At LPL Focus 2018 in Boston, LPL Research Chief Investment Strategist, John Lynch, and Senior Market Strategist, Ryan Detrick, discuss highlights from the Midyear Outlook. When we as investors began 2018, we were tuned into the recent fiscal policy changes that were expected to propel economic activity and the financial markets higher in the coming year. The handoff in leadership from monetary policy to fiscal policy was well underway as a driver of consumer spending, business investment, and corporate profits. Instead of depending on the Federal Reserve (Fed) to move this expansion forward, fiscal incentives are now critical for continued growth, with the new tax law taking the lead.
Read the full transcript below:
John Lynch: Hey, good morning everybody. This is John Lynch, Chief Investment Strategist for LPL Financial, and we are coming at you live today from LPL Focus, which is LPL Financials Premier Advisor event held at the Boston Convention Center. A very exciting vibe in the room today, we have a record number of advisor attendees, more than 6000 advisors and partners and guests floating around today. The room is already filling up and we're real excited about this. I'm pleased and privileged to offer this podcast today with my colleague, Ryan Detrick. Ryan, welcome.
Ryan Detrick: Thank you, John. I'm glad to be here, really looking forward to today's podcast. Boston just has on awesome vibe to it. LPL is everywhere. We went to dinner last night, our advisors are everywhere. It's going to be an awesome couple days, and I'm really excited about today's podcast. It's going to be fun.
John L.: Absolutely. It's a beautiful day really being on the edge of the East Coast. The sun was rising about 5:00 am too, so that was kind of cool also. In the mid-central part of North Carolina, we don't get to see that, do we?
Ryan D.: And the humidity is a little bit nicer too. It's not quite as hot, so it's a nice change but it's exciting, and we're sitting in this really neat room. I see outside, give a little wave to our advisors who are listening to us live outside. They're outside the room, there's Jeff Buchbinder who just walked by, we're waving. So it's going be a lot of fun, John.
John L.: Absolutely. So what we'd like to do for you today, clearly very excited about Focus. A primary responsibility, role, task if you will of research will be delivering our mid-year outlook which was released several weeks ago. But, we want talk about that to our advisors and clients. Certainly, the Midyear Outlook. We've seen some volatility back in 2018. One of the major things we've talked about with the Midyear Outlook is policy, and the economy, and how those changes would be more impactful to the financial markets. Clearly, we've seen that relative to tax cuts, relative to infrastructure spending, government spending, as well as reduced regulation. All those positive tail winds however have run into, Ryan, as you know, the tariff consequence, right? Really, the uncertain about tariffs. So that's really kind of slowed down momentum. We are gaining traction thankfully in beginning of the third quarter. Consequently, we think the fiscal tail winds will offset the head winds of tariffs. Would you agree?
Ryan D.: Absolutely John. So I have a question for you. So this economic cycle, John, is nine years old as of June. The longest ever was ten years in the 1990's. Like you said, there's tariffs; some concern about inflation. This is getting long in a tooth. Do you think we can make the all time record here for economic growth?
John L.: I think we are poised to. We had a very good GDP report release on Friday. I think that while it was below expectations, and oddly enough, you know the beauty of what we do, this is the life we have chosen. You know, we get a number that's 4.1%, the best of the cycle, and the market sells off a few points because it wasn't 4.2% like everyone expected. None the less, if you look at... Some skeptics will say, " Well a lot of that had to do with channel stuffing, if you will. Relative to exports and the fear of tariffs." But if you look at the absence of invitatory building, they actually washed each other out, so you saw a percentage point fully added to GDP from exports, but a full percentage point reduced or subtracted from GDP because of the absence of inventories. So if you get that sort of absence of inventories that bodes well with third quarter GDP, so we think the fundamentals are still very strong.
We've got low unemployment. We've got rising wages. But perhaps the most important thing, and this really had a lot to do with the return of the business cycle, and how we transition the Midyear Outlook titled, to the plot thickens because largely what we called for came to fruition. The tariff situation increased volatility made it a more challenging scenario for investors, so we're trying to guide investors to embrace the volatility because the fundamentals of the economy looks strong. Whether it's consumption, whether it's government expanding, whether it's exports and what our favorite export of the economy is, business investment. Which has grown significantly. We think business investment now that business' have immediate expending capabilities, reduced tax rate, things along those lines. We're looking for manufactory to increase business investment by 10% in the next twelve months. And services, we're trying as you know, make up 85% of the economy. They're going to grow 6%-7%. So overall, we are projecting 7.5% investment growth. So we do believe we can get through 2019 which would make it the longest cycle.
Ryan D.: Great! One thing, John, you mentioned volatility. We were spoiled last year. Fifteen consecutive months for the SFP500. All of a sudden, we have two 10% corrections already this year. We talked about a midterm cycle year, but a 17% average pull back, but the good news, up over 30% twelve months off those lows. I think February was probably the lowest of the year which hopefully was. Now, there is a very good chance that we are going to be significantly higher as we get out into next year.
John L.: You know, that's something important, and we really want to guide our investors and clients and advisors to recognize that. We've not had a pull back like that since October 2015, maybe early 2016. We had maybe a two or three day scare over Brexit. But to have that sort of persistent turbulence in the market, we need to make sure everybody is prepared for that. We will certainly be positioning portfolios accordingly, using that weakness as an opportunity because as the plot thickens we want you to embrace volatility because even if we were to have some sort of volatility sell off going into the midterms. History has shown that the market recovers twelve months later, but more importantly, I don't know if we have seen the cyclical tail winds ever in year nine of the economic cycle be so irreformable. I mean I've been at this more than 30 years, I'm still scratching my head.
Ryan D.: That's right!
John L.: So it's a very exciting time!
Ryan D.: John, you mentioned, "Be prepared." Let's talk a little bit about this week. Now this week, clearly, as I look at it, the calendar tells us August is almost here. So we need to be aware, August and September, historically are the two weakest months. Also, August has a history of when its down, it can really be down. These uncertain events can happen, and August can be a tricky month. There's lighter volume, people going back to school. So those are things we need to be aware of, but more specifically this week, John, we have a Fed meeting on Wednesday. All in all, not much is to be expected from the Fed in terms of interest rate policy, but its always about what they say, and what can happen to the economy about future rates. Japan also has a policy meeting. And that one, there are some rumors last week that they might make a slight change. Japanese yields went a little bit higher.
John L.: Let's talk about the context of that.
Ryan D.: Tell me the context of that.
John L.: Japanese yields catapulted from three basis points to six basis points. Haha. Run for the hills right.
Ryan D.: That's right.
John L.: But that's something that investors need to be mindful of also because it's been such an extraordinary period of monetary policy that our federal reserve has raised rates several times as you all know. The bank of Japan still has their foot on the accommodative gas pedal, if you will. And to some extent, Europe still does as well. I think what is not getting enough press is that investors need to appreciate the fact that while our federal reserve has a mandate to keep a lid on inflation, and to insure as full employment situation as possible, they have to be very mindful in the fact that our rates can't get to far away from Global rates. Because that has a dollar impact, that has an inflation impact, whether its food or energy in the emerging markets. Debt that needs to be re-serviced from emerging markets, dial dominated debt. We're not confined that the Fed's are going to be as aggressive as many fear.
Ryan D.: Interesting, Thanks! So also, next we have the jobs number coming out on Friday. One thing is that this is the Goldie Locks Economy, right? Inflation is still relatively calm. We keep seeing 200,000 job prints. All in all, the economy looks good. Inflation kind of calm. John, we also have two weekly commentaries come out this week. The Weekly Market Commentary comes out. We are taking a look at active management. Why it struggled for awhile; started to do better last year. There are some major tail winds coming out. We wrote about this, again, in our recent Midyear Outlook, but also going to focus more in our Weekly Market Commentary. Then the Weekly Economic Commentary takes a look at GDP, what came out last week. Like you said, we are really going to dive in, take a closer look there.
John L.: Yeah, certainly on the Weekly Market Commentary from LPL Research. I encourage you all to take a peek at that. Really, what we've seen over the last seven, eight, nine years, is that when the federal reserve was printing money.(That upsets the PHD of the Fed) Essentially, printing money. What resulted there is a rising tide lifting all boats. So assets classes and subassembly classes have largely moved in the same direction. Now that correlations, they started to decrease in January and February then the escalated again, so all asset classes started moving the same direction when the market sold off. But the last five or six weeks, we're starting to see the rolling three month correlations start to decline, and that is a very important development because that means. For example, technical analysis was driving the market for the majority of the time, and passive investing was driving the market for most of the time. I think you're going to see fundamental analysis and more active strategies unveil themselves to the wise investor or the prudent investor to take advantage of opportunities during sell offs.
Ryan D.: One more comment for me, John, regarding this week then turn back to you to close things out. You know this is earning season. Last week was the busiest week of earning season; we have definitely some more earnings. But what's happened so far, earnings have been positive overall. But you look at the reaction of financials. Financials have done quite well with the reaction. Technology. You've got a couple big Technology names. We still like technology, but at the same time, financial is such a big part of value which as we mentioned in our Midyear Outlook, we like value of growth here a little bit. Maybe this is the start of, like you just said, everything went the same way for so long. Now maybe we are seeing financials and technology maybe going a little bit different. What do you think on that? Then you can close us out.
John L.: Well, I'm grateful for the opportunity, because as you know, since I joined the firm a year ago, I've been talking about financials, and I haven't been wrong. I've been early in that forecast, right? Now that they're starting to gain some traction, I think that's important because you're right. There a very leading component of the value space. As you know, for the first half of 2018, particularly the second quarter of 2018, we saw small value outperform large value, and that tends to be a good lead indicator. Now that we have financials. Even the industrial space is also starting to do well the last several weeks. I think that really gains the traction for the value of space going forward. We think that's... many of those are primary beneficiaries on the return of the business cycle.
So to close, Ryan, I want to thank you. I am delighted to have the opportunity present with you this morning. You're a great partner and a great friend, as well. So, very excited! We have a very full day, so we have to make sure that we power up with our protein for our second breakfast this morning. Then, we will be meeting with our advisors and partners, and we're very excited about the day.
For those of you who want to keep up more with LPL Research, and I encourage you to do so. We've got a great team, very dedicated hard working team. And we have the two weekly's coming out later today, the Weekly Economic Commentary on GDP. The Weekly Market Commentary focused on active strategies. Tomorrow, Ryan and I will be back on this podcast to talk about further what's happening in markets while advisors are attending this conference. I want to make sure everybody is aware of what's happening so they can serve their clients remotely. And I also want to talk about more detailed aspects of equity and fixed income markets relative to the Midyear Outlook.
I just want to make everybody aware that you can follow us on Twitter @LPL as well as @LPLResearch or #LPLFocus. So once again this is Ryan Dietrich and John Lynch. Thank you for participating today. I hope you have a wonderful day, and we look forward to talking tomorrow.
Ryan D.: Thanks everyone! Talk tomorrow.
The opinions voiced in this podcast are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security. Any economic forecasts set forth in the podcast may not develop as predicted, and there can be no guarantee that strategies promoted will be successful. All performance referenced is historical and is no guarantee of future results. Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments. All information referenced in the podcast is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. Please see the Midyear Outlook 2018: The Plot Thickens for additional description and disclosure. This Research material was prepared by LPL Financial, LLC. Securities and advisory services offered through LPL Financial, a registered investment advisor. Member FINRA/SIPC. To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and makes no representation with respect to such entity. The investment products sold through LPL Financial are not insured deposits and are not FDIC/NCUA insured. These products are not Bank/Credit Union obligations and are not endorsed, recommended or guaranteed by any Bank/Credit Union or any government agency. The value of the investment may fluctuate, the return on the investment is not guaranteed, and loss of principal is possible.