New Bull Market Begins, Now What?

Jeffrey Buchbinder (00:00):

Hello everyone, and welcome to the latest edition of LPL Market Signals. Jeff Buchbinder here with my friend and colleague, Lawrence Gillum. Lawrence, how are you today?

Lawrence Gillum (00:10):

I'm doing great, Jeff. It's a busy week this week, which I'm sure we'll get into, but looking forward to the podcast and the rest of this week for sure.

Jeffrey Buchbinder (00:18):

A busy week, indeed. You know, any Fed Week is a big week, and certainly inflation data adds to the interest for investors. So yes, we will absolutely talk about those two things. In fact, those are a big piece of our agenda today. So here, for those of you watching on YouTube, you can see the agenda. It's Monday, June 12 as we're recording this 2023. And you see here, we're going to start with just a recap, as we always do, of what happened last week. It was positive week for stocks. In fact, it was good enough for the S&P 500 that we just barely eclipsed the 20% mark that tells us we are in a new official bull market for the S&P 500 at least. With that we will try to answer the question, what's next for stocks here now that we're up 20% off of those October lows?

Jeffrey Buchbinder (01:20):

Here's where Lawrence becomes really important to this discussion as a fixed income strategist, he's going to tell us what to expect from the Fed and what that might mean for investors. Then we'll end with a preview of the week, not just the Fed, but inflation data and a number of other key economic reports to digest. So, yeah, as Lawrence mentioned busy, busy week. So let's start with a recap of last week. I mean, the big story, no doubt, was the fact that we entered a new bull market on the S&P, with that, you know, 0.4% gain, it's a gain. It's not a huge gain, but we'll take it. Actually year to date now, the S&P is up about 12%. It was actually the fourth straight positive week for the S&P, and the Nasdaq actually is up seven straight weeks.

Jeffrey Buchbinder (02:07):

That hasn't happened since 2019. You know, not only did we break that 20% mark that most people use as the definition of a bull market, but we have also broken through now the August 2022 highs. So, we're now going back to April of last year to find levels of the S&P that are higher than where we are now. In terms of what worked we actually had a pretty good week in Asia. Not as good in Europe. The U.S. has really led though recently. If you look over on the right-hand side, emerging markets had a very strong week. A lot of that was Brazil. But certainly China chipped in and had a pretty solid week as well. You know, a lot of people are talking about a disappointing reopening for China, but, you know, at some point that market gets so cheap that maybe you're going to attract some interest.

Jeffrey Buchbinder (03:04):

So, we'll call that bargain shopping maybe a little bit in China, I'm not so sure we've seen a meaningful thaw in U.S. China relations that would spark that interest. Turning to sectors consumer discretionary was the winner last week. You know, we talk a lot about how consumer discretionary is really two stocks, right? It's Amazon and Tesla. And so, Tesla was really the driving force behind the strong week for that sector. The gains were driven by a charging partnership with GM. And you know, that was something like two thirds or three quarters of the gain. You know, beyond that, I thought utilities strength was kind of interesting because rates rose last week, which Lawrence will talk about here in a minute. I think the utilities strength was really more a function of higher natural gas prices and that energy sensitivity as opposed to anything about interest rates or a shift toward defensive sectors, it was really not necessarily a defensive week because you see healthcare down, you see staples down. Turning to fixed income and commodities, Lawrence, what did we see last week?

Lawrence Gillum (04:20):

Yeah, it was really a mixed week on the fixed income front. Really a bifurcated return profile for those safest fixed income sectors like treasuries and mortgages versus those that are a little bit more risky, you know, the credit risk sensitive areas of the fixed income markets, high yield bonds, emerging market debt. So, we did see positive returns out of the riskier segments of the fixed income markets last week. Negative returns out of the safer fixed income sectors because of that increase in rates that we did see over the course of the past week. Longer term, we are starting to see some outperformance relative to the core sectors. So, we're seeing mortgages start to perform well. We've had a bias towards mortgages in a lot of our model portfolios. So, it's good to see some life out of the mortgage-backed security space.

Lawrence Gillum (05:10):

And then the Treasury space up about 1.7% over the last three months, six months, still positive return, but just not as great for some of these core sectors. Kind of looking at commodities, commodities we're up about 1.2% last week. Again, a bifurcated return profile for some of these soft index sectors and then looking at that, compared to the energy complex, I think there was a big sell side firm that downgraded oil last week. So, we did see oil prices go lower and natural gas prices higher. So just looking at the energy index in aggregate, it showed a flat. But if you look at those six month returns, Jeff, it's really divergent between that energy index sector and the soft index sectors down 24% for the energy complex, up 25% for the soft index complex. So really it matters where you pick or where you allocate your assets to within the commodity sectors.

Jeffrey Buchbinder (06:10):

Yeah, absolutely. And if you broke out natural gas, it would be worse than that 24%. Of course, that helps us heat our homes, at least when it's wintertime. But certainly, for commodity investors, it's been tough sledding. I guess the good news there is obviously lower commodity prices contributes to lower inflation. I did want to highlight, you know, one thing in the softs index, you know, that's like cocoa, coffee, things like that. They are actually locking up instant coffee in the U.K. I saw over the weekend, right? To prevent theft. Coffee has become so valuable. I think it's related to these El Nino global weather patterns, and we've had some real dryness some places and you know, it's contributed to a little bit of a bounce recently in commodity prices. So, I mean, that tells you maybe that the inflation problem is not completely behind us <laugh>, but it is certainly looking a lot better than it looked a few months back which we'll talk about in a minute. So, I think that's probably a Market Signals first where we actually talked about coffee, other than just the fact that we need to drink it to stay awake.

Lawrence Gillum (07:25):

Yeah, I'm a coffee snob, so I'm going to anger some people here probably, but I think you should be locked up if you're buying instant coffee. So it's one of those things. There is a difference in taste. I like my coffee.

Jeffrey Buchbinder (07:37):

Please don't lock up my in-laws. But otherwise, that's fine by me. I'm a little bit of a coffee snob myself. So in fact, I got my coffee right here. I'll let you guys guess whether it's Starbucks or Dunkin'. I live in Boston. So let's talk bull market. This is exciting. Actually, this bull market, you know, it's just a couple days old, but it wore me out because, you know, I just passed out on the couch Friday night after a long week. I was asleep by eight o'clock, which pretty much never happens. I'm normally a late nighter. But you can see here instead of just putting in a chart of the live S&P, I thought these graphics that our technician, Adam Turnquist, put together were really helpful. You know, the top line is just the path of the S&P 500, and you see that 20% bounce off the October 12, 2022, lows up to 4,293, which is where the official bull market started.

Jeffrey Buchbinder (08:35):

I mean, it started in October, but it is official at that 4,293 level. But then below, you see the breadth isn't that great. 57% of the S&P 500 above its 200-day moving average at that point in time just feeds into that narrative that we've talked a lot about here, that the market, to build a sustainable foundation for a bull market, you really need to see more breadth, more stocks working. We only have about a quarter of the S&P 500 outperforming, which of course creates a challenging environment for active managers. But it also means this bull market might need a little bit of a breather, might be due for a pause before long. And that feeds into you know, where we're going to go next, Lawrence. And also, is consistent with the call that we made last week to just pull back a little bit in our equity allocations to a neutral stance, not a bearish or a negative stance, just a neutral stance.

Jeffrey Buchbinder (09:36):

So, we'll give Adam Turnquist some more love here. We just called him out on the S&P chart. Now, I'll call him out on this table that he put together, which is really cool. So here you're looking at all of the bear markets from low to end. Okay? So, this would be October 12, 2022, to last week, June 8, 2023, where the 20% mark was hit. You pull all of these bear market periods, okay, when the bear market ended, what did stocks do next? Right? That's the key point of this chart. You see here, over on the right average gains one month, three months, six months, 12 months, there's a lot of gains here. So, probably the first takeaway is just these bull markets, when they're early, when they're young, they tend to keep running, right? And really running pretty strong, because if you look at the far right, you know, the average gain over the past or over the subsequent year is about 19%. So, could we get that? Sure. But Lawrence, you actually noticed here in looking at this chart that you know, there are certain bear markets where you see bigger gains and certain bear markets where you see smaller gains.

Lawrence Gillum (10:56):

Yeah. And this is consistent with our recent recalibration of our equity exposure. You know, those numbers are attractive certainly when you look at all those bear markets and subsequent returns in aggregate. But you know, our view is that we're not in a recession currently. So, if you look at just those periods where a recession is not overlapping with the return of a bull market. Returns aren't as spectacular as they are when you are in a recession. So, our view is that we're going to enter a recession sometime later this year, early next year. So, we're not currently in that recession area environment. So, we're not expecting those outsized returns on a 3, 6, 12-month horizon as what we would see here from this table.

Jeffrey Buchbinder (11:43):

Yeah. So, you know, maybe over the next few months, you know, consistent with that, well over the next one-month markets tend to be a little bit choppy, right, when you hit this 20% mark. So maybe we get that choppiness for a little bit longer maybe even get a pullback before another move higher. But we still think, you know, which I'll go through in a minute here. When you balance out the pros and the cons of this market, you know, it kind of comes out to us in a wash. So, we think neutral is a good place to be here. I'll also mention that, you know, this was a long period between the bear market low and the end of the bear, 165 days. We only had a longer one in 1957, 58. And back then, when you had these really long periods to finally achieve that new bull market, the gains tended to be a little bit bigger.

Jeffrey Buchbinder (12:35):

Not sure that relationship holds this time, but I think it's interesting to point out, you know, plus 20, plus 27, plus 18, one year later. So, you know, we, we teased this a little bit, Lawrence, I just want to go back and recap what we talked about last week. The LPL Research Strategic and Tactical Asset Allocation Committee did take a little bit of risk off. The, you know, we're at our price target for the end of the year, 4,300 to 4,400 on the S&P 500, that is technical resistance. It is a narrow market, right? Led by the mega cap techs, and the team continues to see recession within the next six to nine months. Now, people get all scared by the big R word, but we actually think it's going to be pretty mild and short-lived if it happens. And the market may not care all that much because we've been preparing for it, frankly, it might not hurt company earnings all that much because they've been preparing for it too, right? Cutting costs, and, you know, trying to kind of right size their headcount a little bit here lately. Lawrence, another reason that we made this move is the comparison between stocks and bonds.

Lawrence Gillum (13:49):

Yeah, that's right. So if your expected return out of stocks is say, you know, 5% from current levels and your expected return out of bonds is similar, you know, from a risk management perspective, we figured that we can dial down some of the risk of our portfolios and not sacrifice, expected return given the yields that we're seeing in the fixed income markets and the fact that we are closer to our upside target.

Jeffrey Buchbinder (14:15):

Yeah, it's a great point. I mean, frankly, I've really not been a buyer of bonds in my personal account before, and I've just now started. So, maybe that's a sign that bonds are a bad place to be. Maybe I've top ticked the market <laugh>, I don't know. But when someone who's been focused exclusively on equities for their entire 25-year career, <laugh> is intrigued by bonds my guess is there are other folks that are doing the same. So yeah, when you compare that higher hurdle of 5% in T-bills, it's just going to be tougher, we think, for stocks to run away. You know, could they go up another five, 10%? Sure. But we don't think this market's going to completely run away from us. And higher interest rates is certainly part of the reason why. So, let's move forward and get to the Fed, Lawrence, it's the highlight certainly of the week, I think for most market watchers. The end is near. So, we think, you know, there's a decent chance they're done, even though it's maybe a 50/50 shot that we get one more hike. So maybe, you know, walk us through why the Fed might be done, you know, if you believe that, and then what that might mean for rates going forward.

Lawrence Gillum (15:32):

Yeah, for sure. So, this chart will show you just the current fed funds rates and its levels relative to history. And as you can see, the Fed has done a lot already, right? So going from a 25 or a 0.25% fed funds rate at the upper bounds about 15 months ago or so, we're currently at that 5.25% level. So what this turned out to be one of the most aggressive rate hiking campaigns in decades. So, we do think that the Fed is closer to the end. We think that the, you know, the Fed may skip. There's all this jargon out there. Skip, pause, pivot. So, we do think that the Fed is going to skip this meeting this meeting this week, and then potentially raise rates another 25 basis points or 0.25% in July, depending on the data.

Lawrence Gillum (16:25):

So that's not a slam dunk either. So, we do think, you know, this rate hiking campaign is close to the end. The end is near, we think. So, another thing to point out here is this is only the second time the fed funds rate has actually been able to be lifted higher than the previous cycle. So, as you can see on the chart, the path of that fed funds rate has always been lower relative to the previous hiking campaign. It's because the Fed tends to raise rates until something breaks. And this time the Fed has raised rates aggressively and for whatever reason, you know, consumers have termed out debt, companies have termed out debt. There's just less leverage in the system. The Fed hasn't broken anything. So, you know, we do think that the Fed is going to pause, take into consideration the heavy lifting that they've already done. You know, we hear this long and variable lags from the Fed, that rate hikes take a while to flow into the real economy. So given the speed and the magnitude of rate hikes, we think a rate pause is prudent given the fact that, again, they've already done so much and they haven't broken anything yet. So, they can take a step back and see how these rate hikes are going to potentially impact the real economy.

Jeffrey Buchbinder (17:42):

Well, maybe they haven't broken anything Lawrence, but like there's a real expensive piece of mom's China that's just sort of wobbling on the edge of the table. Because, you know, we just had three really big banks fail right? In March and I guess leaked over into April. So, you know that's kind of breaking something. But if that's all we get, because that didn't really become much of a problem, right? We didn't see the big spillover into other areas of the economy because the economy's doing okay. I mean, we'll probably grow, I don't know, percent, percent and half GDP in the second quarter at least based on the data that we've seen so far. Markets at all-time highs, you know better than I do, the credit market isn't falling apart. We've seen maybe a little bit of a crack in the labor market that claims number jumped last week, although it was probably holiday distorted with Memorial Day. Still, you know, we've seen some cracks, small ones in the labor market. So yeah, maybe they haven't broken anything yet, but boy, they're kind of on the edge, I would say.

Lawrence Gillum (18:50):

Which would argue for a pause, I think. And if you think back to August of last year at that Jackson Hole symposium where Chairman Powell came out and said that there's going to be a lot of pain <laugh> over the next 12 months. We haven't seen that. So maybe the Fed can get away with taming inflation and not breaking things to the magnitude that we saw, say back in, you know, 2006, 2007 global financial crisis, which is of course is not our base case. But we, you know, that they've done a lot of heavy lifting, which would argue for a pause, at least to skip this meeting.

Jeffrey Buchbinder (19:26):

Yeah, hopefully we don't have to, you know, make a diving catch of mom's expensive China or grandmas for that matter, <laugh>. So, let's talk about the dot plot a little bit, Lawrence, you know, this a few months ago everybody was talking about how misaligned market expectations were from the Fed, right? The Fed was basically saying higher for longer, no cuts. Market was expecting several cuts this year. That's, you know, they're still a little bit misaligned in 2024. But for this year, it seems like, you know, the market moved to the Fed.

Lawrence Gillum (20:02):

Yeah, the market finally listened to what the Fed was saying and buys into this higher for longer narrative that the Fed has been preaching for months now. There is that divergence for 2024. The market still expects more rate cuts than what the Fed has suggested, at least last March when this dot plot was released. In addition, so this is important because in addition to that, you know, interest rate decision, we get a new summary of economic projections for this fed meeting. We will get an updated economic forecast for growth, inflation, unemployment rate, and then interest rates, which is this dot plot. So, there is a potential risk that despite the fact that the Fed is not going to raise rates this time, they could increase their 2024 terminal rate for that year which would cause some uncomfortable repricing in the fixed income markets,

Lawrence Gillum (20:56):

I think. Trying to get, kind of catch up to what the Fed is suggesting at this dot pot. But to your point, we've argued that the magnitude of rate cuts that were priced into markets was overdone. We thought it was too much too soon. And we've seen a lot of that repricing you know, work its way out of the fixed income markets. It's been painful. That's why, you know, we haven't had these big returns out of fixed income that I think a lot of people were expecting. You know, we think that's going to happen eventually, but you know, now that the fixed income markets have repriced higher because of this you know, higher for longer narrative coming out of the Fed, you know, we do think, we're kind of at those upper-end of our rate forecast for this year. But it's something that we're certainly watching for this meeting and how the markets digest this dot plot, despite the fact that Chair Powell has said, you know, take this with a grain of salt because it's not very meaningful, but markets don't listen and they do take it seriously.

Jeffrey Buchbinder (21:57):

Yeah, it's always interesting to watch the market reactions once the Fed news comes out. <Laugh> is, you know, you could sort of initially go higher and then move lower or vice versa depending on how people interpret the Fed speak. I guess, you know, so one key takeaway here is be comfortable owning bonds and we are slightly overweight fixed income relative to our benchmarks in the asset allocation that we recommend tactically, right? And then maybe the other, the other takeaway from this segment, Lawrence, is drink high quality coffee. Don't settle for the cheap instant stuff.

Lawrence Gillum (22:38):

I think that's a spot-on summation of the call so far.

Jeffrey Buchbinder (22:41):

Good takeaways there. <Laugh>, so let's preview more of the week, right? Although, I mean we can't just talk Fed, the ECB is probably going to hike, you know, I came into this week thinking we'd get 25 basis points from the ECB, but there are rumblings I hear of maybe 50 and then the BOJ or Bank of Japan, take your pick, is also out this week. And that's been getting a lot of attention. I think the BOJ is getting more attention now than it has at any point in the last, I don't know, five years or so, as I can recall, because you have a new you know, new leader, certainly Ueda and there's some anxiety around that, plus Japan's in a unique position to potentially, you know, raise their interest rate cap.

Jeffrey Buchbinder (23:32):

They're getting inflation, which they haven't gotten for decades. I don't know, Japan's just a really interesting place right now. In addition to the central bank meetings. And, you know, feel free to chime in on any of those, Lawrence, we already mentioned the inflation data this week. We get CPI and PPI, the base effects on CPI are really big. So, you know, consensus is looking for four one on the headline down from four nine in the prior month, which is a big move down. I mean, it's, I wouldn't call it, I wouldn't predict it, but it's even possible that we go lower than that and then we see even a three handle on that year over year number. So that I think is worth noting. But the core, we still have some work to do, right? Core year over year

Jeffrey Buchbinder (24:21):

CPI is still over five. You know, hopefully we get something a little bit better than that. There are a number of pieces of evidence that inflation's coming down. I mean, rents have been sticky high, but the real-time measures of rents are showing some significant easing in those pricing pressures. That's encouraging. That's a big piece of CPI, maybe that still takes another, you know, month or two or three to flow through. But that is good news. We've had commodity prices come down. The recent data suggests there's some wage, some easing of wage pressures. So, you know, look for some better news in CPI in the coming months and hopefully starting this week. PPI, I mean there's some really low numbers on PPI. We have, you know, tough comparisons, I guess, when you have surges, it's tougher to see a big move higher relative to those surges.

Jeffrey Buchbinder (25:18):

And so, you saw PPI surge of course a year ago, and now it's, you know, you're seeing kind of the benefits of that with smaller increases, at least based on current forecasts. Anything else here, Lawrence, that you would, you would highlight in terms of data for the week? And as you see here, I pretty much highlighted the whole page, which kind of takes the whole point of highlighting away. But, and nonetheless, that's what I did. I control the slides so I can do what I want.

Lawrence Gillum (25:47):

That's right. He who is in power is in power. So, no, I think it's just, I mean, it's a busy week for our Chief Economist Jeffrey Roach. He's going to be writing a lot of blogs and updates on this stuff. But no, I think, from my perspective, from the bond market perspective, it's going to be Fed, ECB, Bank of Japan. Bank of Japan is an interesting one. It's you know, they're the only developed nation left, I think, that hasn't really sort to tighten monetary policy. But to your point about a new leader, Ueda, he's of the Ben Bernanke background. I think they actually went to school together. So, there is that concern that an academic going into the head of a central bank could cause some issues. A la Ben Bernanke back with the taper tantrum that we saw back in, what was that, 2013. So, there is that risk that the Bank of Japan could shake some things up this week. Our expectation is that's, you know, there isn't a change. But the Bank of Japan likes to surprise market, so we'll have to see how this plays out, but busy week for economic data, busy week for central bank activity and should be a busy week in the bond market as well.

Jeffrey Buchbinder (26:57):

Yeah, and by the way, we still like Japan as a place to invest at this point. But certainly, we'll be watching the BOJ really closely to see if you know, if that's still going to be a good place to be in the months ahead. I'll also highlight the well, first claims, like normally I wouldn't highlight claims, but because we had that spike last week and we expect that to come back down this week, I think that is an important piece. I mean, you really can't have a recession without a weakening labor market. We haven't seen much, a little, but not much evidence of a weakening labor market. So, we'll be watching claims closely. And then Jeffrey Roach also highlighted the industrial production, which I did not highlight, but he did. Industrial production is actually part of the official recession formula.

Jeffrey Buchbinder (27:50):

It's not really a formula, but you know, the National Bureau of Economic Research is the official arbiter of recessions and the way they define recessions is on their website and they actually talk about industrial production being part of the equation. So, haven't highlighted that before, but I think it's probably worth noting. It's, you know, marginally positive. And I guess University of Michigan's sentiment and inflation expectations have been interesting as well in recent months. So, we'll watch that. I mean, 3.1%, Lawrence, seems a little high on five-to-10 year expectations. I think that shows you that people are anchoring to the high inflation we're experiencing now, rather than expecting, you know, the Fed to win this battle and for us to return to the low inflation environment that we had pre pandemic.

Lawrence Gillum (28:39):

Yeah, and that's the risk. If these inflation expectations become unanchored, it turns into this self-fulfilling prophecy of higher inflation expectations begets higher inflation, et cetera, et cetera. So I think that's one of the reasons why we will get this so-called hawkish skip out of the Fed this week. They could be close to the end of their rate hiking campaign, but they don't want markets to think that they're giving up on inflation. So, you know, I think there's going to be a lot of job owning, keeping the, you know, with the expectation of keeping fed funds rate elevated until inflationary dynamics come back to their two-ish percent target. Because we don't want to get those inflation expectations on anchored

Jeffrey Buchbinder (29:17):

The equity guy and the fixed income guy agree wholeheartedly with that. There will be hawkish talk no matter what they do, <laugh>, but they're almost certain to pause. They have given a number of signals that they're going to pause. In fact, if they weren't going to pause, I think we would've already seen the leak through the Wall Street Journal <laugh>. That's just me. So, good stuff, Lawrence. Let's go ahead and wrap any closing remarks? Anything more on coffee?

Lawrence Gillum (29:47):

No, I need some though. It's been a long day. I might go have a cup.

Jeffrey Buchbinder (29:51):

I think I might be ready for cup number three too, it's Monday. Normally I'm, you know, in the two range, but you know, we'll see. I'll figure that out real soon. But yeah, I think we'll go ahead and wrap there. Thanks everybody for listening as always to another edition of LPL Market Signals, Lawrence, great to be with you. I'm so glad you were here to talk about the Fed. Certainly a topic that you know much more about than I do. Of course, we all have to watch the Fed because they move markets. A lot more than the Fed to watch certainly though this week. So we will be back with you next week, as always. Everybody have a wonderful week and take care. We'll see you then.