Stocks Surge as Rates Tumble

Jeff Buchbinder (00:00):

Hello everyone, and welcome to the latest LPL Market Signals podcast. Jeff Buchbinder here, your host for today with my friend and colleague Lawrence Gillum. How are you today, Lawrence?

Lawrence Gillum (00:13):

Oh, I'm doing great, Jeff. Happy to be back on the podcast and happy to eventually talk about munis.

Jeff Buchbinder (00:21):

You know, I've said it before, I, as an equity strategist, have probably never been more interested in the bond market than I am right now. So good to be with you to make sense of not only what's going on in the muni market, but also with the Fed and that real big collapse in yields last week. So here, we'll just take a quick look at the disclosures. It is November 6, 2023, Monday afternoon as we're recording this. And here's our agenda for today. We're going to start recapping that big move down in yields and the strong stock market rally that came with it. Next talk a little bit about the Fed. Looks like they're done. That certainly is a consensus. So, Lawrence, I'm hoping you'll tell me why we think that is the case. I'll do a quick earnings update.

Jeff Buchbinder (01:13):

To be honest, it's not great the past week, but it's good enough. Next, the muni update that we just mentioned. And then lastly, preview a very quiet week on the economic calendar. So, let's start with the best news. You know, I wish stocks could do this every week, Lawrence, but, and frankly, bonds, I wish bonds could do this every week, too. Because it was just a massive rally last week. Stocks up, the S&P is going for its sixth straight up day, I believe today. Up every day last week, up 6%, give or take on the S&P, the Nasdaq and the Russell 2000 did even better than that. Everything worked. Everything was higher, and you even saw the dollar weaken, which helped international equity markets. We've seen you know, not only some decent gains in Europe, but we saw nice gains in Japan last week as well.

Jeff Buchbinder (02:12):

And even, you know, seeing some life out of emerging markets. So pretty much anything with risk attached to it did well. On the sector side, I think what's probably most interesting is how strong the regional banks were, right? We know regional banks have struggled since the Silicon Valley Bank failure and the other bank failures back in March. Those, the banks really benefit from the sharp drop in rates. Remember, that's really why the banks failed to begin with. So you reverse that and you know, take some of the pressure off of those regionals, so really strong week for financials which is good to see. And then real estate too. Real estate's really gotten beat up. Tough year. A lot of you know, folks are still worried about commercial real estate. And real estate, of course, is interest rate sensitive.

Jeff Buchbinder (03:06):

So that has weighed on that sector as well. Well, those concerns were certainly eased some last week with the sharp drop in rates. So we saw a huge gains in real estate. It was certainly you know, better for the higher risk sectors than the lower risk sectors, but a little bit disappointing to see that energy was only up 2.4% as crude oil fell, which you'll see here on the next page. So you know, energy, the energy complex, including oil and gas down 2.4%. The good news there, well, there's two pieces of good news. Number one, the market still sees the Middle East conflict as remaining contained. And number two, that's good for the inflation picture and another reason why the Fed's probably getting a little bit more comfortable with the idea that they are done. So Lawrence, check out these bond returns. You're going to tell us that this is kind of normal, right? We're going to continue to see 2% gains in the Agg every week from here on out, right?

Lawrence Gillum (04:10):

I wish that were the case, but to kind of carry over your everything rally, it was an everything rally in the fixed income markets as well because of that sharp fall in interest rates. Agg up about 2% last week. Mortgages, we've had an overweight to mortgage-backed securities in a lot of our discretionary asset allocation models. It was good to see mortgages outperform last week. They tend to be pretty rate sensitive and with the elevated interest rate volatility over the last couple years, they've kind of struggled a little bit, but it was good to see a sharp rebound in mortgage-backed securities outperforming high-yield bonds. And which is interesting, given the riskier segments of the equity markets that rallied, we actually saw some of the more risky segments within the fixed income markets underperform.

Lawrence Gillum (05:01):

So it was maybe a contrast to what we saw in the equity markets. But nonetheless, it was a good week across sectors. Investment grade corporate bonds up 2%. Mortgage is 2.9%. Treasury is up 1.5%. And it looks like after this sharp reversal in yields last week the Agg, the Treasury market may end up generating positive returns for the calendar year. If this holds up, of course, there's a long way to go. But something that we don't want to see is a third consecutive year of losses for Treasury securities and, or the aggregate bond index. The big rally that we saw last week kind of helped bring back some of those losses into more kind of you know, a territory that can be overcome throughout the rest of the year if rates don't spike higher from current level. So it was a good week for sure. I wish it was an every week occurrence. But I don't know that we can say that just yet.

Jeff Buchbinder (05:57):

Yeah, I don't think we can just post a recording of this podcast every week and call it a day. We'll have to keep doing new ones. Here's the chart of the S&P. You know, look at this V-shaped move here. I think the low, the closing level last week was 4,117. Now we're 4,364 when we priced this on you know, kind of midday Monday. That is a big move. And we just went from basically oversold to nearing overbought conditions in just the span of a couple of weeks. Really you know, kind of dizzying for the technicians to have to reverse course. It actually caught, I think some CTAs, you know, some trend followers, some, you know, managed futures strategies, folks that really play these macro trends, they caught them off guard, <laugh>, frankly, not just the move in stocks that reversed so quickly but the move in in Treasury.

Jeff Buchbinder (06:59):

So, we still think we can, you know, get a little more out of this market between now and the end of the year. You know, we've been talking about 4,400 as a goal, that seems reasonable given we have a seasonality tailwind. And you know, even though earnings season hasn't been great it's been just fine relative to expectations. And if you get rates down you know, like they did last week, 30 basis points down, if you continue to see rates drift lower from here, that supports stock valuations. Of course, wildcard is the Middle East. The you know, I'll let you weigh in on this Lawrence, but it, you know, it's just the opposite of the S&P 500 chart, right? Yields and stocks have been moving in the opposite direction here lately.

Lawrence Gillum (07:47):

Yeah. And this, you really could call last week's move lower in yields you know, a perfect storm in a good way, of why yields fell. I don't know if we're going to talk about more about this later, but really there was three catalysts last week that drove yields lower. You had a Treasury Department announcement in terms of their quarterly refunding needs, and that came in better than market expectations. One of the reasons why we've seen yields higher over the last couple weeks is the amount of Treasury debt coming to market or expected to come to market. Treasury Department came out last week and said that they were going to issue more bills and less coupon securities, so less longer maturity securities. Those longer maturity securities are harder to digest in the market.

Lawrence Gillum (08:33):

That was a positive catalyst for sure. Then you had a federal Reserve meeting last week that it really, went as expected, relatively uneventful, but during the 2:30 press conference Chair Powell kind of confirmed that the risks of doing too much versus doing too little were really balanced at this point. So, markets kind of took that as the Fed likely being done raising rates. And then finally, we got some weaker economic data last week. We, you know, we've talked about the bond market pricing out the prospects of recession because we kept getting these, this you know, stronger than expected economic data. We've seen a more resilient U.S. economy, which is great news, not great news for fixed income but great news, nonetheless. But last week we did see some softer economic data. What took some, some of that pressure off of yields.

Lawrence Gillum (09:22):

So we did see yields move significantly, or, you know, pretty meaningfully lower over the past week 10-year Treasury yields were down about 40 basis points, down about 50, almost 50 basis points from those intraday highs that we saw when the 10-year Treasury yield touched around 5% which seemed to spark a buyer a move in the buyer base to buy Treasuries at that level. But the, you know, 40, 45 basis point move lowering yields over the last week, week and a half has been, it's been a kind of a nice reprieve from the unrelenting move that we've seen over the past couple months in higher yields. So definitely take it. Don't know how long it's going to last but certainly you know, excited for the move over the past week for sure.

Jeff Buchbinder (10:11):

Yeah, certainly the jobs report was part of that picture as well. I mean, you could even add to that, you know, the jobs report was pretty Goldilocks. I'll show you charts of that in a minute. And then you had good productivity numbers as well. So this economy might be more productive than, you know, most had thought. And that allows you to grow with less inflation pressure. So add that to the list of positives. The UAW strikes are over. You've got probably a little bit of a kicker to the ISM now, right? Which was also weak last week. So, you know, bad news is good news still, but what we got was really not that bad. It was kind of middle of the road news, we'll call it. And that really ended up being pretty Goldilocks for the market.

Jeff Buchbinder (10:59):

So one of the reasons Lawrence, I'm glad you're here, is you can explain to me why we think the Fed is done. You talked about it a little bit. The probabilities in the fed funds futures markets are pretty close to zero <laugh>, right? I mean, you can't totally ignore a 9% or a 6% chance of a rate hike, but you know, it's a good bet that they are done. And then they'll, you know, probably start cutting maybe middle of the back half of next year. I mentioned the jobs report. Here's the picture you have. Even though there's been these you know, periodic spikes, kind of looks like an EKG <laugh>, right? You have a steady downtrend for a few months and then out of nowhere you have gotten some pretty strong job reports, but that doesn't change

Jeff Buchbinder (11:52):

the fact this trend is down, there is clear evidence of a slowing job market. That job report on Friday was 150,000 jobs versus expectations of 180. Plus, you had over a hundred thousand jobs removed in revisions to prior months. So you know, further, sort of solidifying this downtrend you even had a little bit of an uptick in the unemployment rate. It's still very, very low at 3.9%. You know, of course, we don't want anybody to lose their job, but to get the Fed off our backs, we do need a little bit of an uptick in the unemployment rate. So it did that, just a tick higher 3.9%. And then what some might argue would be the most important element of the jobs report is average hourly earnings, right? We had year over year slowing to 4.1. You can have a 2% inflation economy,

Jeff Buchbinder (12:44):

we're not there yet, but we could get to a 2% inflation economy and still have wage growth in the mid-threes. So, I mean, that's kind of historical average. So that's not too far away. So this is good news. Clearly, a downtrend, <laugh>, this one's a lot more convincing, right? In March of 2022 you know, we were running at almost 6% wage growth now down to four year over year. And that's going to have a three handle by the end of the year. This is good news, still good wage growth that can support consumer spending, but good news for the Fed's outlook. So, anything Lawrence, you want to add on the Fed before we move on to earnings?

Lawrence Gillum (13:27):

Just one other thing is that although that the Fed is done potentially raising rates they still are reducing the size of their balance sheet. So they are still kind of call it tightening, if you will. So I think that is going to take the pressure off the Fed to keep raising rates at this point. We think rates are probably you know, sufficiently restrictive at these levels. And there's other ways to increase or make financial conditions tighten. And that's through the balance sheet and the reduction of the size of their balance sheet. They're letting $60 billion worth of Treasury securities roll off every month without replacing them. That does serve to tighten financial conditions. So you know, the Fed, we think is not going to be a biggest story over the next, call it couple quarters, as it was certainly over the last couple quarters, which should be good for markets, good for bond markets, good for stock markets. We'll talk about the muni market in just a second. But they've already done a lot, right? So we don't think that they need to do too much more as long as the balance sheet runoff is happening in the background, you know, we think that the Fed is going to reach its 2% goal of its inflation target over time. It won't happen, you know, this year or maybe not next year necessarily, but you know, they've made a lot of progress with their tightening campaign.

Jeff Buchbinder (14:44):

Yeah, they could sure make a run at that by the end of next year. We'll have to see, we'll have our 2024 Outlook out in what about four weeks, I think now, something like that. So yeah, thanks for that Lawrence. I think the key point here is it's another piece of evidence that the Fed has done, because these cuts work with a lag, and they have the QT, you know, selling off bonds, shrinking their balance sheet, which is also going to help us get to that inflation target and get the Fed off our backs for good, which we all of course want. So let's move on to earnings. This is, frankly, it is not really as compelling as it was last week. I was really surprised last week at how strong the numbers were that I reported for you on the last podcast.

Jeff Buchbinder (15:35):

But the, you know, these numbers are still good relative to expectations. So especially the beat rate, you know, 81% beat rate on the bottom line is outstanding. When earnings season began, you know, personally, I thought we could do 4%, now we're over that. So that is excellent. But you know, it's been a little bit, I guess, disappointing that after that really strong start, we didn't add to it too much last week. And it's been a little disappointing that estimates have, you know, started to see you know, bigger cuts than what we saw in the earlier part of earnings season. We're still kind of in a typical place, right? Typically, earnings estimates get cut by 2%, they've been cut by 1.2, that's forward four quarters, but the cuts have been concentrated in Q4. So people are talking about how Q4 estimates have been cut more than 2%, and how that's a negative.

Jeff Buchbinder (16:33):

It does lower the bar, it does point to a little less earnings momentum than we had hoped for, but frankly, it's pretty close to the norm, and it's positive that 2024 estimates have held up so well. So we're just going to call that a wash and say that you know, earnings season's generally been about in line with our expectations. It's been good enough, certainly for stocks to rally, because we know what just happened last week. We talked about it. Essentially earnings just got out of the way of the locomotive that was this rally in the bond market. And you know, allowed stocks to go higher, did not give stocks a reason to either slow down or go down. That's how I would put it here. So I'll turn it back to you, Lawrence, to talk about munis. I think you know, it's not an area that we talk a ton about, but you know, after I read your piece this week on lpl.com, the Weekly Market Commentary, and saw your charts, I thought, wow, this, it sounds like a pretty compelling story for investors.

Lawrence Gillum (17:40):

Yeah, I mean, it's been a tough area for investors. The muni market has gone under the same sort of stresses or pressures that a lot of these other taxable markets have seen. And so through no fault of their own muni investors are in the midst of one of the worst drawdowns for the muni market since the inception of the index. On pace for a second consecutive negative year for muni returns for the index, the national index, which has never happened you know, before. So it's been a tough stretch for muni investors. We do think that stretch may be coming to an end. As we talked about, we think the Fed has done. At the end of Fed rate hiking campaigns munis, just like other fixed income markets tend to perform relatively well.

Lawrence Gillum (18:30):

What we're showing here is after-tax returns. So obviously the, one of the benefits of owning munis is that the tax benefit, so to compare apples to apples we're showing after-tax returns of munis, corporates, the aggregate bond market index, as well as Treasuries. That that first vertical line there is munis, and they tended to perform well on an after-tax basis. So apples to apples after the Fed is done raising rates. So if indeed the Fed is done raising rates like we think they are, that headwind that a lot of these fixed income markets experienced last year should at least abate, if not turn into a tailwind. So on average, the muni market was up about 9% over the next 12 months after the Fed's done raising rates, outperforming most other bond markets including Treasuries and the Aggregate Bond Market Index in general.

Lawrence Gillum (19:23):

So it's been a tough stretch of things, but you know, the reason why we've had that tough stretch for muni investors is because primarily the Fed so with hopefully the Fed getting out of the way, we could see the muni market start to trade on its own internal dynamics, which still remain pretty favorable. The next slide looks at seasonality, and I think a lot of fixed income investors aren't aware of some of the seasonality trends that we experience in the fixed income markets. In the muni market, it's typically because of favorable supply demand markets or favorable supply demand dynamics, I should say, which means that there's not a lot of supply coming to market, particularly during the summer months, as well as towards the end of the year. So with supply coming, with supply expected to turn lower, meaning there's not a lot of bonds coming to market that the market needs to digest, that typically means that there's enough demand to keep prices well bid.

Lawrence Gillum (20:23):

And right now we're about to, or we're actually in those the most favorable seasonals for the muni market November, December, January, and February, to a certain extent, have less supply coming to market over these next couple months than they do typically throughout the year. And that has historically led to positive returns for muni investors. There's a lot going on in this chart chart, but the takeaway is the orange lines there represents the average monthly performance for each individual month on that screen there. November, December, January, February, tend to have strong positive returns particularly November and December. So we could see a good year-end rally for the muni market, which would be a welcome reprieve certainly from the drawdowns that a lot of muni investors have experienced over the last year, year and a half.

Lawrence Gillum (21:18):

And then the final chart we have in the Weekly Market Commentary, it just looks at the default characteristics of munis versus corporates. On that first slide that we showed that show that corporates tend to outperform munis on an after-tax basis. But if we are entering into an economic slowdown, you'd rather own munis and not necessarily investment grade corporates or high yield corporates on the taxable side, just because munis don't default as frequently or as much as taxable alternatives on the corporate credit side. If you look at the 10-year cumulative default rate for all investment grade rated munis, it's around zero. And if you look at just the U.S. corporate credit markets, it's around 1.9% cumulative over that decade. It really sticks out, though, on the high yield side of the ledger, over the last 10 years, the cumulative default rate for high yield munis has been about 4% versus 32.5% for high yield corporate markets.

Lawrence Gillum (22:22):

So, if there is in fact a slowdown, and we do start to see defaults pick up a little bit munis are a bit more defensive than these corporate alternatives on the taxable side. So, you know, we would argue that if we do again, see an economic slowdown, which is kind of our expectation over the next couple of quarters, we expect the economy to slow a little bit. If that is the case munis could outperform most other fixed income markets on an after-tax basis because of the defensiveness of these securities. So that's the Weekly Market Commentary on lpl.com. I haven't checked to date to see if it's there yet, but by the time that this is out and released, I'm sure the Weekly Market Commentary will be there as well.

Jeff Buchbinder (23:08):

Yeah, absolutely. So Lawrence, you haven't done anything to reduce my enthusiasm for the bond market here. Certainly, in fact, when I saw that 32% you know, cumulative default rate for high yield corporates, I actually thought it was a typo comparing it to that 4% for high yield munis, that just seemed so dramatic that difference there. So you're getting a really high quality, obviously bond investment. And then on top of that, the tax savings, of course, is huge and why many of you own munis. And then as we saw last week, you know, yields, we don't know where yields are going to be next month or next year, but there's certainly a decent chance that that 5% holds on the 10-year, and that we get you know, move lower in yields for all the reasons we talked about upfront with the slowing economy and the Fed being done, potentially, most likely, things are all starting to line up.

Jeff Buchbinder (24:06):

So, munis look pretty good. So definitely check out that piece. It's really good one, and we know a lot of you out there are big fans of municipal bonds. So let's wrap up with a quick look at the week ahead. And this is going to be the most boring week ahead I think I've ever done. I mean, <laugh>, I thought that that cumulative default rate was a typo. And then when I ran the economic calendar and I looked at it, I'm like, I thought that was a typo too. Like, where's everything else? <Laugh>. So, but you know, this is it. You know, I normally, I wouldn't even highlight the University of Michigan confidence surveys because you know, it's not typically market moving, but on this list of not much this is all you get and jobless claims you get every week. So I think what this tells you is that the Fed speakers and earnings are going to probably be more important than anything on the economic calendar. And we're just going to continue to watch the the devastating headlines out of the Middle East. So, Lawrence, anything else? Either comments on the Fed speakers, I know Powell's speaking couple times this week, anything on that or any of this data that you want to try to prove that it actually matters to me?

Lawrence Gillum (25:23):

Yeah, no, the traditional economic data isn't all that impressive this week. We have had a lot of economic data to digest over the past couple weeks, so it is good to see a nice reprieve from a lot of economic data. I will say that the SLOOS, the Senior Loan Officer Opinion Survey, SLOOS, is important one, we're recording this as of what is it November 6. It's 2:30 now. That came out about 30 minutes ago, so we'll have to look, we'll have to dig into that and see how that looks. And then, yeah, to your point, Fedspeak 12 Fed speaking engagements this week, two of which are Chair Powell. So you know, probably talk about higher for longer, and the balance between rate hikes is more balanced now. So, it should be a slow economic data week, but there are still some things that are worth watching.

Jeff Buchbinder (26:15):

Yeah, good, good point. The senior loan officer survey didn't make it onto this economic calendar for whatever reason. But we will certainly be taking a look at that. The earnings, it's kind of a lull between, you know, the big names that report, and then the retailers. We always like to look at the retailer results for a read on the consumer. But that's not, you know, that's a month behind, and we're not quite there yet. So 55 S&P 500 companies is a good number of companies. It's just, other than maybe Disney there just aren't a lot of huge names that are going to generate a lot of you know, conversation or potentially move a sector. So I think we'll stop there unless you have any final remarks, Lawrence, anything we missed?

Lawrence Gillum (27:06):

No, I'm glad you didn't bring up your Chiefs and my Bucs, but other than that, no, everything is good.

Jeff Buchbinder (27:12):

Yeah, well, the Chief's offense still leaves something to be desired, but it was good enough, I guess, to beat a really good Miami team. So, yeah, sorry about the Bucs. It was a tough week for them. Hopefully all of you out there your teams won this weekend. Everybody have a wonderful, wonderful week. Thanks as always for listening to LPL Market Signals. Lawrence, thanks for joining, talking fixed income and not leaving me to walk through the muni market, which really would've been a complete disaster, <laugh>. So thanks again, everybody. Take care, and we will see you next week.