The Odd Reaction to Goldilocks Jobs Report

Podcast intro:

From LPL Financial, welcome to Market Signals.

Dr. Jeff Buchbinder:

Hello everyone. Welcome to the latest edition of LPL Market Signals. Jeff Buchbinder here, Chief Equity Strategist, joined by my friend and colleague, Marc Zabicki, Chief Investment Officer and Director of Research. How are you today, Marc?

Marc Zabicki:

Doing well, Jeff, great to join you here on a Tuesday, actually.

Dr. Jeff Buchbinder:

Yes, we are recording this Tuesday morning, September 6. Look like when we came in, we'd have some gains today, but those unfortunately have evaporated, at least at this point in time, late morning as we're recording. Here's what we got for you today. A lot to talk about. It's just a really interesting market environment. We titled today's podcast "Odd Reaction to Goldilocks Jobs Report", right? We thought this report was pretty much right what the Fed wanted to see, but clearly the market has other ideas. So, we'll talk about the jobs report, what it means for markets and our thoughts on what you know may happen here going forward. And then, the third item on our agenda is we're making some changes to the asset allocation, the tactical asset allocation for LPL Research. So, we'll talk about some risers and fallers for our Tactical Asset Allocation Committee.

These are not just things that are working, or not working. These are things that we think are starting to look better or starting to look worse, where our views are changing. So, let's get rolling here. To start, now was Friday's job report what the Fed wants to see? You know, I would argue yes. And it was really interesting, Marc, the way the, the market reacted, right? Initially, stocks popped on the news. It looked like pretty much every component of the report was dovish for the Fed, and yet stocks went down. Did the market read it wrong?

Marc Zabicki:

No. I think the market is reading not necessarily what a jobs report says or what the economy says. I think the market's probably gone back now to reading, is the Fed going to engineer a soft landing or is it not? So, I think the market trading and we'll perhaps get into, you know, August trading versus trading that happens after Labor Day, which we're now day one in that. But the point is I think the market's just revisiting the previously held notion that the Fed was going to be, you know, kind of be a little bit more dovish and perhaps have a higher probability of engineering a soft lending where obviously the conversation in Jackson Hole has changed that narrative just a little bit. And I think I'm probably of one that would say probably didn't matter what the number would actually look like on Friday. I just think the market is actually, you know, reading it negatively at this point. That could possibly change though. But I think that's where we were on Friday.

Dr. Jeff Buchbinder:

Yeah, I think that's right. There was really nothing in the jobs report that made the situation any worse for the Fed. Our Chief Economist, Jeffrey Roach, did highlight that temporary workers reached an all-time high. And so, when you have a lot of temporary workers, they can more easily be cut in a downturn. So, that maybe puts the labor market on slightly weaker ground. But if you just go through all the pieces of this, and you're looking here for those of you watching on YouTube, you're seeing the trend in jobs, right? And what the Fed wants is less job creation. They won't admit it, but that's what they want to cool wage pressure. So, we got that right. We got a couple hundred thousand jobs less month over month. Not only that, but we actually chopped off about a hundred thousand jobs from prior months with the revisions.

So that is certainly dovish. We had the unemployment rate tick up just a bit. You know, not only do we want to see fewer job openings to put downward pressure on inflation, we need a little bit more unemployment. Not a great position to be in, but that's the position we're in. The wage gains were a little less than anticipated by economists consensus. And you know, it's not great, 5.2% year over year, but it is starting to move in the right direction. And then the yield curve steepened, it's steepening further today, because the long end of the yield curve is moving higher. And that's positive. So, you know, I agree with you, Marc, the market just wanted to go down, it wanted to test some of these technical levels that we'll talk about in a minute. Another positive, participation came up.

Jeff Roach again pointed this out in a blog last week on LPLresearch.com. The 45 to 54 cohort of the labor force actually has seen participation go back above pre-pandemic levels. So that's my cohort and we'll call it your cohort too, Marc, even though you're, you might be kind of on the edge <laugh> there, it's always good practice to tell the boss they're young. So, 54, you know, 45 to 54, that's an important piece, right, of the labor market. Obviously, the younger pieces are very important too and everything's really moving in the right direction except for this older cohort, right? There's been a lot of talk about early retirements among the 55 and up crowd, and you see that in this chart, the gray line moving down. So, it's going to be tough to get some of those folks back into the labor market at this point. But the majority of the labor market, you know, we're talking about 75 to 80% participation rates. That's actually not only a good trend. I mean, it's a pretty good level getting near those pre-pandemic highs for those segments as well.

Marc Zabicki:

I wouldn't be surprised actually, Jeff, at some point see that white gray 55 and over cohort to tick up perhaps. I mean, I think it just really depends on the overall wealth effect, whether you call that housing prices, call it, you know, equity markets and obviously, housing prices are still rising, but not to the degree they once were. And then we have an equity market through the balance of 2022. So that may affect some things as well. So yeah, I mean, you would like to see, you know, higher participation rate, you know, overall, but that's a decelerating trend that we've been recognizing now for multiple years.

Dr. Jeff Buchbinder:

Yeah, certainly, these trends are positive, but we do have a little bit more work to go and but, you know, more participation means less pressure on wages and happy Fed. So, you know, the jobs report, we were really looking for that report to help stocks gain support around this 3,900 level that we're breaking right now on an intraday basis, right? Again, I'm calling this thing Goldilocks, relative to expectations, it was Goldilocks, but the market just wanted to go down. The fact that we had a fairly Goldilocks report doesn't take away from the challenges that we have in Europe, right? Which are getting worse, not better. We'll talk about that more in a bit. Doesn't take away from the fact that inflation is going to take time to come down, even though a lot of these inflation indicators are moving in the right direction, that problem won't be solved for many months at the earliest.

So, the market has to be patient and if you're looking for, you know, a panacea, it's really not there. But certainly, this was a positive step to you know, all of those items that I listed off in the jobs report that looked good and are moving in the right direction. But, you know, this 3,900 level, Marc, is really and it's got significance for a number of reasons. I mean, you're more of a technician than I am, but I understand, from talking to Barry Gilbert that there's a Fibonacci level around here. I think it's a 61.8% retracement level, that's in addition to you know, these sort of May lows and June highs, right? A lot of technical significance right here. So, maybe that means the market was just trying to test that 3,900 by selling off this morning to see you know, how firm the ground is underneath this market.

Marc Zabicki:

Yeah, I mean, no question. I think we'll see how we close today, which will be the important level to watch as far as we're concerned. And then, you know, maybe how we close over the next couple days. But I mean, we have an opportunity to bounce off a 3,900 level support. I guess that would be the hope. In terms of you know, seeing further equity market gains, kind of, you know, building off of some of the momentum we've started to witness back in July. So, and I still think there's an opportunity for that. I mean, if you take a look at things from a calendar perspective, you know, Booky, you and I have been doing this for quite a while and I tend to really not spend, you know, a whole lot of time worrying about trading activity in the month of August.

I mean, it's not something that you can, you know, kind of disregard, no question. But as people are all on vacation, markets are trading relatively thinly across the globe you know, I would look forward to market participants getting back to work post-Labor Day and then getting a little bit more of a meaningful trajectory as to what may happen in equity markets or other risk assets kind of going forward. So, we'll see what post-Labor Day brings and then we'll see if we can't bounce off that 3,900 level all on a closing basis.

Dr. Jeff Buchbinder:

Yeah, you know, this is an important level, but I mean, there's not a ton of room between where we are now and those June lows. So, you know, if you think those June lows hold, and we think the odds favor that, certainly, you know, we don't have a crystal ball, but if you think the June lows are going to hold, then this isn't a bad entry point for folks who are maybe positioned more conservatively than they want to, or maybe were regretting missing out on the buying opportunity in mid-June. This is you know, starting to get a little more bit more interesting for value players. The other thing I wanted to mention about this, you know, recent selloff is it looks exactly like 2011. A lot of people are trying to draw comparisons between this market and 1970 which actually makes some sense.

But if you look at what happened in fall of 2011, we had a 17% rally just like we did between mid-June and mid-August. Then we had a 10% correction in November of 2011, just like we have right now. Actually, we're down about 10% right now off these highs from mid-August. So, maybe that pattern holds, and we can, you know, just get that same correction we got 11 years ago and then move higher and that was the resumption of the bull market that you know, went all the way to the end of that decade.

Marc Zabicki:

Yeah, I tell you, Jeff, I mean, we're prone probably the market participants are generally prone to some, you know, kind of irrational activity perhaps, as we all look to gauge expectations around, you know, future Fed policy. I mean, I'm going to lean on the fact that, you know, the Federal Reserve is likely going to be, at least in my view, a little bit more dovish than perhaps that we've built in terms of expectations over the last couple weeks. I frankly, I just think, I think they can't afford not to be a little bit more dovish than perhaps, again, we've been pricing in over the last couple weeks. So, there's that. I think at the end of the day, not that the Federal Reserve is going to be necessarily successful at engineering a soft landing, but I don't know that they're going to engage in the type of ultra tightening policy that they seem to indicate, you know in Jackson Hole, or at least, you know, as Powell indicated in Jackson Hole.

I would kind of chalk some of that commentary up to a little bit of jawboning that he may have been entertaining. So, there's that as well. So, we'll see what September brings. We'll see what, you know, a balancing of rational expectations around the Federal Reserve brings. But I would say you're right, Jeff, in terms of the, you know, the June lows being a nice spot to certainly get support if we don't get it here at 3,900.

Dr. Jeff Buchbinder:

Yeah, absolutely. That would be a 23.5% peak to trough decline if we match those June lows. Given this environment, macro environment, that seems like it's pricing in a fair amount of you know, the inflation problem and the economic growth problem, we'll, of course, see. So, we have another challenge in addition to the macro. We have the calendar, which you alluded to a little bit, Marc, September is the weakest month of the year, historically, whether you look at 10 years, 20 years, or even 70 years, which is where this data set starts, it's the worst. The only way you make it not the worst is you look at midterm years and you actually have a worse June. We certainly lived up to that with a rough June this year. The average over the past 20 years is about a 0.6% decline, so not a huge decline, but it does rank 12th and certainly is you know, getting a lot of attention in the media, people thinking that this might be a reason to be a little bit cautious in the near term.

So, it's another headwind, but we wouldn't necessarily put too much weight on a seasonal pattern. I guess what maybe is more worrisome than that, before I get to the good news, <laugh>, more worrisome than that is when you have a year-to-date decline heading into September like we do this year, you get worse Septembers. September on average, is down over 3% in that scenario. So, there's another reason to potentially be concerned, but if you look at the right side of this chart, look at what's next. October, November, December, three of the best months, in fact, in midterm years, those are the three best months. You, on average, get gains of nearly 3% in October and November in midterm years, and then another 1.2% gain on average in December. So, we would certainly take that if we can get it, that of course, starts the famous six month, you know, "sell in May, go away", the six month seasonal period starting in October, that has historically been really strong.

So, there's good news. It's coming. What are we, 24 days away, <laugh> from ending September. Hopefully it's an unusually strong September. But once we get to October, we'll have that seasonal tailwind with us. So, this is our last segment, risers and fallers. I kind of feel like this is a fantasy football show now where you know, people are talking about who to draft and who's on the rise and who's falling. But we won't talk fantasy football, even though it's draft season. We're going to talk about ideas that we increasingly like or are increasingly cautious on. And there's a few ideas here. Some of them probably won't surprise you regular listeners out there, but some of them might be a little bit new here, and even surprised me, one of them after we dug into it and made the case in our Asset Allocation Committee.

So, let's start with developed international as a faller. You know, I mentioned, Marc, you're more of the technician. But when I look at developed international from a fundamental perspective, I get really worried. I mean, you have, you know, the gas flows into the Eurozone now have been cut off completely. They were to 20% capacity. And Russia's saying they're shut off indefinitely. Germany in particular, is just not ready to not have access to any Russian gas. The inflation outlook over there is getting worse. It's why we may get a 75 basis point hike out of the ECB this week, that's on Thursday. So, you know, the fundamental picture is it's really tough to find anything frankly, to like in Europe. But walk us through the technicals when you look at this. So, we got, you know an RSI is certainly down, and maybe it's oversold, but you have this relative strength trend, which is the second panel, the middle panel, relative strength trend is negative, and you've got some deterioration in the percentage of companies above their 200-day moving averages.

Marc Zabicki:

Yeah, Jeff, I mean, the technicals are almost self-explanatory here. I mean, technical analysis 101, lower highs and lower lows, it kind of tells you the story of developed international. So, the trend is not your friend here. And I'll second your comments on the fundamentals. I mean, I think that's probably the key driver, just the ongoing uncertainty about how Vladimir Putin is going to handle his key customers in Europe in terms of gas supply, that's going to be an ongoing, you know, albatross around developed international markets as far as we're concerned. So, and that's probably not going to be resolved anytime soon. So as long as that albatross is hanging around the neck of developed international markets, specifically as it regards to the relative activity between developed international and U.S. markets, we would continue to be negative in this space.

As you mentioned, inflation is continuing to rise, which is problematic. You know, we talked about perhaps the Fed leaning on the dovish side with policy, when all is said and done, I think the ECB is certainly going to lean on the dovish side, certainly relative to the Fed, when all is said and done, they may take some more definitive action here in the near term. But yeah, I just think that relative to U.S. markets developed international is not our first choice here. It is in fact domestic bias in our suggested exposure.

Dr. Jeff Buchbinder:

Yeah, we were already negative tactically, and now we've become even more negative. So, strengthen our preference for the U.S., the strong dollar is certainly part of it. We'll show you a chart of the dollar here in a second, and really the same story or similar story anyway for emerging markets where it looks like just the U.S. is in a stronger position to manage through these inflationary challenges. But, you know, in EM looking fundamentally you also have the, I mean, the strong dollar is a part of it certainly is a challenge for EM, but you also have deteriorating earnings. Earnings in EAFE, you know, developed international have held up a bit better. Emerging market earnings have been deteriorating here for a while, and the downtrend in earnings estimates has been more pronounced in EM.

So that concerns us, even though valuations are cheap that's a reason to you know, to move away. Our view had been neutral or has been neutral in emerging markets, and we have since turned more cautious as we enter September. So, Marc, as you look at this chart, I mean, you know, we were in danger or are in danger of breaking support on the developed international chart. Now I look at emerging markets, it looks like it pretty much already has broken support here. What do you see when you look at these charts?

Marc Zabicki:

Yeah, more of the same, in terms of emerging markets, you know, technicals here again, the trend is definitively not your friend. We're going to take a look at the dollar, take a look at the commodities and what that potentially means for EM. But yeah, I mean, for my money, for a long time, I think this market still is kind of, and almost is funny to say this out loud, I think the market is still correcting from the euphoria of the BRICs, right? Whether that was probably the peak was 2007ish in the BRIC trade. And now people are just being reminded that the Chinese economy is not infallible. Brazil certainly is not. Russia of course is not, you know, India may be the best house in what is a bad neighborhood at this point just in terms of its go forward ability. But you know, China's not growing at 10% a year anymore. Russia certainly has got its problems. Brazil has got its problems. And I think that it just continues to kind of come into play as people rationalize expectations around some of these key countries. And I think we are cheap, as you mentioned, Jeff, but probably cheap in EM for a reason.

Dr. Jeff Buchbinder:

Absolutely, yeah. And the dollar is certainly one of the reasons why it's tough right now to like international. This rally's just been unrelenting. You have 20-year highs you have to go back, this chart doesn't go back far enough, but you have to go back like 20 years to find the dollar this strong. While that does help exporters outside the U.S. who are selling products into the U.S., that takes time. You know, it's not a great environment for global trade right now anyway. So, in the short term, you know, and this is a tactical view you know, maybe six, nine months, this strong dollar is a real challenge because it just clips your international returns.

Marc Zabicki:

Yeah, no question. And you know, I think if you take a look at what this looks like, a little bit of a parabolic nature in the dollar in terms of its trajectory, that may be worrisome to the degree that, you know, the dollar could kind of roll over just a little bit and, you know, not continue on the parabolic trajectory, but just simply stated, looking at this chart kind of explains what you're seeing on a relative basis in emerging markets, certainly. And then maybe EAFE perhaps slightly less so, but yeah, the dollar trajectory has certainly been a key weight around international equities and I don't know that changes any time real soon.

Dr. Jeff Buchbinder:

Yeah, you have to probably wait until the Fed slows down and then it's clear that the Fed is behind the rest of the major central banks in hiking or, you know, or further along in its hiking cycle. And then maybe you get some relief on the dollar. The commodities trend has broken. We have, actually, on a technical basis, we are downgrading our views of the major commodity groups this month. So, you know, you had this huge correction in June. Copper really led the way down. So, Marc, I mean, other than natural gas, it's just hard to find a commodity that really has a good trend right now. What do you see when you look at this chart?

Marc Zabicki:

Yeah, I think probably a little bit part and parcel of the inflation story that we've already seen inflation begin to roll over in the U.S. I think the peak of commodity euphoria during the course of that inflation story may have already been passed as well. I mean, if I'm looking directly at this chart in bumping our heads, against the kind of the turquoise blue line that you see in front of you is interesting. And then actually breaking below what could have been support, which is the orange line that you're seeing is also interesting. Again, I think the commodity trade perhaps maybe largely over and we've been getting probably less so, but we've been getting some questions amongst some folks asking us about how commodities may be the new bond alternative in terms of the overall asset allocation.

We wouldn't do that at all. So, no, you know, commodities are not the new bonds. We think commodities from a correlation perspective trade too close to the equity market for one thing. And we would not be you know, overweighting commodities here, Jeff, as you mentioned, as a matter of fact, we'd be looking at opportunities to trim exposure here and some of the near term technicals, you know, point to that. And then more broadly a deteriorating trend in commodities likely is not good for EM broadly.

Dr. Jeff Buchbinder:

Yeah, we still like the energy sector you know, certainly producers with their discipline and their, you know, returning capital to shareholders still look like interesting places to be but might be a while before crude oil provides much support still, you know, in the eighties. So, want to make that distinction. We're talking about hard assets, not energy stocks here. So, let's go to a riser. This is the one that surprised me. The technicals in industrials looked pretty good, Marc, even though the economic environment has gotten more challenging, I think, you know, again, starting with fundamentals, it was really surprising to me coming out of second quarter earnings season you know, Bank of America aggregated capital expenditures data for all the reports, and they were up like mid-teens. So capital expenditures for the S&P 500 growing year over year, mid-teens, that's really strong. So, there's been kind of this hidden strength on underlying this market here and, you know, markets buying industrials when maybe common sense would tell you that, you know, that this is a sector you should avoid.

Marc Zabicki:

I think that you're right, Jeff. I mean categorically, I think the other aspect of it is, if I think about it as an asset allocator and you look at where you could be exposed in the U.S. equity markets do you want to be entirely defensive? Obviously, defenses being defensive has worked most generally of late, but do you want to be entirely defensive? And maybe you want to have a little bit of cyclical exposure just in case that, you know, the defensive trade kind of rolls over. And so the question becomes where are you looking for that cyclical exposure? Is it consumer discretionary? Probably not. Is it materials? Well, that trade has already probably seen its best days, perhaps? So maybe there's a little bit of bottom fishing and industrials is the way I like to think about it. So, yeah. You know, I think if you're going to be, you know, somewhat allocated to cyclical groups, industrials may be your best choice as you look across the S&P 500 sectors.

Dr. Jeff Buchbinder:

Yeah, absolutely. Nice little uptrend in the relative strength chart. You know, kind of which of these sectors does not belong, right? It hasn't just been utilities and the other defensives, consumer staples, which we'll get to in a second, it's, you know, industrials has been up there in the sector rankings somewhat surprisingly. So, our view on industrials is now neutral after being negative, and we'd be watching closely for an opportunity even to go more positive than that. The last one we have is a faller, it's consumer staples. This is not a technical move at all. In fact, the technicals look pretty good here, I'm sure, Marc, you would agree. So, but fundamentals, you know, now that we're down where we're down if we think we're getting set up for a Q4 rally, you don't want to be too defensively positioned, right? And so we still like healthcare, we still like real estate among the defensive sectors, but we think staples is one to move away from. And the big reason is the cost pressures, right? I mean, it was certainly widely reported the challenges that Walmart had, which is a big consumer staple. When you're not growing very fast and you have cost pressures, it's really hard to offset that. So, we would suggest starting to move away from staples because of that impending margin pressure.

Marc Zabicki:

Yeah, and the simple math of it, Jeff, is that if you're going to raise our outlook for industrials to equal weight, you have to take money from somewhere. And consumer staples, you know, serves that, this purpose in that regard. And yeah, so there's that. And then there's also, you know, trying to balance the defensive and cyclical exposure in a market that, you know, may see some consolidation perhaps through the month of September. You know, before maybe hopefully we move higher during the course of October and in November. So to the degree that we've got a market that's still trying to find its way, balancing that cyclical and defensive exposure perhaps is the best way to deal.

Dr. Jeff Buchbinder:

Yeah. So, I agree. Something else on the seasonality front, if you take the average midterm year performance, the bottom is September 30th on average. So, maybe you don't have to run right into staples today, <laugh>, or run away from staples today, rather maybe being in defensives for September makes some sense. But we certainly wouldn't wait too much longer than that to start to move away and get a little bit more cyclical exposure. Our view on consumer discretionary is still negative, so we're not suggesting you get cyclical exposure in that sector right now. And then lastly, we're waiting for tech too, waiting for opportunities in tech, but are still kind of cautiously neutral short term. So, let's wrap it up, Marc, by just previewing the week, we've got actually some pretty big central bank news, right? We got the ECB on Thursday, and we got Powell speaking on Thursday in addition to several other Fed speakers. Anything here that you think is particularly noteworthy?

Marc Zabicki:

Well, it's really going to be interesting as to what Christine Lagarde does at the ECB. I mean, I don't know that 75 basis points is in the cards from that central bank. I would be surprised if they go 75 honestly. And then will be interesting kind of contrast perhaps on what, you know Jerome Powell says on Thursday. Does he carry forward the Jackson Hole message? Or does he kind of walk that back just a little bit or maybe the market participants think he walks it back just a little bit. Jobless claims always on Thursday, the ISM number you know, positive likely in that, you know, we are going to continue to see services economic strength relative to goods economic strength. And, you know, Jeff Roach, has pointed out a couple different times now that, you know, you're getting that goods inflation rolling over while services inflation still is running fairly hot. And the services activity in the economy speaks to that.

Dr. Jeff Buchbinder:

Yeah, this I mean, we shouldn't probably focus too much on 50 or 75. It's just one meeting, right? And what really matters is where they end up <laugh>, right? And the path of rate hikes and the path of inflation over the next several months. But yeah, if the ECB goes 75, that's going to surprise some folks. That's going to be a statement, right? Because they're new normally dovish and then jobless claims, that's another area. You know, we made that big move. I think we're 75,000 jobs off the lows roughly, or 70,000 jobs off the lows. And you know, that means that labor market is slowing and there are fewer openings, and that should help take a little bit of the heat out of the labor markets and out of the wages. So, you know, jobless claims is another piece, not just the Friday job report, but the jobless claims recently have also kind of been right where I think the Fed would want it.

So, hopefully all of these central bank comments and meetings will help. There's one in Canada too this week, I think, hopefully will help the markets get more comfortable with the rate hiking campaign and the inflation outlook, but certainly not something we're going to bet on right this minute. So, tough environment. So, with that well actually, we left off one thing right on the week ahead Marc, which is the start of football season. So, for all of you football fans out there, enjoy the start of football. Well, it's college has already started, but enjoy the start of NFL football. Maybe we'll give some picks next week, we'll, see. So, with that we'll wrap. Thanks, Marc, for joining this week for LPL Market Signals. Thanks to all of you, our loyal listeners for joining us, again, fun discussion this week. We will see you next time. Thanks so much.

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