We Don’t Expect a Delta Derailment

JEFF (00:00):

Hello everyone and welcome to the LPL Market Signals podcast. I'm Jeff Buchbinder here, your host for this week, filling in for Ryan Detrick, who's traveling. Really happy to be joined by my friend and colleague Marc Zabicki, director of research. Hello, Marc, how are you today?

MARC (00:18):

Doing well, Jeff, very good to be with you. And Ryan’s replacement, I guess, at least for the time being. So I'll do the best I can.

JEFF (00:30):

Yeah,  we don't want to replace Ryan permanently. So we'll be glad to have him back next week with  your normal host. We'll try to give you another good show here. I think I want to start with just you know, Marc's thoughts on the market here, high level. I mean, there's a lot going on. We were just talking about how, if you look at the news flow, it looks like stocks should be in a bear market.  We're down a little bit today as we're recording this on Tuesday, but, but within about a half, a percentage point of all-time highs on the S&P 500, hardly much of a pullback yet. Marc, what are your thoughts about the market here? Given all that's going on? You've got Afghanistan, you've got Delta variant, certainly some things for investors worry about.

MARC (01:21):

Sure. I mean, it's hard to step in front of the moving train that is the U.S. equity market. And you're probably at this point, I mean, I don't know that, you know, we've got, you know, pretty red day here, you know, overall it's not, it's not that substantial. You know, you know, I think, you know, the, the Afghanistan thing, I don't know that there's long, long long-term and deep implications for global equities per se. So we'll leave international governments to work that out. You know, I think that from, from a Delta variant perspective that probably has a little bit more legs, perhaps a reason to be a little bit more concerned in terms of, you know, what happens to economies, specifically in the U.S. what, what, you know, what the government does in terms of kind of, you know, kind of tightening the reins a little bit, perhaps on this economy or the structures that may, you know, come with any kind of rules changes around you know, kind of quarantining or masks or travel or anything that may come about as a result of this.

MARC (02:28):

You know,  we don't know at this point, but that may have a little bit more leg. So I don't know that there's anything to really worry about yet, but the Delta variant is something that we're keeping a very close eye on. And then there's always that aspect that we all know, you know, August, September, typically not great months  for equities. So, you know, maybe we're getting a little bit of a dose of that today.

JEFF (02:57):

Yeah. Add to that concerns about China, certainly. And then the inflation story is not over. We'll talk a little bit about this. So those of you watching on YouTube can see that we have a packed agenda here. Stagflation is one element of that. So you know, there you go, the inflation story is not quite over and we'll have to watch the Fed. So here's the agenda, we're going to start with COVID, get into an earnings season recap, earnings were so strong. It actually led to us recently raising our earnings forecast and S&P 500 target, big news, certainly. So a lot to cover we'll get in a little bit deeper to all those things we just mentioned here. I'll start, you know, you kind of teed up  COVID Marc, let's start there. As you're looking at the S&P 500 is just straight up and to the right.

JEFF (04:00):

And, and certainly we think it can still go higher. You know, COVID remains a concern with the Delta variant. I think people are hanging their hat on a couple of things I want to get your thoughts on. First, you know, people just don't have the tolerance, there's no political appetite for broad lockdowns. And so it's, it's very difficult to envision a scenario where we get to that. That's first,  second of all, it appears that the Delta variant is being tolerated better, certainly, than the last wave or two of COVID. Of course the big difference is the amount of vaccinations that have been done. So talk to folks sort of put it into perspective here. Just how worried we should be about Delta and how is it different from maybe the last couple of waves?

MARC (04:57):

Yeah, I would say Jeff that's correct. I mean, I don't know that we're expecting any kind of broad-based shutdowns, that type of thing. You know, maybe there's a little bit of a drag economically that may, may come from this, that, that remains to be seen. And your last point was well taken in terms of the, the end impact on, you know, the, the population. While it's never a good idea to have people sick and in ICU beds, you know, at capacity across areas of the country. So  that's a problem, but the vaccinations, the increased vaccinations in the U.S., specifically, has resulted in us or in our ability to kind of withstand the onset of additional number of cases. And that can be seen by the right hand chart in this slide, the deaths, as a percent of cases still remains low.

MARC (05:55):

So that speaks to perhaps our education in COVID over the last year and a half. And it speaks to the vaccination impact on holding down the illnesses, perhaps in terms of the, the impact of those illnesses per person. So you know, the question for us, just from a market perspective and economically, what is the impact of an increase in the Delta variant on the economy and, you know, does it cause us to perhaps raise our eyebrow in terms of the way we think about growth going forward, it's too early to say at this point, but yeah, again, something certainly to keep an eye on. And, and perhaps we're seeing a little bit of that uncertainty, that lack of visibility if you will in, in equities today.

JEFF (06:58):

Yeah, certainly COVID is part of the reason why stocks are a little bit weak today. You know, if you look at some of the high frequency data, you know, number of people going through airports, dining at restaurants, things like that, commuting to the office, we have seen a little bit of a dip over the last couple of weeks. So that'll certainly be something to watch. This is not certainly something we're taking lightly. Actually, we got a little bit of a taste of the impact in the retail sales numbers just this morning that we're certainly a little bit weaker than expected. That is a very COVID sensitive data point. So we'll keep watching that closely. You know, of course the  key driver of stocks over the long-term is earnings. And so when you think about Delta variant and frankly, any of these risks to the economy, we really want to think about how that could impact earnings.

JEFF (07:56):

And so the good news there is, you know, we've talked about this the last few weeks, that earnings season was just outstanding. So I won't spend too much time anyway, reviewing the stats, but just know that you know, the, the upside surprise here was over 20 percentage points for the second straight quarter. Now to put that in perspective before COVID a six, seven, 8% upside surprise was really good. That was about as good as, as we got in terms of the S&P 500 earnings relative to estimates during earnings season. So just absolute blowout. Again, we've essentially had five straight blow outs but you know, the markets don't you know, look backward, they look forward. And so looking ahead, we actually think that the momentum is strong enough to continue to put together a string of upside surprises, maybe not 20 points, but certainly more upside surprises.

JEFF (09:01):

So you see here, you know, up close to 90% growth on this chart for the quarter. And even after we slowdown in the next couple of quarters, we'll still probably be somewhere around 20%. A number of reasons to be confident that if earnings strength continues, one, one of those reasons is revenues have been so strong. This is a chart of revenue surprises by quarter going back a little over a decade, and during the pandemic, they've just gotten better and better and better. So last quarter was the all-time record. This data goes back a little bit before the financial crisis, but it's, it is a record highest recorded by FactSet, biggest revenue, upside surprise, and revenue surprises are more sustainable, right? The profit margins can swing around a lot more, but once companies are locked into a certain level of revenue they tend to have an easier time maintaining that than a specific profit margin. And so we would, we would look at this and say the strong earnings likely to continue, certainly for at least the next few quarters. And we have a very strong economic outlook. So you got to give corporate America a lot of credit, Marc, they've just done a spectacular job managing their bottom lines.

MARC (10:24):

Yeah. And what's interesting to me, given the growth we've already seen, which has been tremendous, you know, kind of post-COVID. I mean, we still have inventories that, you know, kind of decade long decade lows effectively since, you know, low amount of inventories last seen since, since 2011. So, that's a tailwind you know, as we continue to grow out of this COVID environment. Consumer spending likely continue to be a tailwind. I mean, there was, there was a lot of personal saving that went on in 2020 you know, a little bit of a spike in personal saving in early 2021. But, you know, that's been, that's been kind of trending down, but savings rates are like around nine, about 10%, they are usually around, you know, 6%. So there's, pent-up up saving there that probably will be spent by consumers over a degree of time.

MARC (11:26):

So there is a, there is a tailwind out there that we have to see economically. And, you know, just in terms of the COVID situation, the question is does the Delta variant slow the realization of that tailwind a little bit, that would be our concern. And, and, you know, the interesting thing about, you know, I spent the weekend, or not the entire weekend, but a  flight in and flight out of Charlotte airport this weekend, and boy, that place was packed. And so it led me to kind of looking at flight data and you know, we're back other than the dip that you mentioned in some flying that that's occurred over the last couple of weeks, we're back to 2019 highs in terms of the number of flights. So, I mean, it really has been a dramatic rebound. And we think there's a little bit more to go actually, given the low inventories and the consumer spending. So I'm feeling pretty good overall, but the Delta variant causes us to raise our eyebrow a bit.

JEFF (12:35):

So Marc, you and Ryan are supporting the reopening by flying. I have been supporting the reopening with a heavy contribution to retail sales because the Buchbinder household just took advantage of tax-free weekend here in Massachusetts. And let's just say we did some serious damage. So look for the Buchbinder bump in retail sales next month.

MARC (13:03):

Well, I'm going to bet the tax free weekends in Massachusetts don't come around too often, so yeah, get them while they're hot.

JEFF (13:11):

They don't call it “Taxachusetts” for nothing. So thanks for those thoughts. Yeah, no doubt. The inventory rebuild will help earnings going forward, and certainly there's still some reopening to go. And by the way, last thing before we get to our higher forecasts, the guidance has been really strong. The ratio of positive guidance to negative guidance is like 25 percentage points above average. Not quite as good as the prior two quarters, but really strong. So for the companies that guide we've been getting good news, that's been helping estimates go higher as well. So here are our updated forecasts. We outlined this in the Weekly Market Commentary this week, which is available on lpl.com, posted at I believe Monday at noon Eastern. So it might be 1:00 PM Eastern. So I mean the headline here is certainly that the S&P 500 targets going up, but I want to actually focus on earnings. When earnings exceed your expectations by five or 6%, then, you know, you're almost forced to raise your stock market expectations by, you know, the similar amount.

JEFF (14:31):

And that's, that's exactly what happened here. So you know, we went from 195 to 205 for S&P 500 earnings for 2021. And then we went from 205 to218 in 2022, that led to the increase in the S&P 500. Fair value target from 4,400 to 4,450 up to 4,650 to 4,700. So we went up about 250 points, that is about 5%, which is pretty close to the amount that we increased the earnings forecast by. So, you know, again, combination of strong economic growth outlook, fact that companies have done just a tremendous job managing their bottom lines in a difficult period with supply chain disruptions and cost pressures. You got that inventory piece that Marc brought up you know, this, this is just a tremendous environment for corporate profits. So that momentum we think carries through in the next year and can support higher stocks from here.

JEFF (15:39):

Upfront we talked about some of the risks, you know, I'll start with one, and then Marc, maybe you can go into some others, besides the Delta variant, which we all are well aware is certainly a wild card here. The potential for tax increases next year is a risk. Now we've got some probability of corporate tax hikes in our 2022 earnings numbers. So if we do get that, we do think we still have a decent shot at, you know, double digit earnings growth next year, and making a run at that 218, but certainly higher taxes would make that more difficult. So any other things you'd be concerned about Marc besides Delta and taxes that could make those numbers tough to hit?

MARC (16:28):

 Yeah, I'll point to monetary policy. I think, I mean, you know, given some uncertainty in monetary policy, I think we've, we've benefited over the last 12 months from relative certainty in monetary policy. And now we're going to get some, some general lack of visibility in that, in that realm over the next 12 months would be my guess. And the other aspect is, you know, as, you know, is Chair Powell going to be in the seat, you know, come this time next year? Probabilities still favor him being the chairperson of the Federal Reserve. So there's that, but, you know,  there is that uncertainty that's hanging over the market may be just a  little bit. So monetary policy has been so key to, to the recovery and the feel good aspect and for investors and if there was a directional change in that, then that could you know, kind of quell things just a bit.

JEFF (17:32):

Yeah. We get the FOMC minutes tomorrow, so that'll turn the temperature up on the Fed, watching, no doubt, important thing for, for all of us to watch. And, and that's one of the reasons why you know, stocks are so well supported. It's earnings, of course, but interest rates, certainly a key input into stock valuations and you know, at about one and a quarter on the 10-year yield certainly for now yields are providing a lot of support for stocks. I'll add one more thing. You know, Ryan has mentioned this a lot. He's out on Twitter on this today. You know, this was the fastest bull market to double in history or at least since 1950. And you know, we, haven't had a 5% pullback since October of last year.

JEFF (18:25):

So we're probably due for a little bit of a pullback. You know, you mentioned Marc, it’s a seasonally weak time. We've also already eclipsed the average gain in year two of a bull. I think that covers nine bull markets. So that is certainly something to watch as well, that may suggest we need to take a little bit of a breather. The monetary policy and Fed discussion  is a nice segue into the last piece of our agenda Marc, before we get into the, you know, kind of the week ahead even though the week is certainly part over. We did a blog last week on LPL Research.com about stagflation, sighting the misery index. And so monetary policy certainly could disrupt the stock market later this year. And certainly you know, we need continued improvement in the job environment and just the economic environment in general, to support those earnings gains

JEFF (19:28):

we just talked about. So a lot of people have been throwing around the idea that we're heading for 1970s style stagflation, Marc, which just means you've got slow growth and high inflation, those don't usually come together, but they did in the seventies. You know,  I'll start with one big difference and then pass it to Marc. One of the big reasons why we had stagflation in the seventies was, was high oil prices. And, you know, certainly we don't think anything close to you know, that level of stress from oil prices is in the cards even, you know, $150 where we peaked you know, at the early part of the financial crisis, we can’t envision a scenario where we get back there. So sure oil prices are up a lot since the lows of last year. But you know, we are certainly confident saying that this is not going to be a 1970s, you know, runaway oil driven inflation environment. So with that Marc,  any  sort of distinctions between now and then that can cause maybe nervous investors to get a little more comfortable.

MARC (20:43):

Sure. Yeah. And, and in no way, do I believe we're going to get into a sustainable inflationary environment. You know, I don't think the demographics speak to that, particularly here in the U.S. I think we enjoy a day and age where we have, as consumers, perfect price competition for the most part. I mean, I think what you had in the, in the seventies, for example, if materials or input costs rose then manufacturers or products would pass those costs on to the consumer. And then when those prices would ebb, then those costs or the prices for the goods  would remain relatively high because folks lack that visibility into the price competition or the landscape. And I think that is clearly changed today where, you know, I, I believe product manufacturers, retailers, know they can't afford to keep prices above their competition for very long.

MARC (21:58):

So once we get past this supply demand imbalance that's occurring in this post-COVID environment, and I think we will get past that. I think input prices could come down and then prices overall could come down again as product manufacturers deal with that perfect price competition. And you know, our ability to kind of open up the internet and take a look at, you know, anything from a price perspective from used cars to laptops to vacations. So whatever we're interested in, we do have that perfect price competition, and that really keeps a lid on sustainable and inflationary pressures as far as I'm concerned. So yeah,  no worry for me on the inflation front whatsoever.

JEFF (22:52):

Yeah. These, these supply chain disruptions are going to be resolved, eventually. They've been showing up in the auto market with the chip shortage. Those of you who shopped for a car recently have seen that. So once we get those resolved and we get off of this reopening surge, you know, you'll have more modest economic growth, you'll have a normal, we expect supply chain environment, and then it's still cheaper for companies to make stuff and get it to the customer than it used to be because of technology. And, you know, we know from our economics classes in college that, you know, the lower the margin of cost is, typically, the lower the price can be. And so technology and globalization is related to that with cheap labor, but cheap technology has certainly brought the cost of things down.

JEFF (23:43):

And that puts downward pressure on inflation, that structural force is not gone. So certainly we'd be you know, selling the inflation narrative and what would expect things to look pretty normal, you know, maybe not in the next three months, but certainly in 2022. So, you know, the misery index is just sort of a way to gauge stagflation, where you add unemployment and inflation together based on the CPI, the consumer price index. And, you know, we're like 60% below the seventies highs right now, and those stats should get better because unemployment is falling and inflation should fall. So I concur, Marc, not too much to worry about with stagflation. So let's preview the week before we wrap up some of this is already out, so it's not really a preview anymore, but you know, certainly the Delta variant, we talked a fair amount about that.

JEFF (24:49):

We'll continue to watch those stats. You know, a couple of states that were hit first are starting to see cases fall. I think Mississippi might be one of those, I think, Missouri. So, and it's the same thing as watching the U.K., right. You know, the U.K. cases started to rollover as well with this variant. And so that's certainly encouraging, we'll keep watching that. Retail sales were a little bit soft and certainly Delta was part of that. Marc, I don't know if you have any comments on the retail sales, but certainly you know, a 1% decline isn't great. If you take out autos, did a little bit better, down around three quarters of a percent but still down and still, you know, kind of flattish the past few months, is that something people should worry about?

MARC (25:44):

I don't know if one month makes a trend, Jeff. So I would agree with that. I'm not overly concerned about that, you know, given, you know, I think there is some Delta variant impact, as you indicated in that number. I mean, on the, on the good news side this morning, we did get, you know, an industrial production that was better than expectations by a concernable margin and capacity utilization that continues to, to move northwards. So that, that, you know, from a, from a general health of, of the manufacturing economy, that's, that's actually, you know, pretty good  news. Manufacturing production was up, you know, one and a half percent in July, well above expectations as well. So some underlying good news even though the retail sales number wasn't quite up to snuff, but that can be a choppy number.

JEFF (26:40):

Yeah. And certainly we're coming off of the stimulus induced surges of retail sales. You know, we're, we're kind of getting out a little bit more you know, which causes some of the spending to shift, maybe not in the last few weeks, but in general, the recent months as we get out more, some sales like home improvement projects, some sales kind of dip as, as other sales replace those and you end up with kind of sideways choppy action. So, you know, it's holding up at strong levels. We're still up about 16% year over year, which is amazing. Retail sales, you know, blew me away, getting back to pre-pandemic levels only about five months after the recession last year. It was just amazing. And so we're, we're fully recovered in a strong levels, just, you know, the month-to-month is kind of going nowhere.

JEFF (27:37):

We also get some earnings this week, which, you know, actually the home improvement retailers this week. We've seen from Home Depot evidence that this home improvement boom is certainly waning. And frankly we've seen it in the national housing statistics too that maybe the housing market's cooling a bit, which makes sense since we're now, you know, moving so far beyond the lockdowns that really drove that first wave of the housing boom. So we'll, we'll keep an eye on these retail results. Walmart's numbers were generally well received by markets, which is certainly encouraging. It's a tough environment to you know, to grow earnings off of these massive e-commerce numbers that we got a year ago, but in general, they're hanging in there pretty well. The last thing I'll let you comment on this, Marc, is the Fed. So do we expect to see anything in the Fed minutes that potentially causes people to move up their timetable for tapering? You know, it seems like maybe the market is kind of divided now and whether we see of start tapering at the end of this year or early next.

MARC (28:50):

Yeah. I, you know, I think what's going to be interesting to see from the Fed minutes is perhaps  some discrepancy you're seeing between the views of certain Fed members, you know, how much divide there is in terms of getting to that, you know, that tapering plan, you know, sometime perhaps in the latter portion of, of, of this year, I think that's still generally consensus. So it'll just be, I think if you get some signs of contention within the FOMC minutes, that may allow market participants to maybe think about a 2022 tapering onset as opposed to a 2021. So we'll see what the Fed members feel like via the Fed minutes tomorrow and judge from there.

JEFF (29:45):

Yeah. Just for those who, who aren't following this stuff closely, tapering just means starting to reduce the Fed’s bond purchases. They're buying mortgage backed securities and treasuries right now to the tune of 120 billion a month. It'll probably take between nine and 12 months for them to stop. They'll do sort of an even amount each month, give or take, and, and, and that process should start in the next few months. It's been well telegraphed, so it's probably not going to disrupt markets too much. Maybe the concern is that once you taper then the Fed would start raising interest rates, presumably, at least if the environment supported that. Historically stocks had done well during you know, they've had some bumps, but during tapering and the start of a rate hike campaign, generally stocks have done pretty well because you got to have a strong economy to support that move, generally, from the Fed.

JEFF (30:41):

So we would expect  that the stock market follows that same path this time, and generally rises during this rate hike campaign, which frankly could take years. It's going to probably start later this year. But it could, certainly, if Delta variant slows the economy and slows the job recovery, we could certainly see tapering, you know, start in early 2022. So that'll be a big focus for markets this week with the  minutes coming out on Wednesday. So anything else on your radar Marc for people to watch this week?

MARC (31:20):

Well, I mean, yeah, that that'll be the key number. I mean, you know, the Fed minutes tomorrow, you know, also we get tomorrow, housing starts and building permits. So the interesting thing, there will just be, you know, the seeing perhaps the impacts of, of input costs or, or ability to get, you know, materials in order to build more houses and allow for more building permits to occur for the month of July. But, you know, so the housing starts numbers was a little bit weaker than expected last month in June, because, or actually I should say, and, you know, in June because of some of the supply demand constraints in that space. So that'll be something to watch tomorrow as well.

JEFF (32:07):

Yeah. We, we still got to build more houses, no doubt. There's a little bit of a squeeze in a lot of places across the country, so good, good call out there, Marc. I think with that we will go ahead and wrap up unless Marc, you have any closing thoughts? I'll just thank everybody for joining.

MARC (32:28):

Yeah, I would say thanks for joining and look forward to getting Ryan back tomorrow.

JEFF (32:34):

Yes. Thank you, Ryan, for letting us take over for you. I think we survived. I think we took good care of your baby but we certainly look forward to having you back next week and doing your thing. So thank you Marc for joining. Thanks everybody is always for listening and we will be back with you next week. See you then.