Corporate Profits, Consumers, and Crystal Balls

Last Edited by: LPL Research

Last Updated: October 19, 2021

Market Signals Podcast

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Jeff (00:00):


Welcome to the latest edition of LPL Market Signals. Jeff Buchbinder here, your host for this week with Barry Gilbert, filling in for Ryan Dietrich this week, he is off enjoying his anniversary vacation. So Ryan, we miss you. I hope you're having fun. We will try to put on as good a show as possible for all of you today. Barry, welcome to the show. How are you today?


Barry (00:24):


I'm doing well, Jeff and it's great to be here joining you. I can't substitute in for, for Ryan. He is inevitable, but I will do my best.


Jeff (00:33):


Beautiful, well, here's what we got. Action packed today. We're going to start by saying goodbye to a great American, I'm sure all of you listening know who that is. Well, as we always do, we'll just give a quick stock market update and then move into the, you know, the bulk of the content here for today. Three topics. Number one, earnings season just got underway last week, so far so good, but we are seeing signs it's not quite going to be as good as it's been the last couple quarters. Next we're going to talk about consumers, which consumer spending is holding up pretty well considering the challenges. So we'll talk about the retail sales numbers we got last week. And then lastly given Barry's title as the LPL Research Asset Allocation Strategist, we are going to play stump the asset allocation strategists, say that 10 times fast.


Jeff (01:28):


So we'll ask Barry some tough questions and I'm sure he'll give us good answers. So let's,  start on a, on a somber note, Barry, we lost a great American yesterday, Colin Powell you know, this one hit home for me because I've seen him speak so many times. We were privileged to have General Powell speak at the LPL Focus National Conference, a number of times, including last year, actually, and really, really inspiring. So he will no doubt be missed. I think there's something that politicians on both sides of the aisle can agree on, really a great, great guy and really inspiring, dedicated his life to public service. He'll be missed. Do you have any thoughts? Barry, what struck you when you first heard, the news other than the obvious sadness?


Barry (02:30):


Yeah, pretty extraordinary person. I love his 13 leadership principles. You can Google it. You know, that's inspiring. My favorite is the 13th, I think is last potentially to highlight it. “Perpetual optimism is a force multiplier.” And there's somebody who knew about force multipliers as a leader within our armed services. So great quote, 13 principles of leadership from Colin Powell. Give it a look. It is inspiring.


Jeff (03:00):


Yeah, absolutely. I looked at those yesterday too Barry. You know, one is  “It ain't as bad as you think, wake up the next morning and things will be better.” There's the perpetual optimist that he was. “Get mad and then get over it.” I think those are certainly words we can all live by. “Share credit.” That's certainly something that we on our team here in the LPL Research department try to do every day. No doubt a very positive message. I think. So those are some, but yeah, I'd encourage all of you to look at those 13 principles. They're really good. So Colin Powell, we'll, we'll miss you. And thank you for all you did for this country. So moving on there's no good transition from that. So let's go to the quick stock market, outlook Barry. So we had you know, the 5% pullback and rallied right back again. Now we're less than 1% from the all-time high, I believe, as we're recording this on Tuesday morning, really a nice bounce back. The latest rally, I think, has been, probably driven more by earnings optimism than anything else. We bounced back above the 50 day moving average, we're in the positive seasonal time of the year. Things are set up pretty well here for another rally. What do you think?


Barry (04:28):


I think things are well set up. Earnings is the basic driver of the stock market. That's the most important thing. And we've had just an absolutely incredible earnings story in the earnings season just launched. And when you see earnings driving the market those are the right things being lined up. So pay attention to the earnings story. It just started, earnings season and it's going to continue to evolve, but so far so good. That's, that's really your area, Jeff. What have we gotten from earnings season so far?


Jeff (05:01):


Yeah, it's off to a good start. Probably a little better than I expected. We'll get more into that a little bit later on in the podcast, but yeah, so far I've been impressed. I guess the one watch out is we've had a lot of financials and those are the companies that aren't really as impacted by the supply chain disruptions. They're a little bit impacted by the wage pressure, but you know, to really get a good feel for the impact of the supply chain disruptions and materials shortages, and all that, we need to hear from companies in other sectors. So that that'll be a key to watch. So let's, let's move on you know, pretty positive near-term stock market outlook. Talk about the consumer, Barry. So got retail sales last week, and they were really good relative to expectations.


Jeff (05:50):


You know, that blue bar, for those of you watching on YouTube, the blue bar doesn't look like it's up much, but it was about a one percentage point upside surprise versus economist consensus expectations, that's a big upside surprise. Now, you know, there's a lot of challenges facing consumers right now. We, you know, we're all know most of them are COVID related, right. You know, a lot of jobs are hard to fill and a lot of goods are tough to get, and that makes it tough for retailers to actually, you know, fill the orders that they've got. So that was a headwind. And then you still got shoppers, some at least shoppers, a little bit concerned about the COVID environment, which is still affecting consumer behavior. Despite those challenges to see this strong month-over-month gain in retail sales was really encouraging. Thoughts on that, Barry.


Barry (06:47):


Yeah, this tells us that there's still strong demand out there. We know that we have supply chain challenges. We know that they're weighing on the economy. But as those resolve themselves, is the demand going to be there? And at least when you look at the picture from the American perspective, the American consumer, the answer seems to be, yes, there was rotation in spending from services to goods, with COVID that means service spending levels are still low. Those are going to come back as the environment comes back, the demand is there. Savings are, are, are fairly strong right now. Overall, it's a good picture from consumers, consumers drive, depending on how you look at it, two thirds, 70% of the U.S. economy. So found this encouraging.


Jeff (07:34):


Yeah. We’re not going to see the same kind of consumer spending growth that we saw in the second quarter. You know, the economy has slowed quite a bit largely because of Delta. But consumers are still in great shape, agree, a hundred percent with all those savings. You know, stock portfolios are up, housing prices are up. The wealth effect is certainly helping all that savings that you mentioned, Barry. So we think the outlook is, is quite positive for consumer spending over the next couple of quarters, no doubt. And  as you mentioned, big, big driver of the economy, so positive story there which should help support the economy and stock market. Actually, one last thing on consumers, I noticed there's something called the financial obligations ratio, which compares debt service costs to discretionary income. So basically you know, how easy is it for consumers to pay their debts?


Jeff (08:34):


And that measure is essentially at a 40 year low. In other words, consumers incomes are covering their debt at the highest ratio in about 40 years. It's really tremendous and just points to how good a shape consumers are in right now. So let's go to earnings. I kind of gave a sneak preview there. But let's dig in a little bit deeper. So we expect a really strong earnings season in terms of growth, but as you can see on this chart for those watching, going to be a lot slower than last quarter. Well, why is that? It’s because we have much easier, we had easier comparisons last quarter, right? You're comparing to Q2 2020 last quarter, which was when the lockdowns were. This quarter, we're comparing to Q3 2020, which was certainly a quarter that saw a lot more economic activity and a lot more in terms of corporate revenues and profits.


Jeff (09:37):


So don't pay too much attention to how big that slowdown is, right. We're probably looking at slowing from 90% growth to 35, maybe a little better, maybe high thirties, but that is still a really strong growth. So that's really, I think the first key point to keep in mind. This a strong gain in earnings, companies still in good shape. Now because the supply chain disruptions are intensifying. And frankly, you know, these labor shortages and material shortages are really throwing a lot of kind of wrenches at corporate America. We're probably not going to see as much upside as we saw the last couple of quarters. So coming into the last couple of quarters, we saw about 25% upside you know, maybe we get 10% upside this quarter, but that's probably as good as it's going to get. That 10% upside would put us in the high thirties.


Jeff (10:39):


We haven't seen estimates rise as much. We've seen more negative pre-announcements. It's still a positive story. We're still hearing more good things than bad things, but the ratio of those pre-announcements has weakened a little bit over the last couple of quarters and that suggests less upside. So yeah, that's what we, what we see. You know, we're only about 10% in terms of the number of companies that have reported and we're seeing good beat rates, right around 80%. We're seeing nice upside surprises, but again, it's mostly come from financials which don't face quite as many challenges as traditional companies. So what are we watching? First, how long will the supply chain issues last? We're going to be listening closely for, to hear from companies about their thoughts on that. I mean, we've heard from a number of companies, how difficult the environment is. Procter &Gamble was the latest this morning to try and to raise prices, to offset the higher costs.


Jeff (11:41):


It's not easy. You know, other companies that have expressed a concern, Sherwin Williams, Nike, FedEx, companies across a variety of sectors. There are certainly others struggling with the supply chain issues. It’s probably the number one issue for corporate America. Number two, outlook for wage increases. This concerns us a little bit, probably be a bigger problem in a quarter or two than it is right now, but wages are up solidly year-over-year. That probably will continue because if you can't fill a job, tend to pay more to attract talent, that is going to eat into corporate profit margins. And we may see a little bit of a margin compression in Q3 relative to Q2. And the last thing, you know, because we're going to probably see smaller upside surprises, it makes sense that stocks would not react as positively to upside surprises.


Jeff (12:40):


We're already seeing that. Actually, if you look at the companies that have beaten estimates so far, those stocks are only up about 1%, which is not much, that's fairly typical, but not much when you compare it to how much the stocks that miss earnings are being punished. They're down about four to 5% on average, so far. That's a little bit bigger of a negative reaction than we typically see. So there's another kind of piece of evidence that this is just a trickier quarter and you know, investors are a little bit more on edge. So I guess with that, let me turn back to Barry and see if you have any questions or concerns or that I didn't mention, Barry, about earning season, or just any thoughts in general.


Barry (13:25):


Yeah, I think one of the keys with wage increases is going to be whether productivity can increase, if people's wages are higher, but at the same time they're growing more productive because they have access to more or better technology. It can offset some of those wage increases. So concerns about that pressure, certainly. But also want to see what's going to be happening on the productivity side


Jeff (13:52):


Productivity so important in containing inflation. It's generally helped, I would say during the pandemic, but that task is getting certainly tougher with the labor shortages that we've seen the increase in wages and the fact that we've already invested so much in technology. Incremental gains might be tougher to achieve. Osgood call out there, Barry So next is the part of this podcast that Barry’s been dreading for the past 24 hours since we figured out that we were going to use this, this format. We are going to play stump the asset allocation strategist and ask Barry three tough questions. I actually, Barry, I thought about not telling you what the questions are in advance to really make this tougher, but unfortunately you do know what the questions are. You didn't have a lot of time to think about it though, cause we just came up with these last night. So there's still a risk that you get stumped. So  let's move on and we'll ask these, these three questions. So question number one, stocks have come a long way. Does it still make sense to overweight equities? What do you think?


Barry (15:16):


Yeah, I'd asked the people out there, think about that for themselves first. My guess is a lot of people said no. They thought about it in their own minds and historically that's actually good for markets pessimism about markets is a positive. And you do see in sentiment right now that there is pessimism out there right now for markets. The most dangerous time for markets is when people believe that markets can never go down and everybody's buying because of fear of missing out, that's pretty solid support. You look at the outlook overall for the economy, we're facing some important headwinds, but the growth outlook is still above the trend that we were in, in the last expansion, that supports in particular sales for companies which gives a little bit of a boost to earnings growth as well.


Barry (16:11):


We already talked about the fact that for stocks, that earnings are really the most important fundamental you know, we did mention that there was a lot of technology adoption, might still have a little bit more room to run. There might be some benefits from that. We've seen the workplace flexibility, companies have just gotten better at running lean and running smarter at the same time. It's a pretty incredible response. So you talked about earnings season a tougher earnings season, but still things that are supportive probably just overall economic growth as the first, as we said with retail sales, demand is still out there. Just a question of supply catching up. So you take the overall sentiment, which liens negative right now. That's actually positive for stocks. You look at the economic backdrop, which is still supportive and even if the earnings environment is growing more challenging, we do still think it's a good environment for stocks. And so we do think it still makes sense to overweight stocks. Throw in one last thing, which is bonds. Interest rates are low. That's good for stocks for two reasons. One, it means that their borrowing costs are low and they can invest more easily. The other one is it means that the expected returns for bonds are low and that makes stocks more attractive, put those three things together, and we think you have a pretty good picture for stocks. We're still overweight.


Jeff (17:42):


I think you handled the first test pretty well there. I think calling out bond yields at the end there is a really point for me because even if stock returns going forward might be a little bit more modest. Well, maybe a lot more modest than what we've seen over the last 18 months that hurdle to clear to outpace bonds is pretty low. So let's go to the second one. I didn't swap in a question you haven't seen. It is, although this I think is probably the toughest question of the three, international equities are really cheap. Is it a good time to add exposure? Barry, international equities have been a value trap for quite some time, at least based on relative performance, frankly in at least developed international markets have been very weak recently. So what do you think, is now a good time to jump in?


Barry (18:36):


Yeah, let's take emerging markets first. I think that, that one's a little bit easier for us. Emerging markets now, just because of the size of its market, fundamentally means China. We still have concerns about the arbitrary and heavy handed increase of regulation in China. And really the challenge there is that it creates unknowns. It could happen at any time, in any way. Investors don't like unknowns. We already do see it weighing on the economy in China, I believe. So there's a little bit of backing off at this point, but that, that remains an ongoing concern. So we're shying away from emerging markets a little bit. We still like the overall growth prospects. It's not just China. But shying away from that direction. The harder decision is the international developed equities and the U.S. We think that the picture for internationals looking better, we still favor the U.S.


Barry (19:38):


We favor the U.S. because of its emphasis on tech, which has allowed it to control margins as value improves. That is a little bit better for  international. But we've liked the flexibility that you see in the, in the U.S. you know, we've also seen a strengthening dollar, which has favored the U.S., that's another trend that might reverse. So we're watching for things for international to become more of a favorite. We're not there quite yet. But we're having active debates, we're having active discussions. Our view would still be overweight the U.S., underweight emerging markets, stay largely neutral international developed because there are actually some good stories there. Now Jeff, you talk about international equities take a look at this regularly. What are, what are you seeing right now?


Jeff (20:31):


Yeah, I think I think we've got to move past COVID globally. Hopefully that happens soon and, but once we do, and we can have a synchronized global economic expansion then you know, the rising tide lifts all boats. That may be when Europe and Japan start to perform as well or better than the U.S. So that's, that's really the key for me. And I mean, you mentioned the dollar that can certainly help if we do see a reversal, dollar has been very strong recently, dollar weakness combined with a coordinated global economic expansion, I think could be a good recipe for Europe and Japan. But unfortunately we're just not quite there yet.


Jeff (21:18):


So thanks for those thoughts, Barry., Let's go to the last one. Yeah, I guess this is probably just as tough as the international questions. How do you get income for bond portfolios? Right. Rates are very low. It's been very frustrating. Savers are being punished by you know, the Feds low rate policy, certainly, and market-based interest rates very, very low. It's so tough to get income. There's no panacea for this problem, Barry. But can you share some ideas with our listeners on, on maybe where to get a little extra income right now?


Barry (21:52):


Yeah, if you want a little extra income, you have to take on a little bit of extra risk. And the key question is really where should you be taking it? So one opportunity  that we see to diversify a high quality bond portfolio is to look at the bond sector called bank loans. These tend to be floating rates, so they're not as sensitive to interest rate increases. They tend to be higher up in the capital structure. So should they default, their recovery rates tend to be better. And again, it's risky, right? It is a riskier asset class. We're no longer in the investment grade universe. But when we look, when we look at the different options that we have, we think that that's one way to add a little bit.


Barry (22:45):


If you're looking at a payoff for relatively low interest rate risk and the high quality universe we still like mortgage backed securities. So that's not necessarily going to increase the overall income, but it's going to increase the income for the amount of interest rate risk that you might be taking on. Interest rate risk when interest rates go up, stock prices, sorry, bond prices go down. Interest rates up, bond prices down. And so the more interest rates sensitivity that you have in the portfolio, the more vulnerable you are to that. Both mortgage backed securities and loans, they help insulate from that a little bit. So we think that those are two good options. Keep the loans position fairly light because it is risky. But it will add to the income.


Jeff (23:36):


Yeah. And we do think rates are going to gradually rise in the years ahead. And so, you know, at some point those yields will start to look more attractive and it'll be a little bit easier, but we're certainly, you know, we've been struggling to find income for a decade, you know, probably going to continue to struggle you know, for the next couple of years, but rates probably still headed higher. It's just it's going to be a slow grind. So thank you for that last answer, Barry, we got through the three questions. I don't think we stumped you. So nice job handling those. Certainly these are a lot of questions we're getting from our 19,000 LPL advisors regularly that, yeah, these probably are, these might be the three most common questions we've been getting lately, other than questions about D.C. and the goings on there.


Jeff (24:30):


So the last thing we’ve got,  just a couple minutes left. It's just kind of preview of the week. I mean, it's earnings, earnings, earnings, right. We get 80 S&P 500 companies in total this week and everybody, ourselves included, are going to be looking for the supply chain updates, right? I mean, we've got, I saw a stat the other day. I think Bloomberg was tracking the number of times the phrase “supply chain”  was uttered  in a conference call. And it was like thousands already. I mean, just it's really all supply chain and wages. It's really all I think that people are going to be focused on this earnings season. Cause we, we, we know that the demand picture is pretty good. So we'll be watching that closely. Of course, we’ve got to continue to watch COVID trends. And then D.C. negotiations. I mean, really, the economic counters and that interesting this week. Even the D.C., situation's not that interesting cause you know, Barry, we just talked about this before we jumped on here. It might just be a behind closed doors this week and next week when the, you know, the Halloween deadline approaches for the infrastructure package, that might be where it gets more interesting. Right?


Barry (25:49):


Yup, yup. Completely agree. We know that the Democrats have a narrow majority in the house and in the Senate, that means that you have to keep everybody happy and that's tough in a, in a group of large people. And they're trying to figure that out behind closed doors right now, see if they could have arrived at a compromise, but it's not going to get interesting for markets until they get a better sense of what's actually going on.


Jeff (26:14):


Yeah.This negotiation is going to be fascinating to watch because the moderates are really holding their ground. And it has it'll impact virtually everybody, right? I mean, cause we're talking about you know, taxes, big time spending and big time tax increases. So we're still watching, but we're probably not going to get any breakthroughs this week. We'll see. But keep, keep D.C.  on your radar. It's nice though that the economic counter’s quiet so we can focus on earnings because that no doubt is what matters most this week. So I'm going to end the call. You know, we started on a somber note with some thoughts on Colin Powell’s passing and on a happier note, which is today is my daughter's birthday. So happy 10th birthday, Emily looking forward to celebrating with you and family tonight on Zoom.


Jeff (27:06):


Most of my family is, actually all of my family is not in Boston, so we do a lot of Zooms. So it will be fun. We actually had this local rescue zoo bring some animals over last weekend. And Emily had some friends over, which was, which was a lot of fun. You guys can ask me offline about some of the funny animal stories. We could have had an alligator and a snake. We chose not to do those. We did more of the cute, cuddly, furry type animals for her party over the weekend, which was, which was a lot of fun. So  happy birthday, Emily, happy number 10. I love you very much. So with that thank you all of you for listening and thank you Barry for joining great, great content today. We were able to pack a lot into a half an hour. And Ryan, we missed you. We'll be back. It's probably going to be myself and Ryan next week, but the most important information y'all need is that Ryan will be back. He does such a great job. So looking forward, looking forward to having Ryan back. So with that, thanks everybody for joining. Really appreciate it. Thanks for listening to another LPL Market Signals podcast. We will be back with you next week. We'll see you then. Thanks.


LPL Financial Strategists Jeff Buchbinder and Barry Gilbert preview third-quarter earnings season. LPL Research expects solid earnings growth for S&P 500 Index companies in the mid-to-high 30s, though upside surprises are unlikely to be as big as in recent quarters. As the numbers roll in and companies share their thoughts on the future, Jeff and Barry are interested in how long companies expect supply chain issues and materials and labor shortages to last. Wage pressures are also of interest.

Retail sales came in much better than economists’ expectations for September. The solid numbers came in the face of both demand and supply challenges related to COVID-19. Considering consumers still enjoy significant excess savings, rising wages, and a healing job market as COVID-19 cases decline, the gains perhaps shouldn’t have come as a surprise.

Finally, Jeff and Barry discuss some of the toughest asset allocation questions facing investors these days. Elevated domestic stock valuations following strong gains since the pandemic lows coupled with low interest rates make for a challenging asset allocation environment. They gaze into their crystal balls to try to help investors by addressing these tough questions.

Tune in now

Listen to the entire podcast to get the LPL strategists’ views and insights on current market trends in the US and global economies. You can subscribe to Market Signals on iTunesGoogle Podcasts, or Spotify and find us on the LPL Research YouTube channel.



This material 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 discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. 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 of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.

Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities. All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

All index data is from FactSet.

All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

This Research material was prepared by LPL Financial, LLC. 


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