Will Strong Economic Data Force Fed Action in September?

01:01:55.547 — 01:03:04.627 · Jeff Roach

Hello and welcome to the latest edition of LPL Market Signals for the week of August 3. Jeffrey Roach here, chief economist for LPL financial, joined with Chris Fasciano. We'll talk in just a moment here and looking forward to talking some hot takes from last week, some important signposts to look for throughout this week.

Before we get to that, let me give you the official agenda. Uh, in addition to some intros, look at market performance and then what I just mentioned on last week and this week. But more importantly, we need to show you some disclosures, and then we'll get into the meat and potatoes of the conversation. So right off the bat I want to introduce Chris Fasciano from Commonwealth.

And Chris why don't you share a little bit about yourself, your title and perhaps some of the things that you focus on. And then we'll talk market performance and what to look for and some key takeaways for our audience.

01:03:04.627 — 01:03:52.827 · Chris Fasciano

Great, well thanks, Jeffrey. Thanks for having me. I'm looking forward to the conversation. And I am Commonwealth's chief market strategist. I've been at Commonwealth for almost 12 years now. First 10 of those I was part of our discretionary model platform as a portfolio manager, and I've been in this role for about two years now.

Prior to that, I had a long career as an individual equity analyst and a portfolio manager on U.S. small and mid-cap value portfolios. And at Commonwealth, I tend to be the face of the Research Department. I do a lot of advisor meetings, client meetings, write pieces for them to use with their clients and also represent Commonwealth in the media.

So that's kind of how I spend my time. And let's dive into the conversation.

01:03:52.867 — 01:04:18.587 · Jeff Roach

Yeah. Well, speaking of your writing, perhaps you could share a little bit about what you wrote about this week, given the fact that there were some interesting things to tease out of the data. So I'm showing here for our audience the slide on market performance, major indices up here on top. But I think you're probably going to talk a little bit about sectors because that's where it gets interesting.

So yeah. What do you think about last week.

01:04:18.627 — 01:06:27.987 · Chris Fasciano

Yeah, absolutely. It was an interesting week in the market. We seem to have had a lot of those recently. And you can see that the headline returns for the index were all positive. They were pretty good. But it masked the fact that we had a pretty significant sell-off Wednesday coming out of the Fed meeting.

And Chairman Warsh's press conference, followed by very strong Thursdays and Fridays, which brought the market returns back to positive for the week. It was led by the Nasdaq and the S&P 500 had really solid returns by the end of Friday. And it was interesting because if you look at it, you can see where that is coming from, which is that it was a much more narrow rally than we had seen over the previous weeks, where there was a lot of breadth in the market, that was really encouraging.

This time, it was really driven by the communication services and the consumer discretionary parts of the market. We saw some very strong returns for Microsoft and Amazon last week, but the rest of the market was basically flat to down slightly. So, always do you like to see positive returns at the index level.

A little less breadth than we've seen in the past. But still earnings have been really strong and that's driving the market. International had another strong week that seems to continue a trend. And if you flip the slide you see the bond market. The bond market was a little more interesting take out of the out of the Warsh press conference.

And bonds were basically down across the board last week as you saw a steepening in the yield curve. And what was most notable is that the yields on the 30-year Treasury moved through 5.2%, which was the highest they have been since 2007. So that's a pretty significant level. And we can talk about this later.

But it seemed to be that they came out of Warsh's press conference thinking that perhaps the Fed was behind the curve or wasn't willing to do enough to deal with inflation.

01:06:28.387 — 01:09:35.057 · Jeff Roach

Yeah. That's right. And so I think part of the challenge too, in the bond world is, okay, we have an inflation problem now. But do we have an inflation problem do we think or we expect we will have one in 10 years 5 to 10 years even. And it seems like the market's saying no. You know the inflation problem is here.

Maybe I think it's the latest breakevens which help us determine what market is expecting for inflation out in the future and it's somewhere around 2.3%. So clearly above the Fed's 2.2% target, but not by much. I thought that was kind of interesting to kind of see how expectations continue to be pretty well anchored.

Yeah. But that's certainly a risk. And I'm highlighting here that 30-year on the 5.27, the 2-year at 4.29 and then the 10-year right there at 4.73. And I think for our audience, just a reminder. One of the things that we often talk about is, you know, if the 10-year starts going past 5%, you know, that's when there's some pressure on the markets.

If we see the 10-year rise, but not dramatically, it might be telling us, okay, inflation might not be a terrible problem five years from now, but in the near term it is. But also there's pretty strong growth expectations and growth trajectory even for Q3 and Q4 of this year. So we're going to go to the next slide and keep going.

I think one of the hot takes, in addition to some of the things we talked about on the Fed is the fact that the economy is doing a little better than the headline suggests. So last week, markets were trying to digest a very weak second quarter GDP print. So the economy was growing just 1.5%. And you look underneath the hood and you realize, wait a second.

A lot of that softness was driven by two facts. One is we imported a bunch of goods, that subtracts from the headline, and businesses were not really replenishing inventories. So a negative change in inventories that was suppressing the headline number. But if we look at the core numbers of business investment, consumer spending on goods, consumer spending on services, very, very strong, in fact, when you think about it, you calculate those numbers.

The core numbers of just real domestic purchases to final consumers. If you look at those three categories, the two consumers, the one of non-res investment that was pushing in the high threes. So 3.9% quarter on quarter annualized. That's a very hot print. And I wonder if the bond market, Chris, I'd love to get your thoughts on this.

Is the market trying to digest the fact that the economy is still growing above trend despite all the headwinds we have?

01:09:35.257 — 01:10:43.817 · Chris Fasciano

Yeah, I think this is a really key point. I'm glad you brought it up, because when I saw the headline number last week, I was like, ah, boy, we're seeing growth slowing from the previous quarter. But to your point, the underlying data was pretty strong. And I think that's an encouraging sign for markets and investors that we seem to be having pretty solid growth, despite all the headlines that the economy has had to deal with over the last 18 months, from tariffs to war in the Middle East and an oil shock.

And it's certainly possible that that is where the bond market is now focused, is that we're having strong economic growth and persistent inflation. And so in that environment, you would think rates would move higher as opposed to lower. And so I think that's a distinct possibility that the bond market is actually ahead of it.

You could even argue that the equity market believes that too that, as long as we have reasonable economic growth, you're going to continue to have really strong earnings growth from corporate America. So they're not necessarily out of sync. It was just interesting to see that move up in yields longer term last week.

01:10:43.937 — 01:13:06.057 · Jeff Roach

Right. Right. So the economy is better than the headline suggests. That was taken from last week. More recently was in the past. But really over the weekend another hot take here. That's worth talking about. Just highlighting. Of course, our audience can dig a little deeper if you're interested, this is more of a headline here with the U.S. and the Ministry of Finance over in Japan jointly work together to bolster the yen.

The yen has weakened quite a bit. Japan, specifically their entities in Japan, intervened in April last year. That intervention lasted just a few weeks. Very short lived. This time around, as the yen continued to weaken, the U.S. decided to invest, as it were, in buying yen to support the yen, along with the folks in the Ministry of Finance in Japan.

The reason why we want to take note of that is a couple of things. One is there is a self-seeking component to the U.S. contributing to this intervention. You don't want Japan being forced to sell Treasuries in order to raise the money they need to bolster their currency. I think that's one very, very important take.

And then, of course, the second reason is markets, capital markets do, work better when currencies are well behaved not getting out of sync. So that's a hot take. And then the third one here is this weakening dollar, is something to keep track of because this often helps emerging markets when you think about easier debt servicing, with a weaker dollar, you think about emerging market governments and corporations borrow in dollars.

Dollar falls, local currency, cost of servicing those dollar denominated debt declines. So this is important as it improves balance sheets for emerging markets and, reduces financial stress. That's the hot takes for last week. Let's talk about this week and I'll hit it to you, Chris.

This is not a surprise to anyone listening to the headlines but talk a little bit about what we need to watch out for this week.

01:13:06.497 — 01:14:55.457 · Chris Fasciano

Yeah, it's not a surprise to anyone because it just keeps becoming an issue. Every week you see something new, and I've been highlighting this as a risk over the last several weeks. And, you know, you saw when the memorandum of understanding was signed, the crude market basically discounted complete success, that they were going to get to a deal that the Strait of Hormuz was going to open.

That supply would begin to flow back to the levels that we had seen in February before the war started, and crude broke 70 and was back to prices that we hadn't seen since before the war started. Unfortunately, it didn't work out that way. The cease fire ended, military action escalated, and you saw crude go all the way back to 95, which I think starts to weigh on all the things we've talked about the equity market, the bond market, inflation data and what the Fed's going to do.

And now we're in this in-between period where military action has been paused. There may be some conversations going on in back channels about trying to move this thing forward. Oil markets have reacted at least the last time I looked crude was back to about 80. But it's not clear we're making progress, and I think we need to make progress because the longer oil prices stay elevated, it is eventually going to impact both the inflation data and the economy we've talked about.

And it's been surprising how strong the economy's been even giving this headline. But I think if we're talking next month in September or October and this thing still hasn't been resolved, it could begin to become more of a serious issue for investors the way we saw it back in March when the war started.

01:14:56.097 — 01:16:41.937 · Jeff Roach

Yeah. That's right. I think in addition to that, another signpost to watch, is what we're seeing with the manufacturing side of things. So, you know, we got some data earlier today as we're recording here the afternoon of August 3, just receiving some information that manufacturing employment actually grew the strongest since the early parts of 2022.

And I think that's interesting to think about some of the structural things that are going to happen to the economy given trade policy, the world of tariffs now, the way that things have changed geopolitically. And so we could be seeing somewhat of a renaissance in manufacturing employment. That's something to watch out for, to anticipate, continue to track.

And then third and final, before we talk about the remaining parts of this week, is the fact that, you know, when you think about the next Fed meeting mid-September. So we're going to be past this I think psychological point of Labor Day weekend. If you still have challenges in energy markets, you still have a pretty strong, baby boomer and, you know, well-heeled millennials spending, so a strong demand push to prices.

I think what that's going to do is that that will put a lot more pressure on the Fed to go ahead and reset baseline expectations on September 16. So perhaps you could say, Chris, that third bullet point is, related to the first bullet point.

01:16:41.977 — 01:17:11.417 · Chris Fasciano

Yeah. And it definitely related to the first. It might be related to the second too, right. Because I think there is a school of thought out there that we saw three dissents last week at the Fed meeting that one of the reasons they may not have raised rates, in July was they were concerned a little bit about the pro-growth side.

And last month's employment report wasn't great. So if we can see employment pick up, but we still have an inflation problem, those three dissenters may have set the table for action in September.

01:17:11.537 — 01:20:56.767 · Jeff Roach

That's right. And it really is important to think the Federal Open Market Committee views themselves as risk managers. That's what they're doing, right? They're managing the risk that things might go sideways in the employment world, labor market. Then, of course, price stability. But also there is a component of financial stability in general.

So think about the challenges during the Great Financial Crisis. So a perfect segue for the week ahead Chris, you just mentioned labor market. That was something that was concerning in last month's payroll report. This week we will get an updated payroll report Friday morning, 8:30 Eastern time. We get the latest and this would be for the month of July.

Just a reminder for the audience again, these month to month numbers are pretty choppy. It's very important to look at the three-month moving average and the six-month moving average of these things. That determines the trend a lot better, kind of reveals a lot more than, say, the month-to-month numbers.

But this was the previous estimate. So for June we had 57,000 jobs added to payrolls, probably looking closer to 100. I think this might be a little bit low. This is the survey expectations. But given what I said just a moment ago about the ISM employment number, and that's over on the left-hand side of your screen, I just highlighted the ISM numbers from this morning.

That's the whole point of these data points and these reports very, very helpful in giving us an expectation for what we'll see on Friday. So a couple things just kind of key takeaways. You know some closing thoughts here. The economy is growing above trend. And that seems to continue. We look at the more high frequency data.

It does suggest that there's still some more room for the AI infrastructure buildout, for example, that's going to have ripple effects on construction spending, construction hiring and the peripheries, those sectors. So that's one of the reasons why we saw, I think, some improvement in the ISM headline number, as well as the ISM employment number. Despite above trend growth, or maybe along with above trend growth, we have still very, very strong demand and supply induced inflation.

Here's your ISM prices paid. And so that's going to I think set the stage for the rest of the week. It's a busy week. As you can see this is the calendar of economic releases. Couple key points Wednesday. You get the corresponding ISM services side of things. That's very important. We're mostly a services economy, as I'm sure most of our audience knows, that's coming on Wednesday.

And then going into Friday, it really is going to be all hands-on deck here if there's a surprise or not. I'm expecting some modest rise in payrolls that's going to, again, kind of add pressure to the Fed when they regroup in the middle of September. So this week, in addition to the economic calendar, Chris, if you want to maybe mention anything on earnings, there are still a number of earnings reports.

And from what we saw from business owners in the ISM category, there's a lot of give and take among various categories in industries. As you highlighted, Chris, with the performance numbers that we saw in recent days.

01:20:56.967 — 01:21:36.647 · Chris Fasciano

Yeah, I would just, echo what you said. It is another big week for corporate earnings. But we're going to start to see, more breadth and corporate earnings, too. It's been heavy on the banks and the tech the first couple of weeks. We're going to get representation from a lot of different sectors and industries over the next few days, which will really begin to tell the story.

Because we have begun to see the other 490 names in the index start to put out pretty good earnings growth this year, and you certainly want to see that trend continue. So there'll be a lot of information coming from CEOs and CFOs across the entire economy.

01:21:37.007 — 01:21:47.567 · Jeff Roach

Yeah that's right. So thank you for joining us and listening in this latest edition of Market Signals. And until next time take care.