From Slowdown to Growth, A Soft Landing is Still Possible

Podcast Intro:

From LPL Financial, welcome to Market Signals.

Jeff Buchbinder:

Hello everyone, and welcome to the latest edition of LPL Market Signals. Jeff Buchbinder here, Chief Equity Strategist, LPL Research. I'm pleased to be joined by my friend and colleague, Jeffrey Roach, Chief Economist. Mr. Roach, how are you today?

Dr. Jeffrey Roach:

Oh, doing well. The summer is winding down. Kids are going to be back at it in the fall here soon. So good to be here.

Jeff Buchbinder:

Yes, please factor in the Buchbinder back to school shopping into your consumer spending forecast, because my 12-year-old is about to be unleashed back into the mall. So, look out Abercrombie, Hollister, Aeropostale, all of the above.

Dr. Jeffrey Roach:

Yeah, I'm right there with you as soon to be 14-year-old and 10-year-old.

Jeff Buchbinder:

Yes, you get it. So, thanks for joining, Jeff. We've been kind of rotating through the Research Department, giving you a little bit of a surprised co-pilot each week.

So, we'll continue to do this. It kind of makes things fun to bring in different talent each week. So, we're going to spend most of this 30 minutes talking about the economy, of course, because that is Jeff's specialty. The Jeff and Jeff show again. But certainly, I'll provide some updates on earnings season, which have been pretty good. Trying to answer the question whether earnings can still push stocks higher. Spoiler alert, it's going to be hard at this stage because there's not much left. And what's left is a lot of retail. So, unless my daughter can single-handedly save retail it's going to be a challenging, I think, next couple of weeks. Of course, the jobs report was the big economic event of last week, so we'll get Jeff's thoughts on that. And then this week it's all about inflation and the CPI.

So, let's get right into it. First, you know, the stocks have been up three straight weeks. The gains last week were modest, but frankly, pretty impressive given all of the concerns about the Fed. Right? We had this much stronger than expected jobs report, which caused the market to price in more Fed rate hikes and, and frankly, a slower trajectory of falling inflation. And yet stocks still managed to end the week higher. So, I think the word for last week is resilient, Jeff. We are back to, you know, well over 4,100 on the S&P 500 now, and actually getting pretty close to the 50% retracement, which is a key level.

Dr. Jeffrey Roach:

Yeah, you're right Jeff. So, we had our STAAC meeting yesterday, Strategic and Tactical Asset Allocation Committee meeting. And that's a mouthful. Some of the things we that is a mouthful, but man <laugh> we're always told, hey, avoid the acronyms.

Okay, well maybe with the Market Signals podcast, we can get away with it. We just defined STAAC, so hopefully we can get away with it. But the discussion yesterday, you're right, Jeff, so, you know, thinking about where we were just say a month ago, you know, really concerned about the 3,900 level and, hey, can we break 4,000 level and 41? So, what we didn't talk about as much was the VIX side of the equation. And if you look at that side, it has just been consistently trekking on downhill from, you know, a month and a half ago. So, volatility has declined consistently, and that certainly has been a good thing for the markets.

Jeff Buchbinder:

Absolutely. This is a key level for a number of reasons. This 50% retracement has essentially sounded the all clear for all bear markets since World War II.

That 50% level is 4,230, so that we're watching really closely. Basically, what that means is you know, if the market falls, the S&P, 1,200 points, the 50% retracement would be up 600. And so that midpoint historically has been key. Even if you, this is from Sam Stovall at CFRA really interesting analysis. If you take 15% corrections and look at 50% retracements, 20 out of 21 sounded the all clear and stocks proceeded to just get back to prior highs without retesting. So, the key question everybody's asking, are we going to retest or not? Looks like the odds of a retest are falling. They're nowhere near zero, but odds of a retest are falling based on the progress the S&P 500 has made. We've also looked at some of these support levels, you know, either prior lows or recent highs.

And sort of 3,900 to 3,950 is a place that maybe we would land if we do see a bit of a pullback from here. And then last thing, and we'll get to the economy, Jeff, everybody's asking, is this a bear market rally or is this the, you know, the end of the bear? I don't think we know enough to make that call because bear market rallies within bull markets, long bull markets or bull market recoveries can be as much as 13, 14%. In fact, that's pretty typical. And that's what we're up now, 13, 14% off the lows. So, we'll say, I know that's kind of a cop out, but we'll just say we really don't have enough information yet to say this bear is over. So, let's turn to the economy and we'll talk soft landing and what we learned potentially a soft landing and what we learned about the economy from the jobs report on Friday, Jeff, I mean, it was a boomer.

I don't think anybody expected 528,000 jobs, even the most optimistic on the economy. Seems like the odds of recession are quite a bit lower now based on what we saw then, or at least the odds of a recession in 2022.

Dr. Jeffrey Roach:

Yeah, yeah. So, I think the storyline has been, you know, going into the report on Friday, I think a lot of us were revising up our estimates based on the ISM surveys. So, you know, one of the reasons why we look at all these different metrics is that it helps explain other aspects of the information flow. So, ISM services, ISM manufacturing both have a component within them embedded under the headline number that talks about, you know, employment hiring and the such. So, ISM surveys were kind of pointing toward a slightly stronger number for July.

The challenge, and this is where it was a little bit confusing, is we thought, well, you know, claims during the survey period, which is the week that includes the 12th, was softer than it was the previous month survey period. And I think that was kind of the competing you know, data, but, you know, ISM was, again, ISM was the big factor. One of the things that I'm still looking into and trying to understand is, you know, in the household survey, there's been a slight uptick in the number of multiple job holders. It's not alarming levels. I think some of my colleagues in other firms are maybe putting too much emphasis on that fact, you know, multiple job holders and temp help. And, you know, again, factoring the fact that the BLS does tend to revise these numbers a fair amount.

So, we do have to be really careful not to be overly rosy optimistic after this July print. It's, you know, it's possible that this thing will be revised down. However, I don't think anybody's saying, well, it's going to be revised to be negative, a net negative. I mean, that's clearly not going to happen. I think one of the things that's really helpful to think about is the labor market is slowing in a really nice decelerating factor. So, Jeff, we were just joking about our kids, yours are a little bit behind me. Mine's turning 14 this weekend. You know, he's a boy. When he gets behind the wheel, one of the things that I'm going to have to really work on is, hey, look, you get to a red light, you get to a stop sign, don't slam on the brakes. Nobody likes that.

You want to decelerate slowly. And if you average out some of the most recent labor market stats, particularly the July one, and you kind of do a six-month moving average, you see a really nice classic mature driving pattern going right into that stop sign. It's slowing down and not crunching to and screeching to a halt. That's what we'd like to see, you know, as I watch the Fed relative to some of the pressures there. But this graph is basically saying, in addition to what I just highlighted on the labor market report, you also need to factor in that the recovery is still about 5 million away from trend. Look at that orange line. We want the labor market numbers to have about, you know, 155 million. We don't want about 150 in change, but 155 and change.

And so, this is a little concerning because it's the folks that have not reentered, they're on the sidelines, they're not looking for work, hence they're not counted in the unemployed. That's why this unemployment rate is so low, frustratingly low because folks are not looking for work, so they're not counted in the labor force. So, there you have it. That's, that's kind of the big picture from the labor market. But I think, you know, we didn't talk too much about this, Jeff, but the title of this podcast is referencing our Midyear Outlook. So, we talk about turbulence, we talk about landing, we got that beautiful plane picture coming onto the runway. Is the soft-landing still possible? And my argument is given, I just talked about the fact that the labor market is slowing in a real classic nice way, the soft landing, I think still is possible. Not a done deal, but still possible.

Jeff Buchbinder:

Nice tie in there for the Midyear Outlook, which is where that last graphic came from, of course, with the guy on the LPL gear landing.

Dr. Jeffrey Roach:

By the way. Yeah, I wanted to point out he even had an LPL branded hat, which I thought was pretty classy. Our marketing team did a great job with that.

Jeff Buchbinder:

That is cool. I actually have a hat like that. So, good stuff from marketing, check out our Midyear Outlook, if you haven't already. These charts that we're going through now on the jobs report are actually in the Weekly Market Commentary, which we just put out on lpl.com yesterday. I actually tweeted out the link to that just a little bit before we started recording this this morning. It is August 9 as we are recording.

So, let's move forward. Jeff, the next chart you put in the weekly on this jobs report is where have all the workers gone? You alluded to this right, that a lot of people are still on the sidelines not joining the labor force, which is making it tougher to alleviate wage pressures.

Dr. Jeffrey Roach:

Right. And it's not just from the BLS, this theme is still showing up and loud and clear here in some of the other measures, particularly from the National Federation of Independent Businesses, NFIB released a small business optimism index this morning. Again, we're recording on Tuesday the ninth. And NFIB gives us some great metrics. And what I looked at, in fact, I shared this with some of the colleagues, here is small businesses across the country are still saying one of the most challenging problems right now for small businesses is finding qualified workers.

That's it. So clearly inflation is a big issue and that's a frustrating point for businesses but finding qualified workers still there. And this is kind of just another angle for what this graph is just saying, you know, these are participation rates. So, you could look at a number of different ways. Some folks prefer the employment to population ratio. And it's a similar story in the sense that of those in these age brackets, they could be working, but they're not. And in fact, the percentage of those in those age brackets that were working pre-pandemic was higher than it is now across all age 25 to 34. And you just keep on trekking on up to the 55 up in the yellow line here. And so small businesses are struggling to find workers.

Of course, the response typically, you know, ceteris paribus conditions, as we like to say, all other things being equal. The firms will say, look, the only way to attract workers is to raise, you know, the wage for the opening. And so that's exactly right, Jeff, as you just said as it relates to inflation. So yeah. Where have they gone? I'll answer that question by this. They possibly have gone to start their own businesses. That's why you look at business formation statistics being very helpful to explain some of the gyrations in the labor market right now. Mm-Hmm. <affirmative>,

Jeff Buchbinder:

Kind of related to the gig economy and all those Uber drivers and DoorDash drivers that are out there and maybe not necessarily being counted, I know we've talked about this before, that I think continues to present a challenge for economists to keep track of the labor force and using traditional participation statistics.

Dr. Jeffrey Roach:

Well, the household survey will capture that. So yeah, the gig workers are not on payroll, so they won't show up on the establishment survey, but they will show up in the household survey. By the way, we really geeked out in our morning call yesterday, Jeff, talking about household survey and establishment survey <laugh> so yeah, gig economy household. But here's the other thing I think that we can track. That's why the business formation stats is so important because I think there's a fair amount why it's not just think I know, I know there's a fair amount of folks that are doing the application for businesses. They've set up payroll, they, you know, with ADP for example, got their EIN number for tax purposes, et cetera. So, some of these folks not just gigging it, they're actually forming their own bonafide business.

Jeff Buchbinder:

Hmm. Interesting. Well, that sounds encouraging. If that's where folks are going I'm all for it. Yeah.

Dr. Jeffrey Roach:

When I was at an event last week, sorry to jump in here, but you know, I was in Brentwood, Tennessee last week for a big event, and folks wanted to know, well, are there any silver linings? And I said, yes, look at business formation stats, <laugh>, you know, once COVID hit well really it's like 2021, it just skyrocketed the number of business formation applications. So, little teaser there.

Jeff Buchbinder:

Great resignation led to maybe the great startup boom. So, you threw one more chart in here, you know, related to the at least economic growth. And, you know, the job market, recession, no recession and all of that. So, explain to folks what they're looking at here.

Dr. Jeffrey Roach:

Yeah, this is a really helpful story. I think advisors can take this with them to, you know, when they're at the cocktail party with, you know, the question about recession and inflation. And the point is that, you know, you look at those boxed areas that I have in the chart, the little, the dotted boxed areas late nineties, early two thousands, and, you know, 2011, 2011 to 2018ish, were all periods where particularly durable good prices were falling. Not just the rate of inflation slowing, but it was actually deflation so negative, below the zero line, right? So, we're negative territory, meaning prices are actually falling and we didn't have a recession, there was no recession, inflation was cooling off. And in some areas, of course, outright declining. And I think this is a great story to add.

Again, going back to our Midyear Outlook, granted, this is not a done deal. It's not going to be necessarily, quote unquote easy for a soft landing, as the Fed is hiking and tightening financial conditions. But this is all possible in the, in the mid-nineties, the Fed was tightening, the labor market started easing, pretty you know, clearly the Fed stopped it's tightening, held steady for a little bit and actually responded by cutting rates. It's all 95, 96 time period. And you can see this period where, you know, no recession, there's the shaded vertical bars there are indicating the recession periods in the recent decades. So, that's why I just titled the graph, look, we can have a slowdown in prices without a corresponding recession.

Jeff Buchbinder:

The old mid-cycle slowdown, I've heard it referred to.

So, sure that a lot of folks have compared this environment to the mid-nineties. That would be tremendous <laugh> if we could get an outcome like that because as we all know the Fed track record of soft landings is not great to put it mildly. So, just to wrap up the first segment here, we've got, you know, a Weekly Market Commentary, which really has two halves. We recap the jobs report that Jeff wrote, and then we talk about the relationship between stocks and recessions in the second half. And that's what you see here. We just want to remind folks that, you know, stocks react to recessions and recoveries from recessions quickly and early, like several months in advance. So, you know, even if we do get a recession in the next several months, we might have already priced it in because it's likely to be mild because we got that 23, 24% peak to trough in the S&P 500 already into the June lows.

So, we could in theory be in the middle of the recovery from the market pricing in a mild recession. And what that would tell you is just like this table shows, from a recession date start to end, stocks can do just fine. So, even the folks who are saying we're in a recession, or we will be in a recession very soon, need to recognize that based on history, most of the damage is probably done. In fact, in this chart, you know, we're just showing how the S&P does from start of recession to end of recession, you know, on average you're up <laugh> and if you take out 2008 and nine, you'd be up a fair amount because you add the, you know, you take the median, which of course takes out the outliers and then you're up 5%.

So, most of the damage is done and it's going to take a lot of incremental economic weakness and earnings weakness to take us below those June lows or at least meaningfully below those June lows. And then the other point we made, and we've shown this before, so it may look familiar to some of our regular listeners, but if you look at all these bear markets over the last 60, 70 years or so and break them out into recession or no, if you don't have a recession or if you have a mild recession you tend to not only see smaller declines like low twenties, mid-twenties, and you see faster recoveries 10 months on average and not 27 months on average. So if we have a, you know, 10 month recovery, we could be back at the highs in in early 2023.

That certainly I think most of us would take if we could get it right now. So, you know, the key messages here are stocks may have already priced in a recession and these recoveries can be pretty quick, especially if we either don't get a recession or get a mild recession. Because look at the average recovery from a mild bear market with no recession is seven months. We already did seven months, I'm sorry, the length of the bear rather. This bear is already eight months. August is the eighth month. So, you could argue that based on this analysis that the bear is over. So, that's the other point that we made in the Weekly Market Commentary. Again, you can see that on lpl.com. I'm just going to spend a couple of minutes on earnings and then we'll move forward and talk about inflation and what else is on the docket for this week.

I should say talk more about inflation because we have CPI. Here's our earnings dashboard, which we've shown you a few times. The good news is earnings season, you know, it has been quite solid, you know, typical 3% upside. Most folks didn't think we'd get that. If you look at the very long term, like since earnings numbers were aggregated, you know, we have numbers back to the mid-nineties, you know, 3 to 4% is about average and we've got that, earnings are tracking to you know about this, these, these numbers are a touch out of date now because we've gotten a few more results here over the last several days, but, you know, earnings are tracking up to like 6.7% year over year. When we started earnings season, they were tracking to 4%. So that's a nice amount of upside.

And, you know, average upside might not sound exciting, but when you've got a really strong dollar, you've got a slowing economy and you've got these intense inflation pressures, not to mention the supply chain problems that are still going on, these are really, really good results. So, earnings season has been a win and it's a big part of why stocks are up at least in the last six weeks or so. But here's the problem and then I'll pass it over to you, Jeff. The, you know, the big names have already reported, there is not a lot left and what's left is retail, a lot of it anyway. So, even though I'm impressed by what companies have delivered, I just don't think there's enough left to drive this next leg higher in the market in the short term. And we're going to need good news from inflation or the market's interpretation of the Fed to push us up to potentially that 50% retracement level 4,230 that we were talking about before.

Dr. Jeffrey Roach:

Well, you know, I wonder, Jeff, if you have thoughts on this. So, I referenced the NFIB, National Federation of Independent Business Report that I just read through just before we got on this recording and you know, love your take on this. But if I hear from businesses that they are having trouble attracting workers, and at the same time I hear from businesses that they're having trouble passing along prices, higher prices, what is that going to do for your average business owner? How are they going to respond, cut costs somewhere else, or just factor in lower profits?

Jeff Buchbinder:

Yeah, if you can't raise prices, you got to cut costs, right? I think the key here is the revenue line, Jeff. You know, we've had several percentage points of upside to revenues and revenues were expected to be up low teens anyway.

So, I really think that's where that extra cushion is coming from. You know, companies have surprised on the margin side too. They haven't shown as much margin pressure as a lot of people expected, but that extra revenue is really a big help. And why are they generating strong revenue growth? Well, a lot of it is they're able to pass along the higher cost to their customers. You know, we all know we have an inflation problem, and customers are giving companies, in many cases the benefit of the doubt and not pulling back too dramatically. In some cases, they don't have a choice, right? You can pay higher prices at one store or the other store <laugh> either place you go, you're going to play pay higher prices. So, I think the market just gets it. And the combination of pretty good margin, pretty good cost management and that pricing power and strong revenue has enabled companies to get these strong results.

So, you know, maybe they're not going to get, maybe the market won't get surprised in the next couple of weeks as earnings season winds down. But there's no doubt that this will provide support, at least to have the market hang in there. And if market, again, if we're going to retest, we need some significant economic deterioration that we hope we don't get. But there's nothing from corporate America, even though we've had some companies, miss of course, some pretty high-profile companies take down guidance, overall, the picture is just too good for stocks to retest the lows because earnings are weaker or because estimates have come down and they have come down, they've come down about two and a half percent. So, and frankly, that was a win I think for most investors who thought estimates were going to come down even more than that.

So, in fact, our estimates at LPL Research are still below the estimates from the consensus. So, maybe a little more downside estimates because of the economic environment, but we would argue not a ton, at least not in the second half of the year. So, let's turn to the preview of the week, Jeff. And of course the big news is going to be the CPI. By the time many of you listen to this, you'll have already seen the report on Wednesday morning at 8:30 east coast time. This is really the headline of the week, what we're all going to be watching.

Dr. Jeffrey Roach:

Yeah. Yep. You're exactly right. And so, Jeff, as I'm reading this slide, I'm thinking that's right. So, as you just referenced, the watchers of this podcast, listeners, will be you know, laughing thinking, oh, wait, we already know what July CPI is.

So, in order to not sound stale in this conversation, I think what I want to do in thinking about the inflation stats and helping advisors and as they talk to their clients, thinking through the inflation story, I think the best way to do this, and when this number comes out, I'm going to do this myself. I'm going to break it down by durables, non-durables and services. I'm going to look at some components of inflation and I'm going to pretty much ignore the headline. So, yeah, I sound like a broken record when I talk about this, but it's going to be you know, the real value in understanding the trend of where prices are going, the trajectory here, you have to look at the components, you know, what's the trend going on for durables, non-durable services?

And I think it's fair to say that what's most obvious is the bifurcation between those, you know, you had durable prices on a wonderfully dramatic downswing the last several months. And we have to watch services, look at the components in that regard, and that's going to help us think about, all right, you got a July print, the Fed's going to have another month of data by the time they meet in September, they're going to have the August print, so July print, August print, oh, we'll have some high frequency data already for the first half of September by the time the Fed meets and makes a decision here. So it's a little bit up in the air at this point after Friday's strong job report. But I think it's fair to echo Mary Daly's comment. And that is 50 basis points is a reasonable starting point.

And I think that's a great way to go in. Alright, so it communicates, they're downshifting the speed at which they're tightening financial conditions and 50 basis points in September is a good starting point. It's reasonable to use Mary Daly's word and of course Mary Daly is the president of the San Francisco branch of the Fed.

Jeff Buchbinder:

Yeah, I've already seen some folks talking about a bigger hike, which you could have predicted given the jobs number. So, whether we get 50 and then 2 25s or a 75 and a 25, we still think another percentage point of hikes this year is likely. But you know, if that's wrong, it's probably wrong because it's a little less than that, not a little more. At least that's our bias. Maybe it's 60/40 <laugh> not a high conviction lean, but that's our team lean at this point.

Dr. Jeffrey Roach:

That's right, everything's at the labor market right now in terms of just the big picture of what Fed needs to do. So, if you go back to Powell's statement after the most recent meeting, you know, talking about the weakness in business expenditures, the weakness in spending, the weakness because of high inflation pressures, everything was weak, weak, weak, weak. And the one bright spot was the labor market. And so, it really depends on how much the labor market slows, how dramatically it slows, whether the Fed pauses or not in December. I think at this point it's a little bit less likely for them to pause in December and they're still going to be hiking September and November, by the way, they do not meet in October. So basically, have three meetings left for this year.

Jeff Buchbinder:

And we do not expect a surprise intra-meeting hike, but certainly folks are speculating and that could happen, right?

We'll watch as the markets will we'll be watching the Fed closely. The only other things this week really that jumped out at me, I mean of course we have more earnings, but it's in the home stretch we have the you know, the Inflation Reduction Act, which is probably not going to cut inflation at all in the next year or two. But that's going to the House for a vote, I believe on Friday. It is likely to pass. I mean, I guess something crazy could happen. There's not a lot of margin for, maybe I shouldn't call it margin for error. It would be an error on the Democratic side if they couldn't pass this thing at this point. But that is probably going to pass. And you know, it has a few important impacts to keep in mind.

You know, number one, the tax increases on companies with below 15% tax rates, that's actually going to potentially cause S&P 500 earnings to come down a percentage point or two next year. So, that is certainly material. The market doesn't seem to care that much, but it's certainly material. And then starting in 2026, drug companies are not going to be able to raise prices as much. So, that will have earnings impact, but it's a few years away. There's a buyback tax in there. So, companies are probably going to do dividends over buybacks starting next year when that reportedly will be going into effect. So, there could be a small, I mean it's going to be hard to notice, but there could be a small shift in corporate preferences toward dividends as opposed to buybacks as a result of that piece. And then there's some, you know, Affordable Care Act subsidies that could help health insurers.

There's a lot of renewable energy tax credits that could help companies in that area, as well as electric vehicles. So, it's kind of a winner's losers a lot of sort of countervailing forces within that bill. But certainly, for stock pickers, the policy will matter and it'll certainly be interesting to see how the market reacts to lower profit estimates next year for certain companies, especially big tech that have a lot of, you know, lower tax profits overseas. The sort of poster child that gets brought up a lot is Amazon, but there are others. It'll be interesting to see how the market reacts to that when those companies tax bills go up. So that's really, frankly all I think that's meaningful in this bill in terms of stock picking and market impact. And hopefully you know, that's all we get, and we don't get hit by some negative surprises <laugh> as people read this thing because I don't know how many hundreds of pages it is, but it's a big bill.

So, I think we're at time, so I'm going to go ahead and wrap up there and just thank everybody for joining this latest edition of LPL Market Signals. Thank you, Jeff, for walking us through. It's a really complicated economic environment. It's great that people are getting jobs <laugh>, but it makes the Fed's job tougher, and it makes it tougher for us to to analyze this economy. It's really unlike anything we've seen, but we've got a good earnings season and certainly that is providing support for stocks, and we'll now turn our attention to that CPI tomorrow. So, again, thanks every for listening. Thanks as always for joining us on the latest edition of LPL Market Signals. We will see you next time.

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