecasting tool. As seen in Figure 3, the median forecast rarely, if ever, coordinated with actual policy rates (dashed red line). Dot plot medians tended to overestimate policy rates—sometimes by a wide margin. The most egregious example appears to be in 2015 (green line) when the Committee expected interest rates in 2017 to be above 3.5%, when in actuality they were closer to 0.50% that year.  Nonetheless, it is worth watching how these views evolve in the coming months, which means either the Fed lowers its forecasts or the market adjusts higher, putting upward pressure on bond yields.

Summary and investment outlook

Periods of economic regime shifts are difficult for policymakers to manage. This current environment could be eerily similar to early 2007, when the Fed held a tightening bias on rates as they believed the housing market was stabilizing, the economy would continue to expand, and inflation risks remained. Both the January 2007 statement and the most recent one last week specifically mention the FOMC’s process in determining the extent of additional policy firming that may be needed. Clearly, those expectations were not met since we know what happened in later quarters. Despite the reference to 2007, our baseline is the economic slowdown does not produce another “2008,” yet investors should anticipate some volatility as the economic outlook remains cloudy.

With the Fed seemingly pushing out rate cuts, markets are probably going to be volatile over the next few quarters or at least until the inflationary story becomes clearer. LPL’s Strategic and Tactical Asset Allocation Committee (STAAC) recommends a neutral tactical allocation to equities, with a modest overweight to fixed income funded from cash. The risk-reward trade-off between stocks and bonds looks relatively even to us (as we wrote about here recently), with core bonds providing a yield advantage over cash. Moreover, as we wrote in our May 22 Weekly Market Commentary, despite the continued uncertainty around timing, a Fed pause has historically been a positive for core bond investors.

The STAAC recommends being neutral on style, favors developed international equities over emerging markets and large caps over small, and maintains the industrials sector as the top overall sector pick, with communication services and technology as top ideas based on technical analysis.

Within fixed income, the STAAC recommends an up-in-quality approach with a benchmark weight to duration. We think core bond sectors (U.S. Treasuries, agency mortgage-backed securities (MBS), and short-maturity investment grade corporates) are currently more attractive than plus sectors (high-yield bonds and non-U.S. sectors) with the exception of preferred securities, which look attractive after having recently sold off due to the banking stresses.

Jeffrey Roach, PhD, Chief Economist

Lawrence Gillum, CFA, Chief Fixed Income Strategist

Stocks have had a nice run, but at higher prices, the bar for further gains gets higher. We have recently made the case in this publication that there are a lot of reasons to expect the market to go higher between now and year-end. But with stocks at higher valuations, high-quality bonds offering attractive yields, an S&P 500 Index with concentrated leadership facing technical resistance at 4,300, and an elevated risk of a late-2023 recession, we think it makes sense to be a bit careful here. Importantly, though, neutral is not bearish.

Five reasons we’re lowering our equities allocation

There are five primary reasons why the LPL Research Strategic and Tactical Asset Allocation Committee (STAAC) is lowering its recommended equities allocation to neutral today.

Reason #1: Recession Is Likely by Year End

Our base case is for the economy to slip into a mild recession by the end of 2023. However, the solid labor market and elevated surplus savings are delaying the onset of a broad-based contraction. Despite Friday’s strong jobs report, cracks are appearing. The latest Federal Reserve (Fed) Beige Book revealed a recession already started in the trucking and freight industries, and perhaps this is a leading indicator of a broader slowdown in business activity in the months ahead.

If and when a recession begins, the impact on capital markets will likely be mixed since some sectors could skirt the full impact of an economic contraction as upper-income households release pent-up demand for experiences within the services economy. The average loss for the S&P 500 during the six months before a recession has been 1.4% historically, based on data since 1970, though the index did gain nearly 10% ahead of the 1980 and 1990 recessions.

Reason #2: The S&P 500 Is Facing Strong Technical Resistance

The technical setup for the S&P 500 is a story of the good, the bad, and the ugly. The good news is that the market remains in an uptrend and above its rising 50- and 200-day moving averages (dma). Furthermore, after several failed attempts, the index finally surpassed resistance at 4,200 (Figure 1). 

The bad news is that the next major area of resistance sets up near 4,300, which traces back to the August 2022 highs and lines up with a key retracement level of last year’s bear market. With major resistance coming into play only marginally above current S&P 500 levels, we believe the reward-to-risk profile has become less attractive.

Diverging market breadth represents the ugly portion of the technical story. Fewer and fewer stocks are participating in the latest advance, while leadership is highly concentrated in only a handful of mega-cap names. For example, only 43% of S&P 500 stocks are trading above their 200-dma, compared to 79% when the market notched its February high. On an equal weighted basis—meaning every stock in the index carries the same weighting—the S&P 500 is only 1.5% higher on the year, highlighting how much heavy lifting the mega-caps have done for the index’s 11.5% year-to-date advance (as of June 2).

In a typical bull market or even a developing one, widespread participation provides confirmation of the uptrend’s strength and sustainability. When participation in the advance is limited, vulnerabilities emerge as the weight of the market’s advance falls on the shoulders of a limited number of stocks.

Reason #3: Technology Is Overbought and Due for Consolidation

Technology has been the main engine behind this year’s rally, and risk of the sector overheating continues to climb. Since the April 2023 low, the sector has rallied 16% as of June 1, marking the highest rate of change over a 26-trading-day period since February. In fact, whenever the rate of change has crossed above 16% over an equivalent timeframe, the technology sector has historically declined by an average of 2.5% over the following three-month period.

Overbought conditions are also becoming widespread. The sector’s Relative Strength Index (RSI)—a momentum oscillator used to measure the speed and magnitude of price action—recently hit its highest overbought reading since December 2021. Furthermore, nearly 30% of technology sector stocks reported an overbought RSI reading last week.

While overbought conditions provide validation of the sector’s uptrend, and overbought does not mean over, the likelihood of a healthy consolidation and/or pullback appears to be rising. The good news is that if there is mean reversion, it would likely be toward the sector’s uptrend and provide a potential pullback opportunity for investors seeking a better entry point into the sector. In the event of a pullback, both the rising 20- and 50-dmas provide dynamic support levels to watch, along with the August highs near 2,650 (Figure 2).

Reason #4: Fixed Income Yields Are More Competitive With Equities

Higher interest rates make stocks relatively less attractive when compared with bonds for a couple of primary reasons. First, the value of a stock is the present value of future cash flows. So, a higher interest rate raises the discount rate and lowers the value of those cash flows.

Second, higher interest rates also make bonds more attractive relative to stocks, all else equal. We use the equity risk premium (ERP) calculation shown in Figure 3 to compare the earnings from bonds (yield) to the earnings from stocks (earnings yield, or earnings divided by price). Based on the S&P 500 Index price and U.S. 10-Year Treasury yield as of May 31, the ERP is down to 1.3%, in line with the 40-year average and much richer than the near 3% ERP a year ago.

Friday’s strong jobs report increases the risk that interest rates move higher from current levels, as a potential July rate hike is back on the market’s radar. The increasing relative attractiveness of fixed income, coupled with fuller equity valuations, supported the STAAC’s decision to move to an overweight fixed income allocation and a neutral position on equities today.

Reason #5: Seasonal Headwinds

Don’t expect any seasonal tailwinds to help stocks this month. The S&P 500 has generated average and median price returns during June of 0.0% and 0.1%, respectively, making it the fourth worst-performing month since 1950 (Figure 4).

Furthermore, the index has only produced positive returns 54.8% of the time during June. For context, the S&P 500 has posted average monthly gains of 0.7% and finished positive 61% of the time for all months since 1950.

The seasonal setup for the technology sector in June is even worse. Since 1990, the sector has generated average and median price returns during the month of 0.0% and -1.7%, respectively, making it the second-worst month based on average returns and the worst month based on median returns. Furthermore, the tech sector has only produced positive returns 42.4% of the time during June, the lowest positivity rate across the calendar. 

Risks to the upside

Although we think stocks are due for a pullback, or at least some choppiness, there are several upside risks. One we highlighted last week was the stock market’s strong performance historically after a solid first 100 trading days (discussed here).

Other potential risks to the upside include:

• The S&P 500 is still in a bear market (though barely), up 19.7% off its October 12, 2022 low, less than half the average gain one year after a bear market low of 42% since 1950 (the median gain is 34%). The technical definition of a bull market is a close 20% above the bear market low.
• Stocks are still in the favorable third year of the four-year Presidential cycle—the S&P 500 has gained an average of about 15% in the year after midterm elections (and is up 11.9% since midterms on November 8, 2022).
• After down years, as we had in 2022, the S&P 500 has historically gained an average of 15% in the subsequent year.
• Inflation continues to fall steadily, which could help economic growth, company profit margins, and stock valuations by lowering borrowing costs, input costs, and the discount rate used to value stocks.
• The end of the Fed’s rate hiking cycle could provide a tailwind for stocks. Historically, stocks have generated double-digit gains, on average, after the end of Fed rate hiking cycles, though in pre-1990 inflationary periods performance was more mixed.
• A case can be made that recession was already priced in last fall and that a new bull market is developing, potentially eliminating the need for the S&P 500 to return to the October lows as in a typical recession scenario. During bear markets accompanied by recession since 1950, stocks have always bottomed after the recession started.

Latest thoughts on asset allocation

The STAAC now recommends a neutral allocation to equities, with a modest overweight to fixed income funded from cash. The risk-reward trade-off between stocks and bonds looks relatively even to us, with core bonds providing a yield advantage over cash.

The STAAC recommends being neutral on style, favors developed international equities over emerging markets and large caps over small, and maintains the industrials sector as the top overall sector pick, with communication services and technology as top ideas based on technical analysis.

Within fixed income, the STAAC recommends an up-in-quality approach with a benchmark weight to duration. We think core bond sectors (U.S. Treasuries, Agency mortgage-backed securities (MBS), and short-maturity investment grade corporates) are currently more attractive than plus sectors (high-yield bonds and non-U.S. sectors) with the exception of preferred securities, which look attractive after having recently sold off due to the banking stresses. 

Jeffrey Buchbinder, CFA, Chief Equity Strategist, LPL Financial

Adam Turnquist, CMT, Chief Technical Strategist, LPL Financial

Economists like to remind us there is no such thing as a free lunch. In investment parlance, that just means all investments carry risk—even cash. And the big risk with cash is reinvestment risk. That is, while short-term rates are currently elevated, the risk is these rates won’t last and upon maturity, investors will have to reinvest proceeds at lower rates. And if this current cycle follows history, we could see lower core bond yields over the next year, which would mean cash-only investors may miss out on these higher yields. LPL’s Strategic and Tactical Asset Allocation Committee (STAAC) recommends investors maintain a neutral duration relative to benchmarks with the expectation that Treasury yields are likely headed lower (or at least not much higher) over the next few quarters. 

Balancing Short-Term Opportunities with Longer-Term Objectives

After the most aggressive rate hiking campaign in decades from the Federal Reserve (Fed), short-term interest rates are at levels last seen early in the 2000s. Moreover, due to the elevated fed funds rate and the subsequent carryover into the U.S. Treasury market, the Treasury yield curve is the most inverted since the early 1980s (that is shorter-term Treasury securities out yielding longer-maturity securities). This has (finally) allowed investors to generate a return on cash.

However, the Fed’s goal has been to take the fed funds rate into restrictive territory to make the cost of capital prohibitively expensive to slow aggregate demand, which should allow inflationary pressures to abate. Then what? Well, after winning its fight with inflation, markets expect the Fed to start cutting rates as early as this year. After keeping rates at these elevated levels, the Fed will then likely take the fed funds rate back to a more neutral level, which economists believe is 2.5%, or even lower. Just as the aggressive rate hiking cycle took Treasury yields higher, interest rate cuts will take Treasury (and other bond market) yields lower, and that is when the reinvestment risks will show up. And since inflationary pressures are easing, as cracks appear in the regional banking sector, it is likely the Fed is done with its rate hiking campaign, which could be welcome news for core bonds.

In fact, if the Fed is indeed done raising interest rates, we could start to see lower yields on intermediate-term securities before the Fed actually cuts rates. Of the most recent Fed rate hiking campaigns (Figure 1), 10-year Treasury yields were lower, on average, by 1% a year after the Fed stopped raising rates. And while our base case remains a trading range for the 10-year yield between 3.25% and 3.75% throughout 2023 (similar to the 2006 Fed rate hiking campaign, when the Fed kept rates at elevated levels for over a year), we acknowledge there is a strong bias for yields to end the year lower than our expectations, which could mean strong positive returns for core bonds.

Now, we also acknowledge there is a risk that inflationary pressures remain high and that the Fed has to continue its rate hiking campaign into a weakening economy. As we mentioned in our Outlook 2023: Finding Balance, in that stagflationary scenario where the Fed takes the fed funds rate to 6%, we could see the 10-year around 4.75%. However, given where starting yields are, if interest rates increase by another 1% from current levels, fixed income markets broadly could all still generate slightly positive returns over the next 12 months. 

Technical Trends Suggest the Highs Are In

The technical setup for Treasuries suggest high watermarks for yields have likely been reached (Figure 2). Since core consumer inflation in the U.S. peaked last fall, 10-year yields have registered a string of lower highs that together form a developing downtrend. The recent bearish crossover of the 10-year yield’s 50-day moving average below the 200-day moving average adds to the evidence of a potential downtrend in the making. (For reference, moving averages represent the average yield across a select number of trading days and are used to identify trend direction.) The key word here is “potential,” as yields have not registered consecutive lower lows, a major piece of missing evidence to confirm a new downtrend is officially underway.

Despite several retests, support for the 10-year at 3.25% continues to hold. While this level is attributed to the recent April lows, it also traces back to the 2018 highs, a major breakout point for yields as they officially completed a multi-year bottom formation. Given the significance of the 3.25% support level and what we view as limited upside risk for yields based on both technical and macro factors, we suspect 10-year yields will remain range bound in the 3.25% to 3.75% range until a confirmed trend develops.

If History Rhymes…

If history at least rhymes during this cycle and we do see lower yields over the next year, intermediate core bonds could very well outperform cash and other shorter maturity fixed income strategies. Historically, core bonds, as proxied by the Bloomberg Aggregate Bond Index, have performed well during Fed rate hike pauses (Figure 3). Since 1984, core bonds were able to generate average 6-month and 1-year returns of 8% and 13%, respectively, after the Fed stopped raising rates. Moreover, all periods generated positive returns over the 6-month, 1-year, and 3-year horizons. 

Conclusion

Within our discretionary asset allocation models, we’ve maintained a neutral duration relative to our benchmark (the Bloomberg Aggregate Index) with the expectation that Treasury yields are likely headed lower (or at least not much higher) over the next few quarters. And if yields fall from current levels, investors will have likely missed an opportunity to invest in yields we’ve not seen in over a decade.

While we certainly think cash is a legitimate asset class again, it’s all about balancing today’s opportunity with what may or may not be available tomorrow. So, unless investors have short-term income needs, they may be better served by reducing some of their excess cash holdings and by extending the maturity profile of their fixed income portfolio to lock in these higher yields for longer. Bond funds and ETFs that track the Bloomberg Aggregate Index, along with separately managed accounts and laddered portfolios, all represent attractive options that will allow investors to take advantage of these higher rates before they’re gone.

Lawrence Gillum, CFA, Chief Fixed Income Strategist, LPL Financial

Adam Turnquist, CMT, Chief Technical Strategist, LPL Financial

Much has been written lately about the threats facing the reserve currency status enjoyed by the U.S. dollar. “De-dollarization” headlines appear on a near-daily basis, suggesting the dollar’s reign is in looming jeopardy, while counterarguments point out there isn’t another currency with the depth, transparency, and reliability associated with the dollar. Still, critics accuse the U.S. of having “weaponized” the dollar, that is, punishing other countries with sanctions and freezing assets. These accusations have been particularly prevalent as the Ukraine/Russia conflict continues, with Russia and its long-standing allies asserting that the U.S. has illegally frozen billions of dollars of Russian financial assets.

In addition, China has been increasingly active on the world stage as it seeks to elevate the yuan as a reserve currency and dent the hegemony of the dollar’s rule in global trade and overall standing.

Affecting the dollar currently, in economic terms, is that the Federal Reserve (Fed) is near, or at the end of its aggressive rate hike campaign that began in March 2022, and accordingly, the dollar has been edging lower against the basket of currencies of its largest trading partners. As a result, the dollar has been losing the “interest rate differential” that propelled the dollar to an almost parabolic high for much of 2022, while the euro has gained strength as the European Central Bank (ECB) continues to raise interest rates.

The Dollar Within the Global Framework

The dollar, thanks in large part to its liquidity and reliability, is used as the primary currency of choice by the majority of global central banks that keep a good portion of their reserves in dollars. To be sure, central banks have been heavy purchasers of gold as concerns build over the ramifications of de-globalization and what has been viewed as “fragmentation” as new trading blocs are discussed and being formed.

Foreign companies still borrow in dollars and use the dollar in their normal trading operations, with the dollar the leading currency in global trade invoicing and settlements.

Part of the criticism leveled at the U.S. is that the ubiquitous use of the dollar has allowed the U.S. to run an unfairly large trade deficit, at the expense of trading partners. While the U.S trade deficit was $64.2 billion in March, and is the largest trade deficit globally, the United Kingdom, Mexico, and Brazil also run large deficits. 

China Stages a Push to Legitimize the Yuan Towards Reserve Status

Of all of the reporting regarding threats against the dollar’s dominance within the global financial infrastructure, China’s drive towards increasing acceptance of the yuan as a reserve currency carries the most relevancy. As the world’s second-largest economy, it has for many decades had important trade relationships priced in the yuan, or renminbi, the official name for its currency.

Many companies have been using the yuan for decades, as trade with China is an integral part of their global market footprint.

In 2016, the International Monetary Fund (IMF) added the renminbi to its Special Drawing Rights (SDR) basket following years of intense lobbying by China. Established in 1969, the IMF considers the SDR as a “supplementary international reserve asset”. The SDR now includes the U.S. dollar, the euro, the British pound sterling, the Japanese yen, and the Chinese renminbi.

The debate over China’s entry into the SDR centered on its status as an emerging market and concerns over its human rights record. Still, the IMF board voted to allow the renminbi to join the group of developed market currencies, affording its currency a legitimacy of sorts.

China’s President Xi Jinping has been behind an intense effort to secure trade agreements globally, and the results have been successful in terms of global reach, including Russia and Saudi Arabia. Within Europe, China has a long-established relationship with Italy and is carving out deeper bilateral ties with France. Brazil has also been an active trading partner with China. Russia strengthened its relationship with China when it was banned from using SWIFT, the global financial transaction processing system.

But the outreach is also tinged with an anti-U.S. posture, as tensions between the U.S. and China escalate on many fronts, particularly over Taiwan. The “weaponized dollar” theme has been playing well as China’s stepped-up bilateral efforts gain momentum.

Chinese officials point to the sanctions imposed on Russia as an example of how the U.S. has weaponized the dollar, which certainly extrapolates easily to what a U.S.-led effort could do against Chinese assets in the event of a forced takeover of Taiwan. It’s been evident that China has been transitioning away from the dollar as the People’s Bank of China has been a major buyer of gold as it increases its stockpiles. It is estimated the central bank now has 2,068 tons in its gold reserve.

King Dollar Still Reigns

The euro has, since its inception in 1999, become an important global reserve currency in terms of its use in global trade, however, because of its fragmented political and economic structure, its rise towards a more complete reserve status is thwarted. That the yuan is rising in its acceptance by trading partners is apparent, but to be recognized as an authentic reserve currency requires transparency, reliability, and credibility.

The dollar’s backing is exemplified by a sound foundation, a history of credibility, and transparency that cannot be negated by its detractors. King dollar still reigns and will for the foreseeable future.

Investment Outlook

LPL Research remains comfortable with its year-end S&P 500 fair value target of 4,300–4,400, based on a price-to-earnings ratio of 18 and $240 in S&P 500 earnings per share in 2024. But as stocks get closer to that target, LPL Research’s Strategic and Tactical Asset Allocation Committee (STAAC) may reconsider its recommended slight overweight allocation to equities. The year-end forecast range for the 10-year Treasury yield remains 3.25% to 3.75%.

The Committee notes that the outlook for growth stocks has improved, suggesting balanced style exposure, while the outlook for small caps has become more challenging in recent weeks, as credit conditions have tightened amid ongoing small bank stress, supporting an overweight large cap stance. The STAAC has upgraded its view of international equities to overweight on attractive valuations and improved technical analysis trends, while the potential for U.S. dollar weakness in the intermediate term is a potential catalyst. Industrials remain the Committee’s top sector pick.

Within fixed income, the Committee recommends an up-in-quality approach with a benchmark weight to duration. We think core bond sectors (U.S. Treasuries, Agency mortgage-backed securities (MBS), and short-maturity investment grade corporates) are currently more attractive than plus sectors (high-yield bonds and non-U.S. sectors) with the exception of preferred securities, which look attractive after having recently sold off due to the banking stresses.

Quincy Krosby, PhD, Chief Global Strategist