LPL Financial Outlook 2023

Ed. 2023 OUTLOOK LPL RESEARCH PRESENTS: FINDING BALANCE

INTRODUCTION Finding Balance hrough all the challenges, newfound opportunities, and every high and low we’ve experienced during the last couple of years, it’s no surprise why we T might be striving for more balance. Whether it’s about the markets and global economy or what’s happening in our local communities, the news we’re hearing on a daily basis has the potential to disrupt the balance of our lives. But with resilience, perspective, and the support of close connections, we can navigate through it all and regain our sense of equilibrium—even after another dizzying year, as 2022 proved to be. After two years of disruption due to the COVID-19 pandemic, we were searching for some kind of return to normalcy, while at the same time, still experiencing the aftereffects of the pandemic. Some of those aftereffects included the imbalances created by the fiscal, monetary, and public health policy put in place to address the pandemic—and the process of addressing those imbalances has been disorienting at times. If 2022 was about recognizing imbalances that had built in the economy and starting to address them, we believe 2023 will be about setting ourselves up for what comes next as the economy and markets find their way back to steadier ground—even if the adjustment period continues. The Federal Reserve (Fed) spent 2022 aggressively fighting inflation by raising interest rates. In 2023, we expect the Fed to find that point where it can stop raising rates, as inflation starts to come under control. The Fed’s efforts to control inflation throughout 2022 pulled interest rates off of extremely low levels that were historically unprecedented. While that has been painful for bond investors, for the first time in a decade, savers can now get an attractive yield, and 2023 will be more focused on how to potentially benefit from this significant shift. Stock market expectations may also see some realignment heading into 2023. The projections for certain market segments became too high in 2022 following a decade of low rates and a burst of extraordinary technology adoption. We expect 2023 will likely be more focused on the opportunities that may emerge from a market sell-off. LPL Research’s Outlook 2023: Finding Balance is our guide to how the readjustments in the economy and markets may impact you in the coming year. The disruptions may not be fully resolved and there may be more challenges to come, but progress toward finding balance is well underway. And when those disruptions hit the market, it can be hard to find our footing and stay the course. Those are the times when sound financial advice is more valuable than ever, as it helps us find our center, remember our plan, and stay focused on our goals. LPL RESEARCH

OUTLOOK 2023 Sec. OVERVIEW INFLATION: We will likely enter 2023 with GEOPOLITICS: Uncertainty surrounding the a slightly different trajectory for inflation, course of the Ukraine-Russia conflict has particularly services inflation. In recent thwarted diplomatic attempts to reach a months, durable goods prices have clearly negotiated settlement. The intense military decelerated—and in some cases, outright campaign involves a significant contribution declined—but services prices have been from NATO toward the Ukrainian war effort, stubbornly accelerating as rent prices and specifically from the U.S. Depending on health services rose. We could potentially how long the fighting continues, it is be entering a new regime as rents across the expected that many of the NATO countries, country are showing signs of abating. During including the U.S., may debate the financial this transition period for services prices, the burden. Markets historically have navigated coming year could be the time when inflation regional conflicts fairly well despite the ECONOMY: The global economy will likely is convincingly decelerating closer to the human toll. The largest market vulnerability slow from the upper-2% range in 2022 down Fed’s long-run target of 2%. remains the war’s impact on inflation. to the mid-1% range in 2023. Much depends on China's growth path. The divergence between domestic and international economies is most obvious in the inflation regime. Germany, for example, has still been STOCKS: If stocks are going to go higher in COMMODITIES: This year the global experiencing accelerating rates of inflation 2023, a prompt end to the Fed’s rate hiking economy adjusted to a higher interest rate in late 2022, whereas the U.S. has likely campaign will likely be a key component. campaign initiated by most central banks moved past the peak. The longer inflation The timing of the last rate hike of this cycle in order to tackle inflationary pressures. is uncontained, the riskier the growth is uncertain and won’t be clear for a while, As such, expectations are rising that several prospects. If the U.S. falls into a recession, but our view is that the Fed will pause during regions may face a recession or a significant chances are it would occur during the first early spring of 2023 amid an improving economic slowdown will unfold, which would half of 2023 and would likely not be as deep inflation outlook and loosening job market. weigh on demand. Unless there are severe as the 2008 recession, which was initiated by Should that occur, stocks would likely move shortages, commodity prices typically a fundamentally flawed financial market. higher, consistent with history. Stocks have tend to ease until there are signs that tended to produce solid gains after hiking central banks are nearing the end of the cycles end, including a 10% average gain rate hike cycle. one year later. BONDS: The path of interest rates will certainly be largely influenced by the Fed’s behavior, which will be guided by economic CURRENCIES: To say the U.S. dollar growth and inflation data. Equally important POLICY: The 2022 midterm election was closer has vaulted higher during the Fed’s rate is the level of non-U.S. developed government than many expected, but in the end voters hike cycle would be an understatement. bond yields, as foreign investors are an chose to rebalance the power dynamic in Whether it is the result of the interest rate important buyer of U.S. Treasuries. Higher Washington. As expected, Republicans gained differential (that is, that the Fed has been foreign market yields, all else equal, generally enough seats to win a narrow majority in the more aggressive than other central banks) dissuade foreign investment into our markets. House, while Democrats held on to their slim or that U.S. markets have been attracting There are a range of scenarios we think could majority in the Senate. Despite Republican’s more investments from foreign investors, play out over the next year. However, given narrow House majority, their victory in the the result has been staggering. The strong our view that the U.S. economy could eke out House significantly shifts the balance of dollar, while making imports less slightly positive economic growth next year, power, since only legislation with broad expensive, has put pressure on many we think 10-year Treasury yields could end bipartisan support will get passed once the of the large multinational companies with the year around 3.5%. new Congress is sworn in on January 3, 2023. a global footprint. Please see back cover for important disclosures. 02

Sec. ECONOMY Gauging the slowdown in global economies he global economy occur during the first half of 2023 following trough. Since World War II, will likely slow from and will likely not be as deep as the average recession has lasted T the upper-2% range the 2008 recession, which was just over 10 months (down from an in 2022 down to initiated by a fundamentally flawed average of 17 months if you date back the mid-1% range financial market. to 1854), according to the National in 2023 [Fig. 1]. Much depends on Bureau of Economic Research. China's growth path. An important MORE CLARITY ON POTENTIAL Given the unique cause of the 2020 aspect for investors is that the U.S. FOR U.S. RECESSION recession, the time between peak and appears to have fewer headwinds to There are three factors for defining trough was the shortest on record— growth compared with Europe and a recession: depth, diffusion, and only two months. other developed economies. The duration—conveniently referred to One reason we’re currently seeing divergence between the domestic as the “three Ds.” Depth refers to a healthy debate on the likelihood of and international economies is most declining economic activity that is a recession is that for most of 2022, obvious in the inflation regime. greater than any relatively small not all of the metrics were flashing Germany, for example, is still change. Diffusion describes an warning signs. However, recent experiencing accelerating rates of economy that has experienced a data may give us more clarity. The inflation, whereas the U.S. has likely contraction in a wide range of sectors, Conference Board’s Leading Economic moved past the peak. The longer such as trade, business activity, and Index (LEI) has declined for seven of inflation is uncontained, the riskier consumer spending. Duration, likely the last nine months, showing that the growth prospects. the least important of the three the economy could enter a period If the U.S. falls into a recession, Ds, measures the time between the of significant and broad-based the chances are that it would previous business cycle peak and the contraction. The decline is predictable as many sectors, such as housing, started slowing months ago. Since the inception of the index, a decline of this Economic forecasts magnitude over a six-month period has always foreshadowed a recession 2023 annual forecasts GDP growth (Y/Y%) CPI (Y/Y%) in subsequent quarters [Fig. 2]. As United States 0.50% 3.50% such, we think recession risks appear more probable by the beginning of Eurozone -0.10% 4.80% 2023. If the economy does fall into Advanced Economies 0.40% 4.50% a recession, the cause will likely be fig. Emerging Markets 3.50% 5.60% from the consumer sector retrenching 1 after years of inflationary pressures, Global 1.70% 4.90% high housing costs, and slow real Source: LPL Research 11/15/22 Forecasts set forth may not develop as predicted and are subject to change. wage growth. LPL RESEARCH

OUTLOOK 2023 LEADING ECONOMIC INDEX (6-MO % CHANGE) RECESSIONS 10% 5% fig. 0% 2-5% Leading -10% indicators point to more -15% 1958 1966 1974 1982 1990 1998 2006 2014 2022 slowdown Source: LPL Research, Conference Board 10/20/22 Even though investors are tempted workers [Fig. 3]. Investors should to say “this time is different,” we all watch these metrics throughout can take note of general principles 2023 as the economy leads to a about business cycles and the more balanced labor market. markets. The Fed has warned that the We expect the ratio of openings to current inflation fight will be painful, unemployed to fall as the economy so a dip into a recession should not be slows and firms cut their number of that surprising. job openings. Firms often quickly respond to a slowing economy: during Not enough READJUSTMENTS IN THE JOB the 2008 financial crisis, the number MARKET COULD LESSEN PAIN of openings fell by 50% in roughly 16 fig. workers to fill The Fed has repeatedly warned months, so this metric could revert 3job openings investors about the potential for pain quickly. The persistent problem of from the fight with inflation. That pain individuals out of the labor force is mostly likely associated with an has kept the labor market tight, but RATIO OF OPENINGS TO UNEMPLOYED RECESSIONS expected increase in unemployment a potential improvement in labor 2.0 as the job market cools from a slowing force participation in the prime age economy. The Job Openings and population (25–54 year olds) with Labor Turnover report was hardly on improved productivity would be a 1.5 center stage, until Fed Chair Jerome powerful remedy. And in terms of firms’ Powell used a press conference to struggle to find qualified workers, the 1.0 highlight the number of job openings coming year will reveal how firms are in the economy. The pandemic caused responding to current labor market these three metrics to become off conditions and any potential impact 0.5 balance: the ratio of openings to this may have on businesses. If the unemployed, the number of those not labor force grows back to its pre- 0 in the labor force, and the percent of pandemic trend, many of these near- 2002 2006 2010 2014 2018 2022 firms having difficulty finding qualified term conditions would improve. Source: LPL Research, Bureau of Labor Statistics, 11/07/22 04

ECONOMY A third of consumer spending goes to housing fig. 4HOUSING AS % OF TOTAL CONSUMER SPENDING 36% 34% 32% 30% be entering a new regime as rents across the country are showing signs 28% of abating. During this transition 1986 1992 1998 2004 2010 2016 2022 period for services prices, the coming Source: LPL Research, Bureau of Labor Statistics 11/15/22 year could be the time when inflation is convincingly decelerating closer to the Fed’s long-run target of 2%. HOUSING MARKET SHOULD The hybrid work environment If inflation in 2022 was about BEGIN TO NORMALIZE and the corresponding interest to supply constraints, then inflation The housing market is still move to areas with lower cost of in 2023 could center on demand normalizing in response to an living created an imbalance in the constraints. For the past year, economy under pressure from higher housing market, especially during the supply-related problems contributed borrowing costs, nagging inflation, trough in mortgage rates. Regional more to inflation than demand- and uncertainty about future variations will likely remain as related imbalances. China’s Fed activity. Slowing residential geographic reshuffling continues. zero-COVID-19 policy was one investment will create a drag on In 2023, the potential for more multi- of the biggest glitches in supply economic growth at the start of 2023, family dwellings should help bring chains as metro areas and ports but demographics of Millennials and the demand and supply for rentals were shuttered by the Chinese Generation Z could provide some into balance, while more rentals and government. However, things may support for housing demand later in normalizing house prices should be on the verge of changing as the year. Nevertheless, in the near ease inflation. supply and demand get into balance term, housing demand will likely fall throughout 2023, and as inflation further in the coming months, putting INFLATION SHOULD BECOME likely becomes more demand driven downward pressure on median prices. CONVINCINGLY SOFTER and less supply driven. This is Housing plays a significant role Investors and central bankers will positive for policymakers because in consumer spending and investors likely enter 2023 with a slightly monetary policy tools do not work should monitor the housing market different trajectory for inflation, on supply shocks but rather, only on as a bellwether for the health particularly services inflation. In demand; thus, these tools are now of the consumer. Consumers recent months, durable goods prices more relevant than they were when spend roughly 34% of their total have clearly decelerated—and in inflation was primarily from supply spending on housing [Fig. 4], so a some cases, outright declined—but bottlenecks. So as supply constraints decline in housing-related costs services prices have been stubbornly ease and as Fed tools become more should give consumers more for accelerating as rent prices and health impactful, we could see the rate of discretionary spending. services rose. We could potentially inflation decelerating further in 2023. LPL RESEARCH

OUTLOOK 2023 STOCKS Sec. Equilibrium between the macro and the micro quity markets REACHING THE PEAK Note that the two instances lacked balance OF THE RATE CLIMB when stocks struggled the most E in 2022 as the If stocks are going to go higher in after a Fed rate hiking cycle ended, challenging macro 2023, a prompt end to the Fed’s rate 1981 and 2000, were both during environment hiking campaign will likely be a key recessions. A recession in 2023 may overwhelmed business fundamentals. component. The timing of the last be more likely than not, but our Stubbornly high inflation and rate hike of this cycle is uncertain expectation is that if a recession sharply higher interest rates were and won’t be clear for a while, but occurs, it will be more mild than the dominant market drivers, our view is that the Fed will pause in those cases. Fourth quarter 1981 pressuring valuations and inciting early spring of 2023 amid an improving marked the start of the second leg fears of recession and falling inflation outlook and loosening job of the double-dip recession after corporate profits. market. Should that occur, stocks Fed Chair Paul Volcker famously In 2023, we look to equity would likely move higher, consistent broke the back of inflation with markets to find balance between key with history. Stocks have tended to significant interest rate hikes, while macroeconomic factors—inflation, produce solid gains after hiking cycles 2000 was the start of the burst of interest rates, and Fed policy—and end, including a 10% average gain one the tech bubble that contributed to business fundamentals. year later [Fig. 5]. the recession in 2001. Stocks have historically risen after the end of Fed rate hike cycles AVERAGE S&P 500 INDEX GAIN: NEXT 3 MONTHS NEXT 6 MONTHS NEXT 12 MONTHS 40% fig. 530% 20% 10% 0% -10% -20% -30% 04/25/74 02/15/80 05/05/81 02/24/89 02/01/95 05/16/00 06/29/06 12/19/18 AVERAGE Source: LPL Research, FactSet, Ned Davis Research 11/15/22 Indexes are unmanaged and cannot be invested into directly. Past performance is not a guarantee of future results. 06

STOCKS WHAT GOES DOWN Cost pressures amid high inflation TENDS TO GO UP and still-snarled global supply chains fig. They say that what goes up must are the biggest factors, but slowing come down. For the stock market, it economic growth and the strong Potential slight also works the other way. Through U.S. dollar may make any earnings 2023 earnings gain many economic downturns, growth in 2023 difficult to achieve. would be welcomed recessions, and geopolitical crises Many companies over-earned during over many decades, the stock market the pandemic, so some reversion 7by markets has always recovered. Those patient back to normal still needs to occur. and courageous investors who were Inventories also need to be brought CONSENSUS S&P 500 EPS 2022 able to take advantage of those down. Even though some of these CONSENSUS S&P 500 EPS 2023 declines have usually been rewarded pressures have started to ease, lower LPL RESEARCH 2023 FORECAST nicely. Following down years, the S&P commodity prices and slightly looser $260 500 has risen an average of 15% with labor markets have, thus far, had positive returns in 15 out of 18 years limited impact on inflation overall. $250 [Fig. 6]. Since 1950, a down year was Our base case for S&P 500 earnings $240 only followed by another down year per share in 2023 is $220, similar to three times: in 1973, 2000, and 2001. where 2022 is tracking and about $230 Looking at this another way, after $12, or 5%, below the consensus losing 20% or more at any point in estimate as of November 15, 2022 $220 time, the S&P 500 Index has gained an [Fig. 7]. Revenue will continue to get average of 17.6% over the subsequent a boost from inflation, as many blue $210 01/22 03/22 05/22 07/22 09/22 11/22 12 months (monthly data). The positive chip companies during third quarter Source: LPL Research, FactSet 11/15/22 Earnings per share expressed as $ of EPS post-midterm election year pattern, earnings season have demonstrated an Forecasts set forth may not develop as predicted and are subject to change. discussed later in this publication, ability to pass along higher prices due provides another historical analog that to their pricing power. But margins will should be supportive of higher stock likely compress further over the next prices in 2023. several quarters before support from lower costs potentially arrives. WIDE RANGE OF POSSIBLE An upside scenario could EARNINGS OUTCOMES materialize if inflation falls faster than Corporate America faces significant we anticipate, propping up margins headwinds as 2023 gets underway. and potentially putting S&P 500 Stocks have historically bounced back after down years CALENDAR YEAR S&P 500 RETURN S&P 500 RETURN THE FOLLOWING CALENDAR YEAR 50% fig. 25% 60% -25% -50% 1953 1957 1960 1962 1966 1969 1973 1974 1977 1981 1990 1994 2000 2001 2002 2008 2011 2015 2018AVERAGE Source: LPL Research, FactSet 11/15/22 Indexes are unmanaged and cannot be invested in directly. Past performance is no guarantee of future results. Returns displayed are price returns, excluding dividends. LPL RESEARCH

OUTLOOK 2023 earnings per share as high as $235 in 2023 and over $250 in 2024. On the other hand, stubbornly high inflation and a more prolonged economic downturn could introduce downside risk, possibly down to $200 per share in earnings in 2023 before a potential rebound to $230 in 2024. TILTING THE SCALES BACK IN FAVOR In 2022, the bear market decline in stocks was all about the macro picture—high inflation, surging interest rates, and rising recession risks. Strong fig. consumer and corporate balance sheets and growth in corporate profits were not rewarded by investors, who were focused on rising recession risk 2023 year-end stock market and concerns of higher interest rate levels affecting future earnings. Add 8forecast scenarios to that a tense geopolitical landscape and a strong U.S. dollar, and stocks struggled to make any headway Bear case Base case Bull case throughout the year. ESTIMATED 15% 60% 25% Looking ahead to 2023, stock PROBABILITY drivers are likely to be more balanced. ECONOMY Recession Flattish growth, Soft landing possible mild recession Rather than the scales tilting toward rising interest rates and runaway INFLATION Remains stubbornly high Gradually eases Falls faster inflation, we may see falling interest than expected rates and lower inflation supporting INTEREST RATES Stay high or rise further Move gradually lower Fall materially higher stock valuations. Should the outlooks for economic growth and FEDERAL RESERVE Fed tightening continues Fed pauses in Fed signals pause inflation improve as 2023 progresses, well into 2023 early spring 2023 before year-end 2022 stocks may also get a lift from EARNINGS Recession drives Stall amid growth lull, Margins rebound prospects for stronger earnings double-digit decline cost pressures as inflation falls growth in 2024. U.S.-China tensions build, Progress comes slowly China eases COVID policies, LPL Research’s Strategic and GEOPOLITICS Russia-Ukraine escalation in China, Ukraine Europe conflict contained Tactical Asset Allocation Committee Modest P/E multiple Modest P/E multiple Sizable P/E multiple (STAAC) sees fair value for the S&P VALUATIONS compression expansion expansion 500 at 4,400–4,500 at year-end 2023, ESTIMATED P/E based on a price-to-earnings ratio of 16 18 20 18–19 and $240 per share in S&P 500 2022 EPS 220 220 220 earnings in 2024. That target is also 2023 EPS 200 220 235 derived from probability-weighted 2024 EPS 230 240 255 scenarios and based on various paths YEAR-END 2023 S&P 500 for the economy, inflation, interest FAIR VALUE TARGET 3680 4320 5100 rates, and earnings [Fig. 8]. TARGET 4400 – 4500 Our bear case fair value of 3,680 is Source: LPL Research 11/15/22 based on 16 times $230 per share in Estimates may not materialize as predicted. Indexes are unmanaged and cannot be invested in directly. P/E is a price/earnings ratio. 08

STOCKS S&P 500 earnings in 2024, while our Equity asset allocation recommendations bull case of 5,100, which we see as slightly more likely than the bear case, is based on 20 times $255 per share in S&P 500 earnings in 2024. Market cap Style We look for stocks to find better balance between the macro environment and business LPL Research maintains a slight preference Growth-style stocks trailed their value fundamentals in 2023, tilting the for small and midcap stocks relative to counterparts throughout much of 2022. scales toward the bulls. large caps for 2023. Small cap stocks tend As the calendar turns to 2023, value still to perform better in early-cycle economies, looks to have a slight edge based on the OPTIMISTIC ABOUT which we believe will characterize 2023, still very challenging inflation outlook, high TECHNICAL TREND REVERSAL and they may benefit from attractive interest rates, and our positive view of the It has been mostly downhill for the valuations and a potential rebound in the energy sector. However, once inflation and S&P 500 since kicking off the year U.S. economy in the back half of 2023. interest rates start to come down, as we with a record-high. The downtrend Smaller companies are also relatively more anticipate in the first half of 2023, growth since January severely damaged insulated from economic risks in Europe. performance may be poised to turn around. market breadth and momentum. More recently, oversold conditions coupled with seasonal tailwinds Sectors Region underpinned a relief rally off the October lows. While some technical damage LPL Research recommends balanced The energy crisis in Europe has strengthened has been repaired, the S&P 500 exposure to defensive and cyclical sectors our conviction in favoring U.S. equities over remains in a downtrend and below in 2023 in a still uncertain economic their developed international counterparts, its declining 200-day moving environment. Our favored defensive sector is as the U.S. is simply better positioned than average (DMA). We are optimistic healthcare, while we also like the defensive Europe to withstand higher energy costs. for a trend reversal in 2023 and characteristics of the energy sector due to Developed international equities likely suspect it will be accompanied by constrained global supplies. The conditions require a synchronized global expansion to a pullback and/or consolidation for a style shift toward growth—such as outperform, which seems unlikely in 2023. phase for Treasury yields and the falling inflation, stabilizing economic growth, Our negative view of emerging markets US Dollar Index. and lower interest rates—may also drive a is based largely on earnings weakness, In terms of upside for next year, a turnaround in the leading growth sector, heightened geopolitical tensions, and confirmed reversal on the S&P 500 i.e., technology. Industrials is another sector persistent COVID-19 lockdowns in China, should open the door for a retest to watch as 2023 gets underway. though valuations are supportive, and the of the August highs near 4,300. U.S. dollar's rally has cooled of late. Probabilities for a breakout beyond this level would meaningfully increase if Treasury yields and the dollar continue to decline. History is also on the market’s side as the S&P 500 historically spends less than 30% of all trading days below its 200-DMA (since 1950). During this timeframe, whenever the index held below the 200-DMA for a six- month period, forward 12-month average and median returns were 14.2% and 18.3%, respectively. LPL RESEARCH

OUTLOOK 2023 BONDS Sec. Uncovering alternatives in the bond market cross the Treasury interest rates, 2022 was a year of an important buyer of U.S. Treasuries. yield curve, U.S. steeply higher rates. So where do we Higher foreign market yields, all else A Treasury yields think the yield on the 10-year Treasury equal, generally dissuade foreign were significantly security is headed in 2023? investment into our markets. There higher in 2022 with The path of interest rates will are a range of scenarios we think shorter maturity securities higher by certainly be largely influenced by the could play out over the next year. 4%. Additionally, intermediate- and Fed’s behavior, which will be guided However, given our view that the longer-term Treasury yields were by economic growth and inflation U.S. economy could eke out slightly higher by over 2%, taking the 10-year data. Equally important is the level positive economic growth next year, Treasury yield to the highest levels of non-U.S. developed government we think 10-year Treasury yields could since 2007. After years of falling bond yields, as foreign investors are end the year around 3.5% [Fig. 9]. Treasury yield forecasts fig. Hard landing Flattish growth/ Stagflationary environment mild recession Economic growth contracts Economic growth slows Economic growth slows but still slightly positive but still positive Inflation expectations decline Inflation expectations Inflation expectations increase 9 Macro steady and falling conditions Fed cuts rates from Fed cuts rates but Fed hikes rate into restrictive levels still restrictive more restrictive territory Global government Global government Global government bond yields fall bond yields steady bond yields elevated Year-end Fed Funds Rate 2.00% 4.50% 5.50% Market-Implied Inflation 2.00% 2.50% 3.50% Expectations 2-Year Treasury Yield 2.00% 3.75% 5.00% 10-Year Global Bond Yields 1.00% 2.00% 3.00% 10-Year Treasury Yield 2.75% 3.25 – 3.75% 4.75% Source: LPL Research 11/15/22 Rate forecasts may not develop as predicted and are subject to change. 10

BONDS Hypothetical returns: fig. Interest rate scenario analysis 10 Change in interest rates: -1.0% -0.5% No change +0.5% +1.0% Bloomberg US Aggregate Bond Index 12.3% 9.5% 5.2% 3.9% 1.1% Bloomberg MBS Index 12.7% 10.0% 5.4% 4.4% 1.6% Bloomberg US Treasury Index 11.0% 8.3% 4.5% 2.9% 0.2% Bloomberg US Corporate Index 14.2% 11.0% 6.1% 4.7% 1.5% Bloomberg Intermediate Corp Index 10.3% 8.5% 6.0% 4.9% 3.1% Bloomberg US High Yield Corporate Index* 11.9% 10.2% 7.4% 6.6% 4.8% Source: LPL Research 10/24/22 *Assumes 6% Default Rate and 40% Recovery Rate Rate forecasts may not develop as predicted and are subject to change. Indexes are unmanaged and cannot be invested into directly. risk, the opportunity set in shorter Past performance is not a guarantee of future results. maturity fixed income securities has improved as well. With 1- and 2-year Treasury securities both THE ROAD TO RECOVERY for performance over the next year yielding above 4%, cash and cash-like FOR CORE BONDS would be the index’s starting yield instruments finally offer an attractive The core bond index (as defined (dark blue highlighted section). yield. Moreover, shorter maturity by the Bloomberg Aggregate Bond Although, if interest rates decline by investment grade corporate securities Index) is seeing losses unlike any year 0.5%, the Bloomberg Aggregate Bond are offering yields in line with longer since its inception. Core bonds are Index could return more than 9% maturity corporate credit securities— down nearly 16% in 2022 and have over the next 12 months. Moreover, if without the same level of interest rate wiped out five years of index gains. interest rates move back into the low or credit risk. But because bonds are both financial 3% range, the core bond index could One thing to consider is that instruments and financial obligations, return around 12% over the next year. because starting yields are the best which pay coupons and principal Also, and importantly, given where predictor of future returns over the repayments at par when they starting yields are, if interest rates maturity of a fixed income instrument, mature, the potential for recovery is increase by another 1% from current by taking on that additional interest a bit more certain than in the equity levels, fixed income markets broadly rate risk and owning a full market markets that rely primarily on price could still generate positive returns core bond portfolio, investors would appreciation. So, how long will it take over the next 12 months. Given be “locking in” investments at higher to recover this year’s losses? the move higher in yields we have yields for a longer period of time. If Here are some expectations for experienced this year, we think the interest rates do fall from current various fixed income markets under risk/reward for owning core bonds levels, investors that are in shorter different interest rate scenarios has improved. maturity securities would then have to [Fig. 10]. If interest rates don’t However, for investors that don’t reinvest proceeds at lower rate levels. change at all, the best expectation want to take on a lot of interest rate So for investors with an investment LPL RESEARCH

OUTLOOK 2023 Less than 10% of outstanding debt needs to be refinanced before 2025 fig. 11AMOUNT OF INVESTMENT GRADE CORPORATE DEBT MATURING (BILLIONS) $700 $600 $500 $400 $300 time horizon greater than five years, $200 a full market core bond portfolio may make sense. Otherwise, shorter $100 maturity securities offer attractive yields as well. Bottom line, after the back-up in yields in 2022, there are $0 a number of attractive fixed income 2023 2026 2029 2032 2035 2038 2041 2044 2047 2050 2052+ opportunities again. Source: LPL Research, Bloomberg, 10/31/22 WHAT’S NEXT FOR CORPORATE CREDIT? years in particular, corporate [Fig. 11], only about 1% of existing Since Treasury yields are generally borrowers have increased the debt needs to be refinanced in used as the base rate for consumer amount of new debt issued seemingly 2023, and less than 10% needs to be and corporate borrowers, this year’s to prepare for the rising rate refinanced before 2025. So the need increase in Treasury yields pushed environment we’re currently facing. for companies to refinance existing many borrower’s borrowing costs to In fact, new corporate debt issuance debt at these higher levels seems to levels not seen in years. For corporate for investment grade companies hit be currently muted. borrowers, after years of borrowing at record highs in 2020 and 2021 when That said, if the Fed is able to keep ultra-low rates, the backup in yields over $3 trillion of new debt was rates at these elevated levels, and as we’ve seen this year has pushed issued. As such, corporate entities the need for corporate borrowers to corporate borrowing rates back above were able to term out debt by issuing access the capital markets increases, 6%, which is the highest levels since a lot of debt at longer maturities there’s no doubt that corporate 2009. Could higher borrowing costs and lower rates. Also, and notably, profitability will be negatively for corporates reduce profitability and because companies were able to impacted by higher interest expenses. potential growth opportunities? refinance existing debts over the last However, we don’t think it will happen Perhaps, but over the last two few years and push out maturities in the near term. 12

Sec. GEOPOLITICS Navigating a year of increased uncertainty ncertainty surrounding advances, military strength, and THE COMMODITY CONUNDRUM the course of the explicit remarks that Taiwan “must This year the global economy U Ukraine-Russia and will be” reunited with China. adjusted to a higher interest rate conflict has thwarted Because the U.S. has policy toward campaign initiated by most central diplomatic attempts Taiwan and has become increasingly banks in order to tackle inflationary to reach a negotiated settlement. vocal in support of Taiwanese pressures. As such, expectations are The intense military campaign independence, Xi declared that China rising that a recession or a significant involves a significant contribution will never renounce the “right to use economic slowdown will unfold. from NATO toward the Ukrainian force” over Taiwan. Unless there are severe shortages, war effort, specifically from the U.S. The Biden administration commodity prices typically tend to Depending on how long the fighting continues to ramp up its export ease until there are signs that central continues, it is expected that many policy banning sales of technology banks are nearing the end of the rate of the NATO countries, including the that can be applied to China’s hike cycle, and are perhaps poised to U.S., may debate the financial burden, military efforts, which has become begin lowering rates to help bolster especially if Europe and the U.S. enter a source of contention between the economic growth. a recession in 2023. two countries. Importantly, given that the Fed With Finland and Sweden seeking Despite having an economy has been especially aggressive with NATO membership, the relationship weakened by a strict zero-COVID-19 interest rate hikes compared with between Russia and the West is policy that includes massive testing most central banks, the U.S. dollar destined to deteriorate further and and lock-downs of entire regions has climbed dramatically higher could prolong Russia’s determination for weeks and months, there is an versus a basket of major currencies. to overrun all of Ukraine. A complex overreaching concern that Xi will With most commodities priced in geopolitical and military situation continue the policy. Foreign investors dollars, it has put pressure on the could evolve into an even more and businesses are hoping that commodity complex in general, complicated scenario. the uncompromising measures are particularly for countries that rely on The relationship between the lifted so that normal commerce can commodity exports for their income U.S. and China has become more be revived. Analysts are debating and overall budgets, specifically many challenging as China’s President whether Xi, who sees the policy as emerging markets. Xi Jinping began a third five-year the ultimate path toward eradicating Another significant factor for term, underpinned by an extensive COVID-19, will ultimately abandon, or commodity pricing is the role of China consolidation of power. At the even ease, the prohibitive regulations. and its outsized projected need for Communist Party’s 20th Although the global supply chain has Plenum in commodities. This includes a broad 2022, Xi outlined China’s objectives significantly improved, China remains spectrum of metals, agriculture, oil, and focused on technological an integral part of global trade. and building materials. LPL RESEARCH

OUTLOOK 2023 The commodity super cycle spurred In addition, an end of the Ukraine- more vulnerable as the strong by China’s hyper-growth rate in the Russia conflict could help extract dollar weakens demand. Emerging beginning of the century has waned some of the uncertainty embedded in markets with dollar-denominated significantly [Fig. 12]. As China’s agricultural, oil, and an assortment sovereign debt and corporate debt leadership has focused on containing of metal commodities that have been tend to struggle to service the debt COVID-19 at all costs, the once strong whipsawed by the ongoing warfare. as the dollar strength intensifies. economy has stagnated. Additionally, Japan has suffered through the the boom in real estate projects has CURRENCIES—THE END U.S. rate cycle, watching the yen fall slowed dramatically as developers are OF KING DOLLAR? to nearly defenseless levels against mired in debt. To say the U.S. dollar has vaulted the dollar. Much of this is due to Analysts are continually debating higher during the Fed’s rate hike the Bank of Japan’s insistence on when—and if—Xi will ease zero- cycle would be an understatement. keeping the yield on the Japanese COVID-19 lockdown regulations Whether it is the result of the interest 10-year bond in an extremely low and introduce compelling stimulus rate differential (that is, that the and tight range as it adheres to a measures to support the economy, a Fed has been more aggressive than policy called Yield Curve Control scenario in which commodity pricing other central banks) or that U.S. (YCC). Rather than raising rates, could recover substantially. markets have been attracting more the world’s third largest economy Generally, important contributing investments from foreign investors, has kept rates steady via YCC, but factors to support commodity prices the result has been staggering. has been forced to intervene in are the end of the interest rate cycle The strong dollar, while making currency markets to raise the yen by central banks, particularly the Fed, imports less expensive, has put against the dollar. Until the Fed or which in turn, could weaken the dollar pressure on many of the large markets make it clear that the rate and help foster global economic multinational companies with a hike cycle is nearing an end, the yen strength. Moreover, when China’s global footprint, particularly as global will continue to be subject to bouts economic backdrop begins to recover economies are facing slower growth. of extreme vulnerability as long from the current malaise, the signals Also, many emerging markets as YCC remains in place. However, for commodity prices to recover that export commodities and/ the weaker yen can help Japanese should be in place. or import basic commodities are companies compete against U.S. companies in the competitive export market. Commodities index vs. With China, the world’s second largest economy, also not raising fig. China GDP growth rate interest rates as its economy BLOOMBERG COMMODITY CHINA GDP CONSTANT PRICE languishes, the Chinese yuan has INDEX (CUMULATIVE YoY) been hovering at lower levels 250 20 against the dollar. Concerns over regulatory policies, transparency, 12 200 15 and what actions the Xi regime will take to strengthen the economy 10 have culminated in many questions 150 rather than answers. 5 As the Fed moves toward its 100 final interest rate hike, a path that 0 could take many months, the dollar should lose some of its seemingly 50 -5 relentless force and fall to levels that are commensurate with offering 0 2001 2006 2011 2016 2022-10 stability to global markets, but also helping U.S. companies compete for Source: LPL Research, Indexes are unmanaged and cannot be invested into directly. business internationally. Bloomberg 11/15/22 Past performance is not a guarantee of future results. 14

Sec. POLICY Power dynamic rebalanced in Washington he 2022 midterm KEY TAKEAWAY: IT’S OVER HISTORY SAYS election was closer Perhaps the most important outcome GRIDLOCK IS GOOD T than many expected, of the election is simply that we have The other major takeaway from the but in the end, voters it behind us. Historically, midterm election is that we now have “mixed chose to rebalance years have been volatile for markets, government” with Democrats holding the power dynamic in Washington. and 2022 has been no exception. the Oval Office and a majority in the As expected, Republicans gained But the third year of the presidential Senate while Republicans have a enough seats to win a narrow majority cycle has historically been the majority in the House. Markets have in the House, while Democrats held strongest [Fig. 13] and a weak 2022 tended to favor mixed government on to their slim majority in the Senate. may help set up that pattern again. [Fig. 14], since neither party is able Despite Republican’s narrow House We would add a note of caution, to give in to its worst excesses and majority, their victory in the House though, that increased fiscal stimulus any legislation that does get passed significantly shifts the balance of in anticipation of the presidential is subject to compromise. It may also power, since only legislation with election has often supported returns be that the government that governs broad bipartisan support will get in the third year of the cycle and we best is sometimes the one that passed once the new Congress is are unlikely to see that added tailwind governs least, and mixed government sworn in on January 3, 2023. next year. has a tendency to create gridlock. Stocks have always gained a year after midterms S&P 500 INDEX RETURNS ONE YEAR AFTER MIDTERM ELECTIONS DEMOCRATIC PRESIDENT REPUBLICAN PRESIDENT 35% fig. 30% 13 25% 20% 15% AVERAGE: 14.7% 10% 5% 0% 1950 1954 1958 1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010 2014 2018 Source: LPL Research, FactSet 11/15/22 All indexes are unmanaged and cannot be invested into directly. Past performance is no guarantee of future results. The modern design of the S&P 500 Index was first launched in 1957. Performance before then incorporates the performance of its predecessor index, the S&P 90. LPL RESEARCH

OUTLOOK 2023 Democratic president with a Republican or split Congress has been a strong combination for stocks AVERAGE S&P 500 INDEX ANNUAL RETURN (1951–2022) 20% DEMOCRATIC PRESIDENT REPUBLICAN PRESIDENT fig. 14 15% 10% Going back to 1951, a Democratic 5% president with a Republican or split Congress has seen an average total return for the S&P 500 Index of 17.5% 0% versus an overall average of 12.5% DEMOCRATIC REPUBLICAN SPLIT REPUBLICAN DEMOCRATIC SPLIT (excluding 2022). CONGRESSIONAL MAKEUP Perhaps the biggest policy takeaway Source: LPL Research, FactSet 11/15/22 All indexes are unmanaged and cannot be invested into directly. Past performance is no guarantee of future results. The modern design of from the election results is simply that the S&P 500 Index was first launched in 1957. Performance before then incorporates the performance of its predecessor index, the S&P 90. it will be harder to pass any legislation if we have a mixed government, which likely takes any meaningful risk of tax some areas of the healthcare sector, approval, possibly maintaining increases on households or businesses especially hospitals. However, we regulatory risk in areas where off the table. We would consider this would highlight that historically the instruments of the executive market positive, especially on the economic backdrop has typically branch have oversight. However, corporate side. dominated the policy environment a narrow Senate majority has when it comes to the policy impact on given centrist Democrat senators POLICY SUPPORT FOR sector performance. (primarily Joe Manchin, WV, ENERGY, FINANCIALS, Other potential takeaways: and Kyrsten Sinema, AZ) strong AND HEALTHCARE § The path to raising the debt ceiling influence, as their votes are needed There is also typically incremental may become more difficult, and for any appointment that does not improvement to the policy markets have usually reacted have bipartisan support. environment for financials, energy, negatively when it starts to look and defense when Republicans like there’s some possibility the Finally, we are often asked what hold more power. Financials are U.S. could default on its debt. the 2022 election might mean for unlikely to see legislated increases § A recession has the potential to 2024, especially the presidential in regulatory oversight and would be somewhat deeper, if we were to contest. But it’s difficult to forecast no longer face the risk of a new have one, due to a smaller fiscal the political environment two years financial transactions tax with a response. ahead, never mind the market Republican House. Energy is more § A Republican House means implications for any given scenario. likely to see progress on permitting increased scrutiny in areas where Our only forecast is that, like recent reform. And Republicans tend to the House has oversight authority, history, it’s likely to be close but favor greater defense spending. On contributing to gridlock. Republicans have a favorable mix the other hand, a Republican House § A still Democratic Senate gives of who is up for re-election in the may lead to less Medicare spending, President Biden some leeway on Senate. Other than that, we’ll wait which could incrementally weigh on appointments that require Senate and see how things evolve in 2023. 16

CONCLUSION Staying balanced to stay on course e experienced a to loosen. Voters have even chosen ongoing risk from inflation, a possible turbulent year in a more balanced government in recession, and global conflicts; while W 2022 as global Washington—with a single party no also understanding that markets are central banks, led longer controlling the presidency, always forward looking, and thus by the Fed, tackled House, and Senate. anticipating the changes that they inflation and the global economy Even as the environment remains may respond to. By viewing 2022 and cooled. While we can’t know exactly uncertain, the ongoing process of 2023 as a rebalancing process rather when the turbulence will end, the finding a balance may be starting to than as simply a downturn, Outlook economy and markets have already create opportunities for investors. 2023: Finding Balance provides made meaningful progress toward Higher interest rates bring a much perspective on what’s been happening rebalancing. improved outlook for bonds, which and what may lay ahead. Inflation has started to recede, have not seen yields at these levels in Ultimately, we believe the best path a process we believe will continue many areas of the market in more than forward for staying focused in any in 2023, even if it will likely take a decade. At the same time, segments environment is having a thoughtful some time to fully return to normal. of the stock market that had become plan and the right support. Together, Fed rate hikes will very likely end expensive have become more fairly they can help us maintain our balance in the first half of 2023, although priced, while other segments actually even during the most challenging rates may remain at a restrictive look relatively cheap. market periods. Please reach out to level throughout the year. Labor Knowing when to shift toward your trusted financial advisor with markets, which had remained tight opportunities is also a balancing questions about how to stay on course despite high inflation, have started act. We need to account for the toward reaching your financial goals. LPL RESEARCH

OUTLOOK 2023 STAAC Marc Zabicki, CFA Garrett Fish, CFA Senior Vice President, Senior Vice President, Chief Investment Head of Model Officer Portfolio Management Our investment committee is your investment committee Jeff Buchbinder, CFA Vice President, Quincy Krosby, PhD Chief Equity Strategist Chief Global Strategist The Strategic and Tactical Asset Allocation Committee (STAAC) is the investment committee broadly charged with overseeing the investment decisions for LPL’s discretionary asset allocation Scott Froidl, CFA platform. The 11-member committee Assistant Vice Jeffrey Roach, PhD is comprised of the senior members President, Vice President, within LPL’s Research department Investment Analyst Chief Economist and is responsible for the firm’s stock and bond views that ultimately form the firm’s asset allocation decisions. The STAAC determines the firm’s Barry Gilbert, investment outlook and asset PhD, CFA George Smith, allocation that helps define LPL Vice President, CFA, CAIA, CIMA Research’s investment models Asset Allocation Assistant Vice President, and overall strategic and tactical Strategist Portfolio Strategist investment guidance. That guidance is delivered via recommended allocation weightings and a suite of strategy reports, articles, chart analysis, videos, and podcasts. Lawrence Gillum, CFA Adam Turnquist, CMT The committee is chaired by the Vice President, Vice President, director of research and includes Fixed Income Chief Technical investment specialists from multiple Strategist Strategist investment disciplines and areas of focus. The STAAC meets weekly to foster the close monitoring of all global economic and capital Jason Hoody, CFA market conditions, and to ensure Senior Vice President, the latest information is being Manager Research / digested and incorporated into Head of Sustainable our investment thought. Investing 18

This research material has been prepared by LPL Financial LLC. The opinions, statements and forecasts presented herein calculated on an annual basis. It includes all of private and price. Bond yields are subject to change. Certain call or are general information only and are not intended to public consumption, government outlays, investments and special redemption features may exist which could impact provide specific investment advice or recommendations exports less imports that occur within a defined territory. yield. Government bonds and Treasury bills are guaranteed for any individual. It does not take into account the The PE ratio (price-to-earnings ratio) is a measure of the by the US government as to the timely payment of principal specific investment objectives, tax and financial condition, price paid for a share relative to the annual net income or and interest and, if held to maturity, offer a fixed rate of or particular needs of any specific person. 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