What Jackson Hole Means for Markets

Jeff Buchbinder:

Hello everyone, and welcome to the latest LPL Market Signals Podcast. Jeff Buchbinder here, your host for today with my friend and colleague, Dr. Quincy Krosby. Quincy, thank you for joining. Looking forward to hearing your thoughts on the Fed and everything else that's going on in the markets. How are you?

Quincy Krosby:

I'm fine. Thanks so much for inviting me. Appreciate it.

Jeff Buchbinder:

Of course, of course. So I've been off for a few weeks, so it's good to be back with you. We had our national conference, we took a week off, then I was on vacation. So thank you to Adam Turnquist and Jeffrey Roach for filling in for me last week. We'll probably hit on some of the same topics that they touched on last week. In fact, I know we will, because I listened to their presentation. So here's our agenda for today. Market recap. Of course, the strong market reaction to Jackson Hole was probably the biggest story last week. So we'll talk about that a little more than just about how the market responded, but what it means, what's the outlook for the Fed rate cuts and all of that. Then Quincy will do your quick hits. So we're going to touch on small caps and the dollar, and of course it's Nvidia earnings week, so we'll hit on that as well.

Jeff Buchbinder:

That's not the only big news on the calendar. We have core PCE inflation, the Fed's preferred inflation metric, coming on Friday, so that's probably the biggest economic data point of the week. So let's get into it, starting with just the recap. It was a, you know, strong week, about a percent and a half on the S&P, even better for small caps, which I'll show you here in a minute. So here's the S&P 500 chart. We got really close to to the record high from July 16, about 35 points-ish. And then now pulling back a little bit today is, Monday, August 26, 2024 as we're recording this. So we're still only about a percent off of the record high, pretty close, but at the top end of this channel. And so it's going to be.... The point here is it's going to be an imposing test. A tough test for the S&P to break out and go higher.

Jeff Buchbinder:

The breadth metrics are improving though. We show here on this chart, 28% of stocks at four-week highs within the S&P 500. That's a nice reading. It's improved nicely recently. And actually, if you look at the percent of stocks above the 50-day, it's even better. It's almost 80%. So we're seeing some pretty good breadth. Here's where I'll bring you in Quincy. So we had a great week for small caps, right? Up 3.2% on the Russell 2000. So I'm interested in your comments there. And then in general, do you think the market maybe overreacted to Powell? Because I mean, it is not just a one and a half percent week for S&P 500, and look at some of these sectors up more than that. Industrials, real estate, discretionary, I mentioned small caps, even the international markets did pretty well last week, although there was U.S. dollar effect. Do you think this market's gone too far?

Quincy Krosby:

Well, I think we're going to see a test for the market on the 28 after the market closes when Nvidia comes, because that's a major market mover right now, the last year or so. And we're going to hear what they have to say, not just about their earnings, but about the guidance. I think guidance really matters even with the pullback. You know, the market is still almost priced for perfection. And Nvidia is seen as that perfection and if they come in and miss, it is going to affect the entire market.

Jeff Buchbinder:

Oh, no doubt. You cannot overstate the importance of Nvidia's results. I agree one hundred percent. So let's move on. I don't want to spend too much time on the recap. I want to get to the meat of the call here. But the bond market was really strong, of course, partly reaction to Jackson Hole. An essentially, J. Powell just telling us rate cuts are here. The time to cut is now pretty convincing language. So you had about a half a point appreciation in the bond market, which certainly helped the stock market. But with this weak dollar, you also had some nice gains in the commodities space. Certainly crude oil has bounced nicely. There's some geopolitics involved in that, but we've had a big bounce in crude oil. And then you see the metals, you know, gold was up almost a percent. Silver up two plus. So we're seeing some gains in the metal space. Again, responding to the dollar. Anything besides just the dol... We'll get to dollar in a minute, Quincy, but besides the dollar, is there anything else in terms of commodities or currencies that caught your attention last week?

Quincy Krosby:

Well, again, we'll get to the dollar because that is the currency market. But again, what I saw, which was very interesting, is that as the dollar weakened against other currencies, the dollar was being used, the U.S. dollar was being used as a carry trade currency. Because we always talk about the yen carry trade. It's only because the yen was so weak for so long for, you know, 20 years that it was used, but suddenly the dollar weakened and reports are coming in that the carry trade carries on, and many of the hedge funds are using the U.S. dollar as that carry trade currency. So I thought that was very interesting. But I think you pointed to it, what was amazing about the market moves was the way that the small and mid caps gained dramatically because they are above all else interest rate sensitive.

Quincy Krosby:

And Powell, as you said, was about as clear as you can be in saying you're going to get a rate cut on September 18, but now what you're seeing is a debate as to whether or not it could be 50 basis points, and obviously much is predicated on the health of the labor market. Chairman Powell basically, basically said that, you know, he talked about inflation. He said it's coming down, but he pointed to the labor market and whether or not it was cooling, perhaps a bit too much. So that's why the market is fixated now on the September 6 payroll numbers. But I wanted to add one thing because you invited me to add something that was different. Did you notice that he said that yes, the unemployment rate inched higher, but it's still healthy, which it is at 4.3%. It's still a very healthy number. It indicates resiliency in the labor market.

Quincy Krosby:

However, what he said, because again, what the market is focused on are patterns, and that when those unemployment rates climb higher, they tend to climb higher and then higher. But he said the reason, he gave the reason for this, which was, look. We have the labor participation rate increasing and they can't find jobs. The vacancy rate has come down, so therefore the unemployment rate will claim higher. That characterized something that those who are on the other side of the argument suggests, the ones who were pushing for 50 basis point rate cut was, hey. There's something more to this than just labor participation rate. And then they pointed to the lack of 818,000 jobs based on the initial, the initial Bureau for Labor statistics benchmark for revisions of how many jobs were actually created from...

Jeff Buchbinder:

Yeah, we have a chart on that up on the screen now. That 818,000 fewer jobs for the 12 month period, that downward revision was expected, but it was a lot larger, right?

Quincy Krosby:

It was. Well, It was. Some thought it wouldn't be that much, but there were those who thought it'll be over a million jobs and we don't know. We'll get the final number sometime, I believe in February. But the point is that Powell talking, they said, look. We can't allow the labor market to cool anymore. That's basically what he said. That's why the market is so focused on the September 6 payroll numbers. And, but he characterized the labor market as being healthy. Well, we understand that, but the argument is how healthy has it really been? If you have anything in the avenue of 818,000 jobs that were not created, actually not created. So this is where now you're getting a discussion in the, amongst analysts, as to whether or not the Fed would even consider 50 basis points. Certainly right now in projections, the market is looking at 25 basis points, but the initial unemployment claims on Thursday, before we get to September 18 will matter, but certainly the September 6 payroll report is going to be monitored, assessed... Every aspect of it is going to be used to determine what the market thinks the Fed is going to do.

Jeff Buchbinder:

Yeah, and we'll get CPI before that September 18 Fed meeting as well. So yeah. It's too early to have conviction. I guess the market's leaning toward 25, not 50.

Quincy Krosby:

Exactly, yeah.

Jeff Buchbinder:

I think the four cuts priced in for the year is even more interesting, frankly, because that implies there's a 50 in there somewhere, right? Do you think we're going to get a hundred this year or 75 a better guess at this point?

Quincy Krosby:

Again, I think it will all depend on the data and that will be the payroll. The Fed will not hesitate at all, by the way, even up to the election, if they believe that the labor market is deteriorating, their word, at a faster clip. They will come right in and cut rates in between meetings. You know, everyone says, well, it'll scare everyone. I don't think the Fed is going to be thinking about scaring the market. It will be about saving the labor market. And the worry is are they behind the curve? Well, we're going to find out.

Jeff Buchbinder:

Yeah. They kind of mess it up on the way in. I don't think they want to mess it up again on the way out.

Quincy Krosby:

Exactly. They're being very, very careful now.

Jeff Buchbinder:

Yeah. This next chart, so this is from our Weekly Market Commentary for this week about Jackson Hole and the Fed. And this chart just shows the two-year Treasury versus fed funds and fed funds effectively aligns with the two-year, actually vice versa, right? Two-year Treasury aligns with the Fed funds rate. So I think what this is telling you is, you know, we're going to get a series of cuts. It's, as you suggested, Quincy, it's hard to know how many we're going to get because we're going to see a lot more data before...

Quincy Krosby:

Oh yeah, yeah.

Jeff Buchbinder:

We get even two cuts, let alone four or five or six. But no doubt, the economy slowing and a series of cuts is coming. We'll just have to wait and see how far it goes. The debate is around the neutral rate, right? So where will they stop if they decide they want to be neutral? Well, they might get to that point and decide they don't want to be neutral. They might decide they want to be accommodative six months, nine months down the road.So there's a lot of cross currents.

Quincy Krosby:

Let me suggest also, they may want to hold onto some of those basis points. If, if the economy slows, but inflation kicks up, if consumer inflation kicks up in the fourth quarter. That'll be a quandary for the Fed to have to deal with that.

Jeff Buchbinder:

Sure. We're certainly seeing some asset price inflation right now that if this market just keeps rallying right on through the old highs, even though the Fed might deny that's part of their formula, they can't completely ignore market appreciation and easing of financial conditions and signs of froth and all of that. So I agree with you Quincy. We don't have enough information to make a high conviction call on where they're going to stop or even frankly, how many cuts they're going to do in the next six months. But certainly several cuts are coming. I think we all agree on that. So good conversation. Certainly that will put a cap on how high tenure yields can go. And we saw last week, right, the 10-year yield dip below 3.8. When you're in a rate-cutting campaign, that puts downward pressure on the 10-year, right?

Jeff Buchbinder:

It's like an anchor. So that's certainly good for bonds and equities. So let's turn to your quick hits, Quincy, we've got three topics for you and three charts. The dollar, small caps, and Nvidia. I think the dollar's first. Hopefully I put these in the right order. Yes, I did. So here's the dollar. It's... The dollar's actually down based on the DXY index, I believe five out of the last seven weeks. It's not just about Jackson Hole, right? This has been going on a while. This is a very long term chart. I thought it was interesting. There are a lot of fear mongerers out there talking about the dollar collapse, so I just wanted to make the point here that since 2008, actually that's probably not far from when the fear mongering and the dollar began. Basically the dollar's just gone up. It's just stayed strong year after year after year through the financial crisis, through the mini crises we've had, since then through the pandemic. It's obviously passed a lot of tests. So the dollar's not going anywhere is the bottom line there. Wanted to throw that out. But then just more short term Quincy, you know, what's driving the dollar? Is it just the interest rate differentials? Is there something else going on here?

Quincy Krosby:

No, it's the universe rate differential. I mean, it's behaving the way interest rate differentials behave. I mean, take a look at it vis-a-vis the Euro. You know, we wrote about this this morning. Will they, will the European Central Bank cut rates in September? They, when they cut rates before the first time during this cycle, they made it very clear that they weren't going to come in again automatically and don't expect to see a series of rate cuts yet there seems to be a convergence on cutting rates at their September meeting. And by the way, the dollar has a role in this because as the U.S. dollar weakens, the Euro actually edges higher. And what we know is the exporters, particularly in Germany, are suffering. I mean, the demand is down. There are issues with China, bilateral issues with the Euro, European Central Bank and Eurozone with China in terms of tariffs and so on.

Quincy Krosby:

But overall, besides that, if we strip away the political aspect, demand is slowing. So a weaker currency will certainly be helpful. And that may be what finally spurs the European Central Bank to cut rates again in their September, I think the date of September 12, which could very much help particularly Germany, which is the largest economy in the Eurozone. And by the way, the world's third largest economy and heavy, heavy manufacturing and sluggish. So a weaker euro typically does help the way a weaker dollar helps our exporters by the way. And so, it is the interest rate differential. Now, needless to say, you can have an event in which everyone flocks to the dollar for strength and therefore the dollar by the way, having all these inflows coming in can affect where the dollar is. But when we watch the way the dollar has eased against other currencies, again, particularly our peers, you can match it up with data. You can match it up with data indicating slow down, slow down. Especially in the labor market. Especially with regard to, you know, manufacturing for example. Or even the time we had the service sector go into contraction, the dollar eased. That is based on pure economics. It's not political, it is based on economics. So right now, I would have to say the dollar easing, softening is a function of, you named it, the interest rate differential.

Jeff Buchbinder:

I guess we're back to good news is good news and bad news is bad news, which is frankly I think a better place to be. So we'll root for a better labor data because the market's a little bit nervous. The Fed's a little bit nervous about the labor market weakening too much. But the upside to that slowdown that we've seen in recent months, especially just in the last month or so, is Fed rate cuts get priced in and then the dollar gets weak. And that's certainly a better investing environment, you know, not just in general for U.S. investors, but also for U.S. investors in international equities or international fixed income, right? Where you get the currency benefit. If you're unhedged. So wanted to throw that in there. So let's go to the small caps and this... I'm in the process of writing up a report on small caps.

Jeff Buchbinder:

And so I threw this chart in there that just shows that around the start of Fed rate-cutting cycles, small caps don't really do that great relative to much. There's been a lot of excitement about small. I think small caps react more to market rates like the five-year treasury or the 10-year Treasury than fed funds. Now obviously they're connected, but in this case, you know, maybe we saw the rally either come too soon or be too dramatic because as the Fed gets ready to cut, history tells you that maybe that's not so great. What do you think Quincy?

Quincy Krosby:

Well, normally when the Fed cuts it is because the economy is not doing well.

Jeff Buchbinder:

Bingo.

Quincy Krosby:

That really is it. This is a different scenario, especially if the market sees a rate cut commensurate with inflation coming down. That's what the market wants all along. Is that the Fed says, you know what? We don't need these high rates to somehow slow down spending, to slow down the labor market, and slow down wages, and get prices to start coming down. That's what the market wants, but not a rate cut that is associated with, oh my goodness. We're terrified about the labor market and that we all know why, because when the labor market starts deteriorating, it can deteriorate at a faster clip. We know the relationship with consumer spending is that consumers will really slow down spending and then hence, you know, we're headed for a recession. That's not what the market wants. But that's normally, normally what happens when the Fed cuts rates and that's why the small caps tend to be weak for approximately three months following the rate cuts.

Quincy Krosby:

So this time around the Fed, I think is, what shall I say, is engineering a rate cut because inflation is coming down and it feels comfortable about that. It feels as if the data actually are confirming that inflation is coming down. And we'll see, you know, with the PCE this week. I have to say it. Personal Consumption Expenditures Index, the PCE. If that also suggests that inflation continues to come down, that it hasn't stalled again, and that the Fed is talking about a rate cut for September 18, I think that that may save the small caps, especially if the market believes another rate cut will be forthcoming following the September 18 rate cut. But it is interesting, but let's remember too small caps sold off brutally with the unwinding of the yen carry trade and all of the, you know, work concerns about the U.S. labor market. And so right now they're playing catch up and they sure did on Friday. That was probably the strongest gains that I've seen in the small cap Russell 2000 space.

Jeff Buchbinder:

Yeah, no doubt. So I think you're spot on the, I guess in this place where we are now, maybe a soft landing is more likely than not. But if you look back at history, the market was worried about a hard landing and most of the time it got, maybe not hard, but it did not get a soft landing. It got a bumpy landing or a hard landing.

Quincy Krosby:

Yeah.

Jeff Buchbinder:

And that's where you see again, so I'm showing relative strength of small versus large six months before the cutting cycle. Three months before, three months after, six months after... where you get the best performance, at least in the last 40 years, post-1980, is '01. That coming out of the tech bubble bursting, right? Because what led the tech bubble up, it was large caps, large cap tech. What led the way down when the tech bubble burst? Large cap tech. So small caps and the defensive sectors, non-tech sectors, did very well during that aftermath of the tech bubble. Of course, large caps did not. This is not really that environment. It looks more like 95 or 98 or some combination of the two. So that suggests us small caps may be neutral. That's where we're at. We are neutral small, and we don't think this is the time to think about an upgrade. But if you're going to move one way or the other on small caps, we'd air toward the cautious side, frankly. But neutral feels right because they're so cheap, especially high quality small caps. You're hearing that from a lot of strategists out there.

Quincy Krosby:

Jeff, I'd like to add something here too, is I would keep my eye on how the financials, large cap and mid cap financials respond to whatever the Fed says. We've got fedspeakers this week, for example. And the reason is that small caps are very sensitive to the small banks, small- and mid-sized banks within the space. And they tend to follow their larger brethren in determining the health of the bank or the financial sector.

Jeff Buchbinder:

Yeah, that's a great point. Regional banks still want lower rates. Not March 2023 during Silicon Valley Bank, but you know, a little bit of a bump up in the value of bond portfolios for the regional banks would be positive by the market, so we'll be watching rates closely as it pertains to that chunk of the small cap index as well. I know financials are in the high teens as a percent of the Russell 2000. I think banks are close to 10%. So pretty big weight. That really matters. So thanks for that Quincy. Last thing is earnings. I have our latest earnings dashboard up, but I just wanted to get your thoughts on Nvidia and maybe what we've heard from the retailers.

Quincy Krosby:

Well, the retailers, I love this because you can't make this up. Because last week we had the discounters and boy, have they discounted. And before that we heard from Walmart. They had been discounting as well. And the thing that they told us was, that is to say Walmart, was that the folks who were going in there during the worst part of the inflation spiral were those, you know, that they never expected. And those were those folks with household wealth of a hundred thousand dollars or more. They get this information from the credit cards and they said those folks are still going into Walmart, even though, you know prices in food have come down a bit. Not great, but come down a bit. They're still shopping there. The other thing is that Target, right? We typically go from Walmart to Target, but Target had a problem, but they went in and they started cutting prices across the board.

Quincy Krosby:

Now their food section is quite small compared with Walmart, but they went from the food to other essentials and they went straight to apparel and also the home goods cutting, cutting, cutting. And they saw traffic picking up and picking up markedly, including online. So that helped them very much. And then you had TJX, you know, the brands there are home goods. It is TJX and Marshall's. And they said full year Outlook. Excellent. So what this tells you again and again and again is that the U.S. consumer, careful, discerning and really, really making sure that they get value for their purchases. And they are very focused right now on value, but also for essentials. When we looked at the retail numbers that came out and remember that retail number was higher than expectations and it sort of had the market take a sigh of relief that consumers were spending.

Quincy Krosby:

But one thing I noticed, Jeff, is that we are spending more on things that we really need. And the fun things we're kind of waiting and we're waiting for discounts. How about travel? We heard from the airlines they have to put these extra seats up for sale. And I think that U.S. consumers are actually taking advantage of that, particularly at the end of the summer and that last bit of of travel before Labor Day. The other thing I'm paying attention to with all of this is the credit cards because they give us a very important story and whether I'm talking about Visa or MasterCard, we are hearing from them that we are slowing down our spending. Take a look at their share prices. The only thing we haven't heard is whether or not business spending is pulling back and that we will hear from American Express if they have... They will have a view on it when they finally for the next quarter tell us how they're doing. But we are seeing the pressure on the credit card companies and we have to be very respectful of that because they tell a very important story about not just where we were, where we are, but where they believe we're headed.

Jeff Buchbinder:

Yeah, good point there. It's also too early to start talking about how the election is affecting people's spending.

Quincy Krosby:

Yes, yes.

Jeff Buchbinder:

Or corporate investment plans or any of that. I mean, I guess the biggest political issue for markets is going to be the tax cuts that expire in 2025, but there'll be plenty of time to plan for that after the election. So right now, probably not going to affect retailers too much. I'll also say that the Buchbinder family certainly chipped in and did some back to school shopping over the last few days. We were looking for value too, Quincy. So actually I think my daughters both went to TJX without me. They went with mom, but certainly I've spent some time at some of these retailers looking for value and the prices actually aren't bad. I think I've seen evidence of some price cuts at some of the teen retailers. So a pretty good, overall pretty good back to school season, I would say, based on what I've heard from from retailers, and I'd say the same thing about earning season overall.

Jeff Buchbinder:

I mean, of course you can't really evaluate earning season without Nvidia, but to date, tech has been a winner, certainly growing earnings 20%. And then overall the estimates have held up quite well. The growth rates have been quite strong. We've seen some areas like healthcare reverse recent earnings declines and you know, turn those into nice earnings gains we've seen broadening out, right? The 493, as people like to call it, grew earnings mid-single digits. That's the first time we've seen that in a while. But of course the big techs are doing their part too. So really positive messages. I think coming out of earning season. It hasn't been enough to drive a breakout in the S&P 500, but it certainly gives markets a chance at making that next leg higher. We'll just have to wait and see what happens if the S&P gets to this all time high and and tests that resistance. So that's that. I think we kind of covered the week ahead Quincy, so maybe we'll just fly through this, but here's the economic counter. I starred durable goods and consumer confidence, durable goods we got this morning. The numbers were fine, but you had this big jump in transportation orders, which is planes, right? And that makes the transportation orders really bumpy. Otherwise, I don't think that was that meaningful. Any thoughts on that? On that, or consumer confidence? I'm just showing the first three days of the week here.

Quincy Krosby:

It's amazing about consumer confidence. I mean, it continues to come in lower yet consumers are spending, but there is a drain in consumer enthusiasm. And again, how do you manage that with 4.3% unemployment, which in and of itself is still good. I look at the New York Fed survey that came out and it said that Americans are worried about the stability of their jobs, and even more worried about losing a job and not finding another job. And they are also complaining about their wages not keeping up with their perception of inflation. That was a powerful survey. Needless to say, we tend to look at data rather than just surveys. But I thought that one was extremely interesting because it also, Jeff, ties in why we are looking for value. Why the discounters are doing so well.

Jeff Buchbinder:

Yeah, I think the cumulative effects of inflation, you know, you compare prices to 2019.

Quincy Krosby:

Yeah, exactly.

Jeff Buchbinder:

I think that's still in the back of people's minds. They're anchoring to what egg prices cost five years ago. Or milk or other things at the grocery store, which is why the Harris campaign is talking about price controls and all of that.

Quincy Krosby:

She gave that up. I think she gave that up.

Jeff Buchbinder:

She's given that up. Well, that...

Quincy Krosby:

I think so. I think she got hammered and people were like no, no,

Jeff Buchbinder:

It's not even a partisan comment to say that that's not good policy. I mean, we've seen it over and over again. Fixing prices certainly hasn't worked for any meaningful period of time, but nonetheless inflation is still an issue in people's minds. And then just political divisiveness is probably weighing on these consumer sentiment indexes as well. Something we've certainly seen a lot more of in recent years. We'll see what happens to these things as we get past the election. But yeah, people are spending, but they don't... They talk like they don't feel very good about things. So of course later in the week is the biggie, the core PCE. The GDP report is the second revision, right? So it's probably not going to move much off of the first, but it's just a convenient time for us to talk about this economy continues to grow. Recession is not imminent and clearly with the market near all time highs, it's it's responding to that. Anything to add there, Quincy, about either those data points or others here for the last two days this week? My gosh, there's so much data this week.

Quincy Krosby:

There's so much data, yeah. But the expectations are that we will probably see the second quarter revision, the second revision to second quarter to stay at about 2.8%. But for this quarter, the one we are in, we are looking at below 2%. Not dramatically lower, but certainly below 2%, which by the way, can actually help the economy simply because again, it's cooling down. What you don't want collapsing. You just want cooling down. And right now that might be extremely helpful. But again, all eyes on are whether or not we're in a growth scare. Pay attention, I think for everybody, is when we see the reports coming out, look at where the yields go. Look at where the two-year is. Look at where the 10-year. Yes, we want it to ease, but we don't want it to collapse because if it just starts jumping off, we know that the response is that there's a growth scare. Remember we saw that a couple of weeks ago? And it scared the daylights out of the market.

Jeff Buchbinder:

That's right. That was the match that lit the carry trade kindling.

Quincy Krosby:

Yes, exactly. I like that. That's very good. I'm going to use that. I'm stealing that.

Jeff Buchbinder:

Yeah, that's kind of original.

Quincy Krosby:

I love it. I'm going to be using it. Yeah. I'll say it's mine if you don't mind.

Jeff Buchbinder:

You can take credit for it. So thanks Quincy for all that. That's that's a really good insight. The carry trade is still there, but if inflation continues to come down, the market can continue to function calmly. We won't have a spike in rates. We won't have a collapse in the yen most likely. And I mean perhaps we're cautious on this market overall, but perhaps we can just keep going higher. We'll have to see. So we'll wrap there. Thanks Quincy for joining.

Quincy Krosby:

Thank you so much.

Jeff Buchbinder:

Really appreciate it. Thanks all of you for listening to another edition of LPL Market Signals. We will be back with you next week for another edition. Have a great week everybody. We'll see you then. Take care.