Rate Cuts and Election Predictors

Jeff Buchbinder:

Hello everyone, and welcome to another edition of LPL Market Signals. Jeff Buchbinder here, your host again this week, this time with my friend and colleague, Quincy Krosby. Quincy, thanks for joining today. How are you?

Quincy Krosby:

Fine, thank you. Thanks so much for inviting me. I appreciate it's so much going on.

Jeff Buchbinder:

Oh, boy is there. Yeah, rumor has it that a central bank might have done something last week, so you'll have to

Quincy Krosby:

Yeah, I heard it. Yeah, I read about it. Yes.

Jeff Buchbinder:

You'll have to tell me what that's all about. Maybe you can, you know, quickly look it up while we're recording. Yeah. <Laugh>, so probably the most anticipated Fed meeting of my career, if not ever <laugh>, I would say. The debate about 50 versus 25 basis points just went on and on and on. And finally it was settled, of course, that helped the markets do well again, last week. We had an S&P 500 new all-time closing high, so we'll talk a little bit about that. Next of course, we'll talk about the Fed, and then our Weekly Market Commentary for this week is kind of a combination policy outlook. We have some Fed and some election, so you can find that on lpl.com, by the way. So here's bullet point number three, can stocks predict elections?

Jeff Buchbinder:

We'll try to answer that and show you some data that suggests that actually historically stocks have not done a bad job of predicting elections. And then we'll close out with a preview of the week ahead. And, you know, normally I would just talk about the economic calendar, but there are a lot of Fed speakers. We've already gotten some comments this morning. It's Monday, September 23, 2024 as we're recording this. So I think you got to talk about the Fed in the week ahead and not just the economic data. So let's get to it, starting with the recap of last week, new heights for the S&P 500. Here you can see the weekly performance, S&P 500 up 1.4%. That was the fifth positive week out of the past six. The previous all-time high was around 5,667. So we now, at least as of Friday's close, we're at 5,702.

Jeff Buchbinder:

We're not getting a much of a move today in midday trading. I think there's two things that stand out here, at least in domestic equities. Number one is the small caps. Of course, small caps tend to do well when the Fed cuts rates. A lot of people have been talking about that. I might argue that a lot of that gain was priced in ahead of time, but we can talk a little bit about small caps and then the defensive sectors did not do very well last week. So I think that fits with the narrative, Quincy, that the market is pricing in a soft landing. What do you think, anything domestically jump out at you? Is that a fair assessment of the of the pattern of sector performance last week?

Quincy Krosby:

Well, certainly, if you're going to be looking at consumer staples versus consumer discretionary, I think discretionary started to move ahead again. Remember that consumer staples were gaining when the market was worried about the labor market and the strength of the overall economy. So the question is that the reason the reason that the Fed went 50 basis points was it because they were worried about the economy or was it that they believed that they have quelled inflation to a point that the higher for longer regime was not warranted. Consumer discretionary is actually now, again, moving ahead. And that's forward looking. It's growth oriented, and that's what we want to see.

Jeff Buchbinder:

Absolutely. And certainly energy is cyclical. Financials are cyclical. Industrials are cyclical, right? All those sectors outperformed last week. And actually utilities outperformed too, but that was the AI names selling nuclear energy directly to the hyper-scalers <laugh>. So it's, you know, you could argue that utilities is not necessarily a defensive sector anymore because of the AI power generation story there. But nonetheless, high level cyclicals and higher, you know, more market sensitive sectors, let's say, did better last week. I also, Quincy, thought the emerging markets strength last week was interesting, you know, outperformed the U.S. You've talked about this. A lot of people think that EM is a great rate cutting play. What do you think?

Quincy Krosby:

Well, normally, historically, when the Fed actually begins cutting rates, not just suggesting they're going to cut rates, but actually does it, emerging markets tend to get a bit for a variety of reasons. One is that overall, when the Fed cuts rates, especially at 50 basis points, it eases global financial conditions. The dollar, U.S. dollar typically not weakens necessarily unless it believes that the economy is weakening. And that's why the Fed engineered a rate cut at 50 basis points. But nonetheless, the dollar doesn't go jumping back higher unless, for example, it looks as if inflation hasn't been quelled. The point here is that what it does, it softens the U.S. dollar. It allows emerging markets that hold dollar denominated debt to service that debt, obviously much more easily with a weaker, a softer U.S. dollar. Similarly, commodities priced in dollars become more attractive.

Quincy Krosby:

If I'm importing and I'm an emerging market, I have to import, say energy, I have to import crude oil. It's going to be more helpful. And overall, historically, when the Fed begins to cut rates, emerging markets tend to have a strong underpinning. I want to add here, if I may, introduce China, it still is counted as an emerging market as we know. And the fact is that what we're seeing right now as we do this call, is that China has been given almost a monetary olive branch, but only because they have been under pressure as far as their currency is concerned. You know, they're in a deflationary cycle. And so when the dollar was so strong, it put pressure on the currencies in emerging markets, we could, I'm not going to add all of them, but China was one of them.

Quincy Krosby:

What this has done is it has allowed China now to focus on cutting rates, again, a series of rates they already started. Tomorrow, there's going to be an important, an important media press conference with the head of the People's Bank of China and two other officials responsible for the Chinese economy. The market wants to see how much more are they going to do in terms of cutting rates, trying to help the consumer part of the economy, trying to help spur interest, again, in the $25 billion quagmire, that is called the property market. They're going to try to do that. The market is hoping, by the way, that the Fed easing allows China to ease more, but also allows China to perhaps introduce a viable fiscal stimulus package. But the weaker dollar is certainly helping.

Jeff Buchbinder:

Yeah, it feels like China's recognizing there should be a little more of a sense of urgency. So maybe that will add to the positive story about the Fed cutting rates. Yes. And then, you know, positioning data or sentiment data would tell you that a lot of investors don't like China, right? And maybe the weak hands have already been forced out and you get a bounce. So, that certainly is a sensible approach, but probably more of a trade as you,

Quincy Krosby:

It’s a trade. But they're also buying. They have, they've created offshore. They've created institutions that their job is to come in and buy Chinese equities, by the way. So that's why, you know, even this morning we saw, I looked at the market just based on the 14 year, 14, not 14-year, 14-month repo, 14-day repo market. They cut rates. And the question is the equity market following that, or do we have some hands going in and buying some Chinese equities to spur interest in the China story?

Jeff Buchbinder:

Yeah, it doesn't feel like the best time to go long China, right ahead of the election and all of the rhetoric around trade and, you know, winning political points by being tough on China and all that. But, you know, it's seemed to have worked last week. Maybe it'll continue to work here for a little longer. We'll see. So thanks for that, Quincy. You mentioned commodities and the bond market actually is really interesting this week, where you saw the 10-year yield rise a little bit. It's hard to say whether that was really an inflation view or something else, right? But typically when the Fed cuts rates, you would expect the 10-year yield to at least be, you know, go sideways, if not move lower. But it did tick up a little bit. And I mean, I guess you could say that the Fed cutting, if the Fed cuts too much, you're going to simulate inflation. Maybe some people are talking about that Q4 the base effects, right, Quincy and Q4 inflation year over year comparisons might tick up a little bit. I'm not sure. What do you think?

Quincy Krosby:

Well, I saw the initial reaction to bond market when the Fed, Chairman Powell was speaking. It's as if the two-year got the story correct. And the Fed didn't follow the two year, just that the two year knew what the Fed was going to do, and that the two year is sensitive to monetary policy. And it was a check, check, check, check. However, the 10-year yield did go up a bit higher, but maybe it was due to the notion that the Fed is going to be engaged in the economy. So if you weren't a believer that the only reason that they cut 50 basis points is that inflation is coming down at a path that doesn't warrant higher for longer monetary policy, but perhaps part of it was that the Fed is going to be trying very hard to engineer a soft landing, and then that would tick the rate up.

Quincy Krosby:

Because before those rates were coming down, looking at almost, you know, an economy that was weakening and weakening at a faster clip, I think it was, to me, it looked like a move of relief, like a sigh of relief from the 10-year Treasury. It wasn't, I didn't see it in terms of, oh boy, they're thinking inflation is going to come back. But more or less that, gee, okay, the Fed is in there, the Fed is going to underpin the economy. Okay, that's good. And that's, so the 10-year kind of edged, a little bit higher, we'll see we're getting inflation numbers this week. That's going to be very important for the market and the market ultimately, Jeff, is going to make a decision. Did the Fed in fact cut rates to 50 basis points down because they were worried about the economy and the labor market? Were they worried about that? And we'll see the reaction in the market as we have more and more economic data released. We'll see the reaction in the market, and we'll also see the reaction in the yields.

Jeff Buchbinder:

No doubt, no doubt. It seems to me that it's that the Fed has been successful in selling this as a normalization. Yes. And not nothing like, you know, a panic cut into a massive slowdown or anything like that. So, exactly. I mean, the market's telling us soft landing is coming, it could be wrong. But for now it seems like there's conviction in that and that's why we have an S&P 500 that just keeps going straight up. So that's what showing you here you know, the break to the all-time highs. So of course over that prior resistance at the prior highs, and now, you know, you don't have much room between where we are right now and the top end of this rising channel. So maybe that's the next point of resistance. I don't know, maybe it's up 50, 75 points.

Jeff Buchbinder:

But you know, there's a little more downside technically in the near term than upside. So I want to point that out. I'll also point out, breadths been pretty good. We're not overbought on the RSI 14. We're at 64 at last check when I ran this chart. So, you know, over 70 is overbought, so that's good. The advanced decline line has gone straight up and looks just like the S&P, so that's a good indicator of breadth. The percentage of stocks above 50-day, pretty good reading north of 70. So this is pretty healthy bull run. And you know, if we get some help from the macro situation, it will probably keep going higher. We'll have to wait and see. So let's move on and I'll show you a couple charts from the Weekly Market Commentary.

Jeff Buchbinder:

One is on the Fed, and then one is election oriented. So I title this section, we'll talk a little more about the Fed Quincy, because I want your thoughts on how far they're going to go. Right? And I made this point, I believe last week with Lawrence, that it matters more, you know, where you end up, right? How many, how many cuts in the series of cuts, that matters more than just whether you get 25 or 50 to start, right? In fact, I haven't heard anybody make a case that the 25 versus 50 thing really matters a whole lot. In fact, I think a lot of the smartest Fed watchers that I follow thought 50 was coming and thought 50 made sense. And that's of course what we got. So, you know, what might be surprising to people though is that they're not even close to normal, right? So Quincy, this chart shows inflation versus where the Fed is, right? Inflation versus the Fed funds. And even though they cut 50, there's still a big gap here. So, you know, the question is, are they going to go to three, because I'm sure inflation's going to be below three. Might they even go lower than that? Where do you think this ends up?

Quincy Krosby:

Well, it depends on the election, depends on who's going to win. And it depends on the debt. You know, I mean, we haven't been using the expression term premium very much as the Treasury Department began to issue debt. Sort of more short duration. But next year, you know, we're going to be issuing quite a bit of debt and maybe longer duration, and we may have to start talking about term premium. That's the extra amount that you get for buying longer duration notes. So, that's the question. And the other part of the question is, and it has to be answered, is whoever wins, how inflationary is the packages that they plan on introducing? You know, I mean, it's the one thing that we always like to say, well, this is election campaigning rhetoric, right? We're going to do this, we're going to do that.

Quincy Krosby:

But the question is ultimately what is going to be introduced and how inflationary will it be? And that's something that we don't know. At the same time Jeff, as we discuss so often is what's the neutral rate, what's the acceptable neutral rate? Expectations are, it will not go much lower than three and a half, 3.5, but there are those who believe even 3.5 is too low, that maybe it should be in the 4% range, that would be normal in this environment. So there's so much for the market to assimilate. My view on it is that the Fed doesn't know. Just because the dot plot said this or that. I mean, we've even heard Chairman Powell, at one of the press conferences, said, I don't pay attention to the dot plot. Do you remember when he said that?

Quincy Krosby:

I think they beat him over the head because then suddenly it became a, you know, oh, the dot plot will pay attention to it. But the point I want to make is the Fed can't really look ahead that far. The market doesn't look ahead that far. There's too much, too much, especially now with an election. And so much is riding on that. So much is riding on the debt that grows and grows and grows. That good point. I think we go, I really do think we have to go data point by data point, economic data point by economic data point.

Jeff Buchbinder:

Well, we do know we're going to get a lot of deficit spending regardless of who's in the White House. Oh, yes

Jeff Buchbinder:

So <laugh>, you know, that might, again, as you alluded to, create some inflation that could prevent the Fed from going much lower than that three and a half that you mentioned. And you're so right that, I mean, we can't predict this far in the future. We don't know what the economy is going to look like in 18 months. So it was probably an unfair question for me to ask how far they go. But if the neutral rate is three and a half, hypothetically then, and if the economy is weak at the end of 2025, they're probably going to have to go below neutral. So, who knows? We'll see what the economy's doing at that point and go from there. But I think the key message from this chart is that they have room to cut. They can cut another 25 basis points three more times this year, or, well, they'll probably twice more.

Jeff Buchbinder:

Sorry, they're going to, they could cut twice more this year and still be restrictive <laugh>, right? Which is why some people are saying they're going to do 50 in November and then potentially 50 again in December. They want to get there as fast as they can to their view of neutral. I think that's probably unrealistic, maybe 50 and 25. The next question of course is how does stocks do after the Fed cuts rates? We've showed you this before but I think it's really important to revisit, this is consistent with the point we just made. How the economy is doing is really the key in answering the question of whether stocks are going to go up or down after the Fed cuts. So we got this first cut, you see here, these bars represent performance for the S&P three, six and 12 months after the initial cut.

Jeff Buchbinder:

So, you know, the timer just started on Thursday, and you see stocks have been up nicely in most of these cases. However, when you get a recession, stocks are down. Exactly. Makes a lot of sense. So it's kind of binary. You also see these diamonds are the biggest drawdowns that you get in that 12 months following the initial cut. And your drawdowns, this makes logical sense, right? Your drawdowns are more shallow if you have a soft landing, if you do not have a recession during that 12 months. And then if you do, you're going to have a much bigger drawdown. So this one is tough to call, but it certainly leans more towards soft landing than recession. So based on this pattern, I think we're going to be up in a year. We just said we don't want to predict a year out, but there you go.

Jeff Buchbinder:

I just did it. Quincy, I'm going to predict <laugh> that stocks will be up in a year and supported by the Fed. Yeah. So that doesn't mean we're not going to have volatility in the interim, by the way, especially ahead of the election, and who knows what's going to happen geopolitically. So let's go to the election. I just have one chart on this, but it's from the weekly commentary and I thought it was a fun one. It's a table, not a chart. Fun one to talk about. The S&P 500 has accurately predicted 20 out of the last 24 presidential elections. And here's how this works. You look at the three-month performance for the S&P ahead of election day. So in this case it would be August 5 through November 5, well through November 4, we'll call it. If the S&P 500 is up during that period, then the incumbent typically wins.

Jeff Buchbinder:

If the market's down during that period, the incumbent typically loses. Now, we don't have an incumbent this time, because of course Biden's not running, but we have an incumbent party, so this may still matter even though Harris is trying to, you know, separate herself a little bit from the Biden economy, at least at times. So there's a lot of caveats here. We've also had two assassination attempts on President Trump. This is the craziest election cycle, probably we've ever seen. The last two cycles were pretty crazy too. But this one talk about unpredictable, and by the way, this indicator did not work in 2020, right? The indicator said Trump would win and he didn't. So Quincy, do you think this indicator will work this time? Because if it does we're going to have Harris. She's, you know, the S&P 500 is up nine and a half, 10% since August 5. What do you think?

Quincy Krosby:

Well, what matters most is where, you know, I mean, the breakdown is, you know, and everyone knows this, the electoral college. So you obviously you could win the popular vote and lose the election. Then there's the other issue. And that is and there've been a number of reports on this, and that has to do with not just the silent majority, but a silent group of sort of moderate Republicans and also independents and whether or not they would go over to the Republican ticket because they're worried about, they're worried more about crime, they're worried more about the borders. They're that there's worry underpinning.

Jeff Buchbinder:

Huge issues.

Quincy Krosby:

Yes. And that perhaps the polling is not picking up that cohort, if in fact, that cohort is as large as some of these reports suggest. Now, again, you have to look at who's writing the reports and whether or not they are associated with the Republican party. But the ones that I've read, they tend to be more pragmatic and pragmatically written than, you know, party oriented. So that's an interesting turn on that because when we talked about the silent majority back in the day, that silent majority came in and pushed elections where the strategists just did not pick up on that. But nonetheless, also, if you want to add what else looks towards actually the Democrats right now, it's the VIX. There are a number of studies out that suggest that when the VIX lays low, when the VIX stays calm, it tends to it tends to underpin the incumbent party.

Jeff Buchbinder:

Yeah. Actually the U.S. dollar weakness favors the incumbent party too. We haven't seen much of that but we have seen some. Now these patterns could, this could be spurious correlation, right? It may just be a complete coincidence that these indicators are signaling one or the other. There's not a huge sample size, especially on the dollar relative to the S&P, but there are, yeah, sure, these indicators are leaning Harris, this is not a prediction by any stretch, just informing. But the, you know, the indicators and the economy, the economic data, the trajectory of the data unemployment maybe is kind of sideways, choppy, but it's still low and inflation is falling. So, and prices at the pump are certainly down. So those things could change. I mean, a lot could change in the next what, six, seven weeks. But at this point you've got some things certainly helping the Harris camp.

Quincy Krosby:

One other thing I want to add about the dollar, because this is quite important because there's going to be an awful lot about it in mid-October when the BRICS get together in Russia. And the reason I'm mentioning this is that the hegemony and of the dollar of the U.S. dollar as the world's reserve currency, has always been an issue for the BRICS. And everyone I think on this call knows whom we're talking about with the BRICS. Russia actually created the BRICS organization. But the whole goal has been to push the dollar off of that pyramid and allow other currencies to come in, namely the yuan, the Chinese yuan. The reason I'm mentioning this is that there, in the news, you're seeing an awful lot of questions regarding the weakening of the dollar, or softening, I would call it, softening the dollar now.

Quincy Krosby:

And the question that is posed in some of these articles is, is this part of a campaign to oust the dollar as a reserve currency, not to mention the major reserve currency in the world, as opposed to the fact that because the Fed is easing, typically, when a central bank is easing the currency eases against other currencies with the currencies trading partners. In our case, it would be if the market thought that the Fed was actually going to cut more rates over the course of this year because of concerns over a weakening economy, the dollar would probably ease as well. Unless, for example the European Central Bank decided that they had to cut even more. But my point is, there's an economic reason that the dollar is, I would have to say modestly weakening, softening a bit.

Quincy Krosby:

It is due to normal economic conditions and financial conditions. And that is to say that the Fed has given us a 50 basis point rate cut. And if the market believes there's going to be more the market, the currency market will follow that, the currency market's going to follow the economic data, but it is not abnormal. It's actually a normal part of a recalibration, if I may use that term. Chairman Powell used the term recalibration 10 times during the press conference, by the way. But that is what happens. Still, can it be used as a political tool? Absolutely. Because there's again, a theme, a narrative that the BRICS want to push the dollar off. And if that picks up, it makes it look as if the incumbent party is allowing it to happen.

Jeff Buchbinder:

Interesting. Yeah. There's, there's so many crosscurrents to this election.

Quincy Krosby:

Yes, there are.

Jeff Buchbinder:

Yes, yes. We know that, you know, immigration's important issue, we know trade, China relations, war are important issues. Obviously, there are important social issues and abortion. So, you know, take this pattern, this historical pattern with a little bit of a grain of salt. But this does capture the, you know, "it's the economy stupid" (famous James Carville quote) and the economy matters and you know, things are starting to get a little bit better on that front here, certainly over the last few months. So let's shift gears. Just preview the week ahead. Hey, we got the PCE and I think that's probably the most important data point of the week. Quincy, thoughts there or on anything else that investors should be paying attention to this week?

Quincy Krosby:

Yes, absolutely. The durable goods number, and especially the component within that that looks at capital expenditures, what companies are spending on. It's usually a good indicator of optimism or concern coming out of corporate American, what they're going to spend. The good news is, I think that in the Personal Consumption Expenditures Index, I love to say that, the PCE coming out on Friday, the expectations for year over year, actually the expectations, this is all of the analysts coming in with, and they come up with it, average a consensus estimate is that it comes down yet again to a comfortable level that that will underpin the Fed's decision to cut 50 basis points.

Jeff Buchbinder:

Yeah, it does, based on consensus, suggests that the year over year is going to go a bit higher. Those are the base effects that we've been talking about, <inaudible>

Quincy Krosby:

Four, four.

Jeff Buchbinder:

But the trend, the trend is still down, right? We know

Quincy Krosby:

This PCE, the annual year over year Core PCE. I just saw the number of the consensus. This is consensus estimates by the way, right? Yep. It's not that it's going to happen, it's one snapshot of what the market thinks of core year over year.

Jeff Buchbinder:

That's right. Excluding food and energy prices. This is, it's still a good reading. Even if it's, whether it's 2.7, 2.6, 2.8 that's still where you want to be. And the trajectory is lower. Of course, that made the Fed more comfortable cutting the 50 basis points last week, and it could mean they cut 50 again. We'll have to see what this and other data look like between now and I think it's the day after the election. I believe it's November 6. Is that right?

Quincy Krosby:

Yeah.

Jeff Buchbinder:

For the next meeting. Yeah, that it's still a ways off. A very interesting time to have a Fed meeting <laugh>, right when they're, you know, when everybody's sleep deprived because they've been watching election results overnight. But, anyway, the data's going to matter. The Fed's going to be data dependent and we'll have this 25 versus 50 debate again, I'm sure in in a few weeks. So let's go ahead and wrap there, Quincy. Covered a lot of ground, certainly a lot of topics that I know many of you are interested in, especially the Fed and the election. So Quincy, thanks for sharing all your insights. Thanks to all of you for listening to another LPL Market Signals. We appreciate your support and we'll talk to you next time. Take care, everybody.