Converging on the Paths of Least Resistance

The performance of the markets is likely to converge in the second half of the year on a path that likely holds modest gains*. The return of volatility will also be a key characteristic of the second half as markets follow a path with ups and downs.

In our Outlook 2013: The Path of Least Resistance, published in November of 2012, we laid out three paths the markets could follow in 2013 as the path of least resistance: bull, bear, and base.

                    On the bull path, obstacles are overcome and investors embrace market opportunities and drive up valuations.

                    On the bear path, fiscal policy results in a much weaker economic backdrop and markets plunge.

                    On the base path, the path we deemed most likely to emerge, growth in the economy and earnings remains below average, and the challenged markets produce modest gains with a lot of volatility.

Rather than a single path emerging, the paths of least resistance for the economy and markets diverged in the first half of 2013. The different markets took all three paths.

                    Stocks took the bull path as investor confidence rose when the worst of the fiscal cliff outcomes was avoided and the Federal Reserve’s (Fed’s) bond-buying program continued. This helped to lift stock valuations and prompted individual investors to put money into the market at the strongest pace in years, according to flows into domestic stock funds tracked by Investment Company Institute (ICI).

                    Commodities asset classes took the bear path on weakening economic data around the world as tax increases and spending cuts sunk in here in the United States, Europe’s recession broadened and deepened, and China’s growth slowed. Copper, oil, wheat, and gold futures — to name just a few — all plunged during the first half of 2013.

                    Bonds took the base path with the Barclays Capital Aggregate Bond Index remaining between +/-2% through June 20, 2013 and a volatile 10-year Treasury note yield that has ranged between 1.6% and 2.4% over the same time period.

This type and magnitude of disagreement among the markets has been rare. To attempt to coin a new phrase: “a market divided against itself cannot stand.” In other words, the divergence in the paths taken by different markets is unlikely to continue in the second half. Instead, the markets are likely to converge in a second half that likely holds modest — but volatile — gains* for investments such as stocks, bonds, and commodities. In other words, we expect the different markets to follow a similar path in the second half.

View the complete Mid-Year Outlook 2013: Investors’ Trail Map to the Markets

*LPL Financial Research has provided this estimate based on their analysis of investment and market conditions. For details on this forecast, please see the full Mid-Year Outlook 2013 publication.

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