Neutral Is Not Bearish: LPL Research Downgrades Equities to Neutral

Jeff B. (00:00):

Hello everyone. Welcome to the latest edition of LPL Market Signals. Jeff Buchbinder here with my friend and colleague, Jeffrey Roach. How are you today, sir?

Jeff R. (00:11):

It's a happy Monday, so good to be here. And just talking just before we started recording, looking forward to being in the Boston office in a little bit. So that'll be a first for me. So, looking forward to seeing you.

Jeff B. (00:27):

We just moved, so make sure you get the correct address. <Laugh>, we're pleased to be in our new space. So, looking forward to seeing you, Jeff. We have a great agenda for you today. I think, you know, we don't make a move on equities very often, but we have made one today. It's Monday, June 5, 2023, as we're recording this, you know, you'll be listening to it on Tuesday or later. We have downgraded equities to neutral, but importantly, neutral is not bearish. So, we want to be, you know, careful in how we present this. You know, this doesn't mean sell everything and go to cash, not by a long shot. This means we've had an overweight to equities but at higher valuations with some technical resistance coming, we think it makes sense to just be a little bit more careful.

Jeff B. (01:20):

And you've also got higher bond yields. So, we'll go through that. That'll probably take the bulk of the time here that we're with you. But certainly, we'll recap last week's strong market action that put us in a position to potentially break that 4,300 level. It also, by the way, keeps us really close to starting a new bull market based on the technical definition. A 20% closing high above the prior closing low. We actually got above that 20% mark on an intraday basis. So, you know, and then we'll conclude the call with just a look at the economic data for the week. But frankly, it's a pretty quiet week for the economic calendar. And then Jeff, you'll talk about the jobs report. So, you know, first just you know, recap of last week, really strong week, you know, S&P 500 up almost 2%.

Jeff B. (02:18):

Now, most of those games came on Friday after the jobs report so we'll call it backend loaded. We actually, we didn't see this big divergence between the NASDAQ and the S&P. You know, NASDAQ did a little better, but it wasn't dramatically better. And you know, you generally see gains across regions a little bit more mixed in Europe. But generally we saw gains you know, in Asia-Pacific. And then when you go up to the upper right hand corner of this table, you see all countries, EAFE, emerging markets, all higher to varying degrees, but all higher. And then the same story with the sectors you see all of them higher. Now, the defensives were a little bit weaker. We continue to see this pattern where the more economically sensitive sectors do better or what we refer to as higher beta, the sectors that are more sensitive to market movements. So you know, you see materials, consumer discretionary did quite well. Surprisingly, real estate did quite well, and the banks within the financials did well. But based on the market internals in terms of what's working, I think it's fair to say investors are pretty confident, at least in the very near term, maybe over the next three to six months. What do you think?

Jeff R. (03:42):

Yeah, you're right. I think one of your comments just a few seconds ago here on saying backend loaded in terms of how market reactions were last week. I think we're still in this weird period, Jeff, where bad news is good news. You know, I think we're getting past the worst of it, but the good news, bad news, bad news, good news, you know, for markets, I think a lot of what markets were focused on after the Friday morning report was this uptick in unemployment. So is that good or bad? You know, we could make the case that it's good in the sense that markets or Fed, is near the end of its rate hiking cycle as labor markets going to get a little less tight. But it, anyway, it's just kind of interesting in this weird dynamic of bad news is good, because certainly we had that hot headline number. But yeah, the market's a lot of green. If you put this chart in you know, color coded here, a lot of green on the page.

Jeff B. (04:46):

Yeah, no doubt. I mean, there was a little bit of you know, debt ceiling deal celebration, we'll call it, I guess, even though we, and pretty much everybody expected that deal to get done. But I think you're right, Jeff, the Fed, you know, anticipation that the Fed was either done or will be done very soon. Probably part of the you know, what the market was thinking here by going higher. The jobs report certainly was part of it as well. But, you know, the bond market did fine. We actually have, you know, saw gains last week in the bond market. And on the commodity side, while you, you do have a little bit of a decline in oil last week, actually, more than a little bit of a decline in oil. We got an OPEC+ cut today, and oil got a nice little bounce, and some of the energy stocks getting a little bit of a bounce.

Jeff B. (05:40):

So maybe energy's finding its footing because oil has really struggled recently. And you know, certainly natural gas struggling isn't even putting it strongly enough. That's of course for the consumer, but it's, you know, for investors in energy that has been tough sledding recently. And then on the industrial and precious metal side Jeff, we actually are taking our view on industrial metals down this month to neutral, just like we're doing in equities but keeping our recommendation on precious metals related investments, that's still more of an uptrend, whereas we've seen more technical damage, more of a breakdown in industrial metals like copper.

Jeff R. (06:29):

Yeah, I think in terms of the energy space, it's interesting despite the announcement over the weekend, you know, last time I checked, you know, we're not much above $70 a barrel. So, it's interesting to think, you know, with the challenges in the energy space last week and the announcements of OPEC+ not much happening. Clearly, it's a, you know, it's still this unknown about global demand. How much will you know, the large heavy hitters in the global economy use oil and what their demand's going to look like the latter half of this year.

Jeff B. (07:05):

Yeah, until we get more growth from China and evidence of, we'll call it solidifying demand from the rest of the world, it's hard to envision a big move higher in energy on just a supply cut. So, let's turn to the S&P here, Jeff. And this is part of the reason why we think it makes sense to be a little less aggressive in equities right now. I mean, certainly the overweight worked for us for some time now, but as you can see here on this chart, we're right up against that August 2022 high, right around 4,300. That's the 20% mark, roughly above the October lows. So, you know, even though 4,200 didn't look like it was very tough to break through, you know, 4,300 could get a little bit tougher, right? So, you know, our technical strategist, Adam Turnquist, while he points out momentum could continue to carry us higher from here it would be a very logical place for the S&P 500 to pause. So we'll certainly be watching that level very closely. In fact, as we're recording this, we kind of bounced off of it and moved lower, so we can't quite declare a new bear mark new bull market and the end of the bear market just yet.

Jeff R. (08:31):

Well, before we get to jobs, just thinking about, you know, markets last week, you know, I think one of the things as Jeff, you often highlight in our STAAC meetings, our Strategic and Tactical Asset Allocation Committee meetings. That is, you know, as portfolio managers and allocators, we're always trying to say, okay, where could we be wrong? You know, what, where are the risks both to the upside to the downside? And one thing that, you know, needs to be maybe a little more front and center than sometimes we do indeed talk about it is, you know, perhaps, you know, we need to think about the scenario where the Russian-Ukraine war, actually finds some conclusion, some resolution. So, you know, we've talked about, you know, valuations and multiples and hitting that high in that previous charts we just showed. But you know, there's certainly some scenarios out there that are worth, you know, thinking about, right? What's our base case? And then of course, what are all those hypotheticals that could that throw us off track?

Jeff B. (09:39):

Yeah, good point, Jeff. You could also say that the chances of a soft landing have increased a little bit with this latest jobs report, right? We still think odds slightly favor recession, but very mild. People probably are getting a little bit too nervous about that word. Could be a very mild, very short-lived recession that people are kind of already feeling and maybe won't feel it much more frankly yeah. In your place in the economy. So, you know, I guess walk us through, Jeff, your odds of recession now as a result, or how they've changed as a result of this really strong payroll number we got on Friday. And then what does it potentially mean for the Fed?

Jeff R. (10:23):

Well, I think, you know, starting very high level, I think if we rewound the clock here several quarters, I think we you know, we were saying, you know, by summertime, you know, we'll see contraction. I think some of the data suggests that, you know, the recession, if indeed we slide into one is pushed out a little bit later this year. Now, granted, we're recording here June 5. You know, summer doesn't officially start, you know, until a little bit later this month. You know, and so it'd be interesting to see how the July numbers stack up. And of course, you have to wait till August for those July numbers. So, you know, we're saying, you know, the risk is that this recession base case gets pushed out a little bit later this year. But the fact remains that, you know, we're going to see the consumer slow down and pull back after releasing so much pent-up demand, particularly for services.

Jeff R. (11:21):

You know, thinking about travel, thinking about the component where people are, you know, pulling back on the durable goods spending, now they're going gangbusters on the services spending. And, you know, by the end of the summer, maybe, you know, Q3, we're starting to see this pull back. And a lot of it hinges on how well consumers are feeling in regards to, you know, stable job and income growth, you know, the ability to spend without acquiring too much debt. And all that, again, kind of leads us back to what we saw Friday morning, 8:30 Eastern time saw a blowout jobs number, and that was the headline number from the establishment survey, meaning that as the government surveys businesses over 300,000 jobs were added to company payrolls. However, <laugh>, don't you love it when an economist says, however, so the government also surveys households, not just businesses.

Jeff R. (12:26):

The household survey tells a slightly different story. Hence, that's one of the reasons why you had this headline job growth, you know, so very strong. And at the same time, an uptick in unemployment. Unemployment comes from the survey that the government holds and conducts to households. Actually the number of employed people declined according to the household survey, in contrast to the establishment survey, and I actually blog about this, Jeff, on our LPL Research blog page. We say, okay, it's often the case where the establishment survey and the household survey differ. It's okay. You know, we don't need to get into conspiracy theories in this case, they're measuring two different things, right? It's very important to remember that. It's combined, I guess unfortunately, it's combined when the media talk about labor markets, but two very different surveys, and I think, you know, we're seeing the market respond as we saw they did, investors were pretty happy in the sense that unemployment rose up a little bit.

Jeff R. (13:34):

Wages actually slowed down in terms of their growth, nominal growth. And so that means that the Fed can say, well, there's less risk from the wage price spiral. There's a little less tightness in the labor market, and at the same time, businesses are adding jobs, meaning that we're not going to have the economy come to a screeching halt, but we're slowing down in a way that actually is quite positive for the Fed. That's in a nutshell, one of the reasons why you had a very interesting job report Friday, and as a response, investors were quite, quite happy.

Jeff B. (14:13):

Yeah, I think that, you know, you could say that the market rallied and wasn't too concerned about the Fed because we got those two different messages from the two different reports, right? So that, you know, new job creation looked too hot, right? But, you know, that household survey said, no, we're actually kind of cooling off gradually, which is what the Fed wants.

Jeff R. (14:36):

Well, and you could almost argue that during these times of transition, right? We're coming out of you know, this post-pandemic kind of fast bounce, and then a kind of coming off, as you know, consumers are releasing this pent-up demand as we talk about. And during those moments of transition, I think it's believable to say what's more important is the household survey. You know, most of the time investors focus on the establishment survey, but in this case, household surveys really giving us the information we want.

Jeff B. (15:12):

Now, this chart, Jeff, that you put together shows that it's really more about cost cutting than about demand, right? In terms of why layoffs are happening.

Jeff R. (15:22):

Yeah. So, this is just say, okay, within the corporate side, you know, we know the Fed has been quite consumed with this report about the number of job openings that companies are reporting. So this chart kind of says, well, let's take a slightly different angle, but we'll focus on the corporations, right? Like I just said in the previous slide, we've been focusing on households. This case let's focus on businesses. We know the openings to unemployed is really, really high. But we want to say, okay, is there any more information about the corporate side as the corporate side gets ready for a slowdown the latter half of this year? This basically just makes the argument that a number of the layoff announcements that firms are making are being done because firms want to streamline, be efficient, cut costs, and get into a position where, hey, if the economy slows and even slows materially enough for it to become an official recession, businesses have been well prepared.

Jeff R. (16:29):

They've cut, you know, they've cut the fat, if you will, they're efficient. And I think it's interesting because as we sit here today, this is as of May data that last orange spike, as we sit here today, we're saying, you know, it's not a massive slowdown yet, at least from the corporate side. People are still buying, people are still traveling, people are still you know, acting as if, you know, they're going to take an advantage of the decent level of savings and decent level of disposable income growth. And so it's not really a demand problem, firms are saying, firms are saying, hey, we just want to be well prepared if and when we do go into recession.

Jeff B. (17:14):

Yeah. Clearly a lot of firms, tech firms in particular over hired, <laugh> during the pandemic, and so we're still kind of adjusting to that. And actually, we've seen a number of cases where stocks have rallied because tech companies have announced cost cuts and layoffs, right? At some point that relationship flips. But for now, markets are viewing cost cuts as positive. And then you've got one more.

Jeff R. (17:42):

Well, before we get there, Jeff, you just gave me a good idea talking about your comment, which is a great one. The idea of firms over hiring right? In the previous kind of section of time, and now it's particularly in the tech sector, kind of getting back perhaps maybe to a more sustainable run rate. That might turn into being an interesting blog post, or who knows, maybe even a Weekly Market Commentary talking about you know, our own estimates on what it might mean to be over hiring. That's a good comment. Just gave me some ideas.

Jeff B. (18:20):

I squeeze one in there every once in a while. So <laugh>, thanks for acknowledging that. Let's keep going. And this chart on productivity. I mean, I actually think this is one of the keys to keeping inflation at bay going forward, right? It's productivity. So, you don't have these situations where companies are bidding up labor cost, right? Bidding up wages and you know, hurting margins and potentially scaring the Fed again.

Jeff R. (18:48):

Yeah. Well, thinking about, you know, forward-looking earnings, right? Thinking about 2024 and beyond, we need to start doing that. What is most important as we set those expectations, we know our labor force is aging and shrinking? And so, what do we need to see? Well, maybe the fourth industrial revolution, if you will, could be maybe an answer to that, right? What might spike productivity? But in conjunction with Friday's labor market report, this is why I made this chart for the blog, and that is just to say, well, we know if productivity is really the key for keeping the engine going, particularly into 2024, you know, that prime age worker, the 25 to 54 year old is really going to be the important category to watch as we go through the latter half of this year and setting up for next year. Maybe ChatGPT is going to be going to play a bigger part than what we might think.

Jeff B. (19:51):

Absolutely. So that is a very long-term trend and, you know, remains to be seen what impact it'll have on productivity. But I think it's fair to say that labor will be more productive in the future. And maybe that amount of incremental productivity we get from artificial intelligence and machine learning and all of that will be maybe more than a lot of people expect. We'll have to wait and see how that plays out. But with that, let's get into you know, what we wanted to feature today, which is this decision to downgrade equities. The reasons for this move are spelled out in our Weekly Market Commentary on lpl.com. Jeff, you highlighted the blog, that's LPLResearch.com, where we post stuff pretty much every day as opposed to once a week.

Jeff B. (20:45):

We hinted at the first reason that we made this move already, which is you know, the S&P 500 bumping up against resistance. Another reason we did this is because technology's carrying so much of the load and that weight just gets higher and higher as tech continues to lead. So we think tech's due for a breather, as you see here. The title of this slide "Looks Over Extended." You know, when you have an RSI or relative strength index over 70, it's basically saying that, you know, over 70% of the days are up, essentially. And then you've got a big gap between where the sector is now and the 50-day and the 200-day but primarily the 50-day moving average that reflects overbought conditions. We just think techs due for a little bit of a pause.

Jeff B. (21:35):

You've also got a very concentrated market. It's not just tech. It's really the seven biggest stocks in the S&P 500 that are driving almost all of the gains for the year. You know, this is why when you take a look at the equal weight S&P 500, it's actually behind as much as it's ever been behind the market cap weighted S&P 500, where those big seven or eight names are really driving the gain. So, those concentrated markets, they just can't sustain themselves for very long. I mean, could it go for another month or another two months? Sure, maybe even longer. But at some point, we need more breadth for this market to go higher from current levels. So that's another reason we made that move. A third reason here is stock valuations relative to bonds.

Jeff B. (22:30):

So, this is the equity risk premium. It's just a way to compare the income generated by stocks to the income generated by bonds. Of course, the income generated by stocks is earnings. We're not talking about dividends, we're talking about earnings. And then the income generated by bonds, of course is yields. And when you compare those two, you know, a few years ago, I mean, obviously at the bottom of the pandemic, stocks looked cheap, but you go back, coming out of the financial crisis, stocks looked really cheap relative to bonds, because you had effectively zero interest rates. But, you know, we've moved from 5, 6% down to 1. And if you look at this chart, you know, 1% on the equity risk premium is, I mean, we haven't been down there in close to 20 years, so it almost says be indifferent between stocks and bonds based on current valuations.

Jeff B. (23:23):

Because we're pretty much in long in line with the long term averages on this metric at right around 1%. So again, we're not saying go, you know, sell all your stocks in go to cash. We're just saying, you know, the risk reward maybe is more balanced here. And we no longer, at least for now, want to lean into equities. The last point on this, and Jeff, and then I'll let you chime in is seasonality. It just seems like a logical place for stocks to pull back a little bit or at least consolidate and digest these gains. Again, we're almost 20% off the lows. June is a seasonally weak month. We've all heard the "sell in May and go away" adage, you also have weak months in August, September and then into early October. So just sort of, you know, taking the higher yield in bonds right now relative to stocks just looks like a little bit better trade than it's looked like you know, in recent years.

Jeff B. (24:25):

And so, this might be just a good time, we think, to just pull back a little bit, kind of see what develops. We'll, probably like if we're right, we'll probably have a recession, even if it's mild and short-lived in the next, you know, call it six to nine months. You're probably going to get a little volatility ahead of that. You know, maybe not dramatic because this is the most anticipated recession, possibly of our lifetimes <laugh>, but certainly would be logical to pull back, Jeff, a little bit ahead of recession if we get one. And during this seasonally weak summer period that may be the time for markets to increasingly price that in if we see more you know, weakening economic conditions over the next several months. What do you think?

Jeff R. (25:14):

Yeah, well, as you know, I was on family vacation the last little bit. And I took opportunity to do a lot of LPL Research and lpl.com newsroom reading in my spare time, would you believe? And I just wanted to highlight, you know.

Jeff B. (25:34):

That isn't a vacation, Jeff.

Jeff R. (25:35):

Isn't that great? So, I was just going to say, you know, the Weekly Market Commentary this week, is just really a fantastic third chapter to what was written in previous weeks. And it totally makes sense, right? Because as Lawrence Gillum was talking through, you know, kind of the attraction of cash, for example, right? Where bonds are and the hurdle rates. And then Turnquist, I think had, you know, that commentary, I think he co-wrote it with you, Jeff, on just that leadership component. So, when you think about, you know, the natural progression of thought over the last several weeks, it really does make the case pretty clear and simple in why we would want to do this neutral benchmark. I don't know. How about that for a little bit of marketing for our lpl.com newsroom site, huh?

Jeff B. (26:29):

I did not see that coming. But that's where the Weekly Market Commentary is lpl.com, and then you find the newsroom. So, one of my favorite sites for sure. I think it's also you know, a point in time where regardless of how you invest, right? Whether you're, you know, fundamentals, whether you're, you just look at valuations, whether you do technicals, they're kind of all saying the same thing right now. Yeah. Just be a little bit more careful. I think that's the bottom line. So again, the Weekly Market Commentary for this week on lpl.com just walks through what we just discussed, right? It's, you know, why are we taking a little bit of equity risk off the table here? So hopefully folks will see that as useful. Let's go into the week ahead here, Jeff. I mean, we're all going to be watching the S&P 50's quest to break 4,300, which would, you know, kind of convincingly start the new bull market. Would convincingly break the August 22 highs. But, you know, beyond that we've got some economic data. Actually, we already got it this morning. I updated this today. I think the ISM services is probably the highlight of the week, and then maybe people want to watch claims because it's a timely measure of the health of the labor market.

Jeff R. (27:55):

Yeah, that's right. And so, you know, this is the blackout period before the Fed's decision next week, and it's a fairly quiet week after last week's, very active week, even though it was crammed into just four days since we had Monday able to remember those that gave the ultimate sacrifice for our country. But let's think about this, you know, this week in terms of you know, where markets are going to most likely to kind of hold steady waiting for next week, but services component came out 10:00 AM Eastern time this morning. We're recording here in the afternoon, Jeff, as you already said on the fifth. But just to highlight the fact that services has clearly slowed, even though that index is above 50, meaning it's growing, just growing at a slower rate. Below 50 means contracting as I mentioned here with that 50 line.

Jeff R. (28:50):

But really the big question as we're, you know, sitting here closing out you know, looking at the data for May, obviously we're at the beginning here, month of June, so we got a lot of data still to come for month of May, and that is, you know, how much will consumers continue to spend on services? At this point we're seeing that consumers are above trend growth on both goods and services, meaning the consumer is set up for a significant slowdown by the time they get to Q3. And hence that's why we have the the baseline recession call. But at this point, services growing. People want to travel. I was one of them but we're clearly growing at a much slower rate, and I think we're set up for a contraction in the months ahead. But outside of that, not a very busy week this week from an economic data standpoint.

Jeff B. (29:48):

Well, it'll give folks like yourself a lot of extra time to focus on what the Fed might tell us next week, because you're not going to be going to be pouring over a lot of high impact economic data this week. So, you know, the Fed right now, I mean the I guess it's vice chair-to-be pretty much signaled clearly that we're going to have a pause in June and then we'll have a potential for a hike in July. That seems to be the market's base case at this point, although we're going to get quite a bit more important data between now and that late July Fed meeting, right, Jeff? Yep.

Jeff R. (30:29):

Yep, yep. And that's right. And I think from, you know, from our listener standpoint, you know, what do they need to know? They need to know whether, you know, whatever the Fed does, maybe in July. The point is terminal rate will be, or the end of year rate will be lower than it is today. I think that's kind of the one key takeaway as we get, you know, more inflation data, as we get more economic data. I think it's very, very clear to say that December 31 rates will be lower than they are today.

Jeff B. (31:02):

I think that's a pretty decent bet for sure as inflation continues to come down. So, thanks for that, Jeff. With that we will go ahead and wrap. Thanks everybody for joining. And Jeff, thanks for you know, walking us through that jobs report and, you know, kind of sharing your, your economic outlook. I think, you know, probably a number of you have recently celebrated graduations. I know there were a number of them here, actually the high school. I don't have kids graduating high school yet, but the high school in my town is having its graduation tonight. And I've certainly seen a lot of you in social media celebrating graduation. So, I'll congratulate all of the graduates out there. An exciting time certainly and a lot of great achievements. So, with that I will bid adieu, and everybody have a great week. We'll talk to you next week on another edition of LPL Market Signals.