It’s Central Bank Week: What to Expect

Jeff Buchbinder:

<Silence> Hello everybody, and welcome to the latest LPL Market Signals. Jeff Buchbinder here, your host for this week, with my friend and colleague, Dr. Jeffrey Roach. How are you today, Jeff, thanks for joining.

Jeff Roach:

Yes, glad to be back on the podcast. Missed broadcasting in recent weeks, but glad to be with you.

Jeff Buchbinder:

Yes, we've missed you, but thankfully we have a few other folks that participate here regularly. And you know, we soldiered on <laugh>, so, but good to be back with you. We especially are interested in hearing from you because of all of the interesting economic data and particularly inflation data and what it means for the Fed. So that's what we're going to talk probably about more today than anything else. It is Monday, March 18, 2024, as we are recording this early afternoon. We're getting greeted with a really strong rally here to start the week. I guess you could say that the stock market's celebrating St. Paddy's day a day late, because there is a lot of green on our screens which is good to see. Didn't have a ton of green last week.

Jeff Buchbinder:

It was pretty flattish. So we'll recap the market performance. Then we'll preview the Fed. I think the dot plots are interesting beyond just the obvious interest in what Powell signals. The Bank of Japan is meeting this week as well. And this is probably the most anticipated BOJ meeting in, you know, possibly a decade. A lot of attention on the BOJ. So we'll talk about that. Those two topics actually are what we covered on the Weekly Market Commentary this week, which you can find on lpl.com under the Research tab. And then lastly, preview the week ahead, as we always do, it's of course mostly about central banks, but there's actually some really interesting other things going on. We have not only some housing data, but we have an AI conference led by NVIDIA.

Jeff Buchbinder:

And we have several companies reporting earnings that I think are noteworthy. So, lot more than just the Fed and the BOJ. So we'll start by recapping in the flat week here. So, you know, the S&P pretty much went nowhere. It's you know, there's some rotation going on underneath the surface, which a lot of people have been expecting, ourselves included. But generally, we were flat. Still, this market has a lot of momentum, and you know, we at LPL Research are really following the technicals now more closely than ever to figure out where this market may be going next, as opposed to placing too much importance on valuations, which really, you know, don't tell you a whole lot in the short term. I mentioned rotation. We've also got a lot of breadth here.

Jeff Buchbinder:

You can see the percentage of stocks over their 200-day moving average right now is 78%. That's the middle panel here. That is a pretty strong reading, certainly at the high end of recent history. So it's not just the big techs that are working, which by the way, the big techs didn't work last week. And then the relative strength index you know, certainly still high at 62. 70 is the demarcation between overbought and neutral. So we are below that. So this market has cooled just a bit, but certainly maybe a little bit more work to do in terms of digesting the recent gains. From looking at the intermarket performance, I think the first thing that stands out is small caps had a really tough time last week. They are interest rate sensitive. Yields did rise on the strong inflation data.

Jeff Buchbinder:

So you see that interest rate sensitivity in small, you see it a little bit in the big techs, which are interest rate sensitive in terms of stock valuations. And then you see it a little bit in real estate, you know, an interest rate sensitive sector of course. So I think that's one takeaway. But another takeaway here is you know, tech was down last week, but if you look at the three month where tech has been up 11%, look at energy up almost 10. Financials up almost 10, right? So this is not just about tech. You're starting to see this broadening out and you know, other things are working, which is certainly helpful. I mean, you still have double digit gains for tech, but good to see other things working. I guess you know, beyond that, Japan is getting all the attention.

Jeff Buchbinder:

If you look outside the U.S., the Nikkei did have a little bit of trouble digesting the anticipated start or anticipated rate hike from the BOJ. So the Nikkei was down 2.5% in yen terms last week. But look at the year to date, in the bottom right-hand corner, you've got gains of, you know, high teens. So still a very, very strong year, certainly for, for Japanese equities, which we continue to like. The bond market was down last week. Again, I mentioned rates up as the inflation data came in a little bit hotter than we and the Fed would like to see. We're also getting pretty big gains in oil recently. You had Ukraine strike some Russian refineries which pushed oil higher. You also had a pretty bullish inventory report last week. And then copper rallying as well. Got a little bit of a better tone in China. Actually, here's where I'll bring you in, Jeff. I noticed that the Chinese data over the weekend was actually pretty good. So do you think part of the uptick in commodities is related to improving growth expectations in China?

Jeff Roach:

Yeah, it's possible that we're at the trough of some of these markets, and so it, well, I should say specifically the economy necessarily, not necessarily capital markets, but yeah, you think about where China is. So month on month or even year to date numbers might look good but they're coming off a really low base. But it's possible to say, okay, once you know that a country is troughed, the only direction is up, right? And I think that was, that was a driver. I wanted to say just one thing about last week's domestic market returns. You know, one of the things that make us a little more comfortable, Jeff, as you highlighted, the diversity and the breadth of returns, thinking about even an industrials materials sector, you know, we talk about energy, healthcare but, you know, having somewhat of a flattish week, it's a possibility for the markets to kind of take that breather, you know, and not just continue to scream higher and higher.

Jeff Roach:

So that's certainly a good thing. And it's about sentiment. It seems like there's, you know, this improvement from a sentiment standpoint, that was actually one of the things, Jeff, one of the reasons why I was out of pocket last week. We were at some of us from LPL Research at an important LPL conference for some of our top advisors. And one of the things that our Chief Investment Officer Mark Zabicki highlighted was the role of sentiment when you think, I don't know what valuations are telling us you know, what are the fundamentals telling us? Well, let's look at sentiment. And that's certainly a very important metric that we're tracking internally as well.

Jeff Buchbinder:

Yeah, absolutely. The enthusiasm around AI is, you know, it's salient as I'll say. So yeah, we do think this market has to digest these recent gains at some point, but the technical momentum is so strong and the fundamentals are good enough that you know, we're riding the wave here still, so no change to our recommended asset allocation at this point, neutral equities and you know, generally neutral fixed income as well. So let's turn to the Fed. Again, this is our Weekly Market Commentary this week, and probably the most important event of the week, although you could argue the BOJ. So Jeff, this is where I'll bring in for the discussion on inflation, because of course, interpreting the inflation data from last month is really key to figuring out whether some of those dots are going to move.

Jeff Roach:

Yeah, I think the argument and the frustration among traders and investors, those that are looking for longer term investments versus those that are looking for very short term, you know, volatility and dislocation. It's all about your belief that the disinflationary trend is continuing throughout 2024. You know, the argument is, okay, you know, at what point will it be convincing that that trend truly is disinflationary and easing? You know, January was hot. February was pretty hot. One of the things I wanted to highlight for our listeners, Jeff, and this is something that segues nicely into Fed expectations this year, and that is, what do we know about labor costs? What do we know particularly about labor costs within services providing industries? That should help us and give us the level of conviction that we're looking for on the inflation side?

Jeff Roach:

So this is a pretty straightforward graph. It's blue line there is from the Employment Cost Index, it's one of the best broadest measures of labor costs because it includes wages, salaries, benefits, other costs that firms bear for labor. And I took out goods providing industries. I just care in this picture about the services side. Because that's where the stickiness of inflation is. So that's the blue line. The services providing industries. What's the cost of labor here, the Employment Cost Index, and then how is that related to consumer prices? The CPI inflation in the services sector, very choppy. You could see on the services side. But you definitely could say that blue line, we're not quite back to pre pandemic levels, hence the debate in markets. But I think the rotation is pretty convincing that we're starting to see labor costs within services providing industries ease up. And it's just a matter of time. We have to be patient. Hence segueing into Fed speak the patient pause.

Jeff Buchbinder:

Yeah, absolutely. Productivity playing a role here too, right? Because you get the combination of good productivity and easing wages in the services sector, you know, that should help contain inflation for, you know, quite some time, I would think. Is that the right way to think about it, Jeff?

Jeff Roach:

Yeah, well that is right to bring in the productivity numbers because that's exactly what artificial intelligence is advertising it will do for us. One of the things I've been highlighting for in our STAAC meetings over the last little bit is thinking about 90s productivity as a good blueprint for where we are in 2024 and beyond, maybe by 2030, right? So it takes a while for these productivity numbers to become realized and actually work through. It’s the economy and then where it hits the businesses and then ultimately in the full circle of things affect consumer prices. But, you know, part of this is we did have a pretty decent productivity bounce in 2023, and that's certainly one of the reasons why, you know, I'm of the opinion that the disinflationary trend is continuing. We haven't seen it convincingly enough, at least not for the Fed. But productivity certainly is going to help ease the inflation pressures moving forward.

Jeff Buchbinder:

Yeah, I think it's fair to say that some of this recent rally in the stock market is reflecting the market's expectations for higher productivity from AI. You know, that's not necessarily weighing into the Fed's calculus for what to do right now, but it's no doubt a positive story for corporate America and for earnings margins. So, let's go to the Fed now. And so, you know, Jeff, I mentioned the dot plots, you know, it's not the end all be all because it's just an average of a bunch of people's views and those views can be all over the place, but the market pays a lot of attention to it. We combine that with the fed funds rate to see what the market expects. And, you know, we're already down to three cuts, so, you know, down from a peak of close to seven. So the question is, is three, do you think three is kind of where we'll settle out or might you know, might the Fed interpret this inflation data and say, well, maybe it's, maybe it's closer to two?

Jeff Roach:

Right? Yeah, it's funny, you know, you think about where we were just a month or two ago I guess maybe end of end of the year last year markets were very much convinced there's going be a lot more cuts than what the Fed communicated in the most recent Summary of Economic Projections. We were somewhere in between. We said, hey, I think the Fed could do a little more than they say because they often do that. Think about 2015 through the 2017 scenario, they often cut more than they say they will, but certainly not as much as what the market was thinking. So I, you know, I think at this point, if the labor market continues to hold up people can truly feel a net gain in real disposable incomes, then the Fed really can't be that aggressive in cutting rates.

Jeff Roach:

This real disposable income is too strong, and hence, aggregate demand is going to be too strong. I think everything does kind of weigh heavily on that aggregate demand side of things. And then of course, you know, the shock that it's hard to necessarily forecast, but if there's any global supply shock, again, like we've seen in years past, and certainly in the post, immediately following the shutdowns of 2020 and then the re-openings. So there's got to be some surprises if the Fed goes ahead and actually cuts more than they say. Just going back to the importance of this week's meetings among the score of central bankers that are meeting this week, you know, the Fed will release an updated Summary of Economic Projections. I think what to look for inside that SEP, as we call it, Summary of Economic Projections. The SEP tells you individual estimates on where they think, you know, the fed funds rate will go. And it'll be interesting just to watch the dispersion, how hawkish are the hawks and how dovish are the doves. That'll be very important at this point in time.

Jeff Buchbinder:

Yeah, absolutely. Good job defining that acronym, which some of you may not know. We did not define the STAAC acronym. It's just our asset allocation committee within LPL Research. The group that has that neutral equities view, despite the fact that valuations are clearly high. And, you know, this market's really run beyond what we had anticipated when the year began. So want to get that out there as well. Always like to define those acronyms. So thanks Jeff for that. When we will watch, you know, hawks are going to be hawks, doves are going to be doves. That's certainly not going to change, but if enough of them move to two, if enough of them move to fewer cuts and we end up with just two that could cause the market to be a little bit jittery.

Jeff Buchbinder:

And when you do, here's where valuations can matter. When the market gets disappointing news, fundamentally or otherwise, you tend to get more volatility when you're coming from a place of, you know, higher or downside volatility, when you're coming from a place of higher valuations. So we're certainly not you know, thinking that this market's just going to go straight up every day. It's just very hard to predict where the rollover will be. We'll see if it comes from the Fed. But we got to watch the BOJ too. I mean, I don't think the BOJ is going to drive the U.S. market down much, but you know, you have higher yields in the U.S. and the U.S. yields have shown correlation to Japanese yields.

Jeff Roach:

Yeah. Well, let me jump in one more time, Jeff, additional point on the Fed I think that's really helpful. You know, it's interesting, you know, when we talk to business owners and then when we read the Fed, there is a little bit of a disconnect, and I think this'll be something that'll be important to see in press conferences and further conversations. It's this notion that some at the Fed think the economy's just going to revert to 2019 behavior again, you know, pre-COVID. But when you talk to businesses and you realize, okay, there are some structural shifts here, there are certain things that are probably not going to go back to pre-COVID norms. And I think that's where, you know, the savvy investor will benefit, say, okay, what's a temporary dislocation?

Jeff Roach:

Going to go back to pre-COVID? What's a permanent shift? What is something truly new? And I think you can kind of learn and glean from say, Great Financial Crisis. You know, certain things shifted. Some might be regulatory, right? Dodd-Frank. But that's something to watch. How will the Fed pivot a little bit you could say to saying though, okay, these sections, these industries, this, you know, these areas of the economy are certainly in a new regime and COVID has permanently, you know, altered behavior, you know, the way in which we hire and fire, the way in which firms manage you know, input costs, raw materials, et cetera. Anyway, that's another thing to just keep an eye out for, not only just for this most current upcoming statement and press conference, but really in the months ahead watching what the Fed's saying about that issue.

Jeff Buchbinder:

Yeah, we'll be talking about the impact of work from home and hybrid work environments for many, many years to come, <laugh>, because certainly there's a seemingly permanent shift, no doubt, and which keeps us a little bit cautious on real estate in terms of our tactical asset allocation. So, good point, Jeff. We could do a whole podcast on where we are in the cycle. Because frankly, I don't know how to answer that question. <Laugh>, don't answer it, <laugh>. Unless it can be less than half an hour. <Laugh> don't answer that. That's,

Jeff Roach:

Well, you know, it came up during the Humphrey-Hawkins testimony, as we used to call it. Not many people remember Humphrey nor Hawkins, but the semi-annual monetary report to Congress, you know, that chair has to do every year or twice a year, that came up. And that was a very revealing, I think a revealing conversation. But that for another time, another time, another day. Yeah,

Jeff Buchbinder:

That's a really interesting conversation. And it helps you identify where this market or help identify anyway, where this market might be going. So, let's talk about the BOJ, Jeff. So historic hike coming soon. We don't necessarily know if it's coming tomorrow, although, while you know, for those of you listening to this Tuesday, you may know this already, so we don't know if it's coming Tuesday or not. But if it doesn't you know, it's coming in April, almost certainly. The market is pricing an extremely high probability of that, and they've signaled it. So how should investors think about what the BOJ is doing here, Jeff?

Jeff Roach:

Yeah, it's either, you know, it's either you know, this week or April, the end of April. And so I think one of the things to think about this, especially as you, you know, as we're global investors, at least here we are, you know, LPL and the models that we look at we're not just you know, benchmark against the S&P 500. We're broader than that. I think the key here that's interesting, I think in this case, is that every other central bank well, major central bank is at this position of saying, hey, we think we're probably at peak during this tightening cycle. The next decision, the next action is going to be a cut in rates. Japan central bank is bucking that trend. <Laugh>, they're on a different cycle, as it were. And I think that's why it's important, because this certainly could alter what we're seeing in yields particularly, segue maybe for the next chart that we're going to show. But some of the things we flesh out during our Weekly Market Commentary, again, to highlight lpl.com drop down for Research, and you'll see that Weekly Market Commentary there.

Jeff Buchbinder:

Yeah. So segue to the next chart. So we'll go to the next chart, but this shows you that you know, there's probably going to be a few rate hikes coming in the not too distant future. It's not going to be a one and done situation that, you know, Japan has a long track record of being very gradual in their approach. You know, whether it's relaxing yield curve control, right? They had capped yields on, you know, the Japanese equivalent of the U.S. Treasury and you know, they've been slow and deliberate about how to, you know, get out of negative interest rate policy. Because they're still at negative rates on their target. So they're going to get you know, they got a little way to go to get to something more like normal. But in Japan, normal's probably 75 basis points to a hundred basis points.

Jeff Buchbinder:

Something in that range is probably where they are headed. We're showing you a chart of the yield pickup in Japanese government bonds compared to U.S. government bonds. And you see it's negative now. So even though our yields are higher they're not getting the benefit of, you know, essentially selling yen and buying U.S. Treasuries because the hedging costs are expensive, right? So you end up in kind of negative territory. So why do we show this? Why is this important? Because Japan is the largest owner of U.S. Treasuries, right? Well, that's one reason <laugh>, right? And so they can influence where our Treasuries go. They're probably not going to help us too much based on this chart in terms of, you know, buying more Treasuries. And if they're getting a little bit more yield in Japan because they raise rates, then that's even another headwind to Japanese investors buying treasuries. So, you know, we have to think about it as more than just you know, this yield in isolation. So thoughts on that, Jeff? You know, what is what's going on in Japan tell us where U.S. yields are going, if anything.

Jeff Roach:

Yeah, I think there are a number of factors that just influence this decision. You know, one thing I was just going to highlight, you know, one of the reasons, the uniqueness of where the yields are right now relative to where they might be, say, you know, after yield curve control is relaxed a bit is really a function of the economy's growth rate. So we know Japan just has a much lower trend for growth. So productivity's a little softer, obviously, their labor force a little bit smaller relative to, you know, their other metrics and relative to an economy like the U.S. But, you know, growth is a little bit slower. But however, what's interesting when you think about global growth relative to trend we might, in essence, you think of the other developed economies probably growing below trend, say like U.S., Germany, even China for that matter, growing below trend, Japan might actually grow above trend despite their trend being low. But the fact that they're growing above trend continues to make it somewhat of an attractive area for investors. So, a lot to unpack. This is kind of like the comment I made Jeff just a second ago on the Fed's conundrum between, you know, what's a temporary dislocation, what's a permanent shift in the economy? I think we could do a whole podcast just on Japan and some of the uniqueness of that region.

Jeff Buchbinder:

Yeah, no doubt. Of course it also matters because of the yen. They don't want the yen to get too strong because Japan is an export driven economy. So you know, that maybe is contributing to a very gradual approach. In fact, you know, I would be surprised if we didn't get a hike you know, this month or next. But based on the track record of the Bank of Japan and Japan in general, you know, it's not just a tiny, tiny tail risk <laugh>, right? You know, it's probably some sort of 10 to 15% chance that that happens. We'll have to see, but right now the yen's about as weak as it's been. You know, 150 has been support, and a lot of people seem to be interested in buying the yen at that level. So we'll see where it goes, but you're not going to see you know, Japan go gangbusters and start hiking rates aggressively because of that currency impact.

Jeff Roach:

So, if you listen to our head of model management, Garrett Fish, he is telling us now is the time to visit Japan for currency reasons. So, you know, maybe that's

Jeff Buchbinder:

Good call.

Jeff Roach:

Put on for your bucket list

Jeff Buchbinder:

One of the members of our team just did that, Colby Hesson. So yeah, there you go. You don't just get investment ideas from LPL Research. You actually get some travel consulting services as well. So how about that <laugh>? So let's preview the week ahead, Jeff. There's, you know, central banks we already previewed so we don't need to go into that. But you've got some housing data on here that I thought was interesting, so I highlighted it. What are you looking for out of the economic calendar in terms of housing or anything else here?

Jeff Roach:

Yeah, housing's been a hot topic really for quite a while, right? I mean, right after COVID it was a hot topic as people were refinancing, people were moving in earnest. Here we are years after COVID, it's still a hot topic because there's such a regional divergence between, you know, what we're experiencing in the residential real estate that is. And one of the things wanted to just you know, put on our listeners radar this week, get a good look into permits, which is a good leading indicator, building permits, which leads starts, which leads sales. So when you're looking at the overall big picture there that's really extremely important. And the regional divergence is something also to note, but you know, people that are, you know, thinking the rolling recession, do you remember we talked about that?

Jeff Roach:

You know, I guess probably now, what, two years ago, the concept of rolling recession, meaning certain sections of the economy were experiencing a drawdown, and while other sections weren't. So, for example, consumer spending still very strong like in 2023. And yet at the same time housing was in that recession, I think we're past the low point. Look at some of the some of the growth as people continue to relocate from higher cost of living areas to lower cost of living areas, watch the building's permits number, as well as some of the later data that we'll get on the 21st of this week. So that's it outside of central banks, it's a lot of focus on the residential real estate market.

Jeff Buchbinder:

Yeah, the housing prices have been very resilient in the face of higher mortgage rates. So I think, you know, low inventory is certainly part of that, but part of it's also just, you know, consumers are employed, consumers have money, this economy is doing pretty well. And I think you see signs of a healthy housing market when you look at how the home builder stocks have done this year. You would think this would be a really rough time for home builders with what's happened to rates really hasn't been. So continue to be you know, pretty impressed by the housing market. We're also going to get this NVIDIA AI conference this week, which is getting a lot of attention. I think it's part of why, you know, tech is fueling a rally here on Monday as we're recording.

Jeff Buchbinder:

So you know, after a, you know, kind of a disappointing last couple of weeks, I guess, generally, for the mega cap techs, we you know, we might get another bounce here. And again, I mentioned upfront, technicals, I think are your best friend now to try to figure out when to pull back. We continue to get evidence that this is a buy the dip kind of a market, haven't had much of a dip, nothing more than 2% since October. But you know, at some point it'll come, we just wouldn't be too anxious to call a top here. And this NVIDIA conference and the news today that that Apple and Alphabet/Google may be, you know, working together on an AI tool for the iPhone that is really igniting more enthusiasm and keeping this, you know, AI train rolling.

Jeff Buchbinder:

So we still think makes sense to lean a little bit into growth stocks now, despite the fact that, you know, growth has really dominated value for quite some time. So in addition to the AI news this week we're going to get earnings from some pretty big name companies. The I think the two that will probably have the most market moving potential would be FedEx and Nike. We always look to Nike for a clue as to how China business is going. So we'll watch that. And then FedEx, of course, is just like UPS kind of a barometer of economic activity, you know, can maybe give us a clue as to whether we're going to get a 2% GDP economy in Q1, like the Atlanta GDP Now forecast is telling us that we will. So we'll be watching that. It's still a little bit too early to talk about the bulk of Q1 earnings season. But certainly after we get these results and others this week maybe next week we'll start thinking about how that's shaping up. So anything to add there, Jeff, or should we wrap up?

Jeff Roach:

That's good. I think the AI story is interesting. I'm glad you highlighted the conference. Just wanted to highlight, you know, David Otter, one of the experts he nature of work, he's an MIT prof done some really great stuff. He reminds us, you know, that 60% of all jobs today didn't exist in 1940. Thinking about AI is not necessarily coming to get your job, certainly will impact that, but it's a compliment, not necessarily a substitute. One important way to think about artificial intelligence. But that's good highlight there, Jeff, on the conference.

Jeff Buchbinder:

Yeah, thanks. Good point on changing jobs, I can tell you that there weren't too many investment-related podcasts in 1940. So this is <laugh> certainly a new part of our job. So yeah, thanks for that point. So we'll go ahead and wrap. Thanks. Thanks everybody for joining. Thanks for your partnership for your interest in LPL Research. We really appreciate it. We'll be back with you next week and certainly I am sure we'll be talking about AI again, don't think that is going away. And then we'll recap what we heard from the Fed and the BOJ. Thanks everybody. Take care. Have a great week.