The Four Market Themes Shaping the Rest of the Year: LPL's Mid-Year Outlook

Marc Zabicki [00:01] And what has been, again, somewhat surprising from an economic perspective is consumers remain so resilient in aggregate, that is, in the face of higher oil prices, it's been more of a surprise, I think, than even we would've expected.

Taryn Huget [00:25] Hello, everybody. Welcome to If You Could with Matt and Taryn. I'm Taryn Huget.

Matt Enyedi [00:30] And I'm Matt Enyedi. Taryn, how are we doing today? I'm

Taryn Huget [00:33] Doing good. It's nice to have you back.

Matt Enyedi [00:35] It's good to be back. You know, I enjoyed the hot seat just a little bit, but man, this host seat is so much more comfortable.

Taryn Huget [00:41] You know, you were a great guest, but it is nice to have my partner in crime back in his rightful place. Yeah,

Matt Enyedi [00:48] This is the place for me. Okay, folks, look, we've got a lot to cover today, because when it comes to markets, policy, and all that is going on in the world right now, the question is, what should we be paying attention to? So we're bringing back the one and only, the inimitable Marc Zabicki for a meaty conversation today. And Taryn, do you know what I realized?

Taryn Huget [01:06] What's up?

Matt Enyedi [01:06] Marc isn't just a repeat guest. Marc is our first official five-timer.

Taryn Huget [01:11] Then you know what that means, Matt? He gets the five-timer, if you could, velvet jacket.

Matt Enyedi [01:17] Oh, Taryn, I think you got our budget way wrong. This is not Saturday Night Live. And that's not our flow. And sure, we don't have velvet jackets or musical guests or Matt Damon.

Taryn Huget [01:27] Matt Damon. Let's pause on that for a second. Why? I'm just imagining the future of this podcast. I mean, still Matt and Taryn, but Damon in and Yeti out. I think we're onto something here.

Matt Enyedi [01:39] You're not onto anything. That's a terrible idea. He's not interested. And neither am I. Instead of focusing on what we don't have, Taryn, let's focus on the incredible talent that we do. And what an honor to have Marc be our first five-timer because he brings what our clients need every single time.

Taryn Huget [01:53] He definitely does. And today, we're going to dive into some of the key themes from the recently released mid-year outlook, and check back in with some of the other hot topics that we've covered in the last year.

Matt Enyedi [02:04] Yeah, topics that are not only still relevant, they are as timely as ever, and still making headlines as we speak.

Taryn Huget [02:10] All right. If you could, brings Marc Zabicki, and he joins us now.

Matt Enyedi [02:19] Marc, how are you? Welcome back to If You Could with Matt and Taryn. Welcome,

Marc Zabicki [02:22] Marc. Well, thanks, Taryn and Matt. Very good to be here. Always happy to see you.

Matt Enyedi [02:26] Well, we are happy to see you and super excited as our first official five-timer. I've got bad news for you and good news. The good news is I think we'll have you back for a sixth. The bad news is there is no custom velvet jacket coming your way. No jacket. Unless you guys in LPL research can fund something like that.

Marc Zabicki [02:43] I, I would, I would be happy to show up in a custom velvet jacket. And if you don't tell anybody, we can pull that out of the budget, Matt. Hey, you know what?

Matt Enyedi [02:50] Velvet for everyone. Marc, look, I said we're excited because we've had so many incredible conversations with you and members of your team over the last year and a half. And if I think back to some of those topics from Iran, oil, crypto, the future of labor, what's next with IPOs, you and your team's calls have been spot on. But I think what's most interesting, even going back to our first conversation on tariffs April of last year, so many of the things that we talked about then are not only still relevant, they're still on the front page of the headlines. I

Marc Zabicki [03:21] Think that's, uh, exactly true. Clearly, the Iran conflict is on the front page, no doubt. And then the tariff thing continues to bubble up, even though the Supreme Court kind of knocked it down in one sense. The Trump administration is working different angles to continue with that, the tariff direction or the tariff trend, if you will.

Matt Enyedi [03:40] Yeah. And we'll dig into a few of those things over the conversation because like you said, and, and like we've kind of been reading, they don't seem to be going away. I though we would maybe start with a look back at some of the more interesting conversations that we've had that have really stuck with us and remain timely and, and maybe more timely than ever. The one that I wanted you to hit on first is what is going on with asset allocation and diversification, and how should be people be thinking about investing client portfolios? It's something Shiree Belsky introduced to us last year around the death of the 60 / 40 portfolio. And the reason being is it just isn't giving the diversification that folks are actually seeking out of that type of stock bond mix. I'm curious, why is that changing? Why is it so dramatically different than what it was? Is the continued convergence of the correlation something we should expect to continue?

Marc Zabicki [04:32] I, I think the answer is, is yes. Just kind of back up, Matt. I think what you're seeing and what has caught the attention of folks, at least from us and, and others, is that there is a relatively high correlation between stocks and bonds, and that high correlation or relatively high correlation is different from what you've seen out of capital markets over the previous 20 years. Now, the correlations began to rise and, and, and stay relatively elevated post - COVID. So over the last five years, it's really been prevalent that you need another asset class to enhance the diversification properties of a multi-asset portfolio. So that's the crux of the conversation that we've been having, not only at conferences, but within research and every time that we get in front of advisors is it's necessary to have. It's not just because alternatives are more prevalent in terms of, like, the retail audience. They are, but there is a rationale as to why people are having this conversation, and there's the rationale as to why it has gotten more important.

Matt Enyedi [05:37] Let's sit on that for a second, though, because you're talking stock bond alternative. It's a three-part dance instead of a two-part tango going forward. Is that how you all look at it?

Marc Zabicki [05:46] That's exactly right. So in the past, when stocks and bonds moved in different directions, you had that diversification element, and now you are getting less of that in the market, so it's important to add another asset class in order to help you enhance that diversification element. Now, that was increasingly prevalent or very visible, that high stock and bond correlation, actually during the start of this Iran conflict, where you saw stocks and bonds both moving down. And that's typically not what investors have witnessed in the 20 years prior.

Matt Enyedi [06:20] And we continue to see that, right? With the stock market continue to do well and bond prices continuing to retreat. And I guess the question that I have is why? I'm thinking for our clients and how they describe this to the investors they serve, why they might be making a change to asset allocation strategy. Why is it that stocks and bonds are more positively correlated than ever?

Marc Zabicki [06:42] I'm gonna really label that rationale on the geopolitical unrest that we're seeing and the, and the volatility that we're seeing in, you know, kind of global geopolitical conditions. Couple that with the fact that the levels of debt in the US and the world are going higher, not lower. So when you get those two dynamics operating at the same time, it creates a certain degree of consternation, not only in equity markets, but also in fixed income.

Taryn Huget [07:11] Marc, you touched on it at the beginning, the Iran conflict, and it still being on the front page. Go backwards to February 27th when the conflict with Iran broke out. There was a lot of uncertainty around what it could mean for the markets, the economy, and energy prices. You fast-forward five months and the story continues to evolve. I've actually recently read some articles suggesting that we got through that oil supply shock better than many expected, because governments had tools available to soften that impact, whether that was drawing on reserves, changing energy prices, or reducing consumption. But if this conflict continues, which it's feeling like it's going to, do those same options exist today? I mean, do we have the same tools and reserves? And if not, what are the implications?

Marc Zabicki [08:01] I, I think your assessment is entirely correct. I would add to that oil producers in the Middle East also were somewhat successful to the degree that they can be in the near term of moving product, oil in this case, through different pathways other than the Strait of Hormuz. And that kind of hearkens us back to this conversation about, you know, kind of supply chain. So we got into a supply chain conversation in COVID, we're getting into another supply chain conversation when it comes to oil. So oil producers w - had the ability to kind of move some of the product through other means. It's not perfect, but it offset some of the bigger components of risk that the world was digesting as a result of the straight shutdown. So there is that. I mean, we were pulling some levers in, in terms of the strategic petroleum reserve. So that also helped. So in many ways, like the best case scenario would've been or is if Iran decides, okay, we're not gonna engage in a nuclear program and we're gonna open the Strait of Hormuz. That's the best case scenario. Absent that, which is maybe unlikely to happen, then we've probably gotten the next best case is what we're witnessing today, which is a global economy that has really not rolled over. Certainly in the US, we've, we manage our own production here largely, so we're the best of the best case scenarios. It's been a little bit more tumultuous in European markets and, and in Asia Pacific, but so far we've come through the crisis relatively well. I think the best case scenario i- is probably happening right now. Now, the worst case is if this continues longer, then it increases the risks that governments in the Middle East will be revenue impaired from oil flow, and that revenue impairment would cause them to sell down other assets. That could be treasuries, it could be gold, it could be, you know, the dollar, whatever it may be, which would cause kind of more capital market impairment or more tumult in capital markets. And I'm actually surprised, and I think we at LPL Research are largely surprised that we've haven't seen as much of that as we kind of expected given the current conditions.

Matt Enyedi [10:14] And I guess the question is, is are the reserves at risk? And if so, does that mean higher fuel prices for longer? Because you're going to have this not only, "Hey, we got to get oil out to the consumer," everyone's got to refill the reserves that have been hit pretty hard during this period of time too.

Marc Zabicki [10:29] Yeah. It, it feels to me, Matt, that, like, uh, you mentioned the oil price volatility in recent weeks or a couple months is we've gone a- a- above 100 on WTI and back to 70, and now north of that. It feels like the market wants to land around $80, uh, per barrel. So I, you know, I think if we get some path forward here that's somewhat constructive, I think we kind of get back there. So are oil prices still higher in that realm? I, I think the, the answer is yes. And what has been, you know, again, somewhat surprising from an economic perspective is consumers remain so resilient, ev - in aggregate, that is, in the face of higher oil prices, it's been a surprise, I think, than even we would've expected. And that's largely due to the wealth effect, uh, from a post - COVID perspective where there is a K-shaped economy, oh, by the way, and the, the upper end of that K-shape is really carrying the lower end who are feeling more of impact from the price of oil and gas.

Matt Enyedi [11:35] God bless the American consumer.  Uh, they continue to carry us as they've done for so long. I think what we've learned from these past conversations is it seemingly past is not just prologue. In many instances, past continues to be the present because these things take a minute to play out. And speaking of playout, what we really wanted to spend our time talking about today was the recently published LPL research, Mid-Year Outlook. And it is required reading for anyone who's in this industry or anyone who wants to know what's going on. Share with the audience the big takeaways of the mid-year outlook, and even for those who have already read it, maybe some of the kind of behind the scenes of what you all are thinking and how our institutions, our advisors can help the investors they serve with this information to kind of attack the markets and attack their portfolios going forward.

Taryn Huget [12:20] Yeah. And, and one thing I wanna add that I really appreciated about this year's outlook was how you led with the four key themes. You know, for those who aren't living and breathing the markets every day, it was a really digestible way to understand what is most important relevant right now.

Marc Zabicki [12:34] Yeah, the, we thought the, the key themes were important for audiences to kinda digest in this outlook, so we did it a little bit different in this go round. And the four key themes are really AI and, you know, it wouldn't be a market strategy conversation if we didn't talk about AI. The other one was resource nationalism, which we can dig into what that is and how it impacts capital markets. Also, Kevin Warsh and what he's likely to do with the Fed. And then finally, as we approach November, the US elections in the Senate and the House.

Taryn Huget [13:03] So let's unpack those four key themes. Starting at the top with AI, something we've talked about. We can't go a conversation with you without talking about AI. So your headline is that AI is entering a transition phase. What does this mean? Break it apart for us.

Marc Zabicki [13:18] It means that transition phase has to do with how investors are going to begin to look at the money being spent to build out AI infrastructure. So in previous quarters in, in the last couple years, the market's been spending a lot of attention on, okay, the, the amount of money spent and the growth in AI. Great. People are spending quite a bit of money on building out AI infrastructure. I think the conversation is gonna transition to, okay, are we going to get, or are companies going to get a return on investment for that capital being spent on the infrastructure build, the utilization of AI? We think that's going to be the key question that the market's going to be faced with over the next six months, 12 months, 18 months. So the conversation is going to be adjusted slightly from pure build out to return on investment. The same conversation happened back in the, in the '90s when there was a extreme amount of money being spent on internet build out, and that was all well and good. And then people started to ask the hard questions, are we getting a return on that, that investment? And that's when perhaps things got a little bit more tumultuous and winners and losers were properly categorized at that point.

Matt Enyedi [14:36] Yeah, I was gonna say, Marc, that didn't play out too well for a lot of companies, and certainly for the market, March of 2000. And so how are we seeing that transition phase playing out here? We're certainly gonna see, I think the prediction is in ano- another 20% increase in spending on the build-out in 2027. From what you're saying, I expect that they will require some pretty significant increases in revenue and earnings in order to continue to justify the spend.

Marc Zabicki [15:04] The analysts, the Wall Street analysts are gonna be asking a, a different question. So it's, it's not, it's not going to be what are corporations doing to, to grow their AI capabilities. It's gonna be, what are you doing to grow AI capabilities? And then, oh, by the way, are you earning a proper return on that? So there's just gonna be a, an increased level of scrutiny. Again, same thing happened in the internet days. This is a different era, different time, stronger companies, all of that. But we think the same questions are gonna get asked. All

Matt Enyedi [15:35] Right. Hey, why don't we switch to the second foundation or second pillar? Because while AI is something we have been talking about ad nauseum, some might say, the next topic is one I think it's a little bit less known, which is a concept called resource nationalism. And look, this isn't brand new. This is something we saw in the '70s with oil, but I think we're seeing it play out e- even more so now, and against maybe not oil or maybe with oil, but with rare earth minerals and how in- incredibly important they have become to the new modern economy. What is this new resource nationalism? What does it mean to global trade? And, and what does it mean here in the United States?

Marc Zabicki [16:10] Yeah, I, I think all of that is correct, Matt. And I, and I think there's a different end of the story here this time around versus what we may have seen in, like, in the '70s, et cetera. And that really is the trend from globalism that we've witnessed over the last couple decades is being rolled back somewhat. And countries have become more nationalistic as a result of that because COVID pulled back the curtain on extended supply chains and an over-reliance on globalism. And now the Strait of Hormuz really being closed has kind of done the same thing. So I'll leave somebody else to decide whether globalism is right or nationalism is right. That's, that becomes a political conversation. But the reality is, I think, supply chains got stretched. The reliance on other countries and perhaps somewhat unfriendly countries to conduct business with the US, as an example, has caused people to think twice about, okay, can we rely on those other countries for portions of the means of production in order to move the economy here in the US? And I think increasingly the answer is a more of like a pause, or maybe the answer is a full-blown no, depending on you, on who you talk to.

Matt Enyedi [17:23] So we've got pillar one, AI. Pillar two, we've got with resource nationalism. Pillar three, uh, and everyone's always listening, although I'm not sure they're gonna say much, is the Fed and Kevin Warsh. And we've got a new era of Fed. And then we just had a Fed meeting last week, and he's certainly got a big mandate in front of him because inflation remains stubborn, and he's got to kind of reverse things around the debasement trade. He's got to focus on the power of dollar. I think he sees AI as being disinflationary. So what can we expect from the Fed? Are they going to be able to tame inflation? And what will the means they use to get there?

Marc Zabicki [18:00] Oh, great questions. I, I think that Kevin Warsh is a pragmatic individual, it strikes me. So, uh, I, I do like Kevin Warsh. I think he has what it takes to do a good job here. He's got a big job. I think effectively, what he's trying to do is to change the approach of the Federal Reserve a little bit. The mandate's always been full employment and, and price stability. I think he's more focused on the price stability angle than Jerome Powell was. That doesn't necessarily mean he's hawkish. I think he wants a Federal Reserve that's less influential on capital markets and the economy than Federal Reserve has been in the past. And I, I don't know that that's a bad thing. Perhaps the economy and the market certainly have been over-reliant on the Federal Reserve or what's known as the Fed Put. And I think that has led to some imbalances both fiscally and monetarily that it's gonna be hard to roll some of that back. But I think that's what Kevin Warsh is going to attempt to do.

Taryn Huget [19:05] So what do we think about the rate moves from here?

Marc Zabicki [19:07] Well, I, I think the Iran conflict really has caused a little bit of question as to where rates would be. We would have suggested at this point as we sit here, Taryn, that rates would probably be lower absent of the Iran conflict. So we would expect through the balance of 2026, rates to be unchanged. Federal, Fed funds rates not likely to be changed at this point. Now, we think the label that the Federal Reserve and Kevin Warsh is getting right now as being more hawkish is probably misplaced. I, I would bet the next Fed action is going to be a rate cut, not a rate hike.

Matt Enyedi [19:45] It's a bit contrarian. I feel like the markets right now are pricing in a, an increase more than a decrease at this

Marc Zabicki [19:51] Point. I think that's entirely correct, Matt. Um, and, and I, I, I think -

Matt Enyedi [19:54] You heard it here first, folks. You heard it here first, folks.

Marc Zabicki [19:57] Well, um, I appreciate that. I just think that the, the market's got it wrong as the market often gets it wrong in the near term. So I think it's, it's same thing for this case. I, I think that in the face of a spike in oil prices, historically, the Federal Reserve has really never reacted to that because they consider it short-term in nature and call it transitory. So I think what's going to happen is if this Iran conflict and the oil price spike is indeed short-term, then the Federal Reserve likely does nothing. If it becomes more pervasive and this lasts into latter portions of 2026 and into 2027, then maybe the calculus changes.

Taryn Huget [20:37] I'm gonna transition us from near term to midterm. I wanna hit on the final theme, which really pulls this all together because we've covered a lot on the implications for both the markets and politics. And with the midterms approaching and a lot at stake, how do you see the current environment shaping the political landscape? And also from an investor's perspective, how should people think about navigating an election year? How do you approach the different scenarios that can emerge depending on which way the election is gonna go?

Marc Zabicki [21:09] Taryn, I appreciate the question. And, and probably the best piece of advice I could give is to, if I was an investor, I would do little or perhaps nothing as a result of what may or may not happen in November. It's just typically not a good idea. What could happen in November, what's likely to happen in November? Different conversation. And let me give you our insight here is we think, and Kalshi will show you this, Polymarket will show you this, that the Democrats are likely to take the House and the Republicans retain the Senate. What does that mean for investments and your investment selection? That probably means that banks don't do as well as they may have o- otherwise might. Mega cap tech perhaps comes under some additional elements of maybe political pressure and healthcare gets perhaps, you know, marginally better. So absent those things, I don't, wouldn't expect a whole lot in terms of change in the investor mindset, nor should the investors change their mindset as a result of who wins in November or who loses.

Matt Enyedi [22:19] All right, Marc, we are out of time, but certainly not out of insight. And we appreciate you coming so much as our first official five-timer. And it makes me think back to Saturday Night Live in its heyday. And one of my favorite skits from 1984 was when Eddie Murphy would play the role of Clarence Walker, the disgruntled saxophonist who claimed to be the fifth Beetle. History would tell us that he was not in fact the fifth beetle, but keeping in that same vein, we were curious. Is there a fifth pillar out there that no one knows about? Maybe not one that was ready for the mid-year outlook, but one that is emerging that folks might act on. So if you could unveil a fifth pillar, what would it be?

Marc Zabicki [23:04] I will say as a fifth pillar, and again, I don't think, Matt, this is getting a lot of, uh, attention at all. And there is a definitive trend at play where European countries are adding significantly to their defense spending. So to put some numbers on that, like we expect European countries to spend about 450 billion euro in 2026, and then to expand that spending to the tune of about 800 billion euro by the end of 2030. There's a national security implication to this, and this is back to kind of that resource nationalism angle. What people should know is that of the European Union spending on defense, about half of that spending favors US defense contractors. In the expected growth of that European spending is likely going to be a tailwind for not only European defense contractors, but US defense contractors as well. We continue to like industrials in part for that reason, in part for the, the resource nationalism story. So we didn't have time to, or the room to actually write about that, but that's a, a trend that's likely going to pay off in the next two or three or four years.

Taryn Huget [24:21] All right, Marc, before we wrap up, remind our listeners where they need to go to find out more information from LPL Research.

Marc Zabicki [24:28] The best place to go, Taryn, is in fact lpl.com. There is a research tab out there where they can find the latest mid-year outlook, as well as a blog that we write every day, the weekly market commentary. So the best of the best is really available on, on lpl.com. That's the best place to go.

Matt Enyedi [24:46] John, Paul, George, Ringo, and

Taryn Huget [24:49] Marc. And Marc.  And

Matt Enyedi [24:50] Marc. Marc, my bet's on you.  You always sing a fine tune and we always could use a little help from our friends at research and you bring it every time.

Taryn Huget [24:58] Thanks so much, Marc.

Marc Zabicki [25:00] Much appreciated. Thank you both.