Epic Week for Market Watchers

Podcast Intro:

From LPL Financial, welcome to Market Signals.

Jeff Buchbinder:

Welcome everybody to the latest edition of LPL Market Signals. Jeff Buchbinder here, your host for today with my friend and colleague, Marc Zabicki. Marc, how are you today?

Marc Zabicki:

Doing well, Jeff. Fresh off of Focus. More than glad to be with you.

Jeff Buchbinder:

Excellent. Well, thanks for joining. I promised a couple weeks ago when we did the last podcast that we would be rotating in different folks. So, Marc, it is your turn. You are on the hot seat. So, here's what we've got for you today. I mean, what a week, last week was, interesting timing for us to have our national conference because it was just so much going on. You had the Fed meeting where of course they raised rates again 75 basis points. You had the GDP report, which really had more meaning I think, than your typical GDP report because it did make for a second consecutive quarter of negative GDP, which a lot of people think is a recession. That's kind of the back of the envelope way to do it.

 

But we actually would not call it an official recession just yet. We'll explain why here in a little bit. And then lastly a huge flurry of earnings. We had over 170 S&P 500 companies report, so we'll try to pull out some themes from that. I mean, I guess the bottom line here is the market took all this in and really liked it, Marc. I mean, we I'm showing a chart of the S&P 500 now. You know, we're well off the lows here, sort of double-digit bounce. And we got about 4% last week. We had a similarly strong week the week before that. So maybe the question for you is this rally gone too far? Is this still a bear market rally that needs to roll over here a little bit and take a breather?

Marc Zabicki:

Well, actually and that is the $64,000 question, Jeff. I mean, I think we, as a Strategic and Tactical Asset Allocation Committee at LPL Research, are still trying to dig into that very thing. I mean, I think we called it correctly when we raised our equity allocation across the models that we manage and raised our view on equities at the start of July. That has served us well. And the impetus for that was effectively a little bit of what Chairman Powell gave us last week, meaning that maybe the Federal Reserve is going to be a little bit less dovish than maybe the market had priced in over the last two or three months, call it. That was one. And then we've also singled out the effect that you typically get in July, at least historically, where the market, you know, typically bounces back during the course of that month. And we've seen that. And those are the things that we had been part of our focus anyway in raising our equity allocation in July. And we're still trying to figure out, we'll talk a little bit about it, whether that's going to continue or not. Right now, we're not getting great signs that it will, but, you know, we're still looking at things technically as they develop.

Jeff Buchbinder:

Yeah, you are a technician of sorts. So, I know you have some technical indicators you want to look at. I mean, I guess this is a really strong balance. I mean, July, we were up 9% on the S&P 500. That was the biggest gain in July for that index in over 80 years. The biggest July in over 80 years, it was the best month since November of 2020. So, really powerful bounce off the lows. And, you know, there are a number of reasons for it. One, certainly was the fact that so many were bearish, right? We saw investor surveys continue to point to an extreme level of bearishness that you typically only see at major lows, like 2001, 2008 type, 2020 type lows. So, that was certainly one thing. And then you had the market get a little more comfortable with the Fed and the inflation outlook too. So, that led to this bounce. So, Marc, are these technical indicators telling us anything about this bounce and whether it sticks. We've got I think we got three slides here on some technical indicators that maybe some folks listening are not familiar with.

Marc Zabicki:

Yeah, sure. And just a couple things that, you know, we as a group kind of pay attention to. And I've historically been a MACD follower. So, the bottom part of this slide is really the daily MACD and then I also just as almost a staple of technical analysis, pay attention to moving average crossovers, which the upper panel shows the 10-day, the 20-day and the 50-day. And as you get crossovers in succession 10 over the 20, 20 over the 50, et cetera, et cetera, you typically get a little bit more confidence that the rally is sticking. So, we're seeing the 10 over the 20-day, which is a good sign. The 20 over the 50-day, which is still not crossed yet, but developing, and obviously the MACD turned positive in late June, which again, gave us some semblance of confidence that we had gotten a little bit oversold, you know, through the spring months, and we were ready to bounce in in the month of July. And that has in fact happened.

Jeff Buchbinder:

Yeah, we were about as oversold as it gets, and certainly makes sense that we would get this kind of bounce. So, yeah, the MACD is the moving average convergence divergence indicator. Actually, I think Jim Kramer from CNBC is a fan. So, some of you may have heard of this indicator before that aren't watching closely. Some folks refer to these as oscillators. It's basically a measure of momentum. And you know, certainly in July, we got a lot of that, Marc.

Marc Zabicki:

Yeah. And again, you're pointing here to the directional movement index, which is just another kind of a trend indicator that shows like really a confirmation of the MACD, maybe a confirmation of the moving average crossovers we have witnessed so far. So, again, you know, while I'm historically a MACD watcher, it's not the sole thing that I pay attention to. You've got to pay attention to other indicators that confirm some of the, you know, the indicators or add your tools to the toolbox and get technical confirmation about the rally that we've seen, you know, so far. And this is just one of those indicators that does that for us.

Jeff Buchbinder:

Yep. So, you know, I would say we've made quite a bit of progress carving out a low, but we're not quite there to where we can sound the all clear. So, you know, I don't know if this kind of look at the MACD, Marc, gives you more insight into that question, but, you know, we just haven't seen the surge and the breadth combined that, you know, I follow several technicians, certainly don't purport to be one myself, but you know, what I read is you know, a lot of folks look at percentage of S&P 500 stocks above the 50-day moving average, and we're only at about 77%. We want to get to 90, right? Yes. That would be one sign that we can waive the all clear, right?

Marc Zabicki:

And I think, you know, oh, I think Jeff and I, you, we both said this actually, I mean, if you're going to be an asset allocator in this market, which we all are, I mean, you have to follow fundamentals and technical. So, this weekly MACD is a little bit more interesting to us than just simply the daily, because I mean, obviously this shows definitively in the arrow that the market's been under some severe pressure for several months now. And when you get, you know, a bottoming in that pressure and actually the weekly MACD has turned positive, which is interesting to us. And I'm glad you mentioned the breadth aspect because that is indeed important. While we're getting some of these early indications that this trend could be, you know, off and running a little bit, we still don't have the breadth in the market that kind of gets you excited and believing that this is going to be a multi-month process in terms of continuation of the trend. So, we haven't gotten that yet, but we're keeping our eyes out for that.

Jeff Buchbinder:

Yeah. So, progress, no doubt has been made, but we're not waving the all clear just yet. Although, the odds that we actually go back and retest the June lows, it's fair to say, have fallen given the progress that we've made technically anyway, you know. The fundamentals are a little more challenging because we got, we're going to have to wait a while for inflation to come down, unfortunately. And that's the key driver here. That's what drives the Fed, of course, we're going to have to wait a while to see whether the Fed actually pauses this year or not. But the technicals certainly are encouraging. Another sort of segment, I guess you could say of technical analysis is seasonality. And so, we're now moving into August. We're recording this on August 1, late afternoon. And we've got you know, a month that is really weak seasonally,

 

if it's a midterm year. On average, August is down. It's one of the weaker months on a midterm year. But the good news here is if you look at the past 10 years, that's the orange bar for those watching. You've got, you know, on average, pretty solid returns. I think the average gain is around 0.7% in August over the last decade. That actually ranks pretty good. So, you know, seasonally, maybe you could say kind of a mixed signal, but you know, certainly not necessarily a disaster, but you look at September right around the corner, right? That's seasonally the weakest month. Now the counterpoint to this is in midterm years, you tend to see a bottom in August, right? So, even though the, you know, typically you get a weak September, if you average all the midterm year bottoms, it's August.

 

So, you know, we don't have a lot of political uncertainty heading into this midterm cycle at least in my view, because it seems like the market is pretty and the odds makers have a high degree of confidence that we'll have divided government after the midterms. Maybe that enables stocks to do a little bit better here over the next couple of months. So, we'll watch the seasonals, but it's really not, frankly, not a real high conviction signal in either direction right now. So, let's turn to the Fed, Marc. We just had a really good conversation about the Fed earlier today in our investment committee meeting. You know, you could hear what you want to hear from Powell.

 

I mean, some people thought he was dovish, some people thought he was hawkish, right? Frankly, my opinion is the market got a little bit too excited about pricing in this, this pivot, right? But it got a little bit of evidence from Powell, and he seems to be a straight shooter, that the next rate hike will probably be smaller, right? He signaled 75, so I mean, he signaled 50 rather than 75, and the market seemed to like that. Which side are you on? Do you think he really sent us a signal that we can really bank on? Or is it just, you know, people kind of hearing what they want to hear?

Marc Zabicki:

I don't bank on it is the operative phrase, I think, Jeff, I mean, I don't know that we were banking on it quite yet. I mean, and that's kind of why we get together on a weekly basis. That's an asset allocation committee, right? To talk about those very things. So, I believe, and we'll see if this actually transpires as I believe that we are going to get, we are going to, we're starting to see some semblance of a directional change in policy and call it a slowdown, a stop. And then some are calling for the Federal Reserve to get easier with policy in early 2023. So, there's, maybe there's a transition between the Federal Reserve not being your friend here for the last several months based on tightening policy to becoming a little bit more friendly for risky asset prices over the next, call it, you know, six months or what have you.

 

So, Powell seemed to signal that transition may be in some semblance of process. And, you know, granted, you know, we've got, you know, the midterm elections coming up. We've got economic conditions that are still getting a little bit more uncertain. But, you know, the 800-pound gorilla that drives the bus often, perhaps too much, is the Federal Reserve. And if it's going to change direction about the way it thinks policy should be prescribed in the U.S. and globally, then we as asset allocators have to pay attention.

Jeff Buchbinder:

Yeah, absolutely. So, you know, rightly or wrongly, the market took that signal and priced in fewer hikes. So, what we're showing here, this is a chart from our Weekly Market Commentary that just came out today where we discussed the Fed and the GDP report and earnings. And you see here, over the six weeks from mid-June to the end of July, after the Fed meeting, market took about 60 basis points out of its peak fed funds rate forecast. This is what's, you know, the bond market is pricing in, but the highest fed funds rate of this cycle was looking close to four now more like 3.3. So that's taken out two and a half hikes. This is a meaningful move. So, clearly the market got enough to make this move. You know, that's more aligned, I think with where the LPL Research Department thinks the Fed will end up at the end of the year.

 

In other words, maybe three and a quarter, maybe higher, maybe lower, but 4% seems too high. And then if you look out to 2023, the market's actually pricing in cuts in Q1. So, that may be too quick for cuts, but the market took the signal and really moved. And you've seen the 10-year come down the yield, you've seen the two-year yield come down, and that's been supportive for equity prices. So, let's move forward and talk GDP next, Marc, recession or no recession. You know, I think this question gets maybe a little bit too much attention right now. I think it's a matter of degree, right? A mild recession or a stagnating and flat economy is very different than a severe recession, right?

 

And you see in a lot of ways, you know, in terms of what we all feel as consumers and what businesses feel and in terms of how the market responds, right? And so, you know, you'll hear people talk about how the average recession stock market's down, you know, maybe 35%, right? But in mild recessions or mild bull market in mild bear markets, which is what we think we're in, you typically see, you know, down 20, down 25, we already did down 23 and a half. So, we have already essentially, at least in mid-June, priced in a mild recession. So, whether we get a mild recession or not, I don't know if that's the most important question. There are a lot of other questions that are going to be key to driving this market, but this one might be getting overplayed. What do you think about that, Marc?

Marc Zabicki:

Yeah, I would agree with that, Jeff. I mean, I think, and again, we've talked about this, you know, almost ad nauseum in our committee meetings, but I think the key is do you look across the economy particularly in the U.S. but other areas of the world and see a definitive imbalance such that you saw in housing during the Great Financial Crisis, or a long-term capital management or a Lehman Brothers. And we're not finding that, you know, sometimes it sneaks up on you and comes around the corner when you're not expecting it. But overall conditions, we would argue don't set up well for that type of a surprise. Again, you look at the consumers relatively strong from a balance sheet perspective. I mean, there's been some debt built up in corporate America, but we're not a believer that the 10-year is going to five, 4%, 5% or beyond. I mean, here we are today at 2.6, and who would've thought that, you know, a month ago? So yeah, I mean, a recession, a mild recession's probably in the cards as our Chief Economist, Jeff Roach would tell us. But I don't think any of us are expecting for it to be more definitive. And nowhere near as rocky as what we saw in the Great Financial Crisis, for example.

Jeff Buchbinder:

Yeah. That certainly good news. So, you know, still, you know, the clients, people out there are asking the question, they want to know the answer. Are we going to have a recession, are we in a recession? And so, we will answer the question at least as how as we see it, right? And probably the best way to answer that is by looking at this chart. And this just breaks apart the components of GDP, right? We got the GDP report for Q2 last week. And you break that into pieces, and you can see here, I just want to draw your attention to spending on services, which is in orange, right? In Q2 that was really nicely positive. That is essentially a lot of consumer spending, right? Consumers spend more on services than goods. The services economy is actually bigger than the goods economy. If the services economy is doing so well, the job market is slowing, but it's doing pretty well.

 

And consumer spending is doing pretty well, still. It's really hard to imagine that the economy will meet the definition of recession that the National Bureau of Economic Research has said. They've been the official arbiter of recessions for close to 200 years now, I believe. And they need to see weakness across multiple sectors. And if the biggest sector of the economy is strong, even if it's weakening, but still strong, still growing steadily, that they're probably not going to declare a recession in the first half. Now, we could get one later in the year, we could get one in early 2023 as Jeff Roach tells us. But it is highly unlikely that there is enough weakness in terms of the breadth of the economy for us to be in recession already. I think that's a really important point to make. So, we think there'll be a little bit of a bump up in GDP in Q3 as we get back some of the, you know, some of the drag from Q2. You know, we had a big inventory drag, for example, should be able to get some of that back. We'll have to see. But certainly, this alone doesn't tell us we're in recession. So, Marc, you wanted to highlight leading indicators too as another sort of recessionary talking point. What is this telling us?

Marc Zabicki:

I mean, and this is something I pay close attention to on a regular basis, is that it's the slope of a three months moving average of the LEI in blue and the slope of the six-month moving average in orange. And the purpose for this is just to, again, try to monitor directional change in the LEI. I mean, if you look at the chart of the LEI over a period of time, it's slow moving indicator. So, this just captures a little bit of that directional change. And you can see one, and we've inserted a darkened zero line here. When it crosses below zero, it matches historically some recessionary periods, which catches your eye in this chart, but what also catches your eye at the times that it closed below zero on occasions in 96 and 98, and in 2011 and 2016, where a recession wasn't present.

 

And we were starting to get some negative indications from the three-month moving average and probably to follow the six-month moving average. That'll give you that same type of a signal that, you know, a risk of recession is upon us. And, you know, I particularly liked your explanation, Jeff, about the breadth of the economy. I think that makes you know, perfect sense. We haven't gotten a breadth of weakness across this economy. And we are getting some indications of weakness from the LEI, but we're not quite there yet in terms of both lines, you know, kind of getting below the zero line. So consequently, the jury's still out in terms of recession, but if this shows nothing less well than the following, it shows that we're closing it.

Jeff Buchbinder:

Yeah, I mean, it's not a strong economy clearly. So, you know, we don't want to sort of minimize the weakness, you know, the slowdown is certainly affecting some people. We're seeing an increase in layoffs. We're seeing higher filings for jobless claims, right? So, you know, it's soft, right? This is why you're hearing the term stagflation from so many folks. But, you know, in terms of our market outlook with the, you know, with the market down, like I said, 23, 24% at the lows, now we've of course bounced and we're, you know, down sort of low teens, we're still pricing in a lot of negativity and that negativity, right? The stock market climbs a wall of worry that can continue to come off and stocks can still go higher. So, important distinction there. So, Marc, let's turn to our next topic, or really our last topic, which is earnings. And I think it's fair to say that corporate America has impressed again.

Marc Zabicki:

Yes, indeed.

Jeff Buchbinder:

Yeah, even though the numbers don't look great. And remember, stocks were up 4% last week when we got 170 S&P 500 companies reporting. Those individual companies that reported were probably those markets, those stocks, were responding as much to earnings as anything else, right? I mean, just look at Amazon, you know, rallied 10% plus on its results, and there are many more examples like that. So, clearly the market liked it, clearly expectations were really low. But here's what's impressive to me. You know, we have a really strong dollar that's clipping international earnings for U.S. multinational companies, taken probably two and a half, three points out, right? We have a slower economy we just talked about, and we have intense cost pressures that didn't really get much easier in Q2, <laugh>, right? I mean, they got a little bit easier in June, but those cost pressures were pretty intense. And yet the S&P 500 was able to generate 6% earnings growth, so far. We've still got a couple hundred companies left to report, but 6% pretty darn good. That's a couple points of upside. And you can see here on this earnings dashboard graphic that we do, that the beat rates are pretty good too. 67% for revenue, 72% for earnings. This is a really impressive set of numbers, Marc for what is a really hard quarter, no doubt.

Marc Zabicki:

Yeah, I would say so, Jeff, I mean, you kind of listed some of the things that are still positive, you know, consumer spending is still relatively positive as people go out and spend on services, earnings clearly still a positive and that kind of tells you that you know, even if we don't kind of continue with this rally, given the base of earnings that we're seeing from S&P 500 companies and other companies, you know, you probably don't have far to fall from an equity market from kind of like, you know, these levels. So, I think the market got in front of the concern about the economy, got in front of the concern about a too tight Federal Reserve, got in front of the inflation issue. Although we haven't seen inflation from a CPI perspective yet, roll over, I think we're going to see that. But with this earnings foundation the equity market certainly has something to build on, now we'll see over the next couple weeks and months if it wants to continue to build on the early July momentum we've seen. But from an earnings perspective, I've been surprised at how well corporate America has operated, you know, pandemic, post-pandemic and clearly now.

Jeff Buchbinder:

Oh, absolutely. And, you know, coming off the last quarter, which I think you could probably argue was like the sixth straight, really strong, positive surprise, I just gave corporate America the benefit of the doubt <laugh>, right? I mean, they've impressed for so long now I just expect it each and every quarter. But that doesn't change the fact that estimates have come down, though. Expectations were too high. You know, strategists, analysts, pretty much anybody you talked to, expected estimates to come down and they have, but they haven't come down nearly as much as most anticipated. So, if you look at you know, the next 12 months number it's come down a little less than 2% in July. So, not, actually that's in line with the long-term average. So, that's pretty normal in any environment. But in an environment as tough as this we'll call that a win.

 

If you're just looking at 2022 estimates, they've just come down couple dollars, not much, still north of 225, which is our forecast. So, I think this is just resilient. You know, S&P 500, not every company is, you know, holding up, of course, not all these results were good. Not all these results were well received, but overall, the headline estimates have been very resilient. So, this is another positive development. The estimates have come down a little bit more, but, you know, we're through the majority of the earnings. We're not through the majority, we're barely through the majority of the companies, but we're through almost all of the earnings because we're through the really big earning companies, and that's the Apples and the Googles and Facebooks and all those that have already reported, Microsoft, et cetera. So good news on the earnings front.

 

It's not over yet. We got earnings season continuing this week with another 150 S&P 500 companies reporting. In fact, we basically did all of earnings season in two weeks, except for some banks. So, you know, we don't see any reason why the trend will change. So, we should still get good news from corporate America. We've got the jobs report and then we're going to be watching some developments out of Washington. So, which of these, Marc, kind of catches your eye that you think investors should be paying close attention to? I'll let you pick one and then I'll pick one.

Marc Zabicki:

It depends on if we're talking around the water cooler, it's probably the Pelosi trip to Taiwan or the potential. In terms of and so I guess I would have to pick the two political topics that you have here, Jeff, it's the Schumer Manchin machinations, if you will, and then the Pelosi Taiwan trip, or the potential for that. I mean, I think the jobs report is supposed to be around, you know, 270,000 in non-farm payroll lift in July. So, we'll see if that actually, you know, comes to pass. I think we've established that earnings are on a fairly decent trend still, so, and not that the political angles necessarily going to move the market. I mean, frankly, I mean my point of contention in terms of assessing this market, and I think us as a committee in general just are waiting for that breadth of technical activity that we mentioned for one. And actually, probably anxiously awaiting the July CPI number. As a matter of fact, will probably continue to be a market mover as well as some, some Fed officials who are supposed to get out there and stand in front of the microphone this week.

Jeff Buchbinder:

Yeah. So, boy, the Washington developments are really, really interesting. But, you know, since you picked those, you cheated and you picked two <laugh> I'll go with the jobs report. I think the jobs report, well, earnings have kind of lost, I think their ability to really drive this market higher at this late stage in earnings season. So, I'll go with the jobs report, and you know, we're going to have to thread a needle, right? We don't want it to be too strong because that can scare the Fed. But we don't want to be too weak, obviously, because then you're talking about pricing in weaker consumer spending maybe you know, maybe a little bit more of a recession than we expect and we certainly don't want to go there. So, maybe something in that 200 to 250 range would probably be good with hopefully a pretty calm earnings number within that report, right?

 

The average hourly earnings number that we watch and that the Fed watches. So, the jobs report certainly is important. It's one of the biggest economic reports and because wages are such an important part of the inflation story, you know, for the Fed or for anyone, we really want to watch the job market closely to try to get some better news on inflation. We've already got some good news on inflation with commodity prices coming down, particularly oil and prices at the pump and some other commodities as well. And we've seen some survey data reflect lower inflation expectations. That is certainly good. But we certainly recognize that it's going to take time for inflation to come down to a comfortable level. Any evidence we can get that that's starting to happen at a more brisk pace would be certainly welcomed by the market.

 

So, that would be my choice since Marc took the Washington ones. But man, the Schumer Manchin thing, you know, Senator Sinema could stop this. It could be a case where they just take out the carried interest piece of the legislation, which reportedly she doesn't like, that's a very small piece and is not nearly enough to cause this thing to fall apart. But that one's going to be very interesting to watch. And we'll probably end up talking about that next week on our next podcast and maybe for a few after that. We'll have to see. And we're certainly going to revisit the Pelosi Taiwan trip situation, regardless of what happens there because of how important not only U.S. China relations are, but how important Taiwan is to the global semiconductor supply chain that certainly many U.S. companies rely on, so big week or big few weeks ahead of us. So, Marc, any final comments before we bring it home?

Marc Zabicki:

Well, I mean nothing definitively on the equity market other than the fact that we're just kind of keeping an eye on, you know, the, again, the breadths technically see if we can kind of continue this rally that we've seen, you know, so far. I mean, I think in general terms, whether it's Federal Reserve talk or whether it's interest rates and whether it's, you know, the expectations around inflation, it seems like the market's coming back to our multi-month line of thinking here at LPL Research. So, that's always a good thing.

Jeff Buchbinder:

Yeah, absolutely. We're still constructive here. We recognize that we might see a little bit of a pullback after such a strong rally. You know, the rally is not inconsistent with historical bear market rallies, so certainly there is risks that we pull back before the eventual major market low is in. And we'll keep watching the technical indicators to help give us signals there as well as well as the fundamentals. So, with that we'll wrap up. So, thank you Marc, for joining this week. Really good discussion. Boy, it was last week, a crazy week. I mean, we called it an epic week for market watchers, and I think that's fair to say. So, hopefully you all got something out of this podcast and let's just, we'll keep coming back here every week and telling you how we see it. So, with that, thanks again for listening and we will talk to you next week on the next edition of LPL Market Signals. Have a great day everybody.

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