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Marc (00:00):

Hello, folks. Welcome to this latest edition of the Market Signals podcast. My name is Marc Zabicki, Chief Investment Officer at LPL Financial. It's a pleasure to be joined by Tom Shipp quantitative equity analyst at LPL Financial. As we talk about in this Market Signals podcast, a little bit of what's going on from a macro perspective, but also we're going to talk a little bit about some activity from an individual equity sector perspective, specifically around healthcare. AndTom is here to kind of drill down a little bit for us on that. Tom, how are you doing?

Tom (00:42):

Thanks, Marc. I'm doing great. Happy to be here.

Marc (00:45):

Good, good. And, and we are recording this Market Signals podcast on Tuesday, November 8th. So it's good to be with you on this Tuesday. Just looking back, as we always do in terms of global equity market activity, last week in equities, it little bit more of a choppier session in terms of the entire week relative to some weeks we've recently experienced. And we'll get into why, you know, that is, but you know, some inconsistencies around whatwe're seeing from a sector perspective. We'll touch a little bit onhealthcare, which was modestly lower over the past week. Energy continues to ride relatively high. Consumer discretionary was weak. Technology wasweak as well. Some relative strength in Europe relative to the U.S.. So something that was, you know, notable, you know, last week, but generally amarket that seems to be willing to try to clean itself up a little bit, given  the difficulty that we've had so far in 2022.

Marc (02:04):

Not quite as strong as, as we've seen in recent weeks, but not a, not a bad week overall, certainly relative towhat we've seen again in 2022. Bond market,. a little bit of downside pressure as, as yields have risen a little bit again. J. Powell was a, was a driver of some of this activity, but continued, you know, relative pressure and, and in the bond market, commodities perform rather well. I think, I think we owe that to some more bullish activity  in the energy space. Although industrial metalS&Precious metals indices were also nicely higher for the last week. Again, the key drivers, if we've looked back in our rear view mirror over the last several trading days, the Federal Reserve did raise its fed funds rate by 75 basis points to 4% on the upper bound.

Marc (03:08):

And Fed chair J. Powell threw a little bit of cold water on a capital markets in, in some comments that were indeed considered hawkish as he warned against expectations for a near-term pause  from the Federal Reserve. And, you know, I think what he had to say, Tom, and, and you know, you, you can tell me whether you agree or disagree with this, but I think what he had to say was, was within expectations. I mean, I think in general terms he is going to be focused on inflation as the Federal Reserve has been focused on inflation, as they continue to try to dial that down for market participants. But, you know, he's going to continue to stay on the break in terms of rising interest rates or increasing interest rates over the next couple Fed meetings. Although we are expecting not a  75 basis point increase in the next Fed meeting, we are expecting more of a 50 basis point increase. What, what's your take on that, Tom?  Anything from where you sit?

Tom (04:22):

Yeah, yeah, I think that, you know, what Fed Chairman Jerome Powell has to do and is make us believe that we are, you know, basically that we fear the Fed and that we will, you know, as an economy slow ourselves down to, to cool some of that demand. And, and, you know, he's kind of continued to do what he says, and I think where the market sometimes starts to think he may pivot orr whatnot, and I think that those things may, may still happen. But, you know, he has to continue on this drive and, and the notably hawkish stance this time around was not so much, hey, we're going to keep coming with these big, you know, supersized raises, but more so on the, yeah, we're not going to cut anytime soon. We're going to, we're going to hold longer than you are likely thinking, and we're probably going to raise a little higher than we're thinking.

Tom (05:10):

And now I think, you know, the market's seeing the terminal rate at that 5%, and I think that, you know, not even two, three months ago, we didn't think he would, would get there. And, and, you know, there's still a hundred to go to see if he does. But yeah, I think that that's, you know, pretty much where we're seeing it. And I think it kind of supports some of the equity market moves we've seen in terms of, you know, favoring value, favoring things that are you know, have cash flow now, right? So durable cash flows right now lower valuations as the entire market's valuations get pulled down, stocks with already cheaper valuations tended to do better and, and shareholder yield. And by that I mean obviously dividends, but also could be share buybacks or debt retirement.

Marc (05:56):

No,  I think that was, that was well said, actually. And, and what happened from the Federal Reserve is exactly what we expected. 75 basis point increase, and the commentary was, was not far removed from our expectations as an asset allocation committee either here at LPL Research. I mean, we, he's going to stay hawkish in his tone, but, but in fact, we think he's going to ease off the break in these next few FOMC meetings, meaning perhaps going 50 basis points in December as opposed to as, as opposed to 75 and maybe 25 in the early 25 basis points in the early stages of 2023, remains to be seen what we see. But yeah, basically met expectations as far as the work that we do at LPL Research. What was interesting, I'm sure for the Fed was to see the unemployment rate actually kick up to 3.7% from 3.5% in the month prior.

Marc (07:02):

That was the October unemployment rate. Non-farm payrolls came in a little bit stronger than expected at 261,000 versus 193, and the prior month was revised higher. So those, those numbers had some give and take to them. The non-farm payrolls was probably a little bit more robust than the Fed wanted to see, but the unemployment rate ticking up to 3.7%, probably something that the Federal Reserve would, would actually like to see  at this point. And then on an earnings perspective, we are getting modestly positive earnings that are continuing  in the third quarter earnings release season, that is, you know, sluggish is a key word here. The blended 2.2% year-over-year growth rate, according to FactSet, is probably slightly above expectations a little bit, maybe certainly better than some of the worst case expectations that were probably built into the market as we headed into October.

Marc (08:13):

But, but again, actually an S&P 500 in a corporate earnings cycle, that, that is probably a little bit, you know, stronger than I would have expected. And then as we look to midterm elections today and as we look back to last week from an energy and financial sector perspective and Tom, I'll turn it to you here just a little bit, is that we are getting some tailwind in energy, getting some tailwind in financials perhaps because those two sectors may benefit from a more Republican led Congress. Is, is that, is that fair to say?

Tom (08:54):

Yeah, that, that's definitely been some

of the, the, you know, commentary we, we've seen coming out around the market. You know, also heard, you know, bids for industrials as well, kind of in that same, same regard. You could even throw pharmaceuticals in there. As you know, a divided Congress may have less, call it potential regulations, coming toward pharmaceuticals. So yeah, that's, that's a bit of, of where, where we've been hearing things. I, I'm, I'm more focused on, on Thursday's CPI print, to be honest. I think a lot of the midterm and, and you'll get to this, but I think a lot of this is kind of baked in as far as you know, where, where things will likely play out and, and that is likely a divided Congress. But I think, you know, back to our, our Fed commentary, they're going to continue watching the data and, and that, and Thursday CPI I think is a bigger, bigger you know, news eventfor the equity markets at least. Yeah,

Marc (09:49):

Perfect segue into, into the economic data this week out of the U.S. and we are getting those CPI numbers on Thursday, as you just mentioned, that that will be what market participants should actually be paying attention to above all else probably this week, including the midterm elections. Because as you said, Tom, that's, that's perhaps already baked into market prices. CPI will be clearly important for market participants in that we're expecting as the consensus is CPI continually to, to gradually fall. October is expected in terms of the Bloomberg consensus estimate at at 8% versus 8.2% in the prior month. And the core CPI or ex-food and energy is supposed to be relatively flat as, as housing continues to be a, a more stubborn element of, of the broader CPI. So that's what we're seeing there. And then finally on Friday, the University of Michigan consumer sentiment reading something to take note of broadly across the economic calendar and non-U.S. markets will focus on retail sales and GDP out of the U.K. as well as CPI from Germany.

Marc (11:18):

Things that you want to kind of keep an eye on industrial production,yesterday from Germany was actually higher than expected, which is, you know, somewhat interesting. But we'll see how GDP out of the U.K.  and CPI from Germany look later this week. So some, some elements of the U.S. and global economic calendar to pay attention to. Key issues as we touched on Tom, CPI expecting it to fall to 8%, Michigan consumer confidence, U.S. dollar direction, which has been a little bit of a headwind for markets in general, certainly emerging markets. And, and probably adding to some difficulty from an earnings perspective. I know you've got a, a comment on materials, which you're watching closely this morning. And, and, you know, here we list some of the key earnings reports that we're expecting this week. The DuPont numbers were a little bit more robust than expected, I think, Tom., What's your, what's your take on DuPont and what's it, what is it doing for materials sector this morning so far?

Tom (12:34):

Yeah, it's, it's driving the entire chemical complex higher this morning. You know, they had, they beat on three Q and raised four Q guidance. And, and it looked like the, the dollar headwinds actually coming in a little lower than anticipated. But yeah, overall, they've also announced a, a new $5 billion buyback. So this kind of comes back to where I was going with some of these names that, you know, generating cash now and, and are, are paying cash back to investors now, right? There's not a self-help story here. There's not a, you know, what, what's going on? Speculative growth, you know, where we’ve got to factor in higher rates. This is, this is an investment right now, and that's why I think, so not just lifting up, DuPont obviously leading, leading the way, but Mosaic is up too, and, and just quite a few in, in this materials space or, or leading the sector higher as of, you know, what is it, 11:30 AM right now was, was leading the S&P 500.

Marc (13:36):

Yeah. And, and, and that's, and that's been our broader suggestion as an asset allocation committee for that equity exposure. Make it a little bit more value centric, make it, you know, more ballast names in your portfolio. You touched on it, Tom, if, if you are, if you're leading to the more high flying, high valuation names, given the pressure of interest rates in this environment, that's just hasn't been a good place to be. And we don't know that it's going to be a, a good place to be anytime real near term. So as you're taking a look at your equity portfolio at this point, I think you want to make sure that it's got those elements of stability into it. Certainly that's a, you know, it's kind of a, almost a Warren Buffet-esque type of an approach in terms of high cash flow generating companies.

Marc (14:26):

Even those companies that turn that cash flow into a, a steady dividend is also a, a place to be looking as well. As we sit here on a Tuesday midterm election results. So we'll see what comes of that, you know, as, as, as we get those results tonight and perhaps into, into tomorrow. Looking a little bit closer at, in terms of expectations from a Democrat versus Republican scenario, RealClearPolitics constantly puts together this, you know, generic congressional vote polling data and compares how Republicans are faring versus Democrats on a current basis. And obviously you can see what it's looked like in, in recent history. We're expecting perhaps  a House win for Republicans and maybe even perhaps a Senate win for Republicans. We'll see what the results bear over the next, you know, couple days or so.

Marc (15:33):

But clearly market participants are focusing on a congressional power struggle to kind of head back toward the Republican end of the spectrum at the end of today and into tomorrow. And, and again, we touched on some of that activities, perhaps reading into energy, financials and the healthcare sector, which we will get into just a moment. One of the key things, and I just brought this up for reference, is we've heard quite a bit lately about the amount of U.S. diesel inventory  in the U.S. and, and how that inventory is down relative to the recent past. It is down, but it's not entirely abnormal as we look at, you know, back in  2013, 2014 timeframe, and equate that to what's going on now. So while diesel inventories are low and perhaps some semblance of concern can be derived from that, it's really not necessarily that unusual given to where we've, given where we've been in the recent, recent past.

Marc (16:54):

So something to kind of keep an a note on. One of the reasons perhaps for those reductions in diesel inventory has been the amount of truckload milesthat we're recording now here in the U.S., meaning that, you know freight is increasingly utilized to deliver more things, if you will, as opposed to pipeline infrastructure in the, in the U.S. is perhaps not what it should be to deliver oil. So increasingly oil is being delivered by truckload, so some of those increased truckload miles in order to deliver oil. And oh, by the way, stale oil production is back to where it was in 2019. So, so we are getting a lot of oil production in the U.S. and that increasingly has to be delivered by truckload as opposed to pipeline. And that's one of the reasons why truckload miles have been so high, historically high. And then one of the reasons, again, while diesel inventories you know, maybe, maybe low. And turning to healthcare for a moment, you know, Tom, I know healthcare has caught your eye, It's certainly caught our eye as an asset allocation committee here at LPL Research. We are favoring healthcare relative to some other sectors out there. It's important for several reasons, you know, recent earnings results being won. Tom, what's your take?

Tom (18:33):

Yeah thanks Mark. I just wanted to dig in on healthcare is one of our two favorite sectors right now from a S&P 500 sector perspective in the STAAC. And, you know, we've been a lot of talk about energy. It's clearly been the leader all year. And, and as you can see at the top of this chart, they've done quite well. But the, the second strongest performer in terms of earning surprise has been the healthcare sector. And, and both surprise on earnings, as you can see here, seven and three quarters percent. And that's just aggregating the net income of all of the companies versus the net consensus, net income of all, all the 58 companies that are reported out of 64 in the index. So it's an aggregate take. So it's weighted in somewhat, but maybe not weighted by the market cap, but weighted by the actual net income.

Tom (19:24):

And, and what's interesting too, is that 76%, and you can see that green, white red line, well, well, 76% of the companies, of those 58 have beat earnings estimates. And, and so when you, if you dig into this, right, and you go into each of the different industry groups within healthcare and, and sub industries, it's been across the board on the, on the surprise side, on the earnings beat side. So it's kind of been consistent. You know, they've been able to perform better than, than the market thought. Year-over-year revenue is up five and a half percent, but on the earning side it's actually down. So while year-over-year growth and earnings is down in healthcare, it, we have beat the expectations. So we did better than the market thought, but the growth isn't there. And so what that's saying is that, you know, the margin compression is clear from rising input costs, rising labor costs in the healthcare sector, , so year-over-year earnings are down, I think, you know, about 2.4% and then taking that forward, right?

Tom (20:32):

Looking at from the beginning of earnings season what's happened to, to estimates for, for 2023 as a whole. They, earnings estimates are down about 2.6%. And, and looking at the market overall, it's, it's down about 4%. So, you know, holding up a little bit better since earnings season began, taking that all the way back to the beginning of the year, though, healthcare is down about the same amount. So basically this earnings season has, has really propped up healthcare and it hasn't declined as much on a, on a forward looking basis, showing that they've been able to hold up top line better. And, and, you know, yes, there is margin compression, but better than the rest of the, the S&P 500 as a whole. So it, again, it just kind of comes back to, to looking at those defensive type sectors through a slowing economy that, you know, is likely coming in 2023. And, and why healthcare continues to be one of the sectors that we favor.

Marc (21:33):

Yeah, and, and it, as you know, Tom,  it's often relative to the market's expectations. If we've got, you know, not necessarily strong earnings flow from healthcare, but, but better than expectations is often enough of a catalyst to drive that home. And, and again, I like your point about moving into an economic environment that's not going to be that robust. We could see some modest growth through the balanceof this year as we get Q4 numbers sometime in January, but certainly more sluggish growth in 2023. Not  an environment for, you know, high flying equity exposure. So again, more of those ballast names in a portfolio that may fare better than others as the economic conditions get a little bit more a little tougher, if you will. So, good, good point on healthcare. I'll move you to the, the next slide. And I guess this is just another way to kind of look at what you were talking about in terms of relative performance in healthcare versus the rest of the S&P 500 sectors.

Tom (22:52):

Yeah, so, so what we're looking at here, and it has been on, we got over the five days. So if you aggregate all the names five days after they reported earnings, you know, where, where did the aggregate performance of each of the sectors relative to their earnings surprise, right? So you see that healthcare you know, is that second furthest to the right, it was the second highest earnings surprise. And then, you know,  on a five day price change basis, it's also, you know, looking pretty good. As you can see on a five day basis you've got industrials and financials up there above it on the performance. If you look at this on the day of earnings, everything is in the, in, in the red, except energy and healthcare. So basically saying the market has appreciated the better than expected earnings, to your point, everything is relative to the expectations.

Marc (23:45):

Yeah,  exactly. So and we have been talking about as an asset allocation committee, that that balance, that lean more toward value versus growth. We've seen that play out in some results. You want to make sure that your sector exposures are not leaning toward growth, you're not leaning toward more of the higher beta exposures. Again, more of that ballast approach to an equity portfolio. So as we wrap this up Tom, if we, and, and  thank you folks for, for joining us. I mean, what will be important this week is, is to, is to keep an eye on the CPI number keep, keep an eye on the University of Michigan consumer confidence reading. As this market continues to digest what the next move of the Federal Reserve is going to be, where is the dollar going to be?

Marc (24:46):

In such an environment where you have that macroeconomic uncertainty, there's an opportunity to turn to you know, kind of those, those ballast equity sectors, those ballast equity names that may be more favorable in such an uncertain environment, and certainly more favorable for an environment that's going to slow down in terms of economic activity as well. So, good points today, Tom. As people dig into the election results over the next couple days, , we hope the audience has a good week and we will be back with the Market Signals podcast next week. Thank you all for joining.

 

In this edition of the Market Signals podcast, Director of Research Marc Zabicki and Quantitative Equity Analyst Tom Shipp discuss last week's Fed meeting and the upcoming election.  They also discuss some relative strength in the Health Care sector and the focus for investors on being selective with their equity choices in the volatile market environment.

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