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From LPL Financial, welcome to Market Signals.

Marc (00:04):

Good day, everyone. This is Marc Zabicki, Chief Investment Officer at LPL. I am joined by Jeffrey Roach, Chief Economist at LPL. This is the Market Signals Podcast. Today is Tuesday, November 1st, 2022. We get the pleasure of joining you today and I get the pleasure of being joined by Mr. Roach. We’re going to talk quite a bit about the FOMC meeting. We're going to talk quite a bit about the upcoming payrolls number and what that means for investors, and perhaps a little bit of how to think about that. But before we start, we always start the Market Signals podcast with a little bit of a look back. So let's do that. The mobile equity markets have actually been fairly robust over the last 30 days or so.

Marc (01:06):

We ended October yesterday. The Dow Jones Industrial average was up 14% during the month of October because of some related tumble in the technology sector. We did not see that robust of a return set in the NASDAQ composite nor the S&P 500, but both a composite and the S&P 500 were for the trailing month and of last week. Some of the key drivers perhaps are just that, and we'll talk a little bit about this. Some of that expectation that the Fed be may be nearing its end of its tightening cycle.  Some realization that yes, maybe the economy is cooling, but perhaps not falling out of bed, as it were. So some of the key drivers perhaps to pay attention to: If I go and take a look at fixed income markets, commodity markets, it was relatively good week for fixed income, although the month hasn't been that good for fixed income.

Marc (02:15):

We still have gotten some high volatility in market for the month, but we had a pretty good run of it last week, or the last, you know, five trading days. Commodity indices is also enjoying a little bit of momentum over the last week as well. Again, as risky asset prices in general, they have improved. Last week's key drivers, the Apple earnings release was well received generally by investors, and that included not only the Apple stock itself, but also broader markets. And what I think is actually very interesting in terms of the way to think about this market and maybe ushers in a little bit more optimism about what may be transpiring. And that is that when, when we got some not so constructive technology results last week, we didn't get a situation where investors just rotated out of the market or got away from equity exposure in general.

Marc (03:29):

There's some evidence that while technology didn't do as well as other areas of the market, perhaps investors rotated away from technology a little bit, and in two other areas of the market that they thought was a little bit more constructive. So perhaps a little bit of good news, if you will, that investors were not heading for the exits when the technology results were not as robust as, as maybe we had hoped. So instead of heading for the exits, they actually found some opportunities to buy elsewhere. So that was, was probably a slight positive for market activity last week. Jeffrey Roach, I'm going to turn to you on the Q3 GDP number, which was up 2.6%, quarter over quarter annualized, and we're following this out as perhaps a little bit of a piece of good news last week. What do you think?

Jeff (04:31):

Yeah, I think it kind of added the evidence that the economy is slowing but not collapsing. And so I think the point there is that we're not currently in recession. We did have two consecutive quarters of negative growth. That's not always going to happen. It often happens with recessions, but not always a one for one, because you need a significant decline that's broad based that lasts for a few months. That's kind of the three ingredients that the NBER National Bureau economic research gives us. And we haven't seen a significant broad based decline because last several quarters consistently consumers are spending on services. Businesses are spending on capital goods and equipment, software spending on intellectual property, you know, all of that good stuff that, supports the business sector. So it was a decent report.

Jeff (05:31):

It tells us though that the economy is consistently slowing when you take out the real volatile categories, which is trade and inventories. You take those two out and you just look at the core part of the domestic economy, that thing is just trending like a straight line, just slower and slower and slower. But it's kind of a gradual slide. Hey, if you think about, you know, back in the day when you'd skateboard down the steep hills, you kind of like a hill that you can manage. You don't want a hill that looks like a double black diamond hill, and the economy's not cratering, it's slowing, and the markets are digesting that, and it seems like markets are digesting that slow down in a pretty good fashion.

Marc (06:19):

Well, and so, take the next subject, Jeff. You know, housing market, which again is appearing to slow as well along maybe the same slow kind of digestible trajectory. So, would you agree with that?

Jeff (06:35):

Yeah, it's been a little bit more nuanced in housing just because you had this talked about slowdown in new home sales and existing home sales, which is all about the single family resident. What has been a little bit confusing is the multifamily dwellings, the condos, the apartments, that kind of thing. And so that's not about purchases. A lot of times it's about rents and leases. Rents have been growing astronomically recently until about the last two months. You’ve actually started to see a cooling in rents from some of the firms that I track out of Silicon Valley, the website, for example. It’s showing that there's a finally a cooling in the apartment and the rent space as well. Going back to the slow down versus the cratering conversation. Yeah, I think it's going to be hard to speak in the aggregate for housing because it's so much driven by these pockets regionally where you might say a look, Silicon Valley area where I lived before coming back East Coast, a lot of people moving out, a lot of selling, you don't have kind of that balanced approach that you're seeing in other sections of the economy, but the market is clearly cooling on the price level, even rents.

Jeff (08:08):

And that's got to take investors into a little more of an optimism category here.

Marc (08:15):

Yeah. And I mean, if we were getting that slow trajectory in the economy pooling, I think that is good use for investors who maybe in September perhaps had built in some expectation and the market was, or the economy was just going to roll over, plunge lower based on Federal Reserve policy. So as we look at the consumer and talk a little bit about personal spending, again, back to you Jeff. You know how is Federal Reserve looking at personal spending, housing generally economic pooling? How do you think that policymaking body is digesting some of this activity that we saw last week?

Jeff (09:05):

Yeah, I think they're looking at consumer credit. I think when you get down into the weeds, So, again, kind of the big picture is consumers are still spending, they're may be getting less than what they normally got, right? Maybe you're spending the same amount on that grocery bill, but yeah, what's in your cart is a lot less than what it used to be. You're getting less for your money. Obviously, that's kind of the main street way of talking about what happens with inflation. You're getting less for your money. But what's interesting, and I think this is where the Fed really needs to focus on, is as we move in this dynamic where inflation is cooling, do consumers have access to credit, and do they still have enough buffer in their savings to help them limp along during this period where inflation is still hot? Even though inflation is decelerating, it's still hot.

Jeff (10:02):

And that’s kind of the key here. But from a consumer standpoint, obviously a large part of our economy the consumer is spending, I mean, look at air travel. Anybody who's been at the airport recently, I've been at the airport a lot these days, meeting with advisors and clients, and across the country people are traveling, people are going out to eat, people are buying services. That’s actually what drove a lot of the PC number, the recent inflation number. It's all about this massive demand for services, and the consumers are buoyant at this point, tapping into credit, tapping into savings, most likely. And you know, the key is, can they handle six more months of this before inflation really gets back down to something more reasonable?

Marc (10:53):

Yeah, yeah. So as, as we look at last week, we did have a good equity market, good for risky assets in general. We've got some fairly decent economic data. It's certainly data that would indicate that we are in fact pulling and not plunging, which is good news. And then we were getting the notion that participants are seeing some end in terms of Federal Reserve policy at some point early next year and feeling a little bit more constructive about the environment than perhaps they did during the course of, of September. So that was some of the key drivers last week. This week Jeff it's all about really the FOMC, it's all about jobs, but I, but we did get an IM Manufacturing number this morning. I didn't update it on this screen based on the timing of that number, but, I know you have a takeaway on ISM that you would like to share with folks.

Jeff (12:05):

Yeah, so we are recording as of Tuesday morning, and so we did find that ISM report on business very important because this is all about those that have boots on the ground that are buying, purchasing managers, those that are buying and tracking activity at the corporate level. And what I was just highlighting with some of the media contacts that we have at LPL Research is the fact that ISM purchasing managers have actually reported an outright decline on prices paid for inputs, the first time since May 2020. So we've definitely been talking about a slow down in the rate of inflation, but we’re actually just starting this new regime where we could actually say, hey we're entering this new phase, now, we're actually seeing outright declines. I actually hinted at that earlier in this recording about  apartment prices, rent prices specifically that had outright month on month declines, but first time here.

Jeff (13:10):

So this is certainly good news on Tuesday, but it's all about the Fed and specifically, it's all about the Fed's press conference. I think that's specifically what we're going to see probably be the biggest mover for this week. And that is no surprise in terms of the statement, you know, they're going to hike most likely at a 75 basis point. It's possible that we might see at dissenter, but probably not. They'll be unanimous. And, you know, whether they are unanimous or not, again, the big news will likely be in the press conference. This is not a time when they actually issue projections. However, December's going to be that. So next month, again, we're always forward looking here, just like markets are. December's Fed meeting will also include not only a statement on their decision on the on Fed fund's policy, but also a revised summary of economic projections. That's the multi-page document that issues the now infamous dot plot, which is basically the Fed’s dotting their expectations across all members of the committee. So it's not just those on the board, but also the regional presidents. And those dots represent all the individual views on rates and growth and inflation.

Marc (14:38):

So, what could we expect from maybe the market or how market participants may digest the FOMC meeting? What are you expecting to hear from the press conference?

Jeff (14:52):

Well, I think it's going to be a real similar playbook where the Fed's going to want to be careful during that press conference not to get investors ahead of themselves, or too optimistic about, ‘hey, we're talking about this point where eventually funds rates are going to be held flat or actually decline.’ I think the chair is going to want to be sure that he's setting expectations right? And he wants to be stable and calm, of course. You know, markets hate uncertainty. Markets hate quick moving activity. We want to see kind of slow and steady. That's what keeps volatility low. So, I think it's going to be this kind of tug between the markets wanting the chair to say something explicit about slowing down the pace of hikes, and I think the, the other side is the chair going to want to keep expectations very low, stable. It's slow and steady wins the race. And as they say, uh, Fed policy should be a boring job. Just like one of the Fed presidents said, quantitative tightening should be like watching paint dry. It shouldn't be that exciting because you don't want this kind of stuff to instigate any type of volatility in the markets.

Marc (16:23):

Well, so let's take that one step further, Dr. Roach. As the Federal Reserve exits its FOMC meeting, obviously they'll have the payrolls numbers at their fingertips, but you know, as maybe market participants, exit the FOMC meeting or the outcomes of that meeting and start focusing on Friday's payrolls number. We're looking at expectations that payrolls number in terms of private non-farm payrolls a little bit less than the month prior, kind of a slow easing, in that data series as well. Unemployment rate is expected to tick up relative to where it was in the month prior. How should investors digest those numbers in terms of what's going on in the autonomy, and again, what the Federal Reserve is likely to take away from that?

Jeff (17:17):

Yeah, I think, I think investors and the Fed's going to be pretty happy with kind of a goldilocks scenario where the job market's cooling. We know that we're seeing that we should see a little more movement from those not on the labor force moving into the labor force. And that's going to provide a little bit of uptick in the unemployment rate without inflicting among so much pain because it's not about people losing jobs looking for work. Again, it's about people that haven't been in the labor force at all now looking for work. So that's going to be a lot less painless way to see an uptick in unemployment, I think. I think one thing we didn't talk about when you were asking me about the Fed’s meeting that I think is equally important, perhaps one of the most important items right now as the Fed is less and less of a buyer in treasuries, there is a little more volatility according to some metrics in the treasury space. And so I think there might be some conversation about how they're going to continue to roll off their balance sheet and at what speed eventually the Fed's going to be, you know, quite a holder of mortgage back securities, especially right now, they're running off their treasury holdings a little faster than the run rate on mortgage back securities. So I think that they might actually talk a little bit about that, both in the statement and in the press conference to provide some sense of stability in the bond market.

Marc (18:58):

And if we look globally again, Dr. Roach, not just a U.S. economist or a global economist, and we're looking a little bit more difficult conditions in the Euro zone. I know at our Strategic and Tactical Asset Allocation Committee, you continued to point that out. That's largely evident in some numbers that we're seeing as we look at some numbers that occurred on Monday, October 31st, which was yesterday. If we look ahead of what to expect from the BoE, anything that you'd say is important for investors to digest from this calendar?

Jeff (19:40):

Yeah, to put it in a real nice little summary statement, I think we continue to see pretty much in every report that gets out there, that the domestic economy is in slightly better shape. A little more sure footing maybe, maybe not much. It's all relative, but compared to our European trading partners, inflation is still accelerating across the pond. And you know a lot more uncertainty about how consumers are going to weather the winter in the U.K., as well as in Germany, some of the other countries that are under immense pressure. And I think the big picture there is just kind of saying, okay, on a relative basis we're seeing a little more risk internationally. By the way, you even saw that in this morning's ISM manufacturing report.

Jeff (20:36):

I didn't talk about this component, but the export index fell at a greater magnitude than the general New Orders Index. Basically just saying that it's about a greater, faster, slow down, particularly in Europe. So that's I think in a nutshell what we're seeing. The challenge, of course, all is as you asked about, some of the central banking over there on the other side of the ocean. So the challenge is global central banks do like to operate in unison, or at least in harmony, maybe to play off that analogy. They may not be doing exactly the same thing, but they truly like to harmonize and coordinate. Of course, Japan is an outlier, but Bank of England, European Central Bank, Bank of Canada, those major players, and the challenge is when you see the U.S. experiencing a decelerating rate of inflation in contrast to what we see in Europe, that's going to make it a lot harder for international global central banks.

Marc (21:49):

Yeah. Yeah. That’s certainly fair. I mean, we've touched on a lot of this as we took a look through the economic calendar, FOMC meeting Wednesday, jobs numbers on Friday. What has been interesting to me is earnings season really is in full swing for the most part. 71% of companies that are reported S&P 500 companies have reported actual EEPs above estimates, which is slightly down from the average over the last five years, but still probably stronger than a lot of people had really anticipated. We are getting so far through earning season a 2.2% EPS growth in S&P 500 company earnings, in Q3, and that was as of Monday, October 31st. So an earning season that is perhaps a little bit better than some of the worst predictions that were occurring prior to the onset of earnings season, maybe added to some of the more optimistic equity markets that we've seen here in the U.S.

Marc (23:01):

I want to turn your attention, Dr. Roach, in terms of that talk and, and commentary around what the Fed may do in terms of Wednesday’s meeting that exceeds the general expectation. And if you would confirm for us is a 75 basis point hike and then there's an opportunity in the December meeting and early 2023 meetings, perhaps height at a decreasing rate. So talk about what that may look like as we move out in the months ahead in terms of the rate, height, basis, point, context, and then what that may mean for advisors and clients as they think about market position.

Jeff (23:52):

Yeah, so, this is the implied policy rate. So what makes it a little bit confusing for some folks is, you know, we often talk about the upper bound. So the Fed, you know, makes this decision when you see the statement, they're talking about a lower and upper bound, and then the daily operations, I think is what you need to think about in terms of what the implied rate is. So this is the implied rate here that we're showing on the screen. In shorthand, we like to talk about the upper bound, right? So what's that terminal rate? Meaning what's the peak rate that they're going to target from an upper bound? And we believe, the Fed's going to say, ‘All right,we can still front load, have aggressive hikes in November.’

Jeff (24:36):

The consumer can handle it so far, even though we do know that there's lags in, in the impact from rate hikes, but at this point, consumers seem to be handling it with some savings padded there, and, access to credit as well, kind of supporting spending. Again, we're, talking aggregate, so, you know, breaking it out by income. Quintiles, it's a lot different story, but November is coming up, the November hike, which is tomorrow, 75 most likely, and then this conversation where they're kind of starting to move to this new regime, inflation is convincingly slowing. And if they are certainly convinced, the Fed can now downshift to say, a 50 basis point hike in December, and then a 25 basis point hike in early 2023. And that gets us to, you know, in an effective rate of about four and three quarters.

Jeff (25:32):

I think what that does for investors is people are thinking through what does it, what does it mean for my portfolio, what does it mean about my decision to dial or cost average or contribute to my 401k, things like that. I think at this point, it's so helpful to remember we're not all about timing day in and day out moves in markets. We're talking in the next year, two years, maybe that's still very short term by the way, three to five-year outlook. The point is, we're seeing a scenario build out where the Fed has not  terribly broken anything in the economy. Yes, recession risks are rising, and we actually could see contraction in the first half of the year, but this recession is not going to be a deep recession like the great financial crisis.

Jeff (26:28):

So speaking of that recession, again, we don't need to be afraid of that word, right? I told clients recently, it's kind of like pruning in your garden. It's necessary for long term growth, or I analogy too: so it's kind of like when you walk into a concert, or more of a symphony concert, and you hear the instruments tuning, it sounds terrible. It sounds like cacophony. Well, the point is they're tuning. So when the concert begins to actually sound, okay, when they're playing together, conference board model, this is another way of looking at recession risks. We talk about the three-month, 10-year spread. That gets a lot of people's attention. The conference board also has an official model on recession that's helpful to look at as well. Yes, there's some false positives, meaning that this thing might give us a signal, and we actually might not actually ever fall into recession.

Jeff (27:25):

But at this point, it's close to a 90, I think the number is like 97% probability of recession happening in the next 12 months. As we talk to investors, the very natural follow-up question is, well, okay, maybe we're in recession because it's significant broad-based decline, and the National Bureau of Economic Research is going to say yes, recession, but is it deep? Is it long-lasting? Well, that this model is just a yes or no kind of model. It doesn't tell us how deep, and that's the value of looking at some of the indicators that we highlighted earlier in this call. So recession, yes, most likely first half of next year, perhaps even in December, we’ll start to see that, data, come in very, very weak. But at this point we're not seeing a deep recession, like a great financial crisis type of recession.

Marc (28:23):

Yeah. And, that's a key takeaway there, Dr. Roach, is that, and I know we've again talked about recession, we've talked about inflation, we've talked about, yields, market yields almost to an ad nauseum basis, in the Strategic and Asset Allocation Committee. But we've walked away with a base case that CPIs already ebbing inflation pressures are easing. The Federal Reserve is likely not to be that hard on the break anymore as we look months ahead, and you are going a recession that's not deep and long-lasting. Those are some constructive elements to wrap our, our head around, and perhaps again, more constructive than the market had gotten during the month of, of September, when it was all about doom and despair effectively. So, so we talk a little bit about this and as you touched on it broadly throughout this, this call, Dr.

Marc (29:26):

Roach is, you know, said nearing the end, how do investors think about that? We have a probability of a more shallow recession as opposed to a deep recession? You touched on that. We are getting some directional change in Federal Reserve policy going from 75 basis points, maybe to 50, maybe to 25 in the short months ahead, which is, is good for investors to see, good for the market to see, as the Fed begins to look at those inflation metrics that are in fact coming down. So the key question I think for the audience is what do you do about it? You know, how do you think about it? How should I move my portfolio accordingly to what we're, we're seeing out there happening in macroeconomics? And I think one of the areas of focus, again, that we've talked about as an asset allocation committee is core bonds are decidedly attractive at this point in time, and we have long discussed the woeful opportunities previous to this increase in market yields, the woeful opportunities that we had in income producing vehicles in this market.

Marc (30:43):

Well, that's been correct. Now if we look at all areas of the bond market, you are seeing some attractive income that's available to investors, we're suggesting they take advantage of some of those opportunities, specifically in core bonds as a primary focus, but also in U.S. corporate high yield as well. And if you begin to think about an opportunity to wade into the equity market, perhaps a good way to do that would be finding those ballast dividend paying U.S. equity names that perhaps you always wanted to own, , but maybe were more, more expensive a year ago two years ago, whatever the number is, and are now a little bit more attractive in terms of price, a little bit more attractive in terms of PE, but also decidedly attractive from a dividend paying perspective. So those are, how to think about it. Those are a couple things that we would point to as, as key takeaways from what's going on in the market. Dr. Roach, I’ll leave perhaps one of the last words to you. How do you think about this market in terms of how investors should be digesting some of what's going on?

Jeff (32:05):

Yeah, well, think I'll go back to our 2022 Mid-Year Outlook, managing the volatility, go working through it. And I think that's what's kind of the call to action here is the fact that the data is not suggesting a massive collapse. And so we manage through it, we hold through it. Certainly active management is valuable in terms of working through the volatility, but don't focus on the day to day, statements and news bits that come across the wire. I think that's distracting to the long term investor and what a long term investor wants to do with this portfolio allocation. So I'll leave it at the app.

Marc (32:38):

Well said, Dr. Roach and I want to thank you for joining me today. Again, Dr. Jeffrey, Chief Economist at LPL. I am Marc Zabicki, Chief Investment Officer at LPL. We, again, thank you for joining us for this edition of Market Signals Podcast, and we will see you next week.

Speaker 1 (33:15):

This material was provided by LPL Financial is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discuss are suitable for all investors or will yield positive outcomes. Investing involves risk, including possible loss of principles. Any economic forecasts set forth in the podcast may not develop as predicted and are subject to change. References to markets, asset classes and sectors are generally regarding the corresponding market index. All indexes are unmanaged and cannot be invested into directly. Index performance is not indicative of the performance at any investment. All performance reference is historical and is no guarantee a future results. All information referenced in the podcast is believed to be from reliable sources. However, we make no representation as to its completeness or accuracy. Securities and advisory services offered through LPL Financial, a registered investment advisor and broker dealer member FINRA and S I P C insurance products are offered through LPL or its licensed affiliates.

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In this edition of the LPL Market Signals podcast, Director of LPL Research Marc Zabicki and LPL Chief Economist Dr. Jeffrey Roach take a look at what Federal Reserve policy may look like in the coming months.  They also discuss cooling economic conditions and how this could be good news for the market and the Fed in terms of how it may affect inflation and near-term monetary policy.  Finally, they pinpoint ideas that investors should consider in this higher interest rate environment, especially given that high rates may not last a very long time.

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