Stocks and Bonds Both Celebrated CPI and the Fed

Jeff Buchbinder:

Hello everyone, and welcome to the latest LPL Market Signals podcast, Jeff Buchbinder here, your host for this week with my friend and colleague, Dr. Jeffrey Roach. How are you today, sir?

Jeff Roach:

Hey, doing great. Hope you are. Hope you had a fantastic Father's Day coming off of Father's Day weekend.

Jeff Buchbinder:

I sure did. A Happy Father's Day, belated to all the dads. Hope you all had a great weekend and hope you are ready to stay cool, because it's going to be real hot this week in many parts of the country. So after we show you these lovely disclosures, we will get to our agenda. Hey, I've said it before, I'll say it again when you have new highs to talk about, it sure makes doing these a lot more fun. So we're going to talk about new highs as market just keeps going. As we're recording this, it's Monday, early afternoon, June 17, and we're actually making more new highs as we speak. Stocks up, up nicely today. So we'll recap last week, we'll talk about the CPI and Fed meeting takeaways, of preview, our Weekly Market Commentary, which is from Lawrence Gillum, our fixed income strategist, and he writes about keep clipping those coupons <laugh>, right?

Jeff Buchbinder:

So implying that you don't really need capital appreciation for bonds, the yields are pretty good. And then finally preview the week ahead where we have retail sales and housing data. But I think the retail sales data, has the most potential to be market moving? All right, so let's get into it. More new highs, but tepid breadth. So this is a story that's getting a lot of play in the media. The S&P 500 just keeps going up. It's doing that again today as we're recording this. But you don't have a lot of stocks doing the work. So you know, you can see that in the middle panel where we have the number of stocks at four-week lows is quite a bit higher than the number of stocks at four-week highs. And then if you look at the bottom panel here in light blue, you have a percentage of stocks above their 20-day moving average has been falling.

Jeff Buchbinder:

So we're up, but with less breadth. An easy statistic that I can cite to maybe provide a little more context for this, is if you look at how the average stock is doing. So a lot of people are comparing the equal weight S&P to the market cap weight S&P. Of course, the market cap weight has more NVIDIA, Apple, Microsoft, right? It's being driven by those big tech names. But if you kind of cancel that factor out and put all of the 500 stocks on equal footing and just calculate how the average stock is doing, it's quite a bit worse. The average, the equal weight S&P is up four year to date versus the cap weighted up 14. If you just look at more recent time period, you see that the average stock in June is only up about it's actually down 2%.

Jeff Buchbinder:

And the average stock on the cap weighted index is up two and half percent. So you have four points of outperformance cap weighted versus the average stock, the equal weighted in just June. That's a trend that's really been happening all year. So what does that mean? What's the key takeaway? It's that this market needs more breadth to be healthy for its next leg higher. And frankly, once tech slows down, we think this market could pullback. So here, you see, last week was all about tech up 6% plus in the five trading days, a real, I mean, a huge week no other sector was up more than about one and a half. That was real estate that finished second. So that just is another piece of evidence that this is really tech doing the heavy lifting. It's now 31% of the S&P. Of course, that means you had a big week of growth over value. But the other interesting thing about last week, Jeff, was you know, the political uncertainty in France with the snap elections being called by Macron and you know, that spooked the European markets quite a bit here, not just the French markets. France was down, the French equity market was down 6%. The French bond market got hit too. What's your take on that situation, Jeff?

Jeff Roach:

Well, I think one of the things that you could take away is, you know, people got nervous about the risk of a federal budget deficit truly getting off the rails particularly in France. And so, you know, investors are nervous about that. You know, certainly we've had our fair share of jitters, particularly it comes around domestically when, you know, we hit that spending limit. But you know, political, the political structure is really important, Jeff, as we noted several weeks ago regarding the Mexico election, very similar scenario, I think in principle, with what we're seeing over in France where, you know, if the political environment is such where a federal deficit could really deepen and there's not much protection, perhaps not much of those guardrails politically. That's something that creates a little jitters.

Jeff Roach:

You know, it's interesting, Jeff, as I was listening to you talk about the equal weighted S&P and, you know, we truly want to see broader breadth in the market. And I think the corollary from the economic side of things to say, okay, if you have, you know, the 1% or the half percent, you know, of the upper income folks, you know, driving economic activity, they're the ones buying cars, buying houses, et cetera, and then the other, you know, 95 and change percent of the economy, not feeling it. You know, that's the analogy I think of what you're saying and which is exactly right. When you see just a few drivers of the stock market, when you look at the equal weight, it's a little bit of a different picture. So, and that's something that's not as healthy as when you see that broader breadth in the marketplace.

Jeff Buchbinder:

Yeah, we do have you know, a little bit of a corollary with the late 90s tech boom. And if you look back, really you know, the same thing happened, right? Tech carried us into 2000, and then actually when the market rolled over, the equal weight index did pretty well, right? It was really just tech you know, correcting. It was really more than a correction <laugh> tech going into a steep bear market and the rest of the market, at least right after the initial selloff, held up pretty well, if you just look at equal weight or equal weight ex tech. So, you know, the point there is that just because tech slows down, which it will eventually, we don't know when <laugh>, we're watching the technicals very closely for evidence that tech is you know, going to take a pause, but once it does pause we'll be, you know, watching the rest, let's call it the S&P 493 <laugh> to see if they can get the same support maybe that we got in you know, coming out of the tech bubble in, you know, 2001 to 2003.

Jeff Buchbinder:

So let's keep moving. The bond market rallied on the Fed and the CPI, actually, it was more the CPI. I think the two-year yield was down 19 bps, 10-year yield was down about 20. And you ended up with a hugely positive week for the Bloomberg Bond Index. In fact, it was enough to take that index back into positive territory year to date. We're now up 0.1%. It's been quite a volatile year for bonds certainly, but nice to see you know, some green numbers finally, at least for that broad index, not necessarily for all of the sub-indexes. And then I think the other most important thing to point out here is the dollar up 0.4% on this Bloomberg index. So that's a pretty big week and up over 4% year to date.

Jeff Buchbinder:

So, you know, that's a big headwind for international equities. And as you think about how to put together a global portfolio, we think that just adds to the case to favor U.S. We favored U.S. all year, continue to favor U.S. And in fact, based on what happened last week, based on the strength of the dollar, I would say that our preference for the U.S. is even stronger now than it maybe was a couple weeks ago. Anything to add there Jeff on currencies or anything else you see on this page?

Jeff Roach:

Well, it's interesting when you think about how bond markets were trading just before the very hot payroll report that we got, you know, at the beginning of the month, yields were dipping, right? And then we had that surprise, markets were really concerned, didn't know how to fully process that really strong report. And then, you know, just a couple days later, after the markets opened up, after a brief holiday, Memorial Day, we saw very favorable inflation numbers, favorable import export producer prices, et cetera. And so that certainly has provided a great foundation for where we saw things trading over the last week or so.

Jeff Buchbinder:

Yeah, bond investors have gotten a little bit whipsawed I guess you could say. But right now, the weight of the evidence suggests bonds, at least to us, bonds are a pretty good place to be. So let's talk a little more about inflation and the Fed, Jeff, because I think well, this chart really sums up how important the CPI is for markets. I'll let you explain this in a minute, but I think what the CPI really did, is it you know, help people get off of that strong payroll number, right? Instead of pricing in zero or maybe one cut this year, now more people are thinking that we could possibly get two.

Jeff Roach:

Yeah, that's exactly right. And so this chart just highlights the fact that, you know, across all sectors as well as at the S&P 500 level aggregate level, how does the market respond when you get a favorable CPI number over the last two years or so? And the answer is unequivocally, the market <laugh> is very happy. Investors are very happy and relieved. You see that in the equity prices when you have inflation looking better than expectations. I think no surprise that we're off the peaks as things have been improving really for, for quite a while. We had a little bit of a scare earlier this year where inflation was coming in a little bit hot, particularly because of insurance costs. And that certainly did not last very long. We had, you know, a hot January, February, March, but now April and May we're quite in line, if not a little bit better than expected, and markets respond favorably.

Jeff Roach:

So it, it's just a reminder that post-pandemic yes, there's a lot of conversations about the Fed, when they're going to hike, when they're going to cut, what they're going to do but in even the near term, the important thing fundamentally is when does that sticky component of inflation finally ease? And so this graph highlights the response to CPI, and one of the things that's really important for investors to just remember, and our listeners you really have, remember there's two popular measures of inflation. The one that comes out first is the CPI, the Consumer Price Index. You have to wait a little bit longer, a little bit later in the month to get a good, more comprehensive read on inflation from the personal and income and spending reports. But because it's a little bit later in the month the markets, you know, really initially respond to this, that CPI number, which we saw moved in a favorable direction last week.

Jeff Roach:

And this is just a historical look at how sectors and markets respond to that. So, bottom line is, you know, markets are relieved anytime in the last few years here, anytime inflation comes in a little bit softer. You know, the key takeaway and maybe the forward-looking statement that would help folks as they think about the rest of this year is we do think that some of the sticky components are starting to ease up. One of the last line items or components that have yet to ease is that housing component. But even within that, you want to look even a little bit deeper and ignore, well, I shouldn't say ignore, per se, but focus on the rent component. And that's something that we'll see eventually ease as we go later on in 2024.

Jeff Buchbinder:

Yep. We're going to get into that here in a minute. But before we show you the components Jeff, you thought it would be helpful for folks to see just the trend in these various measures? It's a good point that the CPI moves the market more because it's out first, even though it's not the Fed's preferred measure. It's also, I think, important to look at the core trends, right? So that's the orange line and the dotted gray line in this chart. And to me, it looks like a pretty steady downward trend there.

Jeff Roach:

Yeah, we're clearly past peak. And the real argument, I guess, among investors in the last month or two was, you know, what's going on in the first quarter? Is this a new trend? Or is this just an aberration? And the existing trend's going to continue? And now with these latest numbers we got last week, I think we can say a little more confidence that it's not a new trend, particularly look at that orange line, that's the core level. So it strips out the more volatile food and energy prices. Not to say that they're not important for the consumer, but they're a little more volatile. So when you want to track a trend, you look at that core measure. So ex food and energy that orange line is certainly showing a continuation of that downward trend. So we're just waiting on, just waiting on rent prices. That's it.

Jeff Buchbinder:

Well, there's a good teaser for the next slide, which shows you that rent item. And yeah, it's sure sticky. It's, you know, been in the fives the last few months, so what's the prognosis there?

Jeff Roach:

Yeah, that's right. I mean, you, you know, if you want to say, okay, well, what about financial services costs and insurance? As I mentioned earlier, yes, other services prices have been pretty sticky. But in terms of kind of what could be a bellwether for the rest of the inflation experience, that's why we often highlight housing. And that's the one that's really been slow to move. And, in fact, the chairman of the Federal Reserve, Jerome Powell, has actually popularized a metric to say, well, what's core inflation doing when you strip out housing? You know, we strip out the volatile components of food and energy, but what about housing? Because we know, particularly in the rental component, it lags what's actually happening with new leases. So you have a mixture of existing leases and new leases.

Jeff Roach:

So excluding the most sticky component, which is the housing, is what you see, and I circled that there for our listeners. And so on the far right there near the end of it is the core metric ex housing, certainly in the green, in the dark green, no less, Jeff. So, that's kind of the key takeaway here for investors, why are we seeing a little bit of this rally, it's because inflation pressures are easing even the sticky components, and we have a glimmer of hope that the stickiest of all the rent component will ease later this year.

Jeff Buchbinder:

Yeah. And if you look at real-time indicators of rents, they're barely up, right? So, it seems like it's just a matter of time before that rent component cooperates, and we get a core number right around two. We'll see, obviously we can't, you can't predict this stuff with certainty. But you know, it looks good and of course, that supports the Fed in, you know, in potentially cutting in the next few months. We'll see when that comes. We'll show you the dot plots and talk a little more about the Fed here next, Jeff. But I think you know, we're going to get a cut probably by the end of the year, and instead of people focusing so much on whether it's September or whether it's December it probably makes more sense to look at how far they're going to cut, you know, over the next year, right? And so I think that's what's interesting when you look at the dot plots which I'll show you here. So this comes from Lawrence Gillum's Weekly Market Commentary, our fixed income strategist, you know, basically talked about how attractive the bond market is after the Fed meeting, after the CPI. And he put the dot plots in. And you know, Jeff, we were talking about this this morning. This sure reflects a diverse set of views, <laugh>, you know, because these dots are all over the place.

Jeff Roach:

Yeah, I mean, you think of it this way, you know, for those in our audience that aren't necessarily watching this kind of stuff with intensity as we do on a daily basis, you just look at it this way next year, and the following year, and thereafter you see quite a divergence among views. Those dots are spread out. They're not clustered. The key interpretation to that is there's just a lot of different views from the individual members of the Federal Open Market Committee. They are certainly not unanimous <laugh>. That's, I think, the you know, putting it down into where Mr. and Mrs. Smith live on Main Street versus us as we track Wall Street. And this is a diversity of views, and it's diverse because the data is choppy. And there's some challenges with how, you know, the Fed will be in the comfort level in which they'll be in the next really 24 months.

Jeff Roach:

I would say, you know, Jeff, if I were saying, okay, you know, talking to those that are on Main Street of America, perhaps you just focus on the far left and then the far right, and then there's choppiness in between. It just means that everything, the timing of rate cuts has been pushed out. So that's where you say, okay, higher for longer this year, just a little bit of a delay in when the Fed starts their rate cutting campaign. And you could say, all right, on the other end of the spectrum, what perhaps the next 3, 4, 5 years long-term rates will be a little bit higher than what perhaps the Fed thought they would be just in the previous edition of this forecast table.

Jeff Buchbinder:

Yeah. So, that gets into what's sort of the neutral rate, right? Which some people call R star, you know, what rate is it not restrictive or accommodative? Maybe that's a little higher than some people thought a few years ago. We'll have to see. But the Fed is clearly restrictive. Now, clearly has to get easier. The economy is showing signs of slowing, just a bit, but slowing, and we know that inflation's come way down and will likely continue to go down. So, they've got to cut. It's probably going to come pretty soon. Now, that kind of anchors bond yields, right? People might think, well, the Fed is controlling short term rates. So what does that have to do with the 10- year? And it's actually more closely related than you think. We think that the 10-year will be capped because the Fed is in cutting mode or about to be in cutting mode.

Jeff Buchbinder:

And that's one of the reasons why Lawrence likes the bond market. Sure, he is talking his book, but this is why Lawrence likes the bond market so much. When you have disinflation, maybe a little bit of a slowdown in economic growth, although we're still tracking a 2%-ish, but eventually we think in the, you know, next couple quarters we'll see more evidence of a slowdown. And then you have the Fed anchored to cutting, whether it comes in September or December, it almost doesn't matter, but a cut is coming and that sets up attractive bond yields and attractive bond returns. So this just makes the point that yields right now are really attractive relative to their range, their historical range. I think this goes back roughly to 2010. The blue bars are the ranges. The little horizontal dash is the average, and then those diamonds are the current yields.

Jeff Buchbinder:

And so those diamonds are pretty much all at the top of the ranges and above the averages. What does that mean? It means attractive yields. What is the best indicator of bond returns? It's yields, right? Over time. So you get really attractive yields here. Now, you don't have to stretch too far on the risk spectrum to get these good yields. You can build a really high-quality bond portfolio that yields 6%. And at this point, we think it can play defense, you know, we'll eventually have recession, and once we do, you're going to probably see those bonds rally and help offset the losses from your equity portfolio. So that's probably a ways off based on how we see the world. But it's nice to know you've got some protection from bonds because as you know, Jeff, for years, bonds didn't offer any protection. They were yielding next to nothing. They had nowhere to go but down.

Jeff Roach:

Yeah, it's a good reminder too, Jeff, the way that you explained the reason why we care about Fed target rate as it does have ripple effects throughout the spectrum of bond yields. But that 10-year, that's one of the reasons why, Jeff, we were not in that bandwagon of saying, okay, rates are going to jump above 5% on the 10-year, and who knows if not higher. Part of that is a little bit of those looking to create a headline. But that's something very important for our listeners to remember the connections between Fed activity, Fed policy, and how it filters through in the rate spectrum.

Jeff Buchbinder:

Yeah, even, I thought bond yields were going to tick a little bit higher over the last few weeks because of the Treasury auctions, but the market has absorbed new issuance from the federal government very, very well. And you know, both global buyers and domestic buyers, institutions, everybody. So as long as that continues it's very likely that yields stay in this range or move lower. We in kind of the four and a quarter range on the 10-year at last check. So bonds look pretty good here. In fact, we like bonds a little bit more than equities in our asset allocation. We continue to recommend neutral equities and then on the fixed income side, take a little bit of cash from our allocations. We are doing this, taking a little bit of cash and moving it to bonds for the more attractive yields and to lock in those yields.

Jeff Buchbinder:

So underweight cash, overweight fixed income, neutral equities. That's how we're playing it for now. But, you know, we also recognize that this equity market's really moved and you know, we want to be watchful for pullbacks. So let's move on and preview the week, Jeff. The retail sales number, I think is the biggest one on the calendar. I mean, obviously we're going to continue to watch yields closely because they matter. We'll wait for the Fed's preferred inflation metric next week. What else should investors be looking at this week to get clues as to where this market may be headed?

Jeff Roach:

Yeah, so as you said earlier, Jeff, we're recording this on the 17th. So by the time this gets out into the public, perhaps the retail sales number has already come out. I think it's just a reminder for those that look at the data, one of the things that I think is helpful in terms of a good barometer for where the consumer is, and that is look at the restaurant spend within the retail sales numbers. So retail sales are

Jeff Buchbinder:

One of my favorite categories, Jeff

Jeff Roach:

<Laugh>. Yes, yes, for sure. When we're not interested in making our own meals you know, looking at those restaurant spends, that's a great bellwether for how households are feeling. If they're feeling a little bit of that pinch, I think it's a good way to think about what is the consumer spending trajectory look like. So, that's the thing, once that number comes out, drill down into that category and look at the various rates of change that's very helpful for some forward-looking views for the latter part of this year. And then, of course the big picture on the housing market, it's just a reminder in terms of the storyline, it hasn't changed much. We've had an undersupply an under building of homes for a very, very long time, that's not correcting anytime soon.

Jeff Roach:

So even though it might do well, and a good environment for those home builders that have in-house financing, the ability to offer mortgage rates that are below market going and opportunities to continue to build homes where needed. But we've seen an undersupply really since the Great Financial Crisis. So that's going to continue to put a little bit of pressure and imbalance, I would say, in the housing market. But besides that, I think that there are a lot of Fed officials talking this week. So that'll be fun for those of us watching that and looking for clues. They often, by the way, it's helpful. Those Fed speakers often coordinate their comments in order to give markets a little bit of a clue on what's going to happen next, what's their you know, their next step. Forward guidance, we call it, the technical term. Forward guidance is certainly an important part of monetary policy.

Jeff Buchbinder:

I try not to get too caught up in each speaker. I just try to have you and Lawrence tell me what the Fed's going to do and leave it at that. I don't think I find Fed officials speaking as much fun as you do Jeff. So <laugh>

Jeff Roach:

Well, they have dialed back the entertainment level. Back in the day, Dallas President Richard Fisher was one of my favorites. He was always very interesting to listen to. Maybe not quite as entertaining and interesting as the bygone eras, but still interesting and important, nonetheless.

Jeff Buchbinder:

Well, yeah, helps us do our jobs, no doubt, helps us understand what's going on in the markets and clearly the markets liked what they got last week, you know, in terms of the inflation data and the message from the Fed. So we'll continue to watch the data closely and, you know, report back with what matters next week. In the meantime, I'll do my best to support that restaurant spending category for you, Jeff. So, with that we'll go ahead and wrap up. So thanks everybody for listening to another edition of LPL Market Signals. Thank you, Jeff, for joining this week. Again, happy belated Father's Day to all the dads out there, hope you all had a great weekend. We will see you next week. Take care.