Daybreak Holiday: Fed Independence, Market Outlook, Retail Breakdown

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0:59Thank you so much for joining us on this special Labor Day edition of Bloomberg Daybreak. U.S. markets are closed for the holiday. I'm Nathan Hager. Coming up this hour, with summer all but in the rearview mirror, what's the outlook for stocks at the end of a volatile year for equities? We have a special roundtable with Lori Calvacina of RBC Capital Markets and Invesco Global Market Strategist Brian Levitt. Plus, we look at how retailers are faring with school back in session when we'll speak with Bert Flickinger, Managing Director at Strategic Resource Group. But first, we focus on the economy because September will be a very busy month.

1:36On Friday, we get the jobs report for the month of August, and that will be followed by a Fed rate decision September 17th. Let's get a preview with two of our favorites. Wells Fargo Senior Economist Sarah House is with us, along with Jennifer Lee, Senior Economist at BMO Capital Markets. What better day than Labor Day to talk about the labor market? Thanks so much for being with us. And of course, we are just a little more than a week out from Fed Chair Jay Powell's comments at Jackson Hole with his view on labor. Here's what the chairman had to say. Overall, while the labor market appears to be in balance, it is a curious kind of balance that results from a marked slowing in both the supply of and demand for workers.

2:18This unusual situation suggests that downside risks to employment are rising. So, Sarah, I'll start with you. How should we be looking at the labor market right now? Right. So I agree with Chair Powell that right now it's in balance, but it is a very fragile balance. And we continue to see, I think, demand for workers remain pretty tepid. And so that leaves supply is really the big question mark in terms of whether we can maintain this balance or whether we're going to see the jobs market soften in a way that becomes more concerning. So, Jennifer, is that your view as well? Is supply the issue when it comes to where things stand in the labor market?

2:59It's sort of both. I hate to sound weak, like a wishy-washy when I'm saying that, but I'm also very curious about demand, just given that we know that businesses have been very hesitant to make any real hiring, firing decisions on the labor front just until a lot of this uncertainty over trade and over inflation passes through. We see that from all the different surveys that are out there. And this is why I think it's also super important to, you know, sort of look at this with a bit of a more of a skeptical eye than usual, just given all the hoopla over the report over the last month. But look at all the different surveys that are coming out in terms including job openings and the different ISMs just to see what the purchasing managers are saying about hiring.

3:39So I think I'm kind of leaning toward demand as well. Interesting that you bring up the hoopla around last month's report. Of course, this is going to be the first non-farm payrolls report since the firing of the head of the Bureau of Labor Statistics. It does raise the question, Sarah, about whether there is going to be some trust issue with this report coming out later on this week. I think there could certainly could be. And I think this could challenge the response rates even further. So the declining trend in at least the first response to the CES survey has been behind why we're getting such large monthly revisions.

4:19If you look at the third release, it's getting back up to a little over 90 % where it has been. But if you have public authorities saying that this data can't be trusted, that just decreases the incentive for businesses to respond. And so I think it could actually amplify some of the volatility and scope of revisions that we see. What's your trust level in the data right now, Jen? Ever since COVID, we know that the response rates have been lower than usual. But revisions in general are not new. And I'm going to refer to the latest GDP report for the second quarter. The headline wasn't changed too much, but the details.

4:58It was very interesting to see all the details and all the revisions to business investment. So that is going to raise some questions about the quality of the data. But I think it just has to do with, you know, how many people we have on staff to calculate and collect all these surveys responses and put them through. And, of course, again, having the survey responders taking a little bit longer to respond, you know, just sort of puts a lot of questions into the data. So this is why, again, we have to look at all the data around jobs, all the data around the economy to make, you know, some better, I guess, calls on where we see growth.

5:35Well, let's talk about some of that data that you all are looking at. Sarah, what's going into your forecast when it comes to how you see the labor market right now? Yes, I'm looking at a lot of the demand indicators like some of the PMIs that Jen mentioned. So the ISM, but I also like to look at the regional Fed survey PMIs. And what they were showing over the past couple of months is that the degree of hiring remains very weak. They're kind of hovering around contraction territory, just right between positive and negative. But they haven't really gotten worse. Same thing if you look at the NFIB small business hiring plans index.

6:10They've actually picked up a little bit since the spring, kind of right around the liberation day. And so I think when you look at that, the fact that layoffs remain very low, if you're looking at initial claims, that there actually seems to be maybe some hints of stability over the past month or two in terms of the hiring backdrop. And so I think, well, again, lower supply remains a challenge for payroll growth, at least on the demand side. It doesn't look like conditions have gotten materially worse over the past month or two. And in terms of your outlook, Jen, what are you looking at? Are we starting to see signs that policy changes, immigration, trade, artificial intelligence are starting to have an impact on the labor market?

6:57I think they are. And by the way, I just want to add to Sarah's list, the conference board survey. I used to get super excited when I would be looking at the number of people that were raising their hands when they're being asked, are jobs hard to get or are jobs plentiful? And we sort of noticed a little bit more of a deterioration on that front. So, again, sort of to what Sarah was saying, it hasn't changed too much, but we're starting to see some softness building up. And certainly, I think all these policies are having an impact, certainly on the deportation front, when we have the largest deportation effort ever.

7:31And you look at the sectors that are super reliant on these workers. You know, agriculture is the biggest one, with 50 % of the workers being undocumented. And construction is like 20%. Leisure and hospitality, about 10%. So I think it's having a big impact on those particular sectors. And consequently, we should be, although we haven't seen too much of, an impact on inflation. We're speaking with Jennifer Lee, Senior Economist at BMO Capital Markets, as well as Wells Fargo, Senior Economist. Sarah House, as we look ahead to the jobs report coming out later this week, of course, a Fed decision later on this month.

8:11Sarah, how important is this jobs report going to be when it comes to that Fed decision? I think even more than inflation, this is the key report for whether the committee decides to walk through the door for a September rate cut that Powell opened in his Jackson Hole speech. So I think the committee broadly expects some increase in inflation around tariffs. I think the base case is still that it doesn't spill over into services. Inflation expectations remain anchored. And even in those, they're aware of the risk that might not happen. So really it comes down to, is the jobs market hanging in there or is there enough weakening where the Fed does need to move a little bit more towards a neutral posture?

8:54So the committee still thinks that policy is at least modestly restrictive to varying degrees, depending on what Fed official. But I think it really comes down to, are we seeing signs of the labor market weakening to the point where the Fed really needs to step in and help cushion the maximum employment side of the mandate? You have to wonder, Jen, when we did see that second quarter GDP number revised a little bit higher, whether policy is as restrictive as some Fed voters have said it is. What's your view on that? So it's interesting. When I first saw the second quarter GDP report, I thought in some of the details, especially on the business investment front, sort of tongue in cheek, my first comment was, And we're cutting because, you know, because it shows that the U.S.

9:42economy is still resilient, is still holding up. And again, as Sarah pointed out, it's all going to come down to this jobs report because, as Fed Chair Powell said, you know, that the downside risk is coming from jobs. So there's going to be so much attention paid on that August payroll report. And by the way, also, I'm very curious to see how revisions are going to go. Very, very curious. It was all about the revisions last time around. Is that still an issue for you, Sarah, whether we do continue to see these numbers sort of get revised downward and another surprise once again, potentially? I think increasingly we're looking at what is the three-month average rate of employment and really looking at the jobs report inclusive of the net revisions, just given that bias we've had towards downward revisions over the past couple years, where it's just not as much about the most recent print anymore, just given that low initial response rate.

10:42But again, just the credibility of the data seems to be holding up once just if you allow businesses a little bit more time to get in. So we'll certainly be paying heavily a lot of attention to the net revisions, as I think a lot of market participants will be. And of course, it goes without saying that the Federal Reserve is under a lot of pressure to cut interest rates. It seems like every other day President Trump is calling for that. Jen, how much does that weigh on what we could get later this month? That's a tough question and a tough thing for me to answer. I think everyone on the Fed is human, so I'm sure that this is sort of weighing in the back of their heads.

11:23But everyone is a professional and everyone knows that they are going to do what they feel is best for the economy. And some feel that lower rates are definitely the way to go and they should have been cutting earlier. And I'm thinking of a couple of Fed voters in particular. But not everybody's on board. I believe it was Boston Collins who said that wasn't a done deal just yet. So, again, it's all going to come back down to jobs and what happens with the headline, with the jobless rate, with the averages, with the revisions. Also, I also noted that the average duration of unemployment in terms of weeks has been picking up over the last couple of months as well.

12:04And now they're at the highest since 2022. too. So, you know, again, it's going to be all about the headline numbers, but as well, the data, the revisions and the details behind the data. How much pressure do you think the Fed is under when it comes to politics, Sarah? I mean, I think certainly more than we've seen in decades. I think just the public nature of it is pretty obvious here. And I think what that means for the path of rates ahead is I think it's going to, I think, put some questions over the cutting that we are likely to see. So if you think of tariffs in the classic sense of it's okay, it's a one-time increase in prices.

12:44It shouldn't lead to persistent inflation. Policy is still above estimates of neutral. I think that does support cutting, but I think there's going to understandably be some questions over what is the committee's motivation to the extent that we do see cuts later. So it's It's a cloud. Yeah, and I think it's safe to say it's probably going to be one of the closest watched Fed decisions coming up later this month, as probably all of them are going to be for quite some time. Thanks to both of you for joining us on this Labor Day. That was Sarah House, Senior Economist at Wells Fargo, and BMO Capital Markets Senior Economist Jennifer Lee.

13:21And coming up next, we'll turn from the economy to the stock market with Lori Calvacina of RBC Capital Markets and Brian Levitt at Invesco. that says this special Labor Day edition of Bloomberg Daybreak continues. It's 20 minutes past the hour. I'm Nathan Hager, and this is Bloomberg.

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15:49as markets move and headlines break what matters most is context a bloomberg subscription gives you unmatched reporting sharp analysis and powerful tools that help you connect the dots visit bloomberg.com slash podcast offer to learn more thank you so much for joining us for this special edition of bloomberg daybreak u.s markets are closed for Labor Day. I'm Nathan Hager. And we turn now from the future of the economy to the outlook for the stock market for the rest of the year. And what a year this has been. Stock soared to record highs in August, but it certainly wasn't a smooth ride for investors.

16:28Of course, we remember the sell-off in April on the tariff concerns. So to look at what's ahead as we round out this year, we have another special roundtable for you. Joining us now, Lori Calvacina, head of U.S. Equity Strategy at RBC Capital Markets and Invesco Global Markets Strategist Brian Levitt. It is great to have both of you with us today. And Lori, I'll start with you. Have you seen a year like this before? It's a great question, Nathan. Thanks for having me, by the way. And look, I've been in equity strategy in some capacity or another for more than 25 years now. I've never seen a year like this.

17:04And to be honest, that's something we sort of addressed in our year ahead outlook, you know, way back last November was that it was, you know, we thought forecasting was going to be, you know, a little bit more difficult than usual this year. There have been a lot of twists and turns. I think our approach has just been to stay focused on the data and call it like we see it. Brian, how do you map out a rest of the year after all that we've seen in the last eight months? The first thing I would say is I don't think that it's been so out of the ordinary simply from the perspective of, you know, the market had been up quite a bit.

17:40What tends to derail that is policy uncertainty. And so we got that as we move towards more clarity, both on trade policy and with the expectation of what the Federal Reserve is going to do, the markets recovered and they recovered pretty quickly. So it's not entirely out of the ordinary, all the while growth slowing in the U.S., but still resilient inflation expectations up a bit, but still generally stable enough. So all of that's a good backdrop for markets. I would expect that the markets end the year higher on a couple of things. One is going to be more Fed easing and a continuation of this easing cycle, which should support broader parts of the market.

18:30And already you're seeing a broadening of the U.S. equity market, certainly from where we were in 2024. I have a feeling I might be hearing a bit of a contrasting view from you, Lori, after looking at some of your latest notes. I know you've got a year-end price target on the S &P 500, a little bit below where things sit right now at 62.50. Where's your conviction right now? Yeah, you know, and I think where I'm a bit differentiated right now, to be honest, Nathan, is we feel pretty neutral heading into the balance of the year. Now, we do tend to view our price target as a compass, not a GPS. So we always tell people don't get overly precise.

19:09This is a signaling mechanism for how we feel about the path of stocks from here. And I would tell you that kind of post Labor Day, we have been concerned that we could be set up for a little bit of a period of chop. And there are a few reasons for that. One is that seasonally, if you go back and you look at September and October during the past five years, September has been down four out of five. And I think October has been down three out of five. So, you know, it it hasn't been 100%, but this is a period of the year when we tend to experience some choppiness. Secondly, if you look at valuation levels, whether you're looking at S &P market cap weighted, whether you're looking at the NASDAQ 100, which has been kind of everybody's favorite growth trade, or if you look at even the top 10 market cap names in the S &P 500, which is a really good proxy for the AI engine, we've been trading close to levels that have essentially been in line with where we peaked out most recently.

20:01And the market has been, you know, we've been kind of creeping up to these news highs in August, but have really had a difficult time punching through them with any certainty. So, you know, I think that we are seeing some valuation pressure start to seep in. And frankly, you know, I don't disagree with Brian on the idea that the Fed cuts provide a tailwind, but I've been getting an earful from clients about this for the past three months. So we do think to some extent, a lot of this has already been pre-baked into stocks. I'm glad you mentioned valuations because whenever we see these lofty levels, record after record broken over the last several months, there has been the question about whether this market is heading into an asset bubble.

20:42So I put that question to you, Brian. Where do you sit when it comes to where this market is valued right now? The market, the S &P 500 index is overvalued compared to certainly its long term history, but even its more intermediate term history, which probably makes more sense to look at given how the economy and the markets have evolved. So, yes, you are trading at an elevated valuation. Reality, as everyone knows, is that valuations are not timing tools. You need to have some catalyst one way or the other to either see valuations improve or valuations correct. What's more interesting, perhaps, is if you look beyond the S &P 500, which, of course, is just one way of gaining exposure to the market, the valuations are not all that excessive.

21:32I tend to focus on the median stock in that index or even an equal weight index where valuations are certainly not that excessive. So it is concentrated, to Laurie's point, in the top names. also if you look mid-cap if you look europe if you look emerging markets you're also dealing with pretty reasonable valuation so it is primarily an s &p or nasdaq story and that's a call on the ai trade rather than the broader market as far as markets hitting new highs that's fairly common if you go back to 1957 the stock market has hit a new high once every two weeks and actually you've been better off investing historically on days when the market hit a new high than on just any random days.

22:22So I'd advise investors not to be concerned or wary simply because markets that are at all-time highs. You want to think about how market cycles end. Market cycles typically end with a lot of leverage, policy tightening, bankers tightening lending standards, credit spreads blowing out. None of that is happening right now. We're speaking with Brian Levitt. He is a global market strategist at Invesco, along with Lori Calvacina, the head of U.S. equity strategy at RBC Capital Markets. Glad Brian brought up the idea of small to mid-cap stocks as well, because, of course, there is a lot of attention, a lot of focus on the S &P 500.

23:08How are you viewing some of those broader names in the stock market right now, Lori? So look, I'm a former small cap strategist. So I always enjoy talking about this space. And I have seen, if I look across the street, sort of a general impulse to get long the small caps or to go overweight. And I want to say, we're certainly not bearish here, but we think for longer term investors, we like more of a neutral stance as opposed to, you know, kind of recommending an overweight at this point in time. And I think that, you know, what I feel like I can really see pretty clearly in my client conversations is that the excitement over the Fed is something that I think is generating a lot of interest in the small cap space.

23:49And, you know, as Brian mentioned, certain areas like small cap, you know, if you kind of get away from those biggest market cap names in the S &P 500, you've got much more reasonable valuations. So as I look at, you know, kind of the onset of cuts coming, you know, exactly when I suppose is still up for some debate at least. But we do understand the impulse for a trade there, right? And we did see in August, small caps finally broke out of their range that they had sort of been pinned in when you look at the Russell relative to the S &P. So we did have a, you know, kind of a big breakout after Jackson Hole.

24:21And I think you want to respect that momentum and the interest in the rates trade. The problem is that if I look since the end of 2023, whenever the market dials up that dovishness, we see the hedge fund community kind of pile into small caps in a very short term oriented way. And then that trade tends to fizzle out. So, you know, when I'm talking to my small cap PM clients or longer term investors, I really want to understand the risk of it fizzling out again. And I think the reason it keeps fizzling out is that the economic backdrop is just not strong enough to sustain a longer term outperformance trade.

24:53I don't think the Fed alone is enough. What we typically see, you know, when the Fed, you know, is cutting, it's around a recession. And that's when you get the big long term small cap out performance cycles. If you look to the mid 90s adjustments cuts that happened, you only got short term small cap outperformance. What do we see in that economic backdrop right now? Well, my economists are looking for 1.3 % GDP this year in real terms, 1.6 % next year, And consensus has been very similar, maybe a touch higher, but still stuck in that one to two percent range. Average GDP is around two and a half percent.

25:25And we tend to see small caps really only sustain outperformance trades when you're above that two and a half percent mark. Other indicators you could look at economically would be nonfarm payrolls. If you're in an accelerating job growth environment, that's good for small relative to large. But stagnant job growth or decelerating job growth typically is not. And another good barometer is ISM manufacturing. It's been stuck in a rut for a while now. You really want to focus on the direction of travel there. When that tends to move up, small caps have an outperformance cycle relative to large that can be sustained.

25:55But that one is just, you know, we watch it every month hoping it's going to break out and it just it's just stuck in a rut, which I think is a testament to some of the kind of mixed vibes that are still out there right now. Well, I guess there's still a debate about whether the economy is headed into a slowdown. We've got GDP indicators showing that we're still above 3%, at least as far as the second quarter goes. So, Brian, what are you thinking as far as whether the economy is headed into a slowdown and whether this is all about the market expecting that we're going to see rate cuts that can continue to keep this rally going?