Higher Equity Prices Amid Historically Low Volatility | Market Insight Quarterly | Second Quarter 2017

HIGHER EQUIT Y PRICES AMID HISTORICALLY LOW VOLATILITY
  • Economic data received over the last three months has generally signaled that U.S. economic activity improved over the second quarter of the year compared to modest gross domestic product growth of 1.4% in the first quarter. The Citigroup Economic Surprise Index, an aggregate measure of economic surprises, did fall to its lowest level since 2011 in mid-June, but disappointments were against elevated expectations; the consensus estimate of Bloomberg-surveyed economists still has growth accelerating to 3.0% in the second quarter. The more subdued expectations are 2.2% growth for all of 2017, near the expansion average of 2.1%. Measures of consumer confidence remain strong and consumer spending picked up after a weak first quarter. However, wage growth remains only modestly above inflation despite a low unemployment rate. Business confidence likewise remains strong and purchasing manager surveys have indicated continued expansion of both the services and manufacturing sectors of the economy. Economic prospects were strong enough for the Federal Reserve (Fed) to continue to slowly scale back accommodative policy, raising rates at its June meeting for the second time this year.
  • Stocks gained 3.1% during the second quarter, based on the S&P 500 Index; continued steady growth in the U.S. economy, generally improving economic conditions overseas, and ongoing central bank support helped offset ebbing enthusiasm for pro-growth policies from Washington, D.C. Growth outpaced value during the quarter due to biotech strength helping healthcare turn in the top performance. Technology gained as well, but started to show some cracks late in the quarter. Energy weakness hurt value, even though financials did well on optimism overcoming deregulation. Large caps bested their mid and small cap counterparts, but from a global perspective, emerging markets and large foreign markets more than doubled the Russell 3000, building on a strong first quarter as well. The Bloomberg Barclays Aggregate Bond Index returned 1.45%, with longer maturities outpacing short, while more economically sensitive fixed income, including investmentgrade corporates and high yield, outpaced high quality. In the end, the theme for 2017 remains: higher equity prices amid historically low volatility.
  • Long-term rates decline as bond markets become cautious. The Treasury yield curve flattened for the second consecutive quarter as short-term yields rose due to the latest Fed rate hike in June. Long-term rates gradually declined over the quarter on declining inflation expectations, which were pushed even lower by oil’s 9% decline in price over the quarter. The decline in longer-term yields was a tailwind for fixed income generally. The Bloomberg Barclays Aggregate Bond Index returned 1.5%, outperforming Treasuries which returned 1.2% (Bloomberg Barclays U.S. Treasury Index). The longer duration profile of the corporate sector boosted the sector to 2.4% over the quarter (Bloomberg Barclays U.S. Investment Grade Corporate Index). Economically sensitive, lower credit quality sectors continued to rally, with high yield returning 2.2% (Bloomberg Barclays U.S. Corporate High Yield Index) and bank loans gaining 0.6% (Bloomberg Barclays U.S. High Yield Loan Index). Similar to the first quarter, many sectors hardest hit in late 2016 continued to rally during the second quarter. Emerging market debt returned 2.2% (JPMorgan Emerging Markets Bond Index), preferreds rallied 3.8% (BofA Merrill Lynch Hybrid Preferred Securities Index), and highyield municipals returned 2.0% (Bloomberg Barclays Municipal High Yield Index). The U.S. dollar’s -4.7% return during the quarter benefited unhedged foreign bonds, which returned 3.8% (Citigroup Non-US World Gov. Bond Unhedged Index) despite rising rates in many foreign developed markets.
  • § Alternative investment returns were led by the HFRX Event Driven Index, which gained 1.61% during the second quarter. Positive returns within the category’s sub-strategies were widespread, with Merger Arbitrage, Distressed, and Special Situation specialists all profiting during the period. The HFRX Equity Hedge Index gained 1.01%, which trailed the S&P 500 on an absolute basis. However, given most strategies exhibiting a beta profile between 0.35–0.45, relative returns were in-line with the market. The HFRX Systematic Diversified CTA Index led category declines, falling 1.47%. Losses were concentrated in the last week of the quarter, as the sell-off in equity and fixed income markets resulted in steep losses for those strategies positioned long in both asset classes.
  • Despite a nearly 5.0% decline in the U.S. Dollar Index, the Bloomberg Commodity Index declines 3.0%. Oil prices were lower as production cuts from OPEC were met with increased production from other sources, particularly in the U.S., casting doubt on the ability of the oil market to balance. Master limited partnerships (MLP) were particularly vulnerable, with the Alerian MLP Index losing 6.4%. Gold prices fell marginally, which again is not what would normally be expected given the weak U.S. dollar. Copper prices climbed .9%, due in part to signs of stability from China. Agriculture prices were lower most of the quarter, but showcased a significant rebound in the last few days of June to pare losses.
A LOOK FORWARD

Our confidence that earnings growth will continue over the balance of the year has led us to slightly raise our 2017 S&P 500 Index total return forecast to 6–9%, up from mid-single-digits previously, as laid out in our Midyear Outlook 2017: A Shift In Market Control.*We continue to look for the U.S. economy to expand up to 2.5% in 2017, although potential delays in passing major fiscal policies introduce some risk to the downside. We continue to believe that government policy, central bank policy, and steady economic growth have the potential to push the 10 year Treasury yield higher, and that our year end target of between 2.25% and 2.75% with a potential rise as high as 3%, remains reasonable.

Click here to download a PDF of this report.

 

IMPORTANT DISCLOSURES

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indexes are unmanaged and cannot be invested into directly.

General Stock & Debt Equity Risks

Stock investing may involve risk including loss of principal.

Investing in foreign and emerging markets securities involves special additional risks. These risks include, but are not limited to, currency risk, geopolitical risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks.

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

Government bonds and Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate.

High-yield/junk bonds are not investment-grade securities, involve substantial risks, and generally should be part of the diversified portfolio of sophisticated investors.

Long/short equity funds are subject to normal alternative investment risks, including potentially higher fees; while there is additional management risk, as the manager is attempting to accurately anticipate the likely movement of both their long and short holdings. There is also the risk of “beta-mismatch,” in which long positions could lose more than short positions during falling markets.

Distressed Debt is an investment in companies in or near bankruptcy. The investment is often made to gain control of the company with the goal of either improving the operations of the company or disposing of assets. The risks associated with distressed investing arise from several factors including: limited diversification, the use of leverage, limited liquidity, and the possibility that investors may be required to accept cash or securities with a value less than their original investment and/or may be required to accept payment over an extended period of time.

Definitions

Gross domestic product (GDP) is the monetary value of all the finished goods and services produced within a country’s borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments, and exports less imports that occur within a defined territory.

Index Definitions

The Bloomberg Barclays U.S. Corporate High Yield Index measures the market of USD-denominated, noninvestment grade, fixed-rate, taxable corporate bonds. Securities are classified as high yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below, excluding emerging markets debt.

The Bloomberg Barclays U.S. High Yield Loan Index tracks the market for dollar-denominated floating-rate leveraged loans. Instead of individual securities, the U.S. High-Yield Loan Index is composed of loan tranches that may contain multiple contracts at the borrower level.

The Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS, and CMBS (agency and non-agency).

The Bloomberg Barclays U.S. Corporate Index is a broad-based benchmark that measures the investment-grade, U.S. dollar-denominated, fixed-rate, taxable corporate bond market.

The Bloomberg Barclays U.S. Treasury Index is an unmanaged index of public debt obligations of the U.S. Treasury with a remaining maturity of one year or more. The index does not include T-bills (due to the maturity constraint), zero coupon bonds (strips), or Treasury Inflation-Protected Securities (TIPS).

The Bloomberg Barclays U.S. Mortgage Backed Securities (MBS) Index tracks agency mortgage backed pass-through securities (both fixed rate and hybrid ARM) guaranteed by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC).

The Bloomberg Barclays U.S. Treasury TIPS Index is a rules-based, market value-weighted index that tracks inflation-protected securities issued by the U.S. Treasury.

The BofA Merrill Lynch Preferred Stock Hybrid Securities Index is an unmanaged index consisting of a set of investment-grade, exchange-traded preferred stocks with outstanding market values of at least $50 million that are covered by Merrill Lynch Fixed Income Research.

The Bloomberg Commodity Index is calculated on an excess return basis and composed of futures contracts on 22 physical commodities. It reflects the return of underlying commodity futures price movements.

The Citigroup Economic Surprise Index (CESI) measures the variation in the gap between the expectations and the real economic data.

This research material has been prepared by LPL Financial LLC.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity.

Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by Any Government Agency | Not a Bank/Credit Union Deposit

Tracking #1-624225 (Exp. 11/17)