Taxes

Lawrence Gillum, CFA, Fixed Income Strategist, LPL Financial

Josh Whitmore, CFA, Sr. Fixed Income Analyst, LPL Financial
 

TAKING ADVANTAGE OF HIGHER YIELDS

The LPL Research Strategic and Tactical Asset Allocation Committee is increasing its recommended interest rate exposure in its tactical allocation from underweight to neutral. Now that interest rates have moved substantially higher, we believe opportunities in fixed income have improved and are looking to add back to certain areas within fixed income that may benefit.

Because the equity risk within our diversified asset allocation portfolios is still the largest contributor to total portfolio risk, we like the defensive properties that bonds could play on a go-forward basis. In the form of high-quality bonds, interest rate exposure has been a good diversifier to equity risk. And while that hasn’t been the case this year, we think at these higher interest rate levels, bonds can act like that diversifier again. While we acknowledge that interest rates could move higher still, we think the risk/reward profile of adding to rate-sensitive fixed income assets has improved. That said, for those income-oriented investors who mostly or exclusively hold bonds and don’t need fixed income to diversify stock holdings, we think there are ample opportunities in shorter maturity Treasury and investment-grade corporate securities.
 

A Historically Aggressive Fed

In last week’s Weekly Market Commentary, we wondered how much higher interest rates could go. The yield on the 10-year U.S. Treasury yield is up over 3.0% from its August 2020 lows and has already seen the biggest move higher in yields since 1987, when rates moved higher by 3.2%. Since the 1980s, the average trough-to-peak increase in 10-year Treasury yields has been closer to 2.5%, but that includes large rate increases in the early ‘80s when Treasury yields were much higher. Since 2000, the average increase in the 10-year yield during major moves higher is around 1.8%. Clearly, we’re not in normal times, but the move on the 10-year Treasury yield since it bottomed in August 2020 has been significant. As such, yields on most fixed income instruments are trading above longer-term averages.

The significant increase in yields, especially this year, is because of changing Federal Reserve (Fed) rate hike expectations. In late 2021, markets expected the Fed to largely stay on the sidelines and keep short-term interest rates low. However, as inflationary pressures remained (and still remain), the Fed has embarked on a historically aggressive rate hiking campaign [Figure 1]. Because of the Fed’s stated desire to front-load rate hikes, the current rate hiking cycle is the most aggressive campaign since the early ‘80s in both the speed and magnitude of rate hikes. The Fed has signaled that more interest rate hikes will likely be necessary to arrest the generationally high consumer price increases we’re currently experiencing. Markets have already priced in what we think is an appropriate terminal fed funds rate. As such, we think we may be at or near peak “hawkishness” from the Fed, which should allow fixed income yields to stabilize at or near current levels.

Lawrence Gillum, CFA, Fixed Income Strategist, LPL Financial

Inflationary dynamics continue to surprise to the upside, and markets now expect the Fed to pursue one of its most aggressive rate hiking campaign in years. U.S. Treasury yields continue to move higher as well. We think we’ve seen the biggest moves higher in yields, but as long as inflationary pressures continue to surprise to the upside, interest rate volatility will likely remain. We still think the 10-year Treasury yield can end the year between 2.75%-3.25%, but we acknowledge there are risks to the upside.

Last week’s higher than expected inflation report was a game-changer for the Federal Reserve (Fed) and bond markets. With inflationary pressures continuing to run much hotter than the Fed’s 2% target, an even more aggressive rate hiking campaign was priced into markets. Markets are now expecting at least a 75 basis point (bp) increase in its short-term interest rate at this week’s meeting and nearly another 100 bp of hikes in the two remaining meetings this year. Moreover, markets expect the fed funds rate to get to 4.5% by early next year.

GETTING JOBS MARKET BACK INTO BALANCE

Jeffrey Roach, PhD, Chief Economist, LPL Financial

Federal Reserve Chairman Jay Powell reiterated his warning that getting inflation under control will require some pain. Powell is likely making these warnings based on the arcane, clunky relationship between inflation and unemployment. The key to getting the market back into balance is a bigger labor force, and the economy is starting to experience a larger labor force as individuals come off the sidelines and rejoin the job market.
 

“PAINFUL” rise in unemployment?

Members of the Federal Open Market Committee (FOMC) recently issued warnings that the path to lower inflation will be painful. The crux of that view is based on the arcane, clunky Phillips Curve, which illustrates the relationship between inflation and unemployment. Like many concepts in global markets, the Phillips Curve went through many iterations and has plenty of versions. Nonetheless, the FOMC believes that the basic Phillips Curve concept is paramount for this current environment; i.e., the economy cannot get back to a long-run 2% inflation rate unless unemployment rises. And a future rise in unemployment could be significant and pain-provoking, especially for lower income households.

Is current inflation driven by a tight labor market?

The global economy is complex, and a simplification of reality always introduces distortions, so perhaps we should zoom out a bit. The world experienced multiple industrial revolutions, from mechanical to electrical to digital, and some talk about a fourth industrial revolution. Wherever the world is in its revolutionary phase, most agree that inflationary contributors change over time. And sometimes that change can happen quickly. We believe current inflation is a result of large fiscal stimulus during the COVID-19 shutdowns and nagging supply bottlenecks, further aggravated by a host of potential workers who are still on the sidelines.

The latest jobs report gave some glimmer of hope. Over a third of those unemployed and looking for work were previously not in the labor force as shown in Figure 1. As more individuals reenter the workforce, the labor market could loosen organically, especially as individuals currently not in the labor force move directly into a job.
 

CALENDAR CRUELTY

Jeffrey Buchbinder, CFA, Chief Equity Strategist, LPL Financial

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

Jeffrey Roach, PhD, Chief Economist, LPL Financial

The difficult 2022 for stocks may not get much easier because as we now wait for better news on the inflation front, we have to contend with a seasonally weak month of September. While we got some welcome news in Friday’s jobs report, more evidence of falling inflation will take time to materialize. The good news is a seasonally strong fourth quarter is right around the corner. If history is a guide, midterm elections may provide an added late-year boost.
 

SEPTEMBER TO REMEMBER?

September is often a month to remember for investors—but for the wrong reasons. September has historically been one of the weakest months of the year for stocks, as shown in Figure 1.
 

Jeffrey Buchbinder, CFA, Chief Equity Strategist, LPL Financial

George Smith, CFA, CAIA, CIPM, Portfolio Strategist, LPL Financial
 

Selling your business can provide a sense of relief. After putting in your blood, sweat, and tears, you can now reap in the benefits. However, in navigating life after selling your business, you also need to consider how selling your business has affected your finances and what to do with the profits you received. Continue reading to learn about financial moves to make after selling your business.
 

Maximize Your Profits

Most business owners generate a large amount of profits from the sale of their business. With this influx of cash, it’s important to know how to truly maximize these profits. One strategy to consider is converting a significant portion of the profits in pre-tax accounts to Roth IRAs. By utilizing the Roth IRA conversion method, you can put enough money into your Roth IRAs to stay below higher tax brackets. This is also a great way to catch up on retirement savings if you are not on track. Keep in mind the amount that you convert is taxable in the year of the conversion.
 

RELIEF AT THE PUMP AND FOR PORTFOLIOS?

Scott Brown, CMT, Technical Market Strategist, LPL Financial

Quincy Krosby, Chief Equity Strategist, LPL Financial

2022 has been rough all-around for the American consumer. Not only are we battling decades-high inflation, but investors’ portfolios are off to one of the worst starts to a year in history as we near the halfway point. Our technical work is first and foremost rooted in trend following, and the trend in both stock and bond prices so far this year have of course been down. However, one trend that has been strongly higher is energy prices. It may be early, but we see some potential signs that energy trends could be changing, which would not only have positive implications for consumers’ wallets, but also potentially investors’ investment portfolios.

GAS PRICES HIT RECORD HIGHS

Let’s start with the single price that matters to consumers most: gas prices. Even if you drive an electric car, it would be hard not to notice the huge increase in gas prices over the past year. As shown in Figure 1, the AAA national average price for a gallon of gasoline just hit $5 for the first time ever. For many Americans, the amount of gasoline they need is simply fixed, as they must drive to work, school, etc. So when prices rise, the money has to come from somewhere else, and it should therefore come as no surprise that the consumer discretionary sector is the worst performing S&P 500 Index sector year-to-date with a more than 30% loss.

BEAR MARKET Q&A

Ryan Detrick, CMT, Chief Market Strategist, LPL Financial

Jeffrey Buchbinder, CFA, Equity Strategist, LPL Financial

        

The bear market that started on June 13 has left the S&P 500 Index 23.5% below its January 3 high. After the initial positive reaction to the Federal Reserve’s first 0.75% rate hike since 1994 and tough talk on inflation, heightened fears of recession and that the Fed might “break something” sent stocks down for the 10th week out of 11 for only the second time in history (The first was in 1970). To help investors manage through this difficult period, we answer some of the top questions we’re getting about bear markets and list some things to watch to assess progress toward an eventual durable low.
 

HOW LONG DO BEAR MARKETS TYPICALLY LAST?

The current bear market, which began at the January 2022 highs for the S&P 500 Index, is actually already old by recent standards. At about five-and-a-half months old, it is already older than six other bear markets going back nearly 40 years, with only the 2000-2002 tech bubble and 2008-2009 financial crisis bears lasting longer. This means the bear market may be closer to a bottom than many expect. The average bear market since 1950 has taken about 11 months to mark its low, but six out of the last eight bear markets ended within six months [Figure 1].

How this bear market will end will likely hinge on the pace at which inflation comes down, which will dictate the timing and magnitude of the Federal Reserve’s (Fed) rate hiking campaign. How fast the Fed moves will determine how much the economy slows and whether something breaks (like a large financial institution going under, though that’s not our expectation). If a full-blown crisis and recession such as in 2000-2002 and 2008-09 can be avoided, this bear market may bottom soon.

HOW MUCH FURTHER MIGHT STOCKS FALL?

The average bear market since 1950 has seen the S&P 500 lose an average of about 29% (including the near bear markets that saw declines of 19-20%), as shown in Figure 1. That suggests that if this bear market ends up around the average, that stocks may drop another 5% or so. Based on current economic conditions, one could make the case that this bear market could be shallower than typical bears because consumer balance sheets and the job market are still in good shape, and interest rates are still low by historical standards. At the same time, however, the inflation problem won’t be solved quickly, suggesting we could see a slow bleed and end up down near the average of 30%.