Celebrating U.S. Innovation on America’s Birthday

Jeffrey Buchbinder (00:00):

 

Hello everyone, and welcome to the latest LPL Market Signals podcast, Jeff Buchbinder here with my friend and colleague, Jeffrey Roach. How are you today, sir? Happy Monday. Happy holiday shortened week.

 

Jeffrey Roach (00:13):

 

Yeah, happy July 4th to you. Here we are on the 3rd of July, and looking forward to a little bit of a reprieve and glad to do the podcast with you. I was out in Boston last week, so missed the Morning Call, missed some of the activities, our normal Monday activities, but glad to be here.

 

Jeffrey Buchbinder (00:33):

 

Yeah, well, good to be with you. By the time folks listen to this, they would've already, presumably already celebrated 4th of July holiday, so happy birthday America. We don't think we're going to get this out Monday. It's probably going to be on Wednesday, so hope everybody had a good 4th. We will begin by saying yes, it is July 3rd, 2023, as we're recording this. Here is our agenda for today. You see, we're going to start off, as we always do with the recap of the markets, and we certainly have had a really strong finish to the first half. We're then going to talk about the inflation data last Friday, the core PCE. That is certainly why Jeff, our LPL Chief Economist, is great to have on board today. We've got the capital markets green shoots. It's kind of a patriotic theme.

 

Jeffrey Buchbinder (01:27):

 

This week's Weekly Market Commentary highlights some of the green shoots with IPOs, mergers and acquisitions just in general, celebrating the innovation in the U.S. and the dominant global capital markets position that we still have and probably will have for a very long time. And then, as we always do, we will recap or we will provide the week ahead economic calendar. It is jobs week but certainly the ISM matters too. We just got the ISM manufacturing data, which we'll talk about at the end here. So, let's get right into it, Jeff. Boy, this bull market just keeps on ongoing. We had a really strong week last week for stocks. You know, two weeks ago we were down and people thought, including myself, frankly, that maybe that was the start of a little bit of a pause.

 

Jeffrey Buchbinder (02:21):

 

Well, stocks had other ideas and this bull just kept on going higher. We were up more than 2% last week on the S&P. You see here that all the sectors for the S&P were higher. That closed out a really strong June, up over 6%. A strong quarter. Second quarter was up over eight percent actually total return, and then a strong first half up almost 17% total return. So certainly the question people are asking is, well, there's two questions. Why are we up so much and can it continue? Right. So Jeff, I want your take on this. You know, my take is that the market was up last week because market participants were pricing in a higher chance of a soft landing, right? We got a series of pretty resilient economic data. I don't know if you have other ideas, but maybe I'll start there. What would you say to that?

 

Jeffrey Roach (03:20):

 

Well, yeah, I think you're right that in some ways we're basically saying as investors and sitting here and making those portfolio allocation decisions, we're saying, you know, the risk of the Fed breaking something is becoming less and less likely. And of course, when we say, breaking, I think we're talking about, you know, a Great Financial Crisis kind of scenario. So, you know, perhaps a shortened shallow recession might not quite get into that category of something breaking, something blowing up. And so, you know, folks are saying, you know, the economy's slowing. There's no surprise there, but it seems like there's still a little bit more pent-up demand being released for services spending. And I think there's still this really interesting tale of two economies when it comes to real estate. So, on this chart here, Jeff, you're showing, you know, look at that 5% number on the week.

 

Jeffrey Roach (04:15):

 

And, you know, for of course, for the year-to-date numbers, it's not quite as strong for real estate, but I think in more recent times, you're seeing pretty nice level of activity, units under construction, amount of construction spending going for particularly multi-gen and multi-family activity. Little bit of course unknowns on the commercial side, office space, the hybrid work environment, what's going to happen there. But, you know, real estate, I think investors are saying it's worth dipping our toes in the water and putting on a little more risk.

 

Jeffrey Buchbinder (04:54):

 

Yeah, certainly not a sector that LPL Research recommends right now, but something that we have to watch. No doubt. I think the major theme coming out of the sectors, which really hasn't changed in months, is that you have the economically sensitive cyclical areas doing better, right? Tech certainly in that boat, industrials have been doing fairly well recently, consumer discretionary, right? Those are the leaders and the defensive sectors like utilities, staples, healthcare, they're just not attracting interest on a sustained basis. So this is a sign, you know, just like higher highs and higher lows. It's a sign that this bull market is actually real. And it's not just a bear market rally that's going to quickly fade. So, you know, no change on the sector side, which is good. I guess the other point I'd make here is that we have some pretty decent gains on international, but internationals had a hard time keeping up with the U.S. and part of the reason for that is that tech strength, and that's the U.S. innovation that we'll get to here in just a little bit.

 

Jeffrey Buchbinder (05:59):

 

So, let's, let's move on. I mean, the terms of the outlook for the for the market here, we still think we can go higher, but we do think we need a little bit of a breather in the short term. We've talked about that over the last few weeks. We're overbought. And this would be a natural place, especially during the summer holiday season for a little bit of a pullback. So, we'll see. Maybe that starts this week. So, let's do a quick look at you know, bonds and commodities from last week. So, I think on the bond side, you know, we had this pushup in rates responding to some of the good economic data that we saw. So, you know, in an environment where we're still worried about the Fed, Jeff, I might expect stocks to fall as bond yields rise. We continue to hear hawkish commentary out of the Fed, out of the ECB and other central banks around the world. So, you know, to me, that points to a real resilient bull market here in the face of rising rates. What do you think?

 

Jeffrey Roach (07:02):

 

It's been you know, it's been a period really, this reopening post-pandemic finding balance kind of regimes. It's been an interesting time where investors are saying, you know, we know we're not going to live in an environment with such low rates, you know, right after the Great Financial Crisis going into, you know, 2019 you know, thinking about how unusual that period was rates you know, were so low for so long. And then of course, you know, post-pandemic, I think investors are saying it's worth taking on the risk despite rising borrowing costs because, you know, inflation is eventually going to ease and hit that target that the Fed wants. In fact, that might be a segue, I just set myself up for <laugh> for the commodity section on that slide. We just talked about fixed income and rates, Jeff, as you introduced, but, you know, bring that together with the commodity portion. You look at the grains performance over the last week. Part of that is playing off of, you know, what happened maybe earlier in the month. But clearly you have to say that as grain prices ease pretty significantly, you know, that's eventually going to flow into perhaps less inflationary pressures on the foods categories, and that's certainly going to be good news, particularly for lower income households.

 

Jeffrey Buchbinder (08:30):

 

Absolutely. The commodities complex has been you know, an area where clearly inflation's making good progress. We still have inflationary pressures in other areas of the economy that we got to work through, but that is certainly good to see for Fed watchers. So, let's take a quick look here at the S&P 500 chart. We have, you know, again, the series of higher highs, higher lows, but you could just see from this chart that certainly we look a little bit overbought in the short term from a technical analysis perspective. And as we've been saying, when you get valuations, you know, close to 20 times and you couple that with higher interest rates, now the 10-year yield making another potential run toward 4%, we think the tradeoff between stocks and bonds looks more balanced, maybe even tilting a little bit toward bonds.

 

Jeffrey Buchbinder (09:21):

 

So, we still recommend a slight overweight to fixed income funded from cash in our tactical asset allocation. And then on the equity side, just a straight up neutral. So, let's talk more inflation and economy, Jeff, with this next section here. The, I mean, the Fed's already been hawkish, right? I mean, we've already heard dot plots, two more hikes, a July hike is pretty much fully priced in. So, you know, maybe that the worst of the Fed repricing is behind us, right? So maybe the question for you is, you know, does this inflation data that we got last week or the series of resilient economic data points, you know, variety of data points, you know, jobless claims are good, durable goods pretty good, we got some good housing data, right? Does that collection of economic data points sort of offset the good inflation number or relatively good inflation number we got Friday and start to scare the Fed a little bit more?

 

Jeffrey Roach (10:25):

 

Well, I think we're given all that data you just referenced and some of the other important factors. I think we're in a period where this data dependency that the Fed likes to talk about, it may not be that helpful for investors, right? Near term volatility, when, you know, you have one dovish voting member talk about, hey, I don't have my mind made up for July. And then you have the majority very hawkish, you know, on the committee. And so this data dependency, I think, puts really a lot of pressure on investors to say, okay, what data's going to be the most relevant and most impactful for voting members? I think the key to take away here from this chart is just overall, as you read from left to right here, October of last year to May of this year, looking at the fact that, you know, inflation is easing from a number of different vantage points.

 

Jeffrey Roach (11:23):

 

The circled cell that I have in the bottom right is what we got on Friday, and that's that core services, ex housing, given the fact that, you know, 65 plus percent of households are homeowners, still have a fair amount of households that are impacted by rents. It was interesting just that the Fed had focused on this several meetings ago, and that's one of the reasons why I added this to the overall inflation dashboard. But you can't argue that inflation is becoming a lot more comfortable, you know, still above the 2% range, but it's going in the right direction. And that's really what matters for investors particularly. Yes, we're still way above the 2% level but we're going in the right direction.

 

Jeffrey Buchbinder (12:16):

 

Yeah. And our house view, Jeff, on core inflation by the end of the year is around three and a half percent, right? So, that's getting pretty close to where the Fed should be comfortable, wouldn't you say?

 

Jeffrey Roach (12:29):

 

Yeah, that's right. I, you know, so I think another factor that's really important for investors to think about is, you know, the Fed cares about real fed funds rate. So taking that nominal target of the upper and lower bound, that range, subtracting out inflation rates, and we're seeing a real, a positive real fed funds rate, and that's going to give the Fed a little bit more opportunity to have months like they did just this past month in June where they had a pause, we call it the hawkish pause. And but at least it gives them a little bit of leeway to say, okay, let's pause and let's wait and let's watch. You know, as of today, here we are, you know, on July 3, as you mentioned, recording it, you know, the options markets and other ways and tools of measuring the likelihood of a Fed hike, you know, puts the July hike at close to 90% probability. So, you know, most likely the hawkishness of the committee will overpower those that are dovish, like Austan Goolsbee from Chicago, and probably see another hike in July. But these easing inflation rates are certainly something that you know, the Fed will welcome.

 

Jeffrey Buchbinder (13:50):

 

Yeah. And we got a good prices paid number in the ISM manufacturing report. So another piece of evidence that inflation's moving in the right direction. You know, the worry Jeff that you've pointed out a number of times is with services inflation, right? So, is there still a lot of pent-up demand for services activity in this economy? Or, are we kind of at the point where we've normalized,

 

Jeffrey Roach (14:16):

 

Well, spending is still below trend in terms of services. So, this is something that I wrote about right after the report Friday morning. And you look at that orange and blue line, it's just levels of real spending. So, it's adjusted for inflation. So, we can, you know, accurately compare one year to the other year. But you can see the blue line there, consumer spending on an inflation adjusted basis is below trend still, which is really quite amazing. <Laugh>. Now granted you'd say, okay, what about goods? Well, <laugh>, the other story holds there, consumers are way above trend. They've pulled forward a lot of demand for the goods spending. And so, you know, maybe have a little bit more pent-up demand to release for services spending, look at travel plans.

 

Jeffrey Roach (15:10):

 

I think that might be one practical area for, you know, people to look at to show and illustrate that case. But we're still a little bit below trend, so maybe have a little bit more of that spending surge happening in services. But once you get to that trend line, maybe you know, when we get to that normalizing mean reverting behavior, maybe that's when we finally see a recession. We're arguing for the more short and shallow, meaning less than the post-war average of 10 months. Something shorter than 10 months. And perhaps not quite as deep given the fact that banks are a little better capitalized, well, I should say, a lot better capitalized relative to the Great Financial Crisis. So yeah, the recession call a little bit frustrating, right? We started out the year and ended last year thinking that, you know, recession would look like it would be emerging sometime mid to late summer. Now it's probably mid to late fall and winter time period. It's all on that services spending.

 

Jeffrey Buchbinder (16:18):

 

Well, I hope that call is wrong again, <laugh>, then we could push it off even further, certainly. That's the best time to be wrong, right? When you're predicting a weaker economy and you get surprised to the upside. I also want to say, you know, in terms of services spending, I sure hope that airline travel's normalized, because I don't think the system can handle much more airline travel <laugh> than we're getting over this July 3rd, July 4th holiday week for sure.

 

Jeffrey Roach (16:49):

 

Yeah, as you know, Jeff, just you know, personal anecdote, we thought we were going to be missing the crowds in Italy if we traveled in the month of May over there instead of the month of August, right? Everybody, you know, everybody knows, yeah, August is a terrible time to visit Europe, you know, generally speaking, right? So crowded, so hot. It was crowded in May. And so, you know, people are still making up for lost time <laugh>. It's quite amazing.

 

Jeffrey Buchbinder (17:21):

 

Pent-up demand for travel, clearly at work. So, everybody travel safe this week and hopefully things will be a little bit smoother than they've been the last few days. So, let's turn to the IPO, M&A, capital markets world a little bit. I mean, we don't usually talk about this, but I think it's interesting to point out now because, well, first it's America's birthday, right? And so, celebrating our record of innovation, ingenuity, entrepreneurship, all of that is great. We have the best, strongest capital markets in the world, certainly. And that should be celebrated. But you also have, you know, what has been a really sleepy capital markets environment for the last year or so. IPOs, you're seeing the chart right here. IPOs have been way down, but we started to see some green shoots, right?

 

Jeffrey Buchbinder (18:16):

 

We've got, well, the you know, we've seen an IPO from a fast casual restaurant recently. We've seen a couple of others. And the pipelines starting to fill up as you know, executives of these private companies start to see maybe a more favorable economic environment in the coming months, right? You have to really predict what the environment's going to look like in the future when you go public. It's not just about what it looks like today. So, you know, this chart, it's still way down. IPO activity is still way down and it's not going to move meaningfully in the very short term, but it looks like we're seeing some green shoots that 2024 could be a decent year for initial public offerings. And then let's go to the merger and acquisition activity. You know, it's the same story, it's way down, right?

 

Jeffrey Buchbinder (19:07):

 

But, you know, the environment for M&A is getting better too. We don't have to worry so much about the banks, right? The regional bank stress is largely behind us for now, hopefully for good. And then we got past the debt ceiling, and, you know, the economic data has suggested that maybe we're climbing a wall of worry. You know, companies may be more comfortable making a long-term commitment either through acquisition or merger. So even though M&A activity is down about 30% year over year, maybe the second half you see some pickup and maybe you see more deals next year. So this is, I think just another sign of many that this is a legitimate bull market, not just a false bear market rally. What do you think, Jeff?

 

Jeffrey Roach (19:56):

 

Well, you know, certainly you know, cost of borrowing, you know, versus opportunities for firms to put some cash to work. You know, that's certainly going to be driving a lot of the decisions. I think just going back to, you know, maybe that little bit of that July 4th patriotism, you know, it's interesting when you, when you think about the stability of U.S. markets relative to international, you know, counterparts, you know, you see that you know, investors do value the stability, the legal complex in this country, the protection for intellectual property, the opportunity to earn a reward on the risk you take as an entrepreneur. That certainly keeps me bullish on the U.S. long term. I think that's you know, another angle to think about in terms of you know, the IPO slide and some of the introductory comments you made on this topic. But yes, a little bit a little bit of a patriotism coming through our Weekly Market Commentary this week.

 

Jeffrey Buchbinder (20:57):

 

Yeah. As we celebrate the first $3 trillion market cap <laugh>, right? That's really amazing that market cap for Apple is over 3 trillion. So yeah, U.S. innovation, this is why tech's doing so well. It's around innovation, whether it's, you know, artificial intelligence or cloud computing or mobile or whatever the innovation is it seems like the U.S. leads with each subsequent wave. And certainly, that's you know, why we would expect over the long term for U.S. equities to outperform the rest of the world. So, good segment there with the July 4th theme. So, let's talk economic calendar, Jeff, and then we'll wrap. I alluded to the ISM prices paid component, right, which was disinflationary. Now part of it is because the manufacturing sector is weak, totally get that. But nonetheless, it's another example of something that's kind of real time, not totally, but, you know, pretty timely economic data in the ISM because it's a survey about what people are experiencing now, or what they expect to experience in the very short term. So, but I think people are really going to focus mostly on the jobs report on Friday.

 

Jeffrey Roach (22:21):

 

Yeah. So, the report on business for manufacturing always comes out a couple days before the report on business that focuses on services, which clearly services as a larger component of our domestic economy. But, you know, one of the things I highlighted and shared with my fellow STAAC team members, our Strategic and Tactical Asset Allocation Committee, is the fact that, you know, as the global economy slows, you know, new export orders are falling, that demand downturn is certainly going to be a major factor in cooling off the inflation story. Remember last year was all about supply constraints. As supply constraints were easing, you know, we were making the connection between that and you just container traffic and the cost of that traffic coming from country to country. Now things are shifting and the updated narrative really needs to include the fact that slower consumer demand is going to be a major factor on inflation.

 

Jeffrey Roach (23:28):

 

Hence, the prices paid component there that you highlighted for today came out at 10:00 AM Eastern today on the third. And then of course we'll get the services component there on the sixth, but it's all jobs on Friday. Right now, there's still quite a bit of consensus thinking that June numbers are also going to come in pretty hot. And that's, you know, that's going to probably convince even the doves like the Austan Goolsbee's of the world that maybe there is that one more hike that needs to happen. But unemployment participation rates, payrolls, those are all embedded in that very big and very important June labor market report. We'll get that 8:30 Eastern time Friday morning.

 

Jeffrey Buchbinder (24:19):

 

Yeah, so, we're not going to get, you know, any evidence that the economy is sliding into recession in Q3 from any of this data. But certainly, if you know, if this data is too hot, you'll start to see folks increasingly price in maybe a second rate hike one after the July hike, which is very likely to happen. So, you know, that said, markets are forward looking, and so we're probably seeing some of this latest rally is the market saying, you know what, whether it's one more hike or two the end is pretty close. And, you know, after Fed rate hiking campaigns, you tend to see stocks grind higher, not dramatically so, but you tend to see stocks grind higher, and then you tend to see bond yields fall, right? So if we get lower bond yields, more evidence of falling inflation, end of the Fed rate hiking campaign, you know, maybe you could add to these first half gains in the second half.

 

Jeffrey Buchbinder (25:13):

 

We're not going to be out on a limb. You know, our Midyear Outlook will be published next week, and you'll see some fairly cautious comments about the outlook, just because, as Jeff just mentioned, we do think within the next six months, you're going to start to see this economy roll over a bit. And yeah, that's just tough environment for stocks to make a whole lot of headway. But the evidence we see that this is a real bull market with some oomph behind it suggests that, you know, frankly, our call for recession could be a little bit too conservative and our call for maybe the U.S. equity market to just make a little bit more headway in the second half that could end up being too conservative too. We'll have to have to wait and see.

 

Jeffrey Buchbinder (25:59):

 

But no doubt some folks have been, you know, dragged off the sidelines here. You hear the acronym FOMO, the fear of missing out <laugh>. Certainly, a lot of bears have reluctantly come back into this market and helped push it higher. Maybe a little bit too high in the short term, but certainly we'll take what we can get and the strong first half, certainly we can celebrate it here at least for a little bit before we eventually get that pullback that we know always comes at some point. So any closing comments, Jeff, before we wrap?

 

Jeffrey Roach (26:36):

 

Yeah, just you know, the challenge of course is, you know, forecasting models have never had to deal with, you know, a period of time where the world was closed <laugh>, right? I mean, you know, we're still recovering. Here we are in 2023. I've said this to you, Jeff, and our STAAC members. It's amazing to think that you know, the March 2020 shut down that lasted just a little bit. The reopening was so sluggish and convoluted that you know, models are having difficulty forecasting and managing what it might look like after, you know, after a global shutdown. It was clearly a time that models have never had to deal with before. Hence, the reason why we're saying, okay, recession, well pent-up demand, what happens, you know, what happens if the markets continue to rally and we're in this modest 0%, right? No growth at all. Maybe not a recession, but somewhat of a no growth period either way. As you said earlier, Jeff, it's so important to remind, you know, our listeners that, you know, markets are forward looking. It's now about 2024, 2025, right, <laugh>, there's never a dull moment in our world. We need to start, you know, help kind of helping craft that narrative as markets are willing to grind higher, higher lows, higher highs. 2024 might not look too bad after all.

 

Jeffrey Buchbinder (28:12):

 

Yeah, the next time we're with you, we will probably start talking about earnings season a little bit, right? Q2 earnings season is not too far away. I believe we get some bank reports, maybe it's July 14, somewhere around there. That's going to be the next test for markets to see if these gains are justified. Because if we see you know, inline or maybe worse earnings for second quarter, and estimates come down meaningfully for the second half, that's not necessarily our base case. But if that does happen then you know, that could be the time where you see the markets maybe take a little bit of a breather. We'll have to wait and see more on that in two, three weeks. So with that, we'll I'll say it's time for me to go fire up the grill, Jeff <laugh>, start my July 4th holiday, got some family in town, which is always fun. But for those of you listening, you have already probably fired up your grills and celebrated America's birthday. So happy July 4th to all, happy July 4th to you, Jeff and our producer Neal. Hope you guys have a great, great holiday and thanks for all that you do for the Market Signals podcast and for LPL advisors and all of our clients and the public out there.