In this episode of William Blair Thinking Presents, macro analyst Richard de Chazal digs into myriad macroeconomic and market-related events from the past month, including ongoing market volatility, second-quarter earnings season, the intensifying presidential election, and Fed Chair Jerome Powell’s pivotal Jackson Hole speech.
Podcast Transcript
00:20
Chris
Hi everybody. It's August 27, 2024. Back alongside William Blair, macro analyst Richard de Chazal for another episode of Monthly Macro. Welcome back.
Now, I know we always say there's a lot of talk about, but this past month takes that sentiment to a brand-new level.
Just to name a few big pieces of macro related news, since we last spoke, there was the market decline at the beginning of the month. There's earnings season, which, of course, came and went. We've got the US elections, which are now in overdrive. And then Powell has finally indicated that interest rate cuts are potentially ahead. Or as he puts it, “the time has come for policy to adjust.”
Figure we can first focus on Powell's keynote address from Jackson Hole last week since that’s the big elephant in the room, in which he clearly positioned a rate cut was imminent.
And although we still don't have exact details as to when or how much, you know, we'd love to know what your expectations are following the speech. And in terms of when these rate cuts may happen, and maybe the extent of the cut and the potential impact to markets thereafter.
01:22
Richard
Great to be back again. Yeah, definitely crazy busy the last few months. I thought during the last podcast we were just going to be able to just cover the election. Unfortunately, we had to broaden it out a little.
So, yeah Powell. The market has certainly been waiting for that speech for a while now.
That's the sort of the annual Jackson Hole speech. So, listeners don't know it. It's where, the Fed and a bunch of other central bankers and hangers on of central bankers meet over a three-day period in Jackson Hole to discuss sort of big picture, monetary policy issues. And, you know, this has I guess, since Bernanke and maybe Greenspan as well, this has kind of turned into a focal point speech for the fed chair, where they make big picture announcements, so that's, that's been an important one and why the market tends to focus on it.
I think this year was a good speech. It wasn't overly controversial. I think we got what we pretty much thought we were going to get. He divided it up into two parts, one on the current economic situation where the message was basically that the Fed's focus is now kind of officially shifted from inflation to employment.
So, you know, the Fed's now comfortable that inflation is moving down to its 2% target. So, it's back on track to get there. And I think that importantly what it does is it gives the fed the space it needs to start to shift the focus back to the employment side of its mandate. Which is a good thing, because we've now seen the Sahm rule being triggered and the unemployment rate has started to move up. You know, it's now at 4.3%.
Powell, mentioned in his speech that, much of that increase in the unemployment rate, has been for so-called good reasons, i.e., more people coming into the labor force looking for work. So joining the ranks of the unemployed rather than sort of falling from employment into unemployment.
But, you know, either way, I think what you’ve got is a larger pool of unemployed workers. So that supply of workers has increased, and that's been really helpful for inflation, too, because it's helping to sort of ease those nominal wage pressures. And then on the demand side, we're seeing fewer companies hiring. But we're not yet seeing anything in the way of big layoffs yet.
So, I think what Powell is sort of saying is that we're potentially setting ourselves up for this kind of perfect soft landing, the so-called immaculate disinflation where inflation comes down. But you don't have to do it with that painful rise in unemployment to get there.
So, Powell’s message was basically, yeah, I mean, as you said, the time has come statement. So far what he's talking about, these are insurance rate cuts. So, he's not talking about cutting rates because of some, you know, impending or fears of an impending recession. And in terms of the timing, that's very clear that that's now going to happen in September. It's really just a question of how much, 25 basis points is fully priced in.
And that's pretty much a done deal. The market is kind of pushing for, maybe saying you might get 60% that's being priced in with, you know, currently, the futures market is 69%, probability. Powell maybe left the door open, a crack on that. But I think in the end that's probably unlikely. I think we get the 25 not the 50.
And I give you a couple reasons why. I mean, I think one, you know, the Fed really likes this forward guidance. They're very wedded to it and they've given no forward guidance on 50 basis points in the last, you know, dot plot we got which was June, which is actually just a couple of months ago, maybe doesn't feel like it, but it was, you know, they were still talking about one rate cut this year, you know, 25 basis points.
So I think suddenly doing 50 would perhaps make a bit of a mockery of that guidance and the Fed definitely wants to stick to that as much as possible.
There's also a legitimate case that maybe 50, you know, it could scare the market a little. There's always this sort of what does the fed know that we don't, you know, why are they suddenly cutting by 50? I don't quite understand that.
I think the Fed wants to kind of avoid any fear questions around there. And then obviously it's an election year. So, you know, as much as the Fed likes to say its independent, you know, it doesn't want to get involved in politics. And while I think it can get away with 25 basis points pretty easily, 50 ,when, you know, might not necessarily have to do that, might look a little bit provocative when it can then, you know, wait until November after the election.
So, I think we get 25 and then maybe a series of cuts after that and then just briefly, the second part of his speech was sort of the bigger picture discussion on inflation, a little bit of a victory lap, starting with kind of a mea culpa about the Fed. Yeah, we got it wrong on the transitory thing, but so did everybody else.
But then when we realized our error, you know, we pivoted pretty quickly. We started raising rates quite rapidly. And I think that's been helpful, you know, from his point of view in bringing down inflation.
I think what we didn't get in this speech, was any discussion on QE or QT. How useful those have been, how good those have been. And are they going to continue to use those going forward? Nor, I guess, quite sensibly, did we get any kind of sense about where he expects rates to go down to in this easing cycle. So, I mean, I guess you wouldn't really expect him to do that, but the market is always kind of hopeful to get that, you know, at the moment the markets is pricing in basically 3%.
So, we fall from between 5.25 and 5.5% to 2 or 3%, I think could actually maybe be a little bit lower than that, maybe 2.5, 2.75%. But, you know, certainly be more if economy slows more. But, I think that's where we are at the moment.
08:17
Chris
Yeah. It's been hard to keep up with shifting market sentiment lately. Let's touch on that a bit. We've had huge swings since last month. A lot of volatility. What have been the main drivers of this volatility? Do you expect things to calm down anytime soon? Again, I know there's a lot going on. But from your perspective.
08:35
Richard
Yeah. I mean, definitely a lot of volatility during July or of latter part of July and so far in August. You know, things have calmed down a little bit in the last couple of weeks.
I mean, there was definitely that three-day period where I think the market fell by a combined 6.5% from that July peak to that August sort of low, or even larger.
And actually, I think it was about 8.5% so close enough to that sort of 10% bear market marker that gets the market a little bit anxious. But I think it's fair to say that maybe in summer we always kind of hope or expect things to be a little bit calmer.
But I went back and I looked at like, actually how volatile, you know, what are the most volatile months of the year for the S&P 500. What month do you get the biggest variance. And it's by far July and August. Which with August actually being a little bit bigger. You know, maybe it's a myth that we always just hope it’s actually, you know, going to be true, but it never is.
So what caused this?
You know, there wasn't one specific factor we can point you. I think there were probably a number of things, and maybe also one that the market seems to have been pointing out or that a lot of people were talking about, but I think was maybe a little bit of a red herring.
And, that I think was the view that the market was having this sort of sudden tantrum, because it, you know, looking through the rearview mirror, it actually wanted the Fed to cut by 25 basis points in July. And then it didn't get that. And then, you know, further down the road we had that payroll report. And suddenly the market panicked and said, you know, you should have cut in July and you didn't. I think the reality is the market wasn't demanding any cut in July either. Like ahead of that FOMC meeting, a rate cut was priced in with just a 4% probability. And, you know, nobody was really talking about a rate cut at all.
So a little bit rich to fault the Fed for that. Even though I think the Fed does need to start cutting rates soon, given the slowing we're seeing in the economy and the fact that there are actually some pretty good lags with monetary policy, as we're finding out.
The actual cause of the volatility, probably due to about 3 or 4 things.
I think the first was clearly the triggering of that Sahm rule where we saw the unemployment rate go up to 4.3%. Remember, this is sort of anytime the unemployment rate moves up by 50 basis points above the low over the previous 12 months, you've always had a recession with basically no exceptions since 1970, and very few exceptions in the years before that. So, I think the market is clearly worried, that this is, you know, the start of a recession. The Fed's already behind the curve and needs to start cutting rates ASAP. So, there's a little bit of fear around that. Even though the Fed and Claudia Sahm herself saying this time, you know, might actually be a little bit different again for, for those reasons I was talking about earlier, are more people coming into the labor force rather than being laid off?
The other thing I think is interesting is, you know, what we've seen is there's been a huge amount of concentration in these tech stocks, you know, call it the mag seven or whatever you want, but, you know, they've had a great run. And I think that there's been this sort of trepidation that this is not going to go on forever.
It's been a pretty crowded trade. Everyone's hanging out in these stocks, because the reality is if they don't, they're probably going to be underperforming. And the fact that these have been so popular has meant you are kind of at risk of this crowded cinema, type effect where if someone does, you know, start a scare, then you get these kind of panics moving.
And because these are such large mega-cap stocks, you know, they can really shake the market as a whole. So I think that probably added to some of the nervousness. I think in the end there wasn't, you know, obviously a major panic, but definitely some jitters there.
Also I think, you know, the market has been pretty richly priced. So, you've got a forward PE of 2021. That kind of gives you not a lot of margin for error. So, there's not a lot of cushion there should you get any anything untoward happen.
And lastly, I mean, it's always tough to kind of factor in how geopolitics plays into the market here. But I think through July and then from that first debate of Trump, Biden, we really had this Trump trade kicking off. And I think since Biden's departure and the rising prospects of Kamala Harris actually winning, that's created a little bit more uncertainty in the market. And maybe you've had some of this unwinding, of that, Trump factor,
As well as any tensions in the Middle East, which have, you know, unfortunately escalated a little bit more.
So basically, quite a number of factors, I think gross fears being really at the forefront of those, things have calmed down since. But, economic growth is definitely not collapsing. It's somewhat decelerating. I think the soft landing is still the appropriate narrative.
But I think there's no room for complacency.
14:28
Chris
Well, we just wrapped up Q2 earnings season, which didn't seem to move markets in any real notable direction this time around. What would you say were some of the biggest takeaways from Q2?
14:38
Richard
Thankfully, this was one area that was relatively uneventful. You know, that that could have been, you know, had it been much messier, that would have been, you know, another leg down for the market.
I mean, if you remember going into this season, we had a ton of consumer companies all warning about, how the consumer was slowing down. And, you know, there was a lot of concern, from that area. And I think in the end, what we've seen was, you know, some moderate slowing, but, you know, definitely not a collapse. If we look at consumer spending that's held up pretty well. And then in terms of what companies were actually reporting, in terms of the earnings beat.
So how much ahead of expectations are those earnings coming in when they're reported. That's actually been really strong. So we had a pretty strong season of beats which was helpful. If I had a main area of concern, it was less on the earnings side. And perhaps more on the top line side, where the beats on sales were actually pretty low. So, the lowest since 2019. So, it seems like the message there could be that, companies having a little bit of a tougher time on the top line, which probably means that those beats that we got on the bottom line were really being squeezed out through greater efficiencies. And that's not really a bad thing.
But it does potentially mean that there's less cushion to fall back on, if the top line continues to decelerate.
So, I think, you know, expectations for Q3 and Q4 strength have naturally come in a little bit. And we've seen that in the progression of those, those estimates for the quarter.
But overall, I'd say, you know, not a bad quarter, actually a pretty good one. Again, you know, if I'm going to pick some holes, it would be that one sort of sales area of concern. But actually pretty decent.
16:48
Chris
So finally, the RNC and the DNC are wrapped up. So, we're full steam ahead into the final phase of the presidential election cycle. You know, you published a report recently that we should definitely touch on a bit that explores potential investment implications of various November 5th scenarios. So, in your own words, what were some of your key takeaways from that report?
17:10
Richard
So I think at the time of writing that…this is a report, put together with the rest of the research department. So, I wrote the macro a bit, and, each of the sector analysts added their own portions on, on, you know, what potential implications were for their sectors. And I think at the time of writing, Trump was still well ahead in the polls.
17:35
Chris
Yeah. This was written when? Mid-July, right? Is when this came out?
17:38
Richard
So, a little bit after the debate and before, just before Biden had had stepped down. So, I think we look at the polls today. We can look at the prediction markets and the betting markets from predicted. We can see that Kamala is actually now ahead of Trump in the betting markets. I think her probability was 56%. Trump's now 48%. Incidentally, these don't add to 100. There's, you know, various reasons for that. But the point being she's ahead. If you look at some of the polling like Real Clear Politics, you sort of sample polling. And if you look at, you know, the important swing states or those seven states which do actually decide the election, Trump is still ahead in five of those seven, the only two where he's slightly down is Michigan and Wisconsin.
But his margin there has come down, quite significantly.
In terms of their policies, you know, maybe unsurprisingly, they're actually pretty vague. They, you know, to a certain extent, they're just running on Trump being Trump and Harris not being Trump.
18:47
Chris
Right. Right.
18:48
Richard
You know, we don't have such a great idea of what Harris actually stands for.
You know, she hasn't been giving a lot of interviews. So, we'll see maybe the debates coming up, in September, we'll see a little bit more about that. I think she's, you know, on the economy, pretty similar to Biden. Maybe a little bit different on some social issues around abortion or Israel-Gaza. But on the economy, I think she basically wants to raise taxes, particularly on the corporate sector.
So, they've talked about moving the corporate tax rate from 21% to 28%. So obviously, that would have a hit on corporate profitability. Remember, Trump actually cut that from 35% to 21%. He's proposing cutting it further to 20%. And then he sort of lobbed in, once, you know, maybe, maybe 15% would be possible as well.
Harris, I think, also wants to raise the top income tax rate for people earning above $400,000 per year. So, moving that from 37% back to 39.6%. So again, you know, whilst that could have some longer-term benefits where we're basically talking about, you know, she's running a tax increase, agenda, to fund, more of the spending that the Democrats want to undertake.
Their also, you know, the Biden camp and I think the Harris camp, seem to be more pro regulation, certainly than Trump,
But I think what she's been taking certainly the most flak for and where she's actually put herself out as having a sort of, a view on the economic front, has been this, you know, trying to deal with this so-called greed-flation or imposing price controls to, to deal with that. And I think if you mention price controls to any economist, they pretty much have a heart attack. They absolutely hate them. And you know, it's, it's a really bad idea for competitive free markets. And again, she hasn't given a lot of specifics there. But you know she's talking about putting them kind of across the board on a lot of different areas.
We know I mean, economic history tells you that, if you look at things like rent controls, those have backfired quite, quite badly.
You could arguably maybe use them in some areas where you have monopolies, like utilities. But I think in other competitive markets where she's talking about like food prices, where there's definitely not monopolies. Those, you know, seem fairly, fairly dubious. So, I wouldn't say that that's, you know, going to be a great winner for her there.
And then as for Trump, again, he's pretty vague. He seems to basically want to do more of the same of what he did during his first term. So lower taxes, and decrease regulation, which what's normally the case with a second term president is they tend to focus on the areas where they can have the most traction.
So, tax cuts often they have less traction because typically Congress is not of their party, during their second term. So, they tend to focus more on the deregulation front and on foreign policy where the president can basically decide, policy, on that front as well.
I think Trump has, certainly shown himself in the past, to be not afraid of rocking the boat, on that front. So, I think we can definitely, expect more of a foreign policy thrust from the Trump side. Whereas Harris, she, she really doesn't seem to have a strong foreign policy background.
So, we'll have to see what would happen with her there. So, you know what does that mean for the market?
I mean, obviously there's going to be stock specific and sector impacts. And I think we get into that, in that report. For the stock market as a whole, view has really always been that, you know, the president matters, but typically it's the economy that matters more. I.e. it's the underlying structural economic trends. And while the president can have some influence over those, really, those underlying trends tend to be much stronger than a president has over. And, you know, let's say, for example, if you think about when Trump was first elected, everyone at the time before that election was going on about the Trump trade, you know, pretty much actually what we've been seeing recently. And, you know, at that time, the view was, Trump's a real estate guy. You know, he loves low interest rates. He's a big oil and gas guy. The sort of drill baby drill. He loves beautiful, clean coal, and all that kind of stuff. And then if you think about Biden and Harris, of course, they've put themselves forward as, as being very green and strong on climate change and, and all that kind of thing. So, it's interesting that, you know, the two worst performing sectors during Trump's presidency were real estate and energy. And then the best performing sector, during Biden's term in office was energy. And actually there's been more drilling of oil going on during Biden’s term in office than Trump.
So I think my point is, is that, you know, you need to definitely be aware of politics, particularly around regulation and changes there, which definitely have quite a dramatic impact on some stock specific and sector specific.
But I think investing purely on who's in the White House is probably not a great strategy. But conversely, where the president can actually have, a bit more influence, is in the bond market because, you know, they're the ones who actually have a big influence over the supply of bonds, treasuries that are being issued into the market and in conjunction with Congress over what spending levels they decide to do.
And I think what we've seen from both of these candidates is they're not really interested in, deficit reduction or debt reduction, not particularly worried about, spending more on the on the fiscal side. It's just a matter of how they do it through tax cuts or spending increases. And one slight difference being that from the Biden-Harris administration is, you know, we'll go and do this spending.
You know, if that's inflationary, that's not my problem. That's the problem of the independent Federal Reserve. Whereas Trump has taken a slightly different tack on that, saying, you know what he's saying, it's not inflationary. But even if it is, he thinks that the monetary policy should be more in-house. So, he should have more say or sway over, policy decisions taken by the fed.
And I think that's a little bit worrying and that's potentially, you know, more inflationary. So, I mean, let's see, I mean, I think whoever wins, we're probably going to see, interest rates, the level of rates being a little bit higher than what we saw in the pre-COVID period, perhaps a little bit more volatile, than we had.
You know, we certainly, none of these characters have the Clinton type focus on reducing that, debt. I remember, you know, it's just incidentally, is that, you know, back in the, in the Clinton days when the Clinton administration with Robert Rubin was really gangbusters about reducing the deficit. And we actually had some budget surplus for a very short period.
Greenspan was actually worried about insufficient debt issuance, insufficient supply of treasuries.
I think unfortunately, those days have, have long gone. So, we'll see.
27:23
Chris
All right. Well, that's all the time we have for today. Richard, we kept it to 30 minutes. That’s amazing given the amount of stuff that we just went through. So, thanks again for joining. I look forward to chatting with you again next month. There's a lot to look forward to. We'll see you soon.
27:38
Richard
Definitely. Thanks, Chris.