Possible Cracks in the Economy Emerging?

Jeff Buchbinder (00:00):

 

Hello everyone, and welcome to the latest LPL Market Signals. Jeff Buchbinder here, your host for this week with my friend and colleague, Dr. Jeffrey Roach. How are you today, sir?

 

Jeff Roach (00:11):

 

Doing very well. It's always nice to have the Jeff and Jeff show for this edition.

 

Jeff Buchbinder (00:16):

 

Absolutely. Love it. So you know, even though it's pretty cold outside here in Boston I am feeling pretty good today. I think we're going to bring you a good show. Got a lot of good stuff to talk about. Certainly, coming off of a good week in the markets, which helps our mood. So after we look at these disclosures, here is our agenda. So, you know, rally continued last week. Nice gain for stocks, but just wanted to highlight that it was a little bit narrow. Next, we'll talk technicals. Our Weekly Market Commentary this week is a technical check-in, I guess you could say, where we'll look at the S&P and at the 10-year yield. Next and this will be your section, Jeff. We're going to talk about some emerging cracks in the economy, not trying to be scary or anything like that.

 

Jeff Buchbinder (01:13):

 

The point of this is just something to watch out for. It shows maybe this economy is poised to slow down. And then finally the week ahead. It's actually a pretty fun week to preview Jeff, because we have CPI, which is big of course with all the attention on inflation. We also have retail sales, which is an important report as we get closer to holiday season. Earnings. Whole bunch of talk about as we preview the week ahead. Biden Xi meeting. There'll be a lot there. So let's get to it. I'll do this recap maybe a little faster than I normally do to leave more time for the meat here. But the you know, market was up about a percent and a half last week on the S&P. So a solid week, of course, led by mega cap tech.

 

Jeff Buchbinder (02:00):

 

So you see here on the sector side, the tech sector was up almost 5%. You see consumer discretionary up a percent. You see that's where, of course, Amazon and Tesla are housed. You see comm services up over 2%. That's where Alphabet and Meta are. So that's mega cap tech. That's really the story. You know, a lot of people ask, can that group continue to rally? And frankly, with the earnings strength that we've seen and the improvement in the macro environment, I'm talking about cooling inflation and evidence of stability in interest rates. And you know, the fact that we're in this favorable seasonal period right now, it really just started over the last week or so. We actually think the big cap techs can finish the year strong. We see more upside. The flip side of the mega cap techs is the small caps, right?

 

Jeff Buchbinder (02:58):

 

So the Russell 2000 small cap index was a big laggard last week down a little over 3%. The Nasdaq was a big winner up two and a half. Of course, that's from the mega cap tech names. Small caps continue to struggle. This isn't a new story. They're actually down 12 of the last 15 weeks. So market clearly favoring the big guys with the strong balance sheets. The international markets couldn't keep up with the strength of mega cap tech, so you saw some lagging there. Strong dollar was certainly a part of that. But late last week, we did see a little bit of a bounce in Japan. So moving on, the bond market sold off a little bit. Rates did back up a bit. The 30-year bond auction was a little bit of a disappointment, the Treasury auction.

 

Jeff Buchbinder (03:49):

 

And you did hear Powell talk tough on inflation. So you know, a little bit of a negative week in the bond market, but not too much. So yields are in the 4.65 to 4.70 range on the 10-year as we're recording this Monday, November 13, 2023, in the afternoon. The commodity markets were weak. There's probably a little bit of China concern in here, but you know, energy is the biggest laggard in the commodity space lately. You had oil down about 4% last week. And dragging the energy sector with it, that continues to be an area of weakness. We think it'll find its footing soon. But you know, the supply demand situation in oil has been a little bit bearish. You know, too much production, too much supply, and we haven't seen the Middle East situation spill over to the point where it would impact Iranian production.

 

Jeff Buchbinder (04:54):

 

So oil you know, trying to get back above 80. We think there's some upside there, but we are in a little bit of a seasonally weak period. So let's move on to technicals and then we'll get into the economics situation. So starting with the 10-year yield, I mean, you could argue the 10-year matters more than the S&P here. We have you know, pulled back from 5%, as I mentioned, into the 4.65 to 4.70 range. We're watching 4.35. If we can get to 4.35 on the tenure, that would break the uptrend and potentially bring lower yields into play. Now, that's just a technical perspective. You certainly have the fundamentals at work here too. But we do think inflation will come down, continue to come down. We'll see more evidence of that.

 

Jeff Roach (05:46):

 

Yeah. Jeff, I just want to jump in here for a quick promo. You know, when we talk about the Weekly Market Commentary, which you did, Jeff in the outset during our agenda, just remind the listeners that is on our lpl.com website. And so you can get a little bit more into the weeds on where these charts are sourced. So lpl.com under the newsroom is where we have our Weekly Market Commentary.

 

Jeff Buchbinder (06:10):

 

Yes, thank you for that, Jeff. So this, these charts are from that section of our website. This was put together by Adam Turnquist, our chief market technician. And you know, he certainly is very adept at identifying these support and resistance levels, identifying these trends. So, 4.35 is the number to watch on the 10-year yield. 4,400 is the number to watch on the S&P 500. We're right around that number today as we're recording this, did break above it Friday, but we really want to see that level hold for a period of time to break the downtrend in the S&P 500, which is really the mirror image of the uptrend that we've seen in the 10-year yield. Here's where I said that this has been a narrow rally. The you know, we've had these two straight really strong weeks for stocks.

 

Jeff Buchbinder (07:04):

 

But if you look at the percentage of stocks in the S&P 500 that are above their 200-day moving averages, that's how we identify uptrends. It's actually quite low now. Last week it dropped from 44% to 42%. And as you'll see here on this next slide, when you're in the forties or lower on that metric, forward returns tend to be weak. So, of course, this doesn't hold every time, but if we stay in the forties, that is at risk or go lower, that is increasing the risk that this market is down over the next several months or maybe even as long as 12 months out. That's this quintile five, if you break the breadth into these five quintiles, and you see the performance is best when you see really strong breadth readings. So this is a real key ingredient for the market to finish the year strong.

 

Jeff Buchbinder (08:01):

 

We need more breadth, right? Small caps aren't working. If we can get better performance there, better performance down the market cap spectrum beyond mega caps, we think this market will be in a much better position to make its next move higher. So really interesting analysis there. We did break an eight-day winning streak last week. The good news here is that after you end an eight-day win streak, subsequent returns have historically been very strong. So here you see 9.1% average gain 12 months after the end of an eight-day win streak in the S&P 500, which happened last Thursday. So you know, this is, you certainly, you don't want to base an equity market view on this alone, but this is just one of a number of studies building historical evidence that this market can go higher over the next year.

 

Jeff Buchbinder (08:56):

 

You'll see that in our 2024 Outlook. We do think this market will go higher in 2024. So now I'm going to hand it over to you, Jeff, to talk economy. Moving right along. Hopefully we're not scaring folks by saying cracks are emerging. I mean, we just came off of a really strong quarter for GDP, right in Q3 mm-Hmm, <affirmative>, and it looks like we're going to have more economic growth in Q4. So you know, economy hanging in there pretty well now. But why don't we tell our listeners what we should be watching here?

 

Jeff Roach (09:33):

 

Yeah, I think in the same way that we look at the technicals trying to get a good view on where we are, what the base case should be, where the risks are, either to the upside or the downside, I think in the macro space, you know, you want to do the same thing. Anybody looking at markets, you want to say, okay, what are some leading indicators? And the big question before we show the chart, Jeff, the big question really should be in people's minds, can the very, very strong growth rate that we had in the third quarter be sustained going into the fourth quarter? Or are we at this late cycle idea where, you know, we can't keep growing that much above long-term trend. And so I think one of the important factors to look at is how leveraged consumers are, where are they tapping to be able to keep consumption high?

 

Jeff Roach (10:30):

 

And that was really the driver in the third quarter. But really even right out of the gates in January of this year consumers were spending very, very strong. So go to the next slide and we will see where the potential cracks are. And again, this is, again, one of those things where we say, all right this is not necessarily a recession indicator, but it's a leading indicator that provides evidence about the sustainability of growth. And so, you know, you look at this, this is basically serious delinquencies, which means people that are past the 90-day mark for credit card payments, that's the dark blue line and auto loans on the orange line. Granted, you know, it's obvious, you can see a lot more volatility in the credit card space, which makes sense.

 

Jeff Roach (11:20):

 

You know, certainly smaller balances than what you're looking at from your car loans. And so both of those metrics in terms of the balances that they're carried forward are reaching highs relative to where we were pre-pandemic. So Jeff, you think about the economy in 2019, 2018, right? We had some trade wars, we had a lot of debate, particularly in D.C., a lot of political banter, and we were really kind of near a late cycle of this long moderation, right? So if, you know, you look at this graph and you say, okay, look at the gap in time between the two gray columns. This is basically telling you know, we had a recession, the great financial crisis, we call it, in the 08 timeframe. And we had several years of solid growth, no recession.

 

Jeff Roach (12:19):

 

It was quite historic, the length of time between the two recessions. Now granted, COVID was an unusual type of recession, but we were slowing down before COVID as an economy, consumers were slowing down. And so I think that's a really key point to think about where additional pressures might be. And then another key takeaway from this chart is to say, okay, we know that the percent of unpaid balances is higher on those two loans. You could think, you know, we're behind those payments not keeping up to speed. And you want to think, well, what's going to be the penalty? Clearly the penalties are going to be a little bit higher than they were say in previous eras, just because interest rates are much higher. Interest rates on credit cards near all-time highs. And then of course interest rates across the board.

 

Jeff Roach (13:11):

 

So let's go to that next slide, Jeff, because in the context of interest as it impacts the average household, this is something that I thought was helpful to think about. You see, okay, on the surface you say, all right, well, non-mortgage interest rate payments as a percent of wage and salaries is not as high as we saw, you know, going back to 05 going back to the nineties. But I think what, what really, I guess impacts the household the most, this is kind of a behavioral finance kind of concept, is it's the speed at which things change. Jeff, you and I, we talk about this sometime in our in our asset allocation committee meetings. You know, it's that additional derivative. So it's the rate of change, and then it's the acceleration or deceleration of that rate of change.

 

Jeff Roach (14:09):

 

So, and we don't do well, we as humans with quick changes. And that is, I think, the way you want to think about this chart right here. So as a larger chunk is going toward interest payments and the change in which it's going toward interest rates has never been faster. You know, that steep line there has never been that steep ever. And so, you know, again, I think to follow up, Jeff, on what you were saying cracks emerging. Is that overly bearish? Not necessarily, I wouldn't say it's bearish, but it's definitely a yellow flag for caution. This is something we're watching because we want to make sure that we're looking at leading indicators and not catch ourselves flat-footed as the economy turns from 2023 to 2024.

 

Jeff Buchbinder (15:07):

 

Yeah, I mean, I guess the good news is that consumers have continued to spend, but as interest costs eat up a larger proportion of their incomes, they're not going to be able to spend at the same clip. Right? That makes perfect sense. But we handled it pretty well in, you know, the middle of the last couple cycles here. I mean, you can see in the 90s and the 2000s we were up here or even higher. So you know, that's maybe the bullish take on this is this economy's done fine at higher interest rate cost levels, right? I mean, heck, you could even go back to you know, the late 80s, early 90s, right? Certainly, we had a recession around then. But, you know, generally speaking the economy, you know, continued to, you know, chug along from what, 82 to 90 <laugh>, so right. You know, higher interest costs levels, higher interest rate levels, even though rates came down. So, this should be manageable, but I understand what you're saying, Jeff. It's a shock to the system when you're used to zero and then you go to 5%, you know, seemingly overnight.

 

Jeff Roach (16:18):

 

Well, I think too, it's one of those things to say, well, what causes us to be a little more sore or tentative when there's another shock, you know, outside of this, right? So you go back several decades, you're just referencing, you know, long-term capital management clearly a shock. You know, the tech bubble, a shock the 01 attacks a shock. So, it's one of those things to say, okay, where are we maybe kind of, you know, getting a little bit teetering and then, you know, that I guess provides a little bit more of a greater warning. You know, if trade, for example, this is hot off the press, Jeff, we haven't talked much about this yet, but in terms of you know, the news about water levels in the Panama Canal being low, right? So that's going to affect trade. We don't know to the extent that'll truly, you know, ripple through and affect the consumer, but things of that nature, granted it's hard to forecast shocks, right? Who would've ever forecasted COVID <laugh>, for example, right? But it certainly puts us maybe in a little bit more of a tentative position.

 

Jeff Buchbinder (17:34):

 

Yeah, absolutely. So good discussion there. Let's continue the economic discussion, Jeff, and talk about all the data that we have this week. So I you know, highlight what I think is important on this economic calendar every week here, and I have a lot of yellow <laugh>. So I mean, it's pretty obvious that the CPI matters. It's pretty obvious that retail sales matters. That's a big piece of the economy. I think probably something like 15% of the economy. Jeff, you can correct me if that's way off, but I think it's something like that. But housing really matters these days because you've got interest rate sensitivity, as we know, with high mortgage rates. So I highlighted some housing data and jobless claims really matters, right? We're watching the job market closely, that number's ticked up. You know, and some people watch that as an indicator of recession if it, you know, if it moves by a certain amount you know, somewhere around 50 to 75,000 claims off the lows, you tend to get a recession. So we'll watch that one closely too. I highlighted that. I guess that covers it. Oh, and small businesses, small businesses matter. So we watched the NFIB Small Business survey, so got any calls on any of this data? What should people be paying close attention to Jen?

 

Jeff Roach (18:58):

 

Well, I, yeah, I think one major takeaway from the slide here, and yes, you a lot of things highlighted and I guess you could argue that you could even have more highlighted right, import prices maybe not anymore, but when we were very concerned about supply chains impact on consumer prices, import prices could also have been highlighted. I think the key takeaway here is this is going to be a first look in this first month of the fourth quarter. So you can see in that column, most of this is for October. And so that's, I think that's why markets are going to be focused on some of these reports. We're going to get a decent look, to your point about retail sales, this is not the most comprehensive metric on the consumer. We have to wait a little bit later in the month.

 

Jeff Roach (19:48):

 

I have to give government data collectors a little bit more time because the retail sales report is heavily focused on goods. It does have restaurants as services, but you know, most of our economy is a service-based economy. And so that's why you could say, oh, retail sales certainly gives us a good first look, particularly in some of those cyclical components like auto sales. And that's something that's going to be worth focusing on. And then, of course, on Tuesday the 14th, we're recording this, by the way, on Monday the 13th. And you know, tomorrow we're going to have that inflation metric. And I think the reason why markets will be focused there, of course, is that we're going to see a pretty decent moderation in the headline month to month number on the back of declining energy prices. So that's certainly going to be a, I guess you could say a, one of the positive things that we can look at for this coming week.

 

Jeff Buchbinder (20:49):

 

Yeah, certainly core is more closely watched by markets and by the Fed, but core, you know, some of those lower energy prices sometimes seep through to other areas of the economy, maybe not quickly enough to show up in the same month, but you know, I don't know if you've studied that, Jeff, but it seems to me like when you have good, good news on the headline, you usually don't get bad news on the core.

 

Jeff Roach (21:16):

 

Well, you're right. It pays to go into the details, you know, and that's kind of the key point of why we're here at LPL Research to dig down into the details. It's going to be, you know services, it's going to be clearly rents. That's been one of those categories, we're waiting for that to show up in the official metrics. But you're right, it's very important to dissect these numbers whether it's just the headline or the core which by the way core for our non-financial listeners, that is excluding food and energy. Ah, and I see it right there. You have it typed out. So good call out there, Jeff,

 

Jeff Buchbinder (22:00):

 

Thank you, Bloomberg. So you know, we're looking for 0.3% month over month on core. I like that expectation coming in because, you know, if you get 0.24, you're going to round it to two, and the market could rally <laugh> on that, right? We really want to string together some point 0.2s and some 0.25s to get where we and where the Fed wants us to be. You know, if you string together a bunch of 0.3s and you end up at, you know, close to four for your annualized number that is not so comfortable for the Fed, so that one we'll be watching very closely. I haven't looked at the Atlanta Fed GDP tracker, but last I looked at least middle of last week, I think it was already down under two.

 

Jeff Buchbinder (22:46):

 

So makes sense that we wouldn't expect another booming 5% GDP number in Q4, but certainly if we get a booming retail sales number, we'll be you know, kind of in a position to put up a better number than maybe people think. And you really don't have to start thinking about recession until you probably get into, you know, a couple quarters into next year. That's right. At least. So I guess the other thing we got this week is well, we got a couple other things. Earnings, right? I think it's just a dozen S&P 500 companies, but some big retail names, Walmart, Target, I believe Costco, Macy's, TJX, Gap there's Home Depot. So we're going to get a sense for how the consumers shaping up here pretty quickly. So that will be interesting as well, especially as you get closer to the holiday shopping season. Some people would claim that we're already in the holiday shopping season as we prepare for Thanksgiving, or we, you know, buy half price candy at our local drugstore after Halloween. But you know, from what I've seen, Jeff, I want to hear your take on this too. You know, it looks like holiday sales stand a good chance of being up year over year, but they may not be up much. Based on all the sort of you know, historically effective indicators of holiday shopping, what do you think?

 

Jeff Roach (24:10):

 

Well, you know, with a lot of the leisure travel that still seems to be pretty strong. By the way Thanksgiving travel is expected to be pretty strong, and that's certainly you know, correlates with overall holiday spending. And we could see, you know, kind of a 3% year on year growth in holiday sales. Of course, you know, the early online shopping, Prime Days for example earlier in the year suggested that, you know, consumers are still very interested in purchasing goods. It's not just a shift towards services. Remember, we've talked about this over several podcasts and things. You know, we saw an overall shift to services away from goods maybe coming out into 2022. But it's amazing how strong the consumer has been both goods and services. And so at this point you know, like I said, this is going to be a key week for understanding October, how things are going to flow into the rest of this fourth quarter. But so far you know, the cracks are emerging, as we said earlier in the podcast, but it hasn't really hampered spending quite yet.

 

Jeff Buchbinder (25:31):

 

Yeah, absolutely. The you know, if we do get a 3% increase in holiday sales, you know, that's flat volumes, right? Essentially that's all pricing. So you know, it'll be fine, but it wouldn't be great. If you put it into that context, people aren't going to be getting more stuff. They're just going to be paying a little more for it. Historically, I do know that the stock market performance tends to correlate with holiday shopping. I also know that back to school shopping, which was fine, tends to correlate with holiday sales. So you know, should be, it should be a decent season. But we're not going to, you know, blow the doors off <laugh>, I'll say, I guess it depends on what the hot products are, right? What's going to cause people to line up? I don't know. I don't know what those products are, but we'll have to wait and see once we get closer to you know, to Hanukkah and Christmas.

 

Jeff Buchbinder (26:28):

 

So the other thing going on this week is President Biden and President Xi are meeting at this global economic summit in San Francisco. You know, I don't know what's going to come out of that, that's going to be tangible, but I think we'll continue to hear the narrative around thawing relations and you know, if that leads to some real economic benefit, great, you know, the market will respond accordingly. You know, maybe prospects for Boeing, for example, to sell planes to China, more agricultural product purchases. I think Jeff, you might've written about that. So, you know, there's, the relationship is thawing, it seems, based on the headlines, and I guess, you know, I know a lot of people have different views of China and how that relationship should go, but based on just economics and based on the market we would like that that thawing narrative to continue. And any thoughts on that meeting, Jeff?

 

Jeff Roach (27:25):

 

Well, I, you know, I think it's going to be key for the city of San Francisco, so maybe not a global impact per se. It's going to be more opportunities for some, you know, photos, right? It's the photo op kind of meeting. But I think when you think about, you know, a city that has been particularly hit with the ramifications of hybrid work, right? People can leave the city, go somewhere else, lower cost of living area, certainly have challenges in commercial real estate. I think this is going to be a either a really good opportunity or it could be, you know, the other way around. So I'm going to be looking especially with how the city manages the summit. I think it has you know, a lot to do with, you know, how we can, you know, see if this city can rebuild itself after a very, very difficult period of time. So, it's more of a regional impact in my mind.

 

Jeff Buchbinder (28:28):

 

Interesting take. Well, we'll be watching the regional implications and global, so that's a lot for this week. It'll be another busy one and you know, hopefully yields cooperate and stocks can keep going higher. So with that we'll wrap. So thanks Jeff for joining me this week. Thank you all for listening to another LPL Market Signals podcast. We'll be back with you next week for another edition. See you then. Take care everybody. Have a great week.