Productivity Packs Potential for the Economy and the Stock Market

Jeffrey Buchbinder (00:00):

Hello everyone and welcome to LPL Market Signals. Jeff Buchbinder here with my friend and colleague, Jeffrey Roach. Dr. Roach, thank you for joining here to talk a little productivity and artificial intelligence. How are you today?

Jeffrey Roach (00:15):

Doing well, and glad we can record this a little bit early here, right? We're doing this before the expected storms that are going to hit particularly the southeast.

Jeffrey Buchbinder (00:26):

Yes, indeed. This is a special pre-storm edition of market signals. We're recording this on Friday, January 23rd, ahead of the storms. And frankly, we don't know when we'll be able to get this thing produced, but hopefully, sometime Monday or early on Tuesday. So that is the plan. So we haven't quite closed out the week, but we'll, um, we'll give you a recap of the week at least through, uh, mid-afternoon Friday. I think the big story of the week though has already happened, and that was that really sharp rebound, in the market after the Greenland issue was quickly resolved to the market's pleasure. So we'll talk about that a little bit. Artificial intelligence, as I mentioned, is kind of our main topic of the day. And, as you move into the adoption phase, you get more productivity. So Jeff will tell us what that means for the economy. And then we'll wrap up with a week ahead preview with of course, the fed meeting, next week. And what, I guess I'll call the first busy week of earning season. Because these first kind of slow,

Jeffrey Roach (01:31):

When you got to say fed meeting this week because we're, recording earlier.

Jeffrey Buchbinder (01:36):

Good point Fed meeting this week. Very true. Normally we are recording this on Monday, so yes, as you, when you hear this, it will be a fed meeting this week. So thanks Jeff. So starting with the market recap and we just have a five day look here, but that's really all you need to know. The S&P 500 is pretty close to flat just down a smidge over the last five days. And that is, despite a 2% sell off on Tuesday, why did we sell off on Tuesday? Because President Trump threatened Europe with tariffs related to the Greenland issue.

Jeffrey Buchbinder (02:15):

He from Davos, quickly pivoted, reversed course. And effectively that issue I think is pretty much resolved. He pulled back the tariffs and I don't think we're going to have an issue about that anytime soon, if ever again. Other than that, Jeff, I think there was a little bit of focus on AI and the tech companies this week. Because we had, oh, we had, Jensen Wong and Nvidia make some positive comments about how much it's going to be invested in the build out of ai. There's talk about fundraising for Open AI at higher valuations. There's talk about Philanthropic's growth rate, just a lot of these. And by the way, Alibaba's potentially spinning off their chip unit. So all of those things together generated some excitement later in the week about ai. And so you're not going to see, you know, big declines in tech, or the area, the other segments of the market where tech is like consumer discretionary and comm services. So it was a volatile week, but in the end we didn't really end up in a different place than where we started.

Jeffrey Roach (03:25):

Yeah, and that's.

Jeffrey Roach (03:27):

Yeah, that's right. And a couple things that were noteworthy. So upward revisions to the third quarter of growth that was released on the 22nd, some really solid real spending numbers again for, October, November. We actually got two reports in one because of this, the shutdowns to the Bureau of Economic analysis gives us this pretty important report that includes income growth, spending, growth and inflation. The fed's preferred metric. And a lot of these look pretty decent. In fact in the latest Weekly Market Commentary, giving you some updated forecasts, thinking that 2026 as a whole will be above two and a half percent GDP growth, which actually means nominal GDP close to 5%. A lot of people don't think about nominal, but it's really important in terms of forecasting earnings, corporate earnings, that's based off of the nominal numbers. Obviously, companies don't, deflate their earnings numbers by inflation. So nominal GDP is a very, very important number that, probably should get more attention. So that was part of it. I think in addition of course, to the Davos, headlines that came through. Just a reminder too, for our advisor audience and their clients, it's never a good idea to trade headlines. You don't trade on headlines. We're learning that. We're continuing to learn that and see why we don't.

Jeffrey Buchbinder (04:59):

Yes. And investors have been trained in recent years to buy the dip around these geopolitical headlines if the headlines do drive a dip. And certainly we saw that. Another example, last week we'll say. So thanks for that, Jeff. Certainly a pretty quick recovery here. I guess there's a lot of talk about small caps, small caps are off to a tremendous start. So we'll highlight that. We have enough small caps in our benchmark that we aren't upgrading small to overweight, but I can tell you that we're a little more optimistic about small caps now that the charts look better than we have been. And certainly this rotation, it's not just stocks coming, you know, or it is not just proceeds coming out of tech and into small, it's proceeds coming out of tech and the big tech related companies and into cyclical value.

Jeffrey Buchbinder (05:53):

And even a little bit into defensives, right? We've seen, consumer staples make a nice little run here lately. Staples up 6% year to date, industrials up almost seven year-to-date materials up nine, right? These are cyclical value sectors that, are also benefiting from this rotation. So it's really the kind of everything beyond the Mag Seven is starting to work, which is of course a good story for investors. We're getting more breadth and more participation, and we like that. International's not hurting either, right? I mean, we have, despite some of these headlines that maybe caused some jitters around Europe, the Euro STOXX 600 is up about 3% year to date in Japan. Jeff, you watch Japan closely up almost 7% year to date, despite the fact that that bond market has been under some pressure lately,

Jeffrey Roach (06:50):

And it's been a little bit strange. You think about Bank of Japan actually, cut rates here on Fridays. We're recording, sorry, no change, but a lot of debate about, adjusting rates, uh, very, I would say very ambiguous situation in Japan, right? Inflation rising growth seems to be taking hold, but sputtering a little bit, hence there's some volatility coming out of Japan. I was going to say back to the industrials. You know, one of the ways I think of industrials is you think about cyclical growth patterns, particularly in the emerging markets. And, we got some heavy machinery type company names in the industrials. Certainly benefits when there's a little bit of a rebound in growth in emerging markets. So a lot of interesting dynamics past the headlines, you could say, ignoring some of the, the geopolitical uncertainty, quite interesting movements for where we see both, particularly in Latin America, but even in Asia as well.

Jeffrey Buchbinder (07:59):

Yeah, some people might call it a reflation trade, but as cyclical value works, typically commodities work alongside it. And boy, with this storm coming, everybody be safe. It is going to be really cold throughout a lot of the country. And that has driven one of the biggest spikes in natural gas prices that we have ever seen. I believe natural gas prices were up 70% in three days, which has never happened. That combined with the fact that precious metals are getting this nice lift from central bank buying and a little bit of weak dollar and geopolitics, right? All of that's helping precious metals. And then you've got the data center build out with AI helping copper. So I mean, essentially the whole commodity complex now seems to be working. Oh, add to that, Jeff, that there, you might see military action in, in Iran and that could give oil a boost, right? Oil's started to tick up a little bit lately and looks like an interesting maybe short term trade.

Jeffrey Roach (09:08):

Yeah, that's right. And so, you know, as we head into this next week, we're going to see the Fed meet on Friday the 28th. I think one of the things that will add potentially to some of the choppiness is, you know, at the press conference when Chair Powell tries to prepare investors to understand where policy will go the latter half of the year, now granted virtually no expectation that there's much of a change in policy, in January. Inflation's running too hot, the economy's above trend. And so no moves expected on the 28th, but, definitely look for some signals that should, be emerging in that press conference.

Jeffrey Buchbinder (09:50):

Yeah, absolutely. We haven't made any changes to our asset allocation, our tactical asset allocation yet this year, but I think, there's a good chance that something's going to be coming up soon because a lot of these rotations and trends are starting to look like they may be sustainable. We aren't making any calls yet, but stay tuned. So here is the S&P 500 chart and so Khristian Kerr has made this point here lately, and I know Adam Turnquist is also very aware of this as well. 7,000 is a psychological test on the S&P 500. We're closer, we're more like 6915 kind of range right now. So we got a little bit more work to do. It's going to be tough to break through that level. We've gotten close to it and rolled over several times.

Jeffrey Buchbinder (10:47):

So that is a key level to watch. If we can break through that level and get through the upper end of this range where we have been for the last several months, that could be a very bullish technical development. And we could, you know, maybe make another run a couple hundred points higher. So that's something to watch. And then in terms of breadth, we just talked about it, that breadth is better. You're seeing these rotations. It's not just the Mag Seven working. Well, that's what the bottom part of this chart shows you. Percentage of stocks with new four-week highs is at a pretty nice level, 29%. So that has certainly, improved from where were for most of last year. So more breadth is a good sign of a healthier bull market. All right, let's transition to, the main topic for today, which is artificial intelligence and productivity. And maybe it's too early, Jeff, to say that we're entering the adoption phase, but I guess as you'll explain here in a bit, as we get through your charts, certainly there are a number of companies that have started. So why don't you take it away and talk about what kind of productivity expectations we can expect and maybe why growth could be even a little bit stronger than we thought just a few months ago.

Jeffrey Roach (12:05):

Yes, so right. Thanks Jeff. And so one of the data points I've been spending a lot of time with the whole data sets is, conference board data. A lot of times people think of conference board data as the consumer confidence, you know, jobs hard to get, inflation expectations, all that kind of thing. Conference board also collects a real treasure chest goldmine of productivity data, not just for the U.S. but for virtually every country, around the globe. And so, given the fact that, productivity's going to be such a hot topic, and really it started getting picked up, in recent press conferences when the Fed was being, pressured on, hey, you got decent growth, you got inflation still, you know, expected to fall, and you have a slight uptick in unemployment. How can this all happen? Strong growth and uptick in unemployment.

Jeffrey Roach (13:04):

And the understanding was, well, we plan on productivity filling the gap. That was a couple of months ago, and I think that really is something that should be on investors' minds going forward. So what I did was, since that time started going through all of the interesting, data sets and it's not behind a paywall. So our listeners have added a lot of fun, fun data back there underneath it all, but wanted to say, okay, what does 2026 look like if we're sitting in a certain, you know, ranking on productivity? So I started with just saying, okay, well what does the economy look like from a sector standpoint, not from spending and investment and trade and government. That's your normal equation for GDP growth. It's also helpful to say, well, what are the industries? You look at the private sector, you say, okay, what are the big players?

Jeffrey Roach (13:59):

And how has that changed over the last, 20 years? That's what this chart's telling you. We're doing a lot less manufacturing, both in durable goods, non-durables, and in the last 20 years doing a lot more in healthcare, real estate even finance and insurance, a little bit of an uptick. And one of the things that I thought was fascinating was, you know, Q3, even Q4 monthly data looks like growth is still looking pretty good above trend and productivity numbers seem to be setting the stage for when you have a shrinking labor force and you have the opportunity to continue to have a fair amount of output per hours worked. That's the definition of rising productivity growth, output per hours worked. And, just wanted to highlight a couple of the areas. Look at healthcare particularly in this chart and keep them in the back of your head.

Jeffrey Roach (14:54):

Technical professional services. Keep that in the back of your mind here. When you look at another chart and utilization rates, we basically say, okay, where are we, from, from an industry standpoint? Then you go to the next slide and you say, okay, well, where do we sit in the global scale? Where, where do we sit relative to some of our major trading partners? So look for China, far right, pretty low productivity relative to the U.S. Look to the left side of that chart in Norway, little bit of an outlier. Norway's real heavy in oil and gas exports. And so that really heavy capital intensive, economy tends to, tends to have pumped out some really strong productivity numbers just because it's capital intensive. It's not as labor intensive as some of the other industries that, the U.S. has in other G10 countries.

Jeffrey Roach (15:52):

But what I'm making the case here, and this is where it's just kind of interesting from building out in your world, Jeff, the earnings expectations for 2026. You have, you have an economy here in the U.S. that tends to have, a fairly robust set of productivity, even across a lot of industries. And if you go to the next slide, we're experiencing pretty decent productivity in industries where there's really not much AI adoption quite yet. So look at the bottom part of the chart. You see healthcare, you know, like five, notches up healthcare down there, other services, public administration near the bottom of the list basically saying we have pretty decent productivity and we really don't have a sizable utilization rate in a lot of our industries, meaning that I think we're in a pretty good setup where growth can still grow above trend and inflation continue to decelerate.

Jeffrey Roach (17:03):

So if that's not Goldilocks, that's pretty encouraging. Now, granted, just a reminder for our listeners, a lot of folks say, you know, cycles don't die of old age, they get assassinated, meaning, there's some kind of shock, whether it's a geopolitical shock, whether it's a oil market shock, whether it's a terrorist attack, right? In 2001, we often hit recessions because there's some outside shock that hits the economy and really upends business confidence, consumer confidence outside of the likelihood of those shocks. It's fair to say, you know, recession 2026, probably not much higher than 30%, 25%, which is your typical long run probability levels. And we're in a pretty decent situation where, we're in the very early innings of AI adoption, or you could just say, productivity enhancing adoption for these technologies. So we unpack that in the Weekly Market Commentary, kind of set the stage, what does this mean? Highlighting some of the debates that we're having in STAAC, our strategic tactical asset allocation committee. And so that's kind of a teaser, and I'll leave it at that for now.

Jeffrey Buchbinder (18:26):

Great. Well, thanks Jeff. So let me just ask one clarifying question on that. You mentioned growth above trend. Can you describe for our audience what that means? What is trend?

Jeffrey Roach (18:38):

Good question. You can assume everyone's in the data like I am. So, you think about, think about post COVID. We had a really hot economy. You can discount those numbers and you say, okay, pre COVID, what was the economy looking like in between COVID and the Great Financial Crisis, which was kind of '08, '09 trend growth. A lot of people say about 1.9%. That's the trend. So if you're hovering above two, and given the numbers that we got just in the last couple of days, I revised up my forecast for 2026 growth, both real growth and nominal as highlighted earlier. You know, we're at two and a half percent trend, anything above two is above trend. And so you really have to be careful to look around. And what aspects of the economy can still experience above trend growth without overheating inflation? The answer is productivity growth.

Jeffrey Buchbinder (19:35):

Yeah, you mentioned Goldilocks. It's Goldilocks for the economy and the stock market. The stock market doesn't want the Fed to have to slam on the brakes because the economy's overheating, right? Too much inflation would certainly be bad for stocks and stocks also like earnings. And where do you get earnings from? Well, one way you get earnings is margin expansion, and you get margin expansion from productivity, right? Doing more with less. So, I mean, it's really just almost nirvana for the stock market if we can. There's uncertainty. Obviously no guarantees that this is going to work out the way, we all hope. But there is a path to our bull case that we put in the, 2026 outlook of 7,800 on the S&P 500. AI's going to have to really do its part. We're going to have to have strong growth, strong earnings with less inflation.

Jeffrey Buchbinder (20:30):

It's possible but there are certainly risks that we, we've talked about really on this podcast every time we come on here. Certainly geopolitical risk is a risk. Certainly interest rates are a risk. And certainly AI may actually end up disappointing at some point this year. So that's another risk that that we would highlight. So, your last chart here, Jeff, making the distinction in terms of AI adoption by size of the company, right? So I don't know if this is surprising or not, maybe it shouldn't be because the big companies have the money to invest, but, you're seeing the large enterprises adopt AI at a much faster pace.

Jeffrey Roach (21:17):

Yeah, that's right. And so what's interesting from this is taken from a ramp, it's a private, you know, company up in New York that tracks thousands of firms and their subscription rates. So it's very possible that some of these smaller enterprises are using free versions, you know, of ai. But one of the things that I like to think about is, okay, we say, okay, tariffs are a headwind, right? To the typically, you think of it as a headwind, it's a tax. We don't like taxes, you know, we don't like extra fees, right? Impeding transactions that, um, should otherwise have fair, fair and free trade. Small businesses typically getting a little bit more of a hit than the larger firms, maybe less flexible. At least that's the narrative. And so you'd hope that some of the, the technological advancements to offset some of the headwinds from tariffs should show up in, in small enterprises, we're not necessarily seeing that.

Jeffrey Roach (22:17):

Now, granted, to your point about some of the headwinds for '26, now granted, you know, it's possible that there's enough of a frustration with, U.S. policy, trade policy that, you know, other firm, other countries cut out the U.S. if you know enough, angst <laugh> happens. So you know, it's interesting. We don't want to be accused of having rose colored glasses, of course. But I think it is fair to say, well, let's just identify the areas in the economy where the U.S. is significantly different, than our trading partners. And that's going to be helpful in forecasting our expectations on growth. And that's kind of the analysis that I unpack in the Weekly Market Commentary.

Jeffrey Buchbinder (23:09):

Yeah, thanks for that, Jeff. The base case forecast for the S&P 500 is actually below consensus. We're at 7,300 to 7,400 as a year. Unfair value range, most firms out there are a little bit higher than that as is the median and the average. So no rose colored glasses. We just want to be a little bit cautious. But you mentioned it, Jeff, there is policy uncertainty. Midterm elections also tend to cause some volatility. We just want to leave a little bit of a cushion just in case something, comes out of left field. So that's not a lot of a cushion <laugh>, but there's certainly some real strong tailwinds for this market and this economy that suggests it's very likely to be an up year. So we are pretty constructive. All right, let's turn to the week ahead.

Jeffrey Buchbinder (24:03):

Of course, now this week, the fed meeting, Jeff, and the earnings barrage. This is the first week we're going to get any big tech results. I don't count Oracle last month because it's not a December quarter end. I don't count Intel. So next week is when the, the big names start to come through. So I think it's too early to really evaluate earning season. We're kind of right where we started, hardly generated any upside yet. Because we've had so few big companies and the banks, that's where the big companies have been, right? The banks that have reported haven't really moved the needle all that much. So we'll see what happens next week, but we still think, just like the last few quarters, that tech can generate 10 percentage points of upside. So the big techs are probably going to grow closer to 30, than 20.

Jeffrey Buchbinder (24:59):

And the earnings are just so massive that that's really going to provide a strong foundation for the S&P 500 overall, or whatever broad market index you want to use text providing a really strong earnings foundation. So we'll see how much upside we get, but we certainly think we're going to keep that double digit streak of earnings growth coming in Q4. So Jeff, let's talk Fed now. I mean, I don't think anybody really expects a rate cut, but I have heard folks talk about maybe a dovish pause. What do you think or dovish hold, what do you think we're going to hear from the Fed next week? And will we get a chair announced next week?

Jeffrey Roach (25:41):

Well, that would be interesting. I do not expect, an announcement from the President before Wednesday, but that I'm not very strongly holding. I'm not strongly convinced on that, but probably not before that press conference on Wednesday. I think the chair is going to highlight the fact that we're still catching up on some of the data that wasn't released in time during the partial government shutdown in October. So we're still playing a little bit of a catch up. We do know that demand for labor is softening, so payroll gains are getting smaller and smaller, but at the same time, there doesn't seem to be much stress in the labor market because there are very few individuals going and claiming and filing claims for unemployment insurance benefits. That shows up as a weekly number on Thursday morning. So you have you have a fairly stable but weak job market on top of that, you still have some pressure, particularly in insurance, financial services and, housing where inflation is running a little bit hotter. So they're going to, I think, make the case that their next move will be another cut. They're not going to hold indefinitely. They don't plan on holding, rates for all of 2026, but they're going to, I think the chair and all of, the other members once they get back on the speaking circuit, will make that case that the signals are not altogether clear, but on balance, I think they're going to want to protect the labor market, hence ease up on policy.

Jeffrey Buchbinder (27:26):

Yes. And it doesn't matter who the chair is, we're that doesn't change our outlook. Right, based on what other four candidates I guess now that are still in the mix.

Jeffrey Roach (27:38):

Right? And that's a good point. This is not a Chair Powell decision. <laugh>, this is a decision by the Federal Open Market Committee. And that committee is made up of a combination of both Board of Governors and a rotating, selection of district bank presidents. So no change, probably the first change won't happen until April or May.

Jeffrey Buchbinder (28:06):

I guess we're discounting the chances that it's Hasset. Actually, I just found out that Hasset and I were coworkers at the Chicago Fed. I did not realize that until just recently <laugh> many, many years ago, when we were both noddies. Now just, I'm a nobody and he's not. But at any rate, Hassett and Trump basically said it's not going to be Hassett. So it looks like, it looks like Waller and Reider are the kind of the top, top two. So that'll be, that'll be really interesting. But again, the Fed is probably going to cut at least once. I think our house view is still two cuts, this year, right, Jeff? That's right. And that's pretty much in line with consensus. So yeah, not making any bold call there, but as we've seen historically as we highlighted in the 2026 outlook, when the Fed cuts and don't have recession, stocks tend to do quite well.

Jeffrey Buchbinder (29:01):

Jeff, you've highlighted that a number of times as well. It's a really powerful, chart in our outlook. If you haven't seen it, stocks tend to do kind of mid-teens, let's call it low to mid-teens is very common for returns in that sort of environment. If the market is in an uptrend in a bull market, which of course we're in. So, anything else that, you would highlight Jeff for next week or it's just pretty much earnings and Fed? I mean, PPII don't think is that, it's probably not going to be a market moving.

Jeffrey Roach (29:33):

No, just I think everybody's just waiting for an uptick in initial jobless claims as I highlighted, they've been very, very low unusually low. And so that's going to continue to be something on every Thursday, 8:30 eastern in the morning. That's kind of that first thing that we're watching if there's any uptick in stress in the labor market,

Jeffrey Buchbinder (30:00):

Right? And we just learned how to deal with data delays in a shutdown. Maybe now we're going to learn how to deal with data delays in a winter storm, because I have a feeling that the storms that are coming or just arriving depending on where you are, are going to disrupt economic activity. Because a lot of people are going to stay home <laugh>, right? And a lot of people are going to crank up their heat. So, it will, this storm is expected to hit enough of the country that it's going to affect more than just the northeast or more than just the South. Yeah. So, everybody be safe out there. This one sounds quite dangerous. So, with that, we'll wrap. So, Jeff, again, thanks for walking through this week's Weekly Market Commentary, which is on productivity and AI adoption and all of that good stuff, which again, has the potential to really drive a nice, nice year, not just for the U.S. economy, but the stock market as well. So thanks everybody for listening to Market Signals. We will be back with you next week, everybody take care and we'll see you next time.