Checking in on Energy and Soft Landing Prospects

Jeffrey Buchbinder (00:00):

 

Hello everyone, and welcome to the latest LPL Market Signals, Jeff Buchbinder, your host with my friend and colleague, Jeffrey Roach. This, Jeffrey, is a special Dunkin Donuts edition of Market Signals because we just figured out you and I are both drinking Dunkin Donuts coffee. We are not paid sponsors by Dunkin Donuts <laugh>. I just thought that was very interesting because I'm in Boston where that's what everybody drinks, and you are not. How about that?

 

Jeffrey Roach (00:28):

 

We are not paid sponsors. So, yeah, that's good disclosure on that one, but yes.

 

Jeffrey Buchbinder (00:32):

 

I don't expect my friends in the Charlotte area to be drinking Dunkin like we are up here, but that's great. So we got a good show for you today. We got a lot to talk about. It's a real busy week this week in terms of economic data and economic events. You know, unfortunately, we don't have a positive week last week to talk about in terms of market. Because we were down. So we'll recap last week. The energy sector was a winner, but certainly most of the S&P sectors were down. The LPL Research's investment committee upgraded the energy sector. So we'll talk about why we did that and why we think the energy sector's a good opportunity right now. Next we'll do what I call a soft-landing check-in, that Jeff's going to be your area of expertise.

 

Jeffrey Buchbinder (01:25):

 

We've got some charts on economic growth, economic surveys, inflation, et cetera, just to see where we're headed. And then of course, as we always do, we'll preview the week ahead. So let's start with just a quick recap of last week. We have the market performance table here, S&P down about 1.3% for the week. So not a big drop, but, but we were down, the Nasdaq a little bit worse. And then the Russell 2000 small caps even worse than that. So, it was certainly a risk off week. You can see the risk off week in the sector performance too, because while energy was up you had industrials down the most, down almost 3%. You had technology down over 2%. Actually, a big reason why, it's really two stocks, two reasons why. Apple and NVIDIA were both down about 6% last week.

 

Jeffrey Buchbinder (02:26):

 

The Apple decline was certainly in part due to the news that Chinese government officials are banning use of iPhones. Markets, thinking that maybe that restriction widens out and you know, has a meaningful effect on Apple's business. So Apple was down on that news. This week is their big release event. So you know, maybe that stock will get turned around. But anyway, it was a down week last week, and I guess the international market's not really offering much relief because you had declines all across Europe. You had declines in most of Asia as well. Although India, interestingly, a standout. You had the international headwind last week of the strong dollar, certainly, that made it tougher international markets to gain ground. And then just quickly fixed income and commodities here. You had a fixed income week that was driven more by rates and specifically higher rates, than any sort of credit assessment, because essentially every segment of the bond market did the same thing.

 

Jeffrey Buchbinder (03:35):

 

<Laugh> it went down. Whether it's treasuries or high yield or anything in between. All down about 30 basis points. And then on the industrial or on the commodity side the you know, energy stood out just like it did on the equity side, because you had oil higher last week. But look, what commodities did outside of energy you had declines in industrial metals, precious metals. I mean, grains pretty flat, soft commodities down. And I think part of that is the strong dollar again, right? So a strong dollar weighing on your international returns and on commodities. And anything you want to pull out of last week's market activity, Jeff, that kind of you know, underscores the performance I just went through.

 

Jeffrey Roach (04:25):

 

I think if you look at the energy side, so you have a little higher than 1% on the week, but you really need to shift your eyeballs a little bit over to the right, looking at that three month column. And it kind of tells you that part of this story has been in the last three months, there's been this you know, a stronger support for Q3 growing pretty strongly. The soft-landing narrative as you teased out actually just a few moments ago at the outset of the podcast. And as the soft-landing narrative kind of gains ground, perhaps, you know, energy demand might be a little bit better than say what investors thought you know, four or five months ago. So anyway, it is just a highlight. You know, one of the reasons we do this, of course, is when we show these charts not to focus on the very, very short term, right? We want to encourage investors to think about longer term horizons. Hence the reason why we have the one, three months, six months perhaps <laugh>. And maybe we could argue, Jeff, that, you know, we could have even a longer timeframe, but of course that makes the table getting wider and wider. So there you have it.

 

Jeffrey Buchbinder (05:42):

 

Yeah, well, you'll see a little bit longer term charts in a moment as we focus on you know, individual segments of the market. So, let's look first broadly at the S&P 500. So, this is still, you know, generally a positive picture. You have market breadth holding up relatively well. Our Chief Technical Strategist, Adam Turnquist, tells me the MACD still says buy, it's still a positive signal. Maybe not a strongly positive signal, but, you know, generally you know, the S&P's held onto recent gains, this pullback that we've seen lately has been pretty minimal. So you know, we don't have to talk too much about support levels because we've got to go down quite a bit you know, to get to the next level. But you know, generally you've got okay, breadth and okay momentum and we'll just, you know, see if we can get through this seasonally weak period in September, which could be choppy.

 

Jeffrey Buchbinder (06:41):

 

We still got more Federal Reserve risk to work through. We've got a, you know, some economic data that's a little too strong for the Fed still. So you know, talk about that more in a minute, Jeff. But you know, we could still be in a position to get a year-end rally. It's just probably not going to start right now in our view. Just need to, you know, get through a little bit more chop and some of these headline risks before we make that next run. So yeah,

 

Jeffrey Roach (07:10):

 

You could almost say just a takeaway is it's more of a choppy market, not a bearish market, right? You know, kind of balancing, as you were saying, the MACD and some of the technical indicators. You know, it's a lot different feel where we sit here in September versus where we were early August in the midst of the sell off. So, so choppiness perhaps might be the, the key word.

 

Jeffrey Buchbinder (07:33):

 

A hundred percent. A hundred percent. So, you know, that's where we're at. We think the market's pretty fairly valued. Of course, yields matter a lot to the market right now. You can see that if you just look at the inverse correlation between yields and stock prices. That's this green, red shaded area at the bottom of this chart. So we've moved into a period over the last couple months where we're seeing some pretty strong inverse correlations. So the stock market does not like higher yields now, which reflect more Fed rate hikes in general. The, I guess the good news is we're hitting some pretty stiff resistance in the 43s. So if we can hold that resistance level, we're below that today. It's of course September 11, 2023, which I should have mentioned upfront. Certainly, a somber day, a day where we remember those who lost their lives, and we thank those men and women in uniform for keeping us safe.

 

Jeffrey Buchbinder (08:34):

 

So, while I did not lead with that as I should, that doesn't diminish its importance at all, certainly. So wanted to get that in. So, as we're recording this on Monday, you see that you know, we're kind of right up against that 43, actually 433 was the intraday high for yields back in August. And I guess we touched that again recently or I'm sorry, back last year, October. And we would touch it again this year in August. So if we can hold that, then you really have kind of an asymmetric outlook potentially for yields where we could go back down to that 375 level that's our year-end target. And bonds, you know, we didn't gain anything in bonds last week, but we think we're set up for maybe a nice run in bonds over the next several months.

 

Jeffrey Buchbinder (09:24):

 

But if we don't hold that 434 or 433 on the 10-year, we could be off to the races because there's really not a lot of resistance between there and 450, you know, we don't think we're going to go to five but certainly, you know, you have to keep that in the back of your mind as a risk if inflation re-accelerates. And we get, you know, maybe a couple more Fed rate hikes coming. So, that's a quick look at rates. Let's go through the energy upgrade here. And actually in conjunction with the energy upgrade we actually downgraded consumer staples, and we got a little less optimistic about industrials, still like industrials, but tempered our enthusiasm a little bit there. So but let's focus here on energy because that's the big one.

 

Jeffrey Buchbinder (10:17):

 

We now like energy more than the industrial sector. It's our top pick right now. And generally, when we make recommendations, we're talking about nine to 12 months, maybe six to 12 months. So this is a chart of crude oil. So, you know, Jeff, maybe you can weigh it on the kind of supply demand outlook here. I guess, you know, again, we're amateur technicians, but looking at this chart, the top chart is just the price of crude up to, you know, 87. There is, this is a breakout, right? Because you know, you're going above what was previous resistance you know, through, I guess it's 82.59, and now up 87.74, and it really looks like 95 is next. So if we get oil at 95, and, you know, maybe I, if you want to make the case for that, Jeff, but if we get oil at 95, there's further gains ahead, most likely for the energy sector, and certainly the producers are profitable there. So, what do you think is there enough demand for crude to push us, you know, into the mid-90s or higher?

 

Jeffrey Roach (11:25):

 

I think from both the supply and a demand perspective, you could argue, you know, that the future direction of oil prices is up. You know, either both sides of the equation but just harken back just a few minutes ago, Jeff, you were talking about upgrading certain sectors and for our listeners that are LPL advisors, they know about our Global Portfolio Strategy report. That's well-loved among the advisors and it explains some of this, but, you know, overall, I think that the story is, you know, from a supply standpoint upside pressure from a demand standpoint, particularly when you think about our own domestic economy. If we do fall on a recession, it's not going to be anywhere near previous recessions or the Great Financial Crisis. And if it's a soft landing you could argue that's another reason why the demand side of this will push prices up. So, either way, you know, I think from just a price level perspective you know, there's certainly a good, I wouldn't say necessarily a rosy outlook but certainly there's reasons why you'd want to have a portfolio that has some exposure to energy.

 

Jeffrey Buchbinder (12:50):

 

Yeah, so we're now at an overweight recommendation and thanks for the GPS plug there, Jeff. And you know, the sector's only about four and a half percent of the S&P. So, you know, that doesn't mean put 20% of your portfolio in energy, but, you know, have something north of five if you're going to follow our recommendation at least. We think the sector's set up for a pretty solid run here, not just, I mean, we've seen out performance here recently. I'll show you that in a minute. The performance has been so resilient that the rising dollar hasn't really stopped it, right? Oil is usually inversely correlated to the dollar, but you know, the dollar strength hasn't really slowed it down too much. So this is a chart of the dollar. It looks like a very bullish chart of, certainly if the dollar can break through this resistance in the kind of 104, 105 range then you're, you know, you're looking at maybe potentially a big run, possibly another 5% higher or more.

 

Jeffrey Buchbinder (13:49):

 

So the Fed may have something to say about that, but dollar strength is certainly something to watch. The recent performance for the energy sector has been very strong. So, you know, we'll, technical analysis is a big part of what we do, Jeff, as you know. And so when you see some of these energy charts, they just, they all look good, whether it's crude oil or it's the energy sector itself. So here you see I just pulled quarter to date Q3 and you've got energy up 12 plus comm services up almost six is in second place, and only financials in the green, besides those two, in a market that's generally been flat. So you're seeing good performance out of energy. You're seeing, you know, energy estimates potentially bottom here, that's the orange line on this chart.

 

Jeffrey Buchbinder (14:40):

 

I'm just showing forward estimates for energy versus forward estimates for the S&P. Remember, we came through that really strong second quarter earnings season where S&P estimates rose as companies were reporting results, which is very rare, typically very positive, and certainly helped stocks hold their gains. Energy didn't really participate that much. Energy estimates were still coming down, but now we've got rising energy prices and we're seeing estimates tick up which is good to see. And this is a really cool chart that Tom Shipp from our quant team put together. He and Craig Brown just have some of the coolest charts that I've ever seen. Craig's also on the on our quant team. This is the total capital return to shareholders for Russell 3000 energy companies, you know, oil and gas producers and integrated producers.

 

Jeffrey Buchbinder (15:34):

 

And it includes dividends, buybacks, and paying down of debt, right? I mean, paying down in debt, people don't think of that as returning capital to shareholders, but it kind of is. You add all those together and just look at this chart. It's just a rocket shift higher, right? So, in other words, energy companies, you know, many of you have probably heard that they're not focused as much on production, right? They're more focused on actual profits and being disciplined about their investments and all of that. And that's good, and that allows them to return more capital to shareholders. But there's more to this narrative than that, right? The money that they make, they're using that, which is higher <laugh>, right? They're producing more cash flows because of the discipline, and then that those cash flows are being directed more towards shareholders than ever before.

 

Jeffrey Buchbinder (16:25):

 

So, you're seeing this is basically a tripling since the start of the pandemic in the amount of cash return, capital return to shareholders. So, this is a great story and is another reason why we really like the sector now. There's this, there's several positive narratives, but really everything's coming together. They're even reasonably valued still we think. So all in all sectors looks really good. So with that, let's move on. Soft landing check in, Jeff, this is your show. So why don't you take over here and try to you know, put into perspective what this recent data means for the economic outlook and what that might mean for markets.

 

Jeffrey Roach (17:06):

 

Yeah, I think, you know, in this case, it's almost like, you know, I'll address the recession conversation like Mohamed El-Erian addressed the Fed's situation just to a few weeks ago, you know, he was on an interview basically starting to say, hey, the Fed is too data dependent. Kind of making the argument that there are other things going on. I thought that was kind of interesting, but I'll take a, you know, a slight riff on that, you know, and say, you know, perhaps some investors are too recession focused, meaning, you know, we have in the near term this idea that, you know, momentum is slowing. The question is how much will it slow? And then you have in a more longer timeframe conversation, well, what are asset prices doing in expectations for what 2024 looks like?

 

Jeffrey Roach (18:06):

 

And so, yeah, I think it's just so interesting, you know, as our listeners kind of think and hear us say, you know, we're still in that camp, that suggests that the momentum is slowing enough, particularly when excess savings dry up and when that credit card bill comes due, you know, consumers will pull back particularly on services spending, and that'll be such a fairly large driver in the economy to see, you know, see contraction. But, you know, asset prices have moved way beyond that. I think, you know, we're starting to, I think just another point to just highlight that. But this, you know, this story right here is this is just a graph we blogged on it last week. I won't spend a lot of time on it because I'll highlight the LPL research.com website, which is where we blog.

 

Jeffrey Roach (18:59):

 

So whenever there's comments, you can always reference that LPL research.com. Basically just saying, you know, the orange line there showing, you know, inflation as indicated by purchasing managers talking about prices paid, et cetera, have trended down, you know, without question over the last year and a half, but in most recent months, there's a little bit of that concern that, oh, maybe inflation's resurging, hence you know, a little bit of choppiness in markets, an increase in rates pretty much across you know, the whole curve. But rates you know, increased as investors thought, well, inflation's going to be sticking around a lot longer. That's the orange line. But if you look at the blue line, the blue line is basically saying, hey, you know, the services economy is growing. It's the services economy that's supporting overall economic growth right now so far.

 

Jeffrey Roach (19:59):

 

And here we, you know, here we sit September near the tail end of the third quarter and wanted to highlight just a couple things, and we're going to talk about this in our committee meeting tomorrow. And that is, you know, you have huge variants between Fed models. So Atlanta Fed saying, hey, we could see a almost a 6% growth rate in the third quarter. New York Fed saying no, don't get too excited, 2%. The Cleveland Fed. Jeff, not sure if you're tracking all this as much as I am. Cleveland Fed is suggesting that Q3 is going to be negative <laugh>. So, it kind of illustrates, I think, in my view, that, you know, coming out of a pandemic models have been completely torqued. Got to be really careful on how we look at the data. You know, at this point, momentum slowing.

 

Jeffrey Roach (20:54):

 

Most investors are kind of saying, hey, we'll avoid the outright recession, we're saying not so fast. So, that's kind of the main takeaway here from the ISM survey that we got last week. I think Jeff, do we have another slide on ISM on here Yeah. As well? Maybe I'll take this back over to you because it connects the dots between what businesses are saying about activity. That's the blue line the ISM index, and then what it means in connecting the dots between what businesses are actually reporting as it relates to earnings. But at this point you know, we're seeing expectations of that slowdown, and we'll see that as perhaps we go into the latter part of this year and start to see how those earnings will play out for the third quarter.

 

Jeffrey Buchbinder (21:51):

 

Yeah. So with earnings, you have to differentiate between, you know, good results, right? Good earnings growth versus better than expected <laugh>, right? So what we have right now is basically no earnings growth, right? Consensus for Q3 is zero, flat, but that is so much better than most people expected, even just a quarter ago, let alone at the start of the year, you know, a lot of folks were looking at $200 or less in earnings per share from the S&P 500 this year as recently as, you know, Q2 <laugh>, right? Or certainly you know, in the spring Q1. So to get to this point where now, 220, 225, you know, a lot of folks are still looking for, are now looking for numbers that good. Consensus is over 220 now, which is really hard to believe, frankly. That's much better than expected, but it's still, I just want to highlight, that is modest. That is, that is no growth year over year, basically. And that is, you know, setting us up maybe for, we think, mid-single digit earnings growth next year. So that really is consistent with, you know, what you see here from the ISM, which is, you know, kind of creeping back to a flat year over year, you know, low fifties, right, Jeff? Kind of a slow growth environment is consistent with what, like a 52, 53.

 

Jeffrey Roach (23:19):

 

Yeah, in the very low fifties. It kind of illustrates, you know, this threading the needle that the Fed is trying to do. Hit inflation, get back to that 2% target, which is going to be difficult for that last mile, as we say. And at the same time, making sure, you know, tighter policy doesn't break anything. And that's, you know, that's where it relates to, you know, the real economy business activity and earnings potential.

 

Jeffrey Buchbinder (23:50):

 

Yep. Well said. So I guess with inflation, I'll let you walk through this chart. But we get CPI this week and PPI so this is probably going to get the most attention of any economic event on the calendar. You had gasoline prices rise, so that will probably elevate the headline CPI a little bit this week, right?

 

Jeffrey Roach (24:13):

 

Yeah, and that's exactly right. So that little uptick in the dark blue line is based on expectations that because we had a fairly sizable increase in energy prices, headline CPI, blue line, will have an actual uptick in the year on year rate. Month on month, it's going to be pretty hot, you know, 0.5. I think consensus is even a little bit hotter than that 0.6% month over month. But I think, you know, it's key to remember, and I think investors will focus on this. The Fed talks about core inflation, particularly the inflation metric, not from the CPI report, but from the other sister report from the personal income and spending that we get. We'll get that later in the month of September. And either way you look at it, you know, we'll have a little bit of uptick headline later this week, but we're clearly on the downward trajectory.

 

Jeffrey Roach (25:16):

 

Look at the orange line. The orange line strips out the volatility from food and energy prices. And so, you know, that's continuing to tick down. And, you know, this forecast that I have here, Jeff, is based on, you know, a 0.2 month on month trend, which is pretty conservative. It's possible that as things slow down, particularly in rent prices, we're going to have something a little bit softer. So if anything, I think there's risk that that orange line right there will tick lower by December than what I even have here in this chart.

 

Jeffrey Buchbinder (25:58):

 

So I know you've been talking about a three and a half kind of core PCE by the end of the year. Is that still a reasonable expectation? Are we thinking that it could be lower?

 

Jeffrey Roach (26:08):

 

It could even be lower. Yep. The 3.3% I think is where we sit right now. By the end of December the year on year rate for the deflator, they call it from the personal consumption and expenditure report. So, you know, it's truly going in the right direction. It hasn't been particularly choppy. We've had a little bit of surprises here and there, in fact, just a couple, I guess, what was it, two weeks ago maybe, or last week, we had that surprise on you know, financial services uptick in inflation from, you know, insurance. A lot of those were one-offs. So it'll be interesting as we continue to see a little more of those numbers cool off by the end of the year. But again, going back to what I said, I think on the previous slide, you know, going, you know, we will hit, you know, a tad higher than 3% inflation in December, but it'll be a little bit tougher to get down to that 2.5%, and then 2.3, 2.1 <laugh> that last mile is going to be real challenging.

 

Jeffrey Buchbinder (27:18):

 

Right. But they just need to average around two.

 

Jeffrey Roach (27:21):

 

Well, that's, yep, that's a great point. You highlight that, that's great for our listeners to remember. You know, that actually came out at the Jackson Hole meeting in 2020. That was virtual, no trips to the Grand Tetons there, no fly fishing. But it's an average over the long term of 2%, which means we were hovering below 2% for several years leading up to the 2020 pandemic. So, you know, if you're a little above 2%, you average that out that certainly is going to argue for the Fed saying, hey, we are finally at the end of our tightening cycle. I think we're getting very close to that point.

 

Jeffrey Buchbinder (28:05):

 

And markets should like that, both stocks and bonds. So, we'll keep watching the inflation data closely. That's the, you know, main event this week. You see here on the economic calendar. We've got CPI on Wednesday, followed by the PPI, you know, wholesale prices, producer price index, on Thursday and retail sales. I mean, this is a week of pretty important data. I'm going to go out on a limb and say that the Atlanta Fed GDP tracker goes down after this week because it is so hot right now. <Laugh> five, I just looked this morning, 5.5% Q3 GDP based on the data that's been reported, that just seems totally out of whack with what's going on right now. Is there anything else on here? Well, any comments on retail sales, first of all, Jeff, and then anything else on here that you think people should be thinking about for this week?

 

Jeffrey Roach (29:01):

 

Well, I think you can think of the week of inflation being, you know, a part one, part two. Part one comes with CPI on the 13th. Part two shouldn't be overlooked. Sometimes it is. And that's the University of Michigan corresponding inflation report. So it's, you know, it's not hard data, it's survey data but I think it's worth putting together. That's why I kind of have a two-part series. Wanted to highlight that. And then in terms of the retail sales report, you know, and our listeners should remember, and they probably heard us talk about this before, but retail sales is heavy goods focused. The only services really is restaurant services. Everything else is pretty heavy goods part of the economy. And at this point of the cycle we're most interested in services and we're not going to get a good read on that from the retail sales report. But yeah, my key takeaway is for our listeners is it's heavy inflation week. We're not going to get any Fed speak this week. The Fed committee members are in their so-called blackout period. So that is pretty much the two weeks before the September 20th meeting. So at this point, yeah, it's all inflation.

 

Jeffrey Buchbinder (30:25):

 

Yeah. And the ECB, which is obviously related to inflation, I believe their meeting is Thursday. I think the market's pretty much split on whether they hike, you know, on the one hand, they have a little bit more of an inflation problem than we do. So that points a hike, but on the other hand, they have more of an economic weakness problem, <laugh>, especially Germany, than we have. So that points to a pause. So, I think those are interesting. When you go into meetings 50/50, that's when you know, you really want to pay attention. So, we'll see what happens there. That'll be interesting. And then I mentioned that, you know, the big Apple event this week. I think those are probably the key market drivers we'll continue to watch yields, oil prices and the dollar. So, anything else you want to highlight, Jeff, that we missed before we close? And you did a good job of promoting some of the stuff we got going on.

 

Jeffrey Roach (31:17):

 

Yeah, and just one last thing is, you know, so that meeting on the 20th the Fed does release its updated summary of economic projections. So that's going to be tightly watched and scrutinized. And so that's worth highlighting as well. So, in addition to a statement and a press conference, we'll have a whole deck of papers to go through with that summary of economic projections.

 

Jeffrey Buchbinder (31:46):

 

I will close with this. My favorite market news story of the day is the proposed acquisition of Hostess Brands by Smuckers. Because, you know what? If I could get jelly inside my Twinkies, I'm going to be a happy camper. So I'll end with that one. Thank you everybody for listening. We appreciate. Oh, I actually have one more thing to promote. The Weekly Market Commentary. Sorry, I left this out. The Weekly Market Commentary is about the BRICS, right? Brazil, Russia, India, China plus, which now includes South Africa. So, for those of you who have interest in the BRICS, which we actually make the case that they still matter. Here, you see the GDP for the BRICS is bigger than the U.S. It's north of 35 trillion. So, you know, just kind of walking through the outlook for that segment of the world and why it matters. Although the LPL Research team is still cautious on emerging markets broadly, we'd be more active there and try to avoid or mitigate China risk for emerging market investments. So that is our close. So with that, again, thank you for tuning into LPL Market Signals. We really appreciate it. Jeff, thanks for joining and walking through the economic outlook and more. Everybody have a great week and we will see you next time. Take care. Take care.