Is King Dollar’s Reign Over? Not So Fast.

Jeff B (00:00):

Hello everyone, and welcome to the latest LPL Market Signals. Jeff Buchbinder here with my good friend and colleague, Dr. Jeffrey Roach. How are you today, Jeffrey?

Dr. J (00:11):

Doing well. We're recording this May 9, so we're getting closer and closer to the summertime. How about that for putting smiles on everybody's faces?

Jeff B (00:21):

Absolutely love it. 75 and sunny pretty much all weekend here in Boston. It is Tuesday morning as we're recording this. Normally due Monday afternoon, but schedules pushed us back a day. But we can still look back at a glorious weekend here. I know it was pretty nice down there in Charlotte for you too, Jeff. So here's our agenda for, for today. Boy, a lot to talk about given we had such a big week of market news last week, right? We had the Fed meeting, we had the jobs report. This continues to be talked about, the debt ceiling, so we'll talk about all that. The main topic for today though, is king dollar, the topic of our Weekly Market Commentary, which you can find on lpl.com.

Jeff B (01:13):

So the bottom line is king dollar still rules in our view. So we'll make that case for you next. I'll have highlight a couple of key earnings season takeaways, and then we'll preview the week ahead. So let's start with a market recap, Jeff. And we had, you know, four down days last week, and then a really big rally on Friday. So it wasn't a good week, but it sure could have been a lot worse with that Friday rally. You know, we ended up down a little bit about three quarters of a percent. But really the chart pattern here hasn't changed in quite a while. So we're still in that, I don't know, you call it 3,800 to 4,200 range. And you know, failed a couple of times to try to get over 4,200. So it looks like that's providing stiff resistance, but we still have this pattern.

Jeff B (02:10):

We've talked about the last few weeks of higher lows. It's not quite higher highs, but those higher lows from October, that pattern certainly looks nice. So, you know, the chart is somewhat constructive, but certainly we want to be a little bit careful you know, buying aggressively at the high end of the range, because we could certainly go right back down. And Jeff, you have increased your odds of recession here recently. Maybe a mild one, but higher odds of recession, and we know certainly stocks don't tend to do too well heading into one of those.

Dr. J (02:44):

Yeah, it's interesting. So, you know, adding some of the color that we get from our chief market technician Adam Turnquist, you know, he was mentioning in this graph just, higher highs, higher lows and you might say, as you, Jeff, rightfully so. Well, you know, the higher highs, maybe if you go back, you know, November, January it's been a, a fairly flat and choppy market. You think about last week, and, and Jeff, you're exactly right, you have a Fed meeting. You have this new language on, you know, the, the chances of pausing for June, which we think is going to happen, and some choppiness with the labor market. So I think we can be more certain we're higher lows. And certainly this is somewhat of a bullish trend if you look at it all the way back from October. So it's I think the choppiness makes sense when you think about some of the near term risks in addition to the recession as you just asked me but also the debates in Washington about the debt ceiling, just to name a few of the multiple challenges right now.

Jeff B (03:50):

Absolutely. So let's look at the interim market returns here. And you see, it was a little bit of a defensive week, right? But pretty well losses across the board. I mean, you had some gains in certain markets in Europe, but generally down I like to focus at the sector level to get some idea of how confident the market is, right, based on cyclicals versus defenses. And we see, you know, down week for financials. That's the other big story, the big risk out there which is the regional bank health, right? So we've continued to get headlines around that and huge moves in some of the regional banks that markets think maybe are weaker. And you know, there you see financials down 2.6% last week. And then we had you know, energy down almost 6%.

Jeff B (04:47):

You know, oil is really struggle here recently. We've talked about that on this podcast and elsewhere recently, how the China reopening has not helped oil, frankly. And we're down, we were in the sixties for a bit now. We've moved up a little bit from that. But oil continues to struggle. We've downgraded energy to neutral based on the technical analysis work that Adam and the team do. So that's been very disappointing place to be, certainly lately. And then you got to look at technology, maybe Jeff, and then I'll hand it over to you. Tech helped by Apple, right? So the pretty well received results there. We've a good earning season generally for tech. So you got some gains there. What other kind of moves here, catch your eye.

Dr. J (05:37):

Yeah, I think just kind of thumbnail sketch, you know, the energy story I think is driven by the global slowdown risks. And so you see that in the week and monthly numbers right there in the sector section. And then of course, I think the other thing that's worth noting is the European performance relative to the us. So one of the things that we've talked about in our STAAC meetings, short for strategic And Tactical Asset Allocation Committee meetings, but in our STAAC meetings, we've talked about the fact that recession risks in the U.S. are actually higher than they are in Europe right now. So that's something to take note for sure.

Jeff B (06:18):

Yeah, well, we also upgraded our views on international equities this month. And now favor international over the U.S. certainly that those recession odds are consistent with that choice, although they're certainly more involved in that decision particularly valuations and the potential for a weaker dollar, which ties into our main topic for today. So turning to fixed income, you know, we had kind of mixed performance last week. Not particularly big moves, 10 year yields, been pretty range-bound. Mid threes, that's where we think it'll be all year. It'll bounce around a little bit, but there's, there's not a particularly interesting story here, a little bit of weakness in credit, which is consistent with what you would see when equities dip and then turning over to commodities there, you see the energy move, you know, down 11% over the last month, down 7% just in the last week alone. So that's energy broadly including nat gas, but certainly oil, a big piece of that. Any comments on either the bond market or the commodity market share?

Dr. J (07:29):

Yeah, so another shout out, like I mentioned earlier, a great team at LPL research. Another great team member is Lawrence Gillum, our fixed income strategist. He's got a blog out. Jeff, I think it's worth highlighting when you look at that left side of the page here with the fixed income moves. You know, we just got out of the Fed, the latest senior loan officer survey, the opinion survey, and tightening credit has important ramifications for high yields. So just a quick shout out to go to LPLresearch.com, and you can read a blog post on that. So that's certainly going to be something that's, that's going to add a little more pressure in this space, particularly in the high yield space as, as credit standards tighten.

Jeff B (08:12):

Good point. Jeff, we continue to recommend high quality bond portfolios, not taking too much mm-hmm. <Affirmative> credit risk there given the stresses in the banking system although they're widely known, but certainly the tighter credit markets are a piece of why we become a little bit more worried about a recession later this year. That'll certainly come up as we move through the presentation here, Jeff. So in terms of the market recap last week, of course the Fed was a big story. So we got a couple of slides on the Fed. We got a couple of slides on the job support, which was certainly the biggest story on Friday. So I think the key takeaway from the Fed, I mean, obviously most people think they're done, right, so that we'll start there. But what I think is really interesting is as inflation continues to come down, even if they hold rates steady, it's like they're tightening.

Dr. J (09:13):

Yeah. And I actually drill into this a little bit more in the econ market minute but for this week, but, you know, I wanted to just a quick takeaway for those that are interested in watching markets and understanding the interplay between monetary policy and how risk assets trade. I think one big takeaway is the fact that inflation is easing allows the Fed to actually consider a pause maybe later this year, consider an actual cut, and still have the fed funds rate above inflation rates. And that's the key takeaway. You look at that gray line fed funds rate above inflation rate, that means there's a positive real fed funds rate. That's exactly the kind of leeway and a little bit of that longer leash that the Fed policy-makers have right now. So that's certainly supportive of what the market's pricing in. We believe in general that the Fed could respond by easing a bit by the end of the year. Probably not the same magnitude as how the market's trading right now, but that's the key takeaway here. Look for a pause in June and even perhaps a cut by December.

Jeff B (10:29):

Yeah, the market probably shouldn't be rooting too hard for a cut, because a cut means incremental economic weakness, probably unexpected, incremental economic weakness. Stocks probably do better if we get a pause and a hold because the economy continues to hold up. At least that, that's my take. But good thought there. So, you know, here's the, the pause, right? The or the cuts, really, this is fed fund's futures what they're pricing in right now. And you get a full cut in September fully priced in, and then you can see all the way on the right hand side, when you get into January, 2024, you get four cuts. These are 25 basis point cuts, so you get almost a full percentage point cut priced in in January of 2024, we think. Jeff, this is too aggressive.

Dr. J (11:18):

Yeah, maybe a 50 to 75, but not a full 100. By the way, just for our listeners, just a reminder that, you know, this is live data. This moves pretty aggressively. So for example, we've done this before, I think in blogs or market commentaries where, you know, we'll show this in in the various snapshots <laugh>, Jeff, and it kind of illustrates the point that, you know, after a CPI report or after a jobs report, you know, this whole graph can completely move around. So that's important to just highlight this is as of May 8. But our point is, yeah, maybe ease a bit. We don't want necessarily a full a hundred basis point cutter more because that implies significant weakness and our main baseline cases as credit tightens, as the consumer slows, as businesses slow the economy contracts. But it's a shorter and more shallow recession than your post-war average. So yeah, this is a quite a volatile snapshot and you'd see that if we looked at it over time, for sure.

Jeff B (12:31):

Yeah, no doubt. So my advice to folks is be careful with your scenario analysis, ‘cause you can't have a bunch of cuts and a solid economy <laugh>, those just don't go together, right? So let's turn to the jobs report, Jeff. This is why we were up so much on Friday, right? I think that S&P was up 1.8, 1.9% just in that day alone. So what did the market like? I mean, we got a much better-than-expected job count, right? But people are certainly concerned still about the Fed. So it looked like market said good news is good news, right?

Dr. J (13:11):

Right. Well, I think the markets liked that it was a decent jobs report without it being a gang buster's job report. So most people and most media reports talk about the month to month gains and payroll. There's so many other ways to look at this labor market. One of the things that I think's a little bit alternative view here, one thing is what I'm trying to get at with this chart here is just to say, okay, instead of just looking at month to month changes, because that's very volatile, let's actually look at total employment on a levels basis, not a change basis, a levels basis. And it kind of the point that I'm taking away here is even though the economy has recovered more than in aggregate, more than all the jobs lost since February, 2020, it's a very uneven recovery. We still have a lot of jobs lost in the leisure and hospitality space.

Dr. J (14:10):

Those people have moved on to other sectors. And what this graph is just saying is even with the job gains, we're not back to trend. Meaning, hey, there's been people that's graduated from college, they should be entering the labor force relative to population growth. What does the trend look like? That's that red dotted line. And the point is that we're below trend even though we've recovered a lot of those jobs back, we're not quite there. We're still in essence, kind of finding our balance. And it's somewhat of an uneven recovery as we find that balance. That's the key takeaway here from this chart,

Jeff B (14:51):

<Affirmative>, Yeah, certainly nicely ahead of the pre pandemic levels of employment, but not quite where we would've been without a pandemic. So you know, you mentioned some people coming back to the labor force, Jeff, that's what this chart shows, right? We're actually getting pretty good participation now.

Dr. J (15:11):

And I think this is really important to think when we have this scenario of recession, perhaps it's higher probabilities here than in Europe, as we talked about just a couple slides ago. And the follow up question is, well wait a second. You know, if we don't have a lot of workers or folks have taken early retirements, how are we going to not avoid a worse deep recession? And what I'm kind of highlighting here is when you look at the categories that are most impactful in growth, it's the prime age 25, 54, the prime age worker. So it cuts out those that are maybe coming out of high school, maybe associates, or maybe college. And it also ignores those that are 55 up, perhaps those that have gone to take early retirement since COVID prime age workers are actually back to 2001 levels.

Dr. J (16:10):

If you just take the share of those prime age workers relative to the population, right? We're not going to confuse the fact with, hey, are they looking for a job or not looking? Are they considered unemployed or not? Just say, let's look at employed relative population. We're actually back to levels way before the pandemic, meaning that even as the economy slows, there's enough of those prime age workers that could keep productivity growth enough so that we're not in a deep and prolonged recession. That's the kind of how this all fits in the big puzzle. A lot of moving parts. But this is one of the really important pieces in the puzzle to talk about.

Jeff B (16:55):

The most exciting thing for me about this chart is that I'm still in my prime, although only barely <laugh>. But beyond that, this is a really important piece of the inflation puzzle, right? Because more labor supply means in theory, less upward pressure on wages, of course, something that the Fed’s watching closely. That's not all that there is to the inflation picture, but it's certainly an important piece. We want people to continue to join the labor force and get away from the bidding wars of the last few years and the difficulty finding talent. So let's go to the dollar here. Jeff, this has gotten a ton of attention recently. In fact, I think we talked about it a little bit on the podcast last week. So we decided to write a weekly commentary on this.

Jeff B (17:46):

Quincy Krosby did that for us. Did a really nice job kind of boiling this down. So these are really, these are pretty simple concepts, these next two charts. But they're kind of noisy. This probably require a little bit of explanation, but this is just foreign exchange turnover, which is just a transaction has two sides, right? In one currency and out the other. So the share of a currency in trade is all these add up to 200%, right? And so you look at the, the U.S. here, the dark blue bar that's higher than all the others. These are like 85, 90% readings and they pretty much stayed there. So for global trade, king dollar still reigns, right? So Jeff, if you look down at these others, I mean, you've got obviously a lot of trade in the euro certainly and a fair amount in the yen. Fair to say that Chinese yuan is increasingly used in global trade. If you look, this is a triennial survey from the Bank of International settlements. So you only get every three years, right? But if you look over to the right, there's clearly a trend of more in Chinese currency, but it's way down, barely registers still.

Dr. J (19:06):

Yeah, that's right. So you're looking for the green color there with yuan, the REM B. And so you really, you know, you don't even see it right until 2010, right? Just that little bit of that green. And you see that kind of inching up higher. The takeaway for me is that as the infrastructure matures, you're going to see more activity. So that's why you kind of see this maturation in the Chinese markets. But you know, if you look at some of the headline numbers that come out of the Bank of International Settlements report, I want to give you this stat cause I think it's just really pretty impactful. So the U.S. dollar, I'm reading this straight from the BIS’s report, U.S. dollar is a component of 88 point a half percent of all FX trading. <Laugh> roughly 89%. And this is the latest numbers, well, it was, it was actually 87% in 20 13, 88 0.3 in 20 19, 88 0.5 recently. So you actually could say, if anything, it's becoming more and more relevant in terms of just transactions. So I think you might say, okay, well, in some ways the dollar sharing the stage, if you will. But there's really no data to support that. You know, king dollar’s has been kicked off the throne, if you will, to keep the analogy,

Jeff B (20:33):

No doubt, still dominant in trade, and it's not going to change for quite some time. So this is you know, a little bit of a different perspective right, Jeff, where we show the percentage of reserves allocated to the dollar globally, and this has been coming down, although after a surge in the nineties still almost 60%. So I think one thing happening here is you've got more central banks buying gold, right? And then you know, you've also had some central banks just decide they want to diversify their currency exposure globally. But to me, this again, it's not going to change dramatically over until you get out many decades. And something really structurally changes with the U.S., the U.S. has the advantage of transparency, right? Credibility, governance, all of that that you really can't match the Eurozone’s fragmented, right? Which Quincy discusses in the commentary and certainly China doesn't have the predictability and the credibility to be a reserve currency globally. So sure, this is coming down and maybe some of the newsletter writers are trying to spook people with this kind of chart where it's coming down, but this doesn't mean that the dollar is going to lose its status as a reserve currency or anything like that.

Dr. J (22:00):

But I think it's important too, just in terms of part of the numbers that percentage allocated actually adjust by mere exchange rate values, right? So in terms of, you know, as the dollar weakens perhaps, right? The reserves in essence just become a little bit lower. But I think it's important. Again, key takeaways from all this is, you see dollar moves driven by a couple main reasons, of course one is economic growth paths that diverge, right? Think about Europe, think about Asia, think about the U.S. So diverging growth paths diverging inflation scenarios. Perhaps, you know, diverging activity as central banks manage swap lines, right? So during the crisis with SVB, Silicon Valley Bank, you know, our central bank was working in conjunction with others with dollar swap lines. And of course, different, different policies in terms of, you know, monitoring fiscal approach. So you know, even though this might look like a downward trend, I don't know if that this chart needs to be taken without the context of the previous chart. You basically take those two charts together to develop your view. That dollar probably is still on the throne still.

Jeff B (23:24):

Yeah, until we see a safe haven rally where global currency flows, don't go to the dollar <laugh> there, there's nothing to worry about here. I think that's probably the bottom line for me. So good discussion there. Let's turn to earning season. This has been really positive, Jeff. I mean, we've had some of the highest beat rates we've seen recently. Some of the biggest surprises in terms of the percentage upside overall that we've seen recently. So coming into earning season, we were looking for, or at least consensus was looking for 7% earnings declines in Q1. We're now tracking to about two. Now we're over 80% done, so that's probably not going to move much from there, but that's already about five points of upside. Maybe we get another point and end up down one.

Jeff B (24:16):

So really nice positive surprise when many, including ourselves, were worried about downside risk here in light of the bank stress in the first quarter. There are a number of other challenges, of course, with tech and economic growth and all of that. But throw it all together and companies are really surprised nicely. I think the biggest reason is profit margins, which I allude to here in the in the title on this slide. It's hard to believe, I think, for many folks out there, but margins have actually increased quarter over quarter for the S&P 500 mm-hmm. <Affirmative>, at least based on the numbers we've gotten thus far. That is tremendous. So cost controls has certainly been part of it. We've also had pretty good revenue growth approaching 4% for the quarter. So really great.

Jeff B (25:08):

And so that's one key takeaway. And then I'll go to the next one here. And this is just forward estimates for the S&P 500. And while many are looking for double digit declines in these estimates, they've actually stabilized and started to move higher. So you know, we may not get any earnings growth this year for the S&P 500. Consensus is roughly flat. We see a little bit of downside to that, but we're not going to get a collapse based on what we just heard from corporate America. Jeff, what do you think?

Dr. J (25:40):

Well, we do know from the challenger job cuts reports, that's been fairly consistent for the last year and a half, that the cost cutting has been the driving reason why firms are cutting labor, right. Cutting jobs, labor costs are a fair chunk of total business operating costs. And so, you know, we know that firms have been very aggressive in the cost cutting trying to get more efficient preparing for the downturn, if you will. So it's quite an interesting time where folks, if you run a business, most likely your inventory management, your HR headcount management is in a much better space going into a, you know, potential recession than say, firms going into what it looked like going into the great financial crisis, for example.

Jeff B (26:33):

I think it's important to point out that corporate executives are preparing for recession, and they have been for some time, maybe a mild one. I mean, I know I brought this up before, but how long has it been since Jamie Diamond and JP Morgan said that there's a hurricane coming <laugh>, right? That was quite a while ago. We reiterated it, then backed off of it, but that's been a while, right? And if you take surveys of corporate executives, you've seen these surveys, Jeff, the predominant view is recessions coming in the next 12 months. So that has allowed these cost cuts at least to be proactive enough to limit margin compression. So that's helped drive that slight uptick in margins quarter over quarter, which has been great and certainly helped support stocks here in recent weeks.

Jeff B (27:21):

Also note that you typically in a mild recession or an inflationary recession only get a couple hundred basis points of margin contraction, and we've already gotten that. So you can make an argument that the recession's priced in to margins already, which I think is really, really interesting. So let's move to preview the week here. Jeff, although we're already, you know, into it, but the big news of the week I think takes place, many of you're listening to this you know, at the end of the day, Tuesday, right as the meetings in the White House take place, right? With congressional leaders. So maybe we'll start there. Thoughts on the debt ceiling. Are we going to make any progress here in the White House Tuesday afternoon?

Dr. J (28:06):

Well, I think any of us that have been around the block for a little bit and watched you how politicians interact and prepare and plan, right? Unlike what we just said earlier, Jeff, about business owners preparing for the slowdown, anticipating it by managing costs and et cetera. You know, you clearly don't see that in the public sector, of course. But I think they're going to wait till the end. I think both sides of the aisle will be aligned that there, there's no winners if the U.S. defaults on debt. And, and so, you know, the, the probability of a U.S. default is, is pretty much nill. So I think going into some of the other major movers this week, it's of course on the 10th we're going to have the CPI report for April.

Dr. J (29:00):

And I think, you know, given the fact that Manheim used vehicles are down used vehicle prices a little bit different story in new vehicle prices, but you have some downward pressure or at least softening. So if you get a month on month change of say a 0.3, you know, you're probably going to have a year on year number below 5%. And I think that's going to be a great number for those that you know, want to put more risk into their portfolios. But right now, consensus is saying hold steady, we're at 5% previous month for April. You know, most likely 5%. I think there's downside risk to that given what I just said. So you know, a four, as long as it's not 4.96 <laugh>, right? How is that, how is that going to be rounded up? Maybe this is where we're going to start saying, Hey, we need more significant digits to this estimate, right? <Laugh>, that's actually, I remember that was, a big conversation back when I was on the trade floor BofA years ago, you we wanted more significant digits here, not just what's printed on our Bloomberg screen.

Jeff B (30:19):

Yeah, I actually rounded this to the 10th place for this slide. But yeah, even if we get 4.99, it's still going to be kind of consistent with this trend of inflation gradually coming down. Maybe the recent weakness in oil prices will help that as well. And we'll get some good news relative to expectations on the  CPI. And then same thing, PPI, I mean, maybe we're not going to get another big drop in the PPI, I think we got last month moves all over the place, but certainly we should continue to see this decline. You know, we're talking about how a four handle would be well received, you know, after being in the fives, you know, maybe we get a four handle on CPI and maybe we get a one handle on earnings, which would be earnings growth down 1% year over year would be a win as well. So anything else to highlight here for the week that folks should watch Jeff?

Dr. J (31:15):

I think the 10th is going to be the big one. You know, on Friday University of Michigan consumers have been undershooting inflation for a while, so there's really no surprise there. So I think most of the focus is going to be on that CPI report. And then of course the continuation of those discussions in Washington regarding the debt ceiling.

Jeff B (31:37):

Yeah, and then earning season is continuing this week, but it's really slowed down. We, I think we only have 32 S&P 500 companies reporting. So, you know, again, the numbers are pretty well locked in and I think the fact that estimates have held up so well and margins have been so resilient are, you know, those stories, very positive stories and stories that will not change with another few dozen companies. So I think with that, we'll go ahead and, and wrap up. Thanks Jeff for, for joining this week. I know we had to juggle around schedules ‘cause of your travel plans, but good to have you back in the rotation after a little bit of a hiatus. We will be back with you of course next week for another edition of LPL Market Signals. Thanks again for joining everybody, have a great day. Take care.