Markets, Central Bank, Consumer Confidence: Historic Global Moves

Podcast Intro:

From LPL Financial, welcome to Market Signals.

Dr. Jeffrey Roach:

Welcome to a new edition of Market Signals, and we are recording this on Tuesday, September 27. Your host here, Dr. Jeffrey Roach, Chief Economist for LPL, and joined by Marc Zabicki, Director of Research, and also the Chief Investment Officer. Marc, how are you?

Marc Zabicki:

Doing well, Jeffrey. Good to be with you.

Dr. Jeffrey Roach:

We do often see each other in person in the office, but Market Signals here recorded virtually. So unfortunately, you know, we have to switch back and forth home office to real office, but either way, here we are, Market Signals, important disclosures. Remember, we are careful about how we talk. We're not talking about guaranteeing and certainly not wanting to assume we know the future. So, some of these comments will be forward looking in nature, but you know, the limitations of us here. So, there we go. Hot topics we'll talk about the pound, talk about little bit of oversold conditions. We'll talk about the aggressive nature of recent Fed activity and then hot off the press this morning, as we're recording Tuesday here, we were heard from the conference board that consumer confidence improved.

We'll talk a little bit about that, what that might mean. And so there you have it, our roadmap for today. And as always, your research team is available to help you, assist you in any way. And glad to be available. Reach out as always with questions. So, pound sterling right off the bat. We do have a colleague going over to the U.K. in a little bit. I actually came and did my visit a little bit too early, Marc, apparently, if I waited a little bit, I was over there with the family in June, and if I waited a little bit things would've been cheaper. Would you say?

Marc Zabicki:

Could've saved some money there. Every economist is interested in saving a little money, right,

Dr. Jeffrey Roach:

Exactly. So, you can't time it perfectly. But you know, hey, at least we didn't you know, go over there, two, three years ago. But, you know, pound sterling hitting all time lows. A lot of new people in office over in London particularly that's adding some volatility. We are seeing kind of this new budget. We talked about this a little bit yesterday, Marc, in our Strategic Asset Allocation Committee meeting. As advisors know, we meet regularly as a committee to hash through events of the week, of the day and what that might mean for portfolio allocations. But any thoughts as we dive into some highlights here with what's going on in the currency markets and fixed income markets Marc?

Marc Zabicki:

Sure, sure. I mean, I think the Federal Reserve has got our eyes trained on the dollar and the dollar strengths, and, you know, the dollar's been across, you know, most currencies out there, the dollars is really strong. And based on you know, the actions of the Federal Reserve, I mean, you could probably take a look at the dollar right now and raise a little bit of an eyebrow and ask the question of how parabolic or how straight up, effectively that, the dollar could go. Thinking that at some point, you know, we may in fact, you know, show some weakness in the dollar in the weeks or months ahead, meaning that it can't continue to go up in a straight line. And especially if we get some inflation readings that are a little bit more palatable. And if we get some concept that maybe the Federal Reserve will have to, you know, go or do less work in terms of policy maybe causes a little bit of a breather for the dollar and probably a little bit of breather for risky assets, honestly.

Dr. Jeffrey Roach:

Yeah, exactly. So, you know, this graph for those of you that may be listening while you're exercising showing a graph here on the relationship with the dollar pound exchange rate, as well as the 10-year gilts for the U.K. And so, what's happening, you know, across the pond here is you know, and I can appreciate a lot what's happening over there. I have a very soft spot for supply side economics in my heart. And enjoyed reading and thinking about Art Laffer being in graduate school at Clemson University. And so, as a supply sider, when I'm reading about tax cuts and trying to make the environment a little bit better for both consumers and businesses alike over in the U.K., I think, okay, well, that's great. That's, healthy stimulus.

But at the same time, if we're seeing, all right, there's an aspect of stimulus that will be inflationary. And so, you know, I think markets are very nervous about inflation getting even worse than it currently is in the U.K, and clearly putting downside weakness in the pound. And you can see this graph, I actually put this graph together before yesterday's trading activity where, you know, the pound even weakened even more. But the point is that it's in relationship as Marc as you just said. A lot of it not only is just the supply side conversations that's happening in the new government in London, but also the fact that the U.S. Central Bank has been very aggressive in raising rates. And in many ways, "Ceteris Paribus", has upside pressure on our own domestic currency. But clearly something to watch out for, adding to the overall global volatility in the markets right now.

I think that's the point that we wanted to highlight in this podcast is you talk to clients, and you talk to folks about markets, what's adding to some of this market volatility is some of the other very aggressive central bank activity mentioning here as well as Bank of Japan. We'll just put that in passing. So next hot topic. Moving on to sentiment. Marc you can add some comments here but wanted to put it over to you. In the top of the podcast just highlighting some of our hot topics for this edition. The second hot topic here is some of the sentiment numbers. This is the first of two graphs but in terms of equities and volatility, Marc, what do you think and how should advisors think through what's happening right now?

Marc Zabicki:

Sure. I mean, we call this tool for the toolbox number one, and there are plenty of sentiment tools out there. This is just one that I kind of historically have looked at for kind of a long time, just almost as a commonsense check-in on how markets are reacting relative to volatility. So, what this is, is basically as the nameplate indicates the S&P 500 trailing one year return to volatility ratio on a weekly basis. So, what this means is so, when returns are high and volatility is low you have this ratio appearing on the upside of this graph. When S&P 500 returns are low and volatility is high, the ratio will appear on the lower end of this graph.

So, it's basically a measure of extremes. So, we sometime in 2021, as this chart shows reached an extreme in optimism you know, clearly overbought conditions as this chart would point out. And now we've kind of conversely reached an extreme in pessimism oversold conditions that, you know, this chart goes back, you know, call it, 10 years, 11 years is the timeframe that we're looking at. There is no lower point over the last, you know, 10, 11 years than that point that we see today. So almost an extreme low in sentiment, you know, based on what we are seeing in this chart, which common sense kind of tells you that when you see these types of extremes on the high and the low, that the market is almost in a coil spring kind of mode.

And if we get any kind of good news, and this is your arena, Dr. Roach is, you know, maybe we get some good news on inflation, maybe we get some good news from the Federal Reserve relative to inflation. And, you know, in a coiled spring effect, we get a bounce back in risky assets. So, from a contrarian perspective, although sentiment is decidedly weak, the market's been down notably over the last several weeks, some good things perhaps to look forward to if we do get that ballot of good news.

Dr. Jeffrey Roach:

Yeah, that's right. And so, it's a great segue for, you know, where we'll go in the next slide, thinking about these extremes and what could be the impetus to kind of move us back from one extreme to another extreme. Use that coil component here. So, you think about where we are from an investment sentiment standpoint, you know, bullish, bearish, and so toolbox number two here showing on the screen. I think it's a great natural next step to add to what your earlier comments are, Marc.

Marc Zabicki:

Yeah, yeah. Tool for the toolbox, number two, again, there are multiple different tools in the toolbox sentiment, fundamental, technical and otherwise. But I mean, we're looking back 12 years in this chart here. The American Association and Individual Investor surveys, those that responded in a bearish fashion are 65% in the last weekly reading, which is a historic high over the last 12 years. So again, a contrarian would tell you that, you know, you may want to bet the other way in terms of what this chart shows you. Extremes in pessimism you know, generally, typically lead to reversals in the level of sentiment out in the marketplace. So again, if we're looking at the tool for the toolbox, number one and the number two, we can perhaps deduce that the market may be in a position for that coiled spring rebound.

Should we get that piece of good news on the inflation, maybe the PCE number this week. Dr. Roach can, can get us there, but who knows? I mean, I do think from a market strategy and an asset allocation perspective we are indeed in pretty definitive oversold territory here. So, and the retest of the lows in June, we saw yesterday, we are today getting that bounce, which is good news and probably not much of a surprise as we bounce off those June lows because the obviously an important level of support here.

Dr. Jeffrey Roach:

Yeah, that's great. And I think, you know, the natural follow up to that then is to say, okay, we're at this extreme level of bearishness, why? You know, the so what or how did this happen? And I think that kind of flows real nicely into this next chart where we're saying, okay, I think part of the reason why we're seeing such negativism is in response to an aggressive Fed that's never been this aggressive historically. And so, in this graph, we're just saying, okay, given all of the various tightening cycles from the last several decades, let's look at how the Fed has hiked and how they've tightened over time and at what speed. And so, this dark black line is the current tightening cycle, and you can see that by far and away, this is a tightening cycle that's happened much faster in magnitude than any other tightening cycle.

And I think that's kind of that natural iteration of this conversation with folks saying, okay, why are people bearish? Why is the market nervous? Okay, we talked about the unusual nature with, you know, the U.K. and how currency markets are trading. Let's add to the storyline an aggressive Fed that is tightening faster than they've ever done before. And I think in some ways that kind of makes sense, where you see, all right, the Feds typically in the last several decades, you can kind of see this fact that the Fed never really tightens above the previous peak in rates. You kind of, you know, you see high rates and then they start easing because of economic weakness. They start tightening again. They never quite reached the previous cycle's peak. Not so this time around, right? It's a whole new era in the sense that the Fed said, all right, given the fact that we have such unusual characteristics in the stickiness of inflation, we're going to hike, we're going to be aggressive. We actually heard this again yesterday, which was Monday. The Cleveland Federal Reserve President was talking about the fact that rates need to be higher for much longer. I think that's really changing market expectations even in the last, you know, 48 hours about what rates might look like going into 2024 now. So, I think that's part of the challenge, markets responding to a very aggressive Fed, tightening much faster than they normally fight. Hey, Marc, you want to follow up on this.

Marc Zabicki:

Actually, out of curiosity here. Just from your perspective you know, how much of what the Fed is saying, which, you know, I think we're taking the Fed at its word, it's going to continue to raise rates somewhat aggressively and maybe not quite on a 75 basis points level of aggression, but you know, how much of what you're hearing from the Federal Reserve would you categorize as jawboning?

Dr. Jeffrey Roach:

Well, I think they're what we call jawboning is what they call forward guidance. And so, you know, in previous FOMC kind of cultures, particularly with Bernanke back in the day, you know, one of the tools that the Fed actually had was not just, you know, adjusting short-term rates and money supply and interest paid on excess reserves and all these other things that they do. You know, forward guidance is a real tool, and forward guidance just means in everyday English. It just means that the market needs to hear what the Fed's planning on doing. So the forward guidance means the Fed's saying, hey, we need to see rates here, or we won't change our policy until we see inflation moving in this direction. You know, and all of that kind of conversation is important. And I think part of the way that the markets respond and financial conditions tighten is by the forward guidance, just the talking.

So, the fact that they give speeches saying, we're serious about you know, inflation fighting, we're also mindful that we're talking about a long run average 2% rate. So, I think in many ways, when the Fed can be convinced that inflation is easing and you know, it's unequivocable inflation easing going in the right direction, I think in some ways that is just as good as you know, that forward guidance saying, all right, we're moving toward this 2% target. And it'll take a little bit of time, but moving to, you know, a plus 8% on the CPI to seven, that's a move in the right direction. If we're looking at the deflator moving from, you know, an upper sixes to a 6% year on year rate, which we'll most likely see at the end of this week, I think that's actually going to be fairly positive for the markets and investors knowing that inflation's moving the right direction. So forward guidance is a legitimate part of what the committee members do in going around giving talks.

Marc Zabicki:

And that's some of the base case in terms of our work as a Strategic and Tactical Asset Allocation Committee at LPL Research with some of the work clearly that you're providing, Jeffrey, in terms of inflation outlooks, we do think inflation is going to ebb here. The question is degree and how fast we get back to, you know, some more palatable inflation numbers. And that's why we're a little bit cautiously optimistic here from, as we get this, you know, ballot of extreme pessimism. If we do get some inflation numbers that are within expectations or better than expectations and show that continued trend of deceleration inflation, then I think the market like that a little better, don't you think?

Dr. Jeffrey Roach:

Yeah, exactly. You know, and it's funny too, just to bring up something, I had a conversation with some friends and they were saying, well, okay, what's the deal with you economists and market, you know, participants talking about core inflation? Isn't it true that food and energy are very important for the average American household? The answer is yes. And the reason really for the focus on core is its statistical properties. It's easier to forecast and model out when you take out some of the highly volatile components, but the bottom line is headline numbers are important, and the Fed actually has stated that, the headline numbers are important, and that's why on Friday, I think it's very important for all of us to focus on the fact that given the decline in energy and gas prices and some components of imported food prices, services, we're starting to see that headline number ease a little bit.

And I think, you know, before we, you know, end the podcast, it is fair to say, well, is there anything positive to talk about? You know, we talked about some of the historic just moves, particularly in pound sterling, I'm thinking. But, you know, in the moves in Fed policy, et cetera, what's good? Is there anything positive? And I think we can actually give some good news and end on a positive note, because this morning, Tuesday, we had a rebound in consumer confidence. And you know, one of the things that you know, we often look at is, you know, those leading indicators that suggest when a recession hits, we're going to actually talk about later this week, and some other deliverables that we do here out of LPL research, talk about the fact that, a spike in unemployment, as the Fed has warned, is really consistent with a recession.

So, we're talking about increasing the call and the risks of recession next year. But if you think about where we are this year, particularly in the third quarter, you know, you think about the fact that, you know, July, August has been pretty a little bit better, pretty you know, calming from a consumer standpoint and from some of the pricing standpoint. Now, granted you know, July and August was short-lived in terms of how equity markets were moving, September's been a whole nother story. But this latest uptick here in this graph just showing consumer confidence overlaid with the column, the gray column there showing the official recession as defined by the National Bureau of Economic Research. And you saw, you see this uptick that's for September, September moved back up to triple digits 108 is the latest measure for consumer confidence.

And the reason why I think it's important is something that you can take away. I think as advisors, you talk to your clients and thoughtful about how various age cohorts, income cohorts, are experiencing the current economic environment a lot different than any other cohort. So, you know, the Consumer Confidence Board conference board gives us the numbers broken out by age. And I thought it was worth highlighting on the podcast just because people don't often talk about this, but again, it kind of gives you an edge as you access LPL Research, what do we give you that's non-consensus or, you know, not necessarily hitting mainstream media? And one of the things I thought was worth highlighting is that when you break out consumer confidence by age, there's a very different experience for those under 35 versus those over 55.

So, kind of looking at, you know, the barbells of the labor force, if you will. And that dark blue line there, the under 35s, you know, everybody took a hit during the pandemic and had a little bit of a head fake, you know, coming into 2021. And then we realized the nagging influences of inflation and then eventually you know, a war from Russia has depressed confidence. But if you kind of just look at that, you know, eyeball it, you know, from 2019 to where we are currently, the under 35s are pretty close to pre-pandemic levels, and it's a lot different experience than the over 55s. And the reason I think, kind of connecting the dots here between confidence and what we're seeing in the labor market and why the labor market's so tight, you have all these openings, you don't have enough unemployed people, people looking for work.

It seems to be this, you know, this frustration with the over 55s. And I don't know if it's perhaps maybe you know, a frustration with what the hybrid work environment might look like, maybe on the positive end it's the, you know, wealth effect, the fact that you know, the over 55s have a much larger a war chest than the under 35s, and they can weather kind of taking a timeout, if you will, a gap year or a gap year or two thinking of you know, those after college. But it's a lot different. I don't know, Marc, if you want to comment on this, it's interesting thinking about just the different experiences based on where you are in demographics.

Marc Zabicki:

Yeah, probably hard to pinpoint, Jeff, just in terms of the over 55 folks, is maybe we've got a situation where they're over 55, perhaps more on a fixed income. And then the gas prices were really eating heavily into that inflation, eating more heavily into that perhaps than the under 35s really digest. And then, you know, maybe some of the lifts that we've seen in today's number is related to honestly, you know, oil prices, gas prices, which have in fact come down. I mean, we're at like $77ish WTI this morning. So there's probably some semblance of a direct correlation with oil prices and consumer confidence. And as we know, oil prices affect, you know, you know, nearly four corners of the economic system when it comes to inflation. And so having oil prices kind of ebb here, which is an expectation of ours by the way certainly is helpful to all three of these lines probably.

Dr. Jeffrey Roach:

Yeah, that's right. And so, if you take that narrative that the over 55s are taking the gap year or two, that by definition means they're going to be on a fixed income <laugh>, you know, whatever they're drawing from retirement, right? They don't have, you know a paycheck to play off of. And so that clearly kind of adds to that storyline. And I think, you know, one of the things that we need to see in order to provide real salve for the markets is this kind of this recovery from these 5 million folks that are on the sidelines, that were in the workforce pre-pandemic, they're still on the sidelines for whatever reason. We really need to see a greater labor force participation rate in our economy, and particularly those that you know, that are over 55.

And here's the really good news, and I think, this is where we can wrap it up talking about you know, the next you know, day and the remaining days of this trading week, and that is, you know, out of Tuesday morning's consumer confidence report, we saw that inflation expectations for the average consumer is well anchored. That's one of the things that you'll hear out of policymakers when they talk about forward guidance and talk about plans and talk about, you know, how tight will they be and for how long will they continue this aggressive rate hike. A lot of this hinges on inflation expectations, and sometimes it's a little confusing. I think when I talk to end clients, they say, okay, it really is important because it affects consumer behavior today, today's behavior is based on tomorrow's expectations.

And so, we don't want a runaway inflation expectation and people, you know, clamoring to get things now, stock up on things now, because they're nervous about future prices. And in the details of this consumer conference report for September, we saw an even better improvement that inflation is expected to come down, consumers are reporting that, and they're acting upon that. And that clearly does add a little bit of I guess salve, thinking about how aggressive will the Fed have to be but inflation expectations are well anchored. But here we are. It is a busy week this week. We feel like we say that every week. So, Tuesday, as you can see, I highlighted consumer confidence. Wednesday, Thursday and Friday. I would say the biggest one is probably the Friday number Marc, as you've already highlighted a few times throughout our remarks on this podcast.

But the preferred metric of inflation, the PCE deflator, it's based on the personal consumption expenditures of the consumer here in the U.S. What they're actually selling, what they're actually buying and in what proportions. I think gives us and central bankers the best read on how inflation is impacting consumers. We'll get that 8:30 eastern on Friday morning, and we are expecting the headline number to march on down to 6% year on year. And we expect in the coming months to finally break below 6%. And that will clearly add confirmation in our view that inflation has decelerated, has peaked and decelerated. So, Marc, what do you think? Anything you want to add?

Marc Zabicki:

Well, I mean, yeah, I think the timing is interesting. Just we took a look at two indicators from a sentiment perspective, and they're both at, you know, pessimism peaks over the last 10 or 12 years, and then we're talking about Friday perhaps getting a nice look at an inflation number that may in fact be continuing to trend lower. So we combine the two, good news on inflation, perhaps on Friday, peak pessimism, current state of the union today that makes for that perhaps that coiled spring type of a reaction we may get from risky assets. So, something to, to kind of digest here in terms of the way to think about, you know, market positioning. And I know over the last couple weeks watching the market go down on a material way is not easy to digest from a behavioral perspective.

But right now, we may be on the cusp of getting some better news from an inflation perspective, we're certainly in the throes of that deep pessimist pessimism. And that maybe provides a level of opportunity for investors and some respite for those investors who have been allocated to equities and other risky assets over the next couple weeks. So, we could see a little bit of a tradable bottom here. Should we get a PCE number that actually is more palatable?

Dr. Jeffrey Roach:

Yeah, that's exactly right. Well said. And as always, we're thankful for your business. Thank you for listening, and until next time feel free to reach out to us for any questions and support. Take care.

Podcast Outro:

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