Implications of Russian Mutiny on the Market

Jeff Buchbinder (00:00):

Hello everyone, and welcome to the latest edition of LPL Market Signals. Jeff Buchbinder here, pleased to be joined by Quincy Krosby. Quincy, we got a lot to talk about based on the developments in Russia over the weekend. How are you today?

Quincy Krosby (00:15):

Fine, thank you. Thank you so much Jeff. Appreciate it.

Jeff Buchbinder (00:19):

Sure thing. I'm showing off a little bit of a different background today. I'm actually in the Boston office, the Boston LPL office, and this just, we thought was a nice background as opposed to that curtain which I usually use when I am not in the office. So, changing it up for you, but it's still me. So, here's our agenda for today. Thanks everybody for joining us. We're going to do a quick market recap, like we always do, of course. Then we're going to get into the global topics where Quincy's insights are really, really appreciated. Russia and more we'll call it, but it's going to be a little bit about Europe and a little bit about China. And then this young bull may be due for a breather is the topic of our Weekly Market Commentary.

Jeff Buchbinder (01:05):

So, we'll show you the charts from that publication, which is out and available on lpl.com as you are listening to this. And then lastly, preview the week ahead, the economic calendar, which has the core PCE deflator, which is the Fed's preferred inflation measure, An important one. So, let's start with the market recap here, Quincy. The winning streaks for both the S&P and the Nasdaq came to an end. They were great winning streaks. Five weeks for the S&P, eight weeks for the Nasdaq. Don't see those all that often, so certainly we've had a nice run here. But you see here the S&P 500 down about 1.4% last week. And the Nasdaq the same, small caps actually were hurt a little bit more, down almost 3%. It was a global selloff.

Jeff Buchbinder (02:01):

So, you see losses in Europe and in most Asian markets. I mean, really the focus I think last week Quincy was probably on the fed as much as anything because we had, of course, the testimony from Powell in front of Congress. So, you know, we're continuing to digest the, you know, the fact that we might get two more hikes from the FOMC. What else do you think caused the market to pull back last week? Was it, you know, worries about concentration that we've heard a lot about, narrow leadership? Was it something else?

Quincy Krosby (02:36):

Well, I think, you know, once you have a market that moves into overbought territory, it doesn't take that much to you know, to cause a bit of a pullback, profit taking. I think one of the main reasons was it wasn't just the Federal Reserve, it was a shower of global central bank rate hikes. It was amazing because, you know, a couple of weeks ago it was just the Reserve Bank of Canada, not just, but the Reserve Bank of Canada, the Bank of Canada, and the Reserve Bank of Australia. And then last week it was the Central Bank of Switzerland, the Norwegian Central Bank, the Bank of England. We had the European Central Bank. We even had the Bank of Turkey, Central Bank of Turkey in addition to the Federal Reserve. It is as if the global central banks are determined, determined to restore price stability, and it looks as if they're determined to do it, even if it means slowing the economy.

Jeff Buchbinder (03:40):

Yeah, great point. Certainly, markets maybe translating the hawkish moves overseas into, you know, more action from the Fed. And maybe that's giving the people who had previously thought the Fed was just going to hike maybe one more time or not at all, second thoughts. So yes, good point there. I mean, you know, because the economic data recently has not been all that concerning, right? I mean, in fact, the odds of a soft landing have probably increased in recent weeks based on the data. We had strong housing data last week, for example. Mm-Hmm. <Affirmative> and it looks like housing may even contribute to GDP in the second quarter. If you look at the, you know, the sector breakdowns, certainly you know, it wasn't a good week for tech, but it didn't get hit that hard, tech down 2% for the week.

Jeff Buchbinder (04:31):

You did see the defensive sectors hold up better, you know, in particular healthcare, which was actually the only sector in the green. Right? I know within healthcare, you know, the managed care group, which has really had a rough go of it lately was one of the winners. You also saw some strength in some of the pharma names. So, you know, of course we don't know if this is going to be the start of a trend toward the defenses. The charts don't look very good right now, certainly, but it was one week where defenses were certainly the, the place to be. So, moving on quickly to the bond market, you know, with stocks falling, you typically see bonds rise, especially when yields are up like they are now. So that's indeed what we saw a little bit of green in fixed income, or at least high quality fixed income. Okay. And then on the commodity side, you know, one of the reasons why you saw energy weakness last week certainly was you had crude oil down almost 4%. The energy index was down less than that because natural gas prices were up. But energy price, weakness overall certainly weighed on the energy sector. Anything else to call out here, Quincy, before we keep moving?

Quincy Krosby (05:43):

Nope, let's keep moving. <Laugh>,

Jeff Buchbinder (05:45):

Keep moving. Well certainly commodity weakness can tie into your China comments here in a bit. So let's get into the, what we'll call three global hot topics. You know, y'all know the one, the main hot topic is the move over the weekend, the mutiny in Russia. So really looking forward to getting your thoughts on that, Quincy. But we also had a weak business sentiment report in Germany. The Ifo index dropped a few points more than expected. And so that's maybe shining a light on Europe again as a potential source of global economic weakness. Mm-Hmm. <Affirmative>, the LPL Research Strategic and Tactical Asset Allocation Committee does like international right now a little bit better than the U.S, although we're neutral equities overall. So certainly, any weakness in Europe potentially would have our attention.

Jeff Buchbinder (06:38):

And then lastly China, you know, China, whenever you talk international, we want to talk China. So, interested in your thoughts there, Quincy, is that economy you know, just putting away the controversies that we all know about, right? China's economy just continues to perplex me. Just, you know, this reopening that everybody was so excited about really hasn't materialized. So, I want to get your, your latest thoughts on what you've seen in China over the last week or two. So why don't we start with Russia, I guess, you know, my first take on this was that this increases the chances that we can get some sort of resolution, you know, an end to the fighting in Ukraine over the next, I don't know, several months. But you know, you might have a different take. What do you think are the implications for, you know, first the war and secondly for the economy from this, I guess short-lived mutiny over the weekend?

Quincy Krosby (07:35):

Well, so far, we haven't seen anything that, you know, the ramifications haven't moved over into the projections for the global economy. You did see oil prices climb higher as a result. That was a knee jerk reaction. But the oil prices have come down quite a bit. The fact is, I mean, at least as far as the market is concerned, we've moved on, right? We, we have moved on. I, you know, I follow the Japanese yen, I follow the dollar, gold. In essence, the market says, okay, now let's look ahead. Let's look at the things we need to focus on. However, there are issues, outstanding issues, because we want to know the markets, want to know the markets are monitoring what's next. This was a very odd quote, unquote, end to the episode, very odd ending where he was the head of the Wagner Group was given the okay, go to Belarus.

Quincy Krosby (08:39):

Nothing is going to happen. That's not the way Putin runs. That's not the way he operates. And today we had the head of the Wagner Group come out and say that, you know, this had nothing to do with Putin. This was not a coup, this wasn't towards the Kremlin, it was only towards the defense ministry, you know, and by the way, over a number of weeks, there have been issues with why are the Russian troops firing on us, right? That was one. Second, where's the equipment that we need? Where's the food that we need? And so, he tried to tie it to that, although it's really odd, you know, you can't help it. But nonetheless, the question is what about Putin? And what is interesting here, Jeff, and what's being monitored is what is next with him where, you know, he is in a bunker.

Quincy Krosby (09:43):

What are the people closest to him telling him? And the question now is how does he come out and reassert his authority? Because for all intents and purposes, the view is globally that his authority has been diminished. And given his, you know, his ego, given the way he sees the world, and given that he's essentially alone only with those who tell him what he wants to hear, he must come up with a move that asserts his dominance. And that's the question. And the question is, what could that be? And many of the choices are not exactly what, you know, what markets want to want to focus on. So, that's what we're waiting for. You know, whether or not internally they remove him, that is not in the cards at this point. But you know, what we've forgotten about is all of the earlier reports that he is actually very sick physically with cancer and with Parkinson's, that could be used as rationale for removing him, that had been mentioned many times months and months ago. So, again, there are more questions now than there are answers, and that's sometimes you just have to wait. But the concern is, and I just can't stress this enough, that if he feels compelled to underscore his dominance, you just don't know. It's like lighting a match, in fact, it is like how he went into Ukraine thinking it would be over in just a short period of time.

Jeff Buchbinder (11:32):

It's been nowhere close to a short period of time. And yes, I've heard the talk Quincy about Putin's health, in fact, somebody even speculating that he might be dead. That would be quite a secret to keep <laugh> from the world in the digital age. But it's certainly possible. I mean, so we failed to mention, we're recording this on Monday late afternoon. It's June 26, 2023. And this is a very fluid situation. And so, we may yeah, we may learn more very soon, but you're right, a hundred percent right that you know, if somebody challenges Putin's power based on what we know of Putin, they don't just waltz into Belarus and hang out and all is forgotten. I have a hard time believing that just like you do.

Quincy Krosby (12:20):

No, no. He is known for going after his enemies anywhere in the world, including here in the United States of America.

Jeff Buchbinder (12:32):

Absolutely. So, Putin is weakened. The theory is that that brings this conflict to a close sooner. Would you go so far as to say that, you know, maybe you know this thing's over in a few months? And if so, what's the path to this ending?

Quincy Krosby (12:53):

Well, one thing that could happen is that the Ukrainian forces take advantage of this vacuum right now and just move in. They were supposed to launch an offensive that they could take advantage of it, right now. This is important, although there are also reports that the Wagner Group is still in Ukraine. So, you know, again, more uncertainty, but it is clear that the troops, whether it is the mercenaries, which is the Wagner group, which by the way, just so folks know, has been active for years in the Middle East and in Africa. They are an important military component for military affairs in that part of the world. But the question really is, is the military in this Russia so weakened by all of this and leading up to this, that this is a good chance, again, for Ukraine, has new weaponry that's come in to go out there and use it and use it forcefully. And what's next? If they can come to the table and discuss a you know, a negotiation, a negotiated peace, what you have is then the rebuilding of Ukraine. And that's something that has been discussed already. All of the agencies worldwide either on a, you know, multilateral basis or the multilateral organizations are drawing up what Ukraine needs to rebuild. That is going to cost billions and billions of dollars. And infrastructure spending is going to be extremely important.

Jeff Buchbinder (14:40):

No doubt. Yeah, that's of course a long-term path. But yeah, sure. I'm sure Ukraine is figuring out how to take advantage of this potential incremental weakness. And there was already a lot of talk about a weakened Russian military, about some you know, discourse amongst the troops and all of that. So, if that's all right, and then you add this to it, then yes, this may get us to an end quicker. Certainly, we would all love to get to that point. So, thanks for those thoughts, Quincy, really interesting situation to follow, you know, who knows what's going to happen over the next several days. So, let's turn to Europe. I mean, this business sentiment index, the Ifo index did surprisingly drop a few points. And that's causing speculation that maybe Germany, you know, the recession extends another quarter or two. What do you think happens to the European economy in the near term? Are they going to be mired in recession for the rest of the year, or could they snap out of this pretty quickly?

Quincy Krosby (15:51):

Well, you know, they could snap out of it pretty quickly, because we've seen how tied they are to the fortunes of China. The market was disappointed last Friday because there had been a state council meeting, which is their Chinese cabinet, expecting more information about what they may do on the fiscal side to help the Chinese economy. Anything that helps the Chinese economy, helps the trading relationship with Europe, and particularly Germany and France and Italy. So that could help them. And remember when we thought that the Chinese would use more, not just monetary policy to help the economy, but would launch a fiscally charged, underpinned program to help the unemployment rate, help that help the youth unemployment situation, plus have employment pick up across the country. We thought that that would then come and help commodity prices, and also the industrial part of Germany and also the rest of rest of Europe, that would help.

Quincy Krosby (17:01):

So, the market's still waiting for that. And there are those analysts who believe that the Chinese government is working on it. You know, we just got a report where consumer spending is down. Remember, consumer spending was up, remember when we talked about it and how they were spending on travel, on luxury goods, and we saw the French luxury goods index move higher, or the European Luxury Goods Index move higher. But now we're hearing reports that folks are saving money, they're worried about the economy, and they're just saving. And also, the unemployment rate does have them fearful that if things deteriorate more markedly, you know, they will themselves be laid off. So, there's caution in China right now, and again, they could turn it around, but remember one thing that the Chinese are doing now, there's a major audit going on because any infrastructure project includes the municipalities.

Quincy Krosby (18:00):

But when the municipalities are mired in debt, it becomes difficult for them to engage in a major infrastructure project. So, what the government is doing is they want to get a full picture of the debt. And again, a major audit is going on, but you know, the clock is ticking. And that is something that is important for President Xi, who by the way, is watching very closely what's going on in Russia. They do not look at this and think this is a positive move. But they don't, you know, they never want to have any demonstrations in China. So, they've got to move. And if there is a catalyst, it will be the unemployment rate about 20%. And a good portion of it is young people and new college graduates. So that's the thing, it's a waiting game. And more and more analysts are saying, wait a minute, this notion of 5%, or around 5%, is how the Chinese government characterized it toward the end of the year is just maybe even lower if they don't do something and do something quickly. So, this is a big disappointment, by the way. And the other disappointment is the global slowdown. So, their exports are down, as you know, the demand for their manufactured goods is similarly down. So, it's a double whammy for them.

Jeff Buchbinder (19:29):

Sure. And the U.S. economy shifting more towards services and away from goods.

Quincy Krosby (19:29):

Jeff Buchbinder (19:35):

Is certainly not in China's sweet spot. So yes. Yeah, I mean, back to Europe, you know, Europe is really driven in large part by their exports to China and to the U.S. And so if you have, you know, lackluster growth in those two places, it's really hard for Europe to make much hay. I think that's an important point. And then in China, I mean, really the goal is stay in power for Xi and the CCP, right? So if they can't keep their people employed with incomes, they have a problem. So, you know, you'll probably continue to see stimulus there.

Jeff Buchbinder (20:13):

Yes, yes. So, thank you for that, Quincy. Let's move on and talk, bring it back to the U.S. and talk about this bull market, how it may be due for a breather, not directly tied necessarily to what's going on in international markets but certainly some of these international jitters are kind of not helping this bull market continue to move higher. So the Weekly Market Commentary about this bull needing a break available on lpl.com. Here's the first chart from that piece where we just talked about how we're overbought, right? And a simple way to look at overbought is the relative strength index. It's basically, you know, measure of frequency of gains in a mm-hmm. <Affirmative> a short period of time. And so when you get over that 70 level it marks the difference between a kind of a normal market and an overbought market, we start to get a little bit nervous about the short term.

Jeff Buchbinder (21:14):

So here we got over 70, now we're breaking back down below that 70 level. It tells you maybe that a bit of a pullback is here. And you can just look at the top panel of the chart of the S&P, it just looks like it's come a pretty long way in a pretty short period of time. We're up about 21% off the October lows, now. That 21% off the lows, which is the tally of the new bull market coming off of the October bear market lows, that actually is a pretty normal return for this stage. So, this chart just compares the median bull market eight months in, and the average bull market eight months in, to the, the bull market we're in now. And you see here you know, the median 25%, the average 33%, and then we're at 21.

Jeff Buchbinder (22:07):

So we're kind of in that range. Not spectacular, not mediocre, but kind of, you know, in the range. You know, when you take out the spikes coming out of 09 and coming out of the 2020 lockdown period of the pandemic, you know, you get a much lower number <laugh>, right? So that's, I think why median is a better representation of where we are. So, you know, this suggests there's more upside over the next four months as the you know, the bull market completes its first year, assuming it lasts that long, and we think it will. So modest gains may be ahead, but frankly, not a whole lot in the near term. The last chart that we have in the commentary shows you duration in performance of bull markets historically. And you know, this makes the point that if this really is a bull market, and by the way, there's more evidence than just 20% off the lows, because we're seeing cyclical leadership, right?

Jeff Buchbinder (23:08):

We're seeing some breadth, not great breadth, but some breadth that suggests maybe you know, this really is a bull market. It's not just, you know, up 20, down 20. So, but you look here, if this is a new bull market, and we, you know, technically it is, and if it unfolds like some of these other bull markets in history, you know, four or five years left, we'll see, obviously hard to predict. And then you're going to have potentially, if you follow the pattern, you know, maybe high teens type of annualized returns, that would be normal. Now, because we had kind of a shallow bear, maybe you would expect more modest returns going forward from the next bull. But certainly, you know, it's not unrealistic to expect, let's call it mid-teens type gains. So even though we're a little bit conservative now with that neutral equities, history tells you that you don't want to get too defensive here because certainly good chance that we see solid gains over the next several years.

Jeff Buchbinder (24:15):

But then last point, then I'll hand it over to you, Quincy, the drawdowns during bull markets are pretty much as big as the drawdowns you get in any market, right? In any given year, the average maximum drawdown, so the maximum entry year loss is about 14%. If you just isolate bull markets, the average maximum entry year loss, this is all based on the S&P 500 is about 13%. So even though we think this is a new bull, and we think it lasts a fair bit of time, that doesn't mean you're not going to have some volatility with it. Quincy over to you.

Quincy Krosby (24:52):

Well, you know, when we have secular bull markets, those are markets that are going in emerging as a bull because something major has changed, that's what a secular bull market is. Doesn't mean you don't have bear markets within a secular bull market. You certainly do, but the overall trend is a bull market. That was what was introduced in August of 1982 when Paul Volcker lowered rates after creating two recessions to thwart inflation, that was a secular bull market, and it was one of the best bull markets we've ever had in this country. So this market,

Quincy Krosby (25:34):

Yeah. Yeah. But what I'd like to see, and it would give me more confidence that this is indeed a proper bull market, a strong one, is I want to see more participation in the S&P 500 of those names crossing their 200-day moving average. Usually when something powerful hits, you will usually see close to 90% crossing their 200-day moving average. So, when this began just what was a week, two weeks ago, the number was about 66% crossing its 200-day moving average. Today, it's down to about 54%. You get, there's more confirmation when you cross that level, that 200-day moving average. And I'll point something else out for seasoned portfolio managers, that's what they pay very close attention to, to the 200-day moving average, to see that fervor, that underpins that surge of interest in the market.

Quincy Krosby (26:38):

So, I'm waiting, I'm hoping that we will see it because it's important psychologically, obviously, the fear of missing out is important. The short covering also is important, but to become a true believer as opposed to just being, whoa, I better go in because if I don't, my numbers aren't going to be good. You want to see that, and I'm hoping that is in fact what we'll see. Powell is speaking this week, Chairman Powell, we're also getting the PCE, the Personal Consumption Expenditures Price Index, the PCE, as you mentioned, their preferred measure. If that comes in cooler, than expectations, and typically it runs cooler, than the Consumer Price Index, the CPI. I think that perhaps we could have a strong rally if that in fact is what the data release suggests on Friday morning.

Jeff Buchbinder (27:33):

Yep. You're seeing that on the screen here. The PCE deflator is no doubt the highlight of the week for the yes. economic calendar. I mean, certainly, you know, consumer confidence and surveys of inflation are important. Certainly jobless claims takes on greater importance when we're so laser focused on wages and the job market and how that translates over to what the Fed's going to do. Yeah, totally get that. But PCE is no doubt the highlight of the week, and it seems like it's not a very high bar to clear, you know, flat month over month, right? 4.7%, yeah,

Quincy Krosby (27:33):

Jeff Buchbinder (28:10):

Year over year. Again, but, you know, we have kind of stubbornly sticky services inflation, rents that take time to come down, those sort of things. So we'll see. But, yeah, we, we are poised for a little bit of a rally here. We think if we get a better number than that. And then the last point I'll say on this is, you know, the reason that we're in this mess that we're in right now with inflation largely pandemic, it's the reason that we're having let's call it elevated risk of recession, right? If, frankly, if inflation is no longer a problem in a year, let's say, that could really provide a lot of fuel for this bull market, right? Oh, People might look at, you know, at the previous slide, 14% annualized returns for typical bull market.

Jeff Buchbinder (29:01):

People might look at that and say, wow, that's a lot to expect. But if inflation's under control and interest rates come down and earnings are no longer pressured by inflation and by this lackluster growth, which is largely because inflation's high, we could really have a nice several year run. So, that's kind of on the other side of the canyon, so to speak. We're clearly not there yet. We don't have the Fed out of the way but that could be the, you know, the real catalyst to generate what could be a really solid multi-year bull market.

Quincy Krosby (29:38):

Absolutely. Absolutely. And you know, the dollar would be attractive, not collapsing, but it would certainly be allowing financial conditions to ease a bit if the Fed is finished.

Jeff Buchbinder (29:55):

Oh, a hundred percent. I mean, in fact, we're already seeing signs of that happening today. So, you know, hopefully the banking stress that we saw a few months ago is behind us. And any tremors are you know, let's call them small ripples that don't influence the financial system as a whole. That's our view, you know, high level, house view that we're not going to see any major disruptions from other banks stress, but it's certainly too early to declare that episode over. So, things could look a lot better than they do now in a year. I think that's probably the key takeaway from looking at the inflation situation and the Fed in the context of the current bull market. So with that we'll wrap. Thanks Quincy as always for joining another episode of Market Signals. Thanks to all of our listeners for joining as well. It was good to see some of you over at an event here in Boston for some of our advisors today. Everybody have a wonderful rest of the week, and we'll see you next time.