How Are Recent Geopolitical Events Influencing Financial Markets?

Embark on a voyage to uncover the evolving saga of financial markets, where we transcend the usual chatter about interest rates to dissect the fabric of economic expectations and market reactions. Join us as we, Keith and special guest Brad, chart a course through the intricacies of how human behavior intricately weaves into the tapestry of financial dynamics. Prepare to have your perspective broadened; learn why a robust economy might just sway the Federal Reserve's hand away from the rate cut button, and discover what this means for your wallet.

Our discussion sails into the headwinds of geopolitical tensions and their subtle yet profound effects on global market trends. We navigate the ebb and flow of oil prices, examine the lustrous peak of gold, and reveal how international relations, such as Treasury Secretary Yellen's overtures in China, are more than just diplomatic moves—they're economic chess pieces. Stay abreast as we anticipate the first quarter earnings season, where the winds of April's historical stock positivity are tempered by the cautionary whispers of "sell in May and go away."

As the constellation of topics aligns, from the impact of hawkish Federal Reserve officials to Big Pharma's market dance, Brad generously shares his navigational charts for the complex waters of interest rates and Treasury yields. After our rich dialogue, I'm left reflecting on the journey we've taken together, grateful for your company on this expedition. For those eager to continue the adventure, find Herald Lantern's latest episodes casting light on the hidden corners of the financial universe on platforms like Apple Podcasts, Spotify, and Pandora.

** For informational and educational purposes only, not intended as investment advice. Views and opinions are subject to change without notice.

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Transcript

Alan Eppers: 0:00

And now introducing Mr Keith Lanton.

Keith Lanton: 0:03

Hi, good morning, Welcome to the Monday, april 8th.

Keith Lanton: 0:10

Today is a big day for the Earth. Many are observing an eclipse today, a full block out of the sun by the moon, and for those in the path of totality, they will experience complete blockage. This is on the heels of the small earthquake that was felt here in the tri-state area last week and we're some suggesting that we're seeing all sorts of signs of things to come, and financial markets are always trying to interpret all these different inputs and come up with a thesis on what the future is going to look like, and we will discuss some of that this morning and what the new thesis and narratives are. Also, today is April 8th, is one week before Tax Day, april 15th. A reminder for anyone on the call to make sure that you either file your taxes or file an extension. If you file an extension, make sure that you send Uncle Sam the funds that you expect to owe, because, even though you can delay filing your tax return, if you owe money to the government, you can't delay paying them or they will hit you with penalties and interest expenses.

Keith Lanton: 1:33

Also last week to fund the IRA or Roth IRA for 2023, if that's appropriate for you. So still time to make some last minute contributions and some last minute tax decisions. So, as we get started with the second week of the second quarter, I'm going to start out with just a few thoughts, a few quotes, and then I'm going to talk about how the thinking has changed about financial markets going forward. We were very focused on interest rates and now we are starting to change what we're focused on. We'll talk about the evolution of that narrative. But to get ourselves thinking about this week and this presentation of ourselves, I'll start with a quote this morning by Jay Danzy your smile is your logo. Your personality is your business card. How you leave others feeling after having an experience with you becomes your trademark.

Keith Lanton: 2:37

Thinking about how we can do better and learn from mistakes that we make. Harold Smith said more people would learn from their mistakes if they weren't so busy denying them. And finally, albert Einstein said the world will not be destroyed by those who do evil, but by those who watch them without doing anything. Poignant words in a world where we have a continuation of conflict and wars and animosity between different peoples here on this planet, here, and we can think about our little place in the universe with this eclipse on this planet Earth. But back to financial markets and back to us being individuals and humans and our emotions and how they drive us and how they impact the decisions that we make us and how they impact the decisions that we make, and we as individuals form a collective when we think about markets, which are an amalgamation of individuals, and how markets act and react, and to think about how it is that we focus on what we focus on in terms of deciding what the future will look like, in terms of things being better or worse in the future. So financial market behavior mimics human behavior. After all, market prices represent the average price that individuals place on specific investments. Therefore, financial markets and asset prices are representative of an accumulation of human emotions and human behaviors.

Keith Lanton: 4:03

Now, studies consistently show that human happiness is not derived from whether an experience is a positive experience or a negative experience, or whether or not it's a happy experience or a sad experience, but rather, was this experience that we just went through, did it exceed our expectations or did it disappoint? Went through? Did it exceed our expectations or did it disappoint? This is more important than actually what the experience was is what was the experience relative to our expectations? Even though an experience may be wonderful, if we were expecting it to be super wonderful, we may very well come across and walk out of there disappointed. On the flip side, if we expect something so terrible and it turns out just to be negative, we may say, hey, things are looking a lot brighter than they were just a few minutes ago.

Keith Lanton: 4:48

So financial markets react the same way that humans do, and that's why, when a company reports great news and you see the stock go down, you say to yourself this makes no sense. They just came out with blockbuster earnings. Everything was terrific. They exceeded everything from last quarter. They came out with tremendous guidance going forward. But it's all relative. To what were the expectations going in? If market participants expected not 20% growth but 30% growth, well, 20% growth turns out to be disappointing. Stock drops, even though the news on its surface looked terrific.

Keith Lanton: 5:22

And expectations are ever shifting as we digest more information, our expectations change. As our expectations shift, what we focus on and what is important going forward, that also shifts, and this is what I would call creates a change in narrative, and I would say last week we got an inflection point in change of narrative as we got more data last week. So, thinking about this change in narrative, what took place last week Well, going into 2024, the narrative or the expectation of us as an accumulation of individuals was that inflation was dropping, the economy was slowing down. Was that inflation was dropping, the economy was slowing down?

Keith Lanton: 6:05

There were wars and geopolitical instability taking place, especially relations between the US and China, that were going to have a significant impact on the economy. Obviously there were wars taking place in the Middle East between Israel and the Palestinians and, of course, the war in Russia and Ukraine, and all of this was going to have an effect on psychology. Unemployment was going to start increasing, the US economy was going to start slowing down and therefore the narrative was we have to pay keen attention to what the Federal Reserve is going to do. When are they going to lower interest rates? We were laser focused on every word that Chairman Powell uttered. When would he cut rates? How much would he cut rates? What would he do in?

Keith Lanton: 7:04

order to provide the grease to the US engine that was expected to start sputtering, to make sure that that engine kept going and that we didn't have a thud or a hard landing but rather a soft landing. And last week, all that focus that was being paid on the Fed, well, people started to dramatically reassess. It had already begun, certainly, but we began to dramatically reassess as we got some more information. It started on Monday, april Fool's Day, last week, when we got the ISM manufacturing number, which isn't always paid attention to recently, but manufacturing here in the United States came in stronger than expected and the market started to say, hey, perhaps there's something going on here that's even stronger than we thought before, again relative to expectations. And then on Friday we got the employment data and that was very robust, pretty much by any measure that you looked at. The unemployment rate dipped to 3.8%. The private household survey, which determines the unemployment rate, showed an increase of 495,000 jobs. The nonfarm payrolls number, which is a different way of calculating the new jobs creation, well, that showed an increase of 303,000 jobs. Expectations were an increase of anywhere between 180,000 and 200,000 jobs. And on top of that, average hourly work week increased from 34.3 to 34.4, important in measure of employment going forward, because if those who are working are working longer and harder, that means that potentially there's more people that need to get hired. But the silver lining to all of this was that the average hourly earnings did not increase. They were up three-tenths of one percent, arguably, if you get to the next decimal point, a little stronger than expected. They were actually up just under 0.35%, but nevertheless it continued, showing that wages were not accelerating despite the fact, at least for now, that employment is increasing.

Keith Lanton: 8:54

So last week, in reaction to this news, the market buckled. We certainly got an initial sell-off and some concerns, but it did not break. And that's because a new narrative is now emerging and what we're going to focus on going forward is going to change. The new narrative is that maybe we don't need recuts, perhaps the economy is strong enough to stand on its own. So what is the market now focusing on? Well, the market's still very concerned about inflation. They want to see growth with moderate inflation. So the market is very concerned about the inflation rate in CPI and we get the CPI report this Wednesday. We'll talk a little bit more about that in detail, but that'll certainly get lots of attention.

Keith Lanton: 9:36

Markets are also starting, just beginning to focus on oil and gold prices, because the market's just trying to say, hey, oil and gold prices are going up. That's usually associated with inflation. What's going on here? And that's going to be something, I think, that markets analyze in greater detail going forward as we start to shift the eyeballs a little bit towards those two metrics in terms of what's going on. But, most importantly, the markets are focused now on inflation in conjunction with earnings, earnings and earnings. So we're beginning the second quarter. First quarter earnings are going to be coming out. Why are earnings so important? Well, they are critically important because of the new narrative is that the economy is strong enough to stand on its own. We don't need federal reserve rate cuts to keep this economy going Well. We better see that these earnings are coming in strong, because that will be the juice that provides the energy for this market to continue to move forward. So if we can get moderate inflation with good earnings and good future earnings, then the new thinking goes we do not need rate cuts.

Keith Lanton: 10:42

Ironically, some economists are concluding that some of this job strength that we're seeing, and some of the reasons that we're seeing job strength without wage pressure, is because the US is seeing a net gain in jobs immigration into this country. Obviously, this is something that is controversial, but nevertheless, the numbers speak for themselves. We are seeing the increase in the number of people being employed. We are seeing it happen, at least at the moment, without any meaningful inflation, and the new thinking is that the United States, different than some of our neighbors in Europe, are experiencing this growth and the stronger economy that we're having relative to these other economies, because we are seeing a net increase in immigration. So market returns over the next several months will be dictated on what the markets deliver relative to our new expectations. In other words, what does the what does the earnings look like going forward? What is the earnings guidance going forward? That is going to always get lots of attention, but this time the narrative is going to be what do these earnings look like? What does the future earnings look like? Can the markets sustain themselves despite the fact that we may see higher interest rates for longer? And is that okay? And this is what we will be focused on, at least into earnings season at the end of this week when earnings season kicks off in earnest. So what's going on?

Keith Lanton: 12:12

This morning we are seeing futures modestly to the upside. Dow futures are up about 20. S&p futures are up about 5. Nasdaq futures are up just over 20 points as well. European stocks are broadly higher, led by miners on the back of rebounding iron ore prices.

Keith Lanton: 12:30

Mentioned that we are looking forward this week to that CPI report and the earnings at the end of the week from the big banks, and perhaps we're seeing a muted start to the week as a result of the fact that we are waiting to see what these numbers look like. So people aren't committing either way. I'm talking about the Federal Reserve and the potential for changes in interest rates. Well, there is a change of expectations in terms of what we will see going forward. The markets now are factoring in two reductions in interest rates Swaps, markets employing about 60 basis points of easing of interest rates by year end, and that is weighing on Treasury prices. Ten-year yield now is up eight basis points to 446, and all eyes are on the key 44.5 level to determine whether or not rates revisit last year's highs. Comments from Federal Reserve Bank of Dallas, president Lori Logan, added to the more hawkish picture after she said it's too early to consider cutting rates at all. So we continue to see this march higher in the 10-year.

Keith Lanton: 13:39

Some good news this morning perhaps some deflation of the geopolitical tensions. We're seeing oil down about 50 cents a barrel this morning after Israel said it would remove some troops from southern Gaza, with the forces recuperating and preparing for future operations, including an offensive on Rafah. Iran is also preparing a response to a suspected Israeli attack on its consulate in Syria. Elsewhere in commodities markets, gold reached a new record above $2,350 an ounce, as traders are continuing to add to their gold positions. Treasury Secretary Yellen was wrapping up four days of meetings in China as part of efforts to improve economic ties between the two countries. Yellen repeatedly framed China's strategy of boosting its manufacturing capacity as a widespread global concern and urged leaders to focus instead on revving up the domestic economy, while Chinese Premier Li on Sunday advised Yellen against turning economic and trade issues into political matters. And the takeaway, at least, is that the meetings that did take place, both sides reported them as cordial.

Keith Lanton: 14:51

Here in the US. The US plans to award Taiwan Semiconductor Manufacturing $6.6 billion in grants, as much as $5 billion in loans to help the world's top chipmaker build factories in Arizona. The award is one of the largest announced under the 2022 Chips and Sciences Act. All right, going forward this week. We've talked a lot about it already.

Keith Lanton: 15:13

On Wednesday, the Bureau of Labor Statistics releases the Consumer Price Index for March. Consensus estimate is for a 3.4% year-over-year increase, two-tenths of 1% more than in February. Core CPI, which excludes food and energy, is expected to rise 3.7%. That would be one-tenth of a percent less than previous month's recording. So far this year, the CPI data has come in hotter than expected, so that will certainly go on lots of attention on Wednesday. Also on Wednesday, the Federal Open Market Committee releases the minutes from its mid-March monetary policy meeting. On Thursday, the European Central Bank announces its monetary policy decision, widely expected, to keep short-term interest rates unchanged at 4%. All eyes will be on the ECB's next policy move, which many expect to be a rate cut, and traders are eyeing the June meeting. So any indications of what the ECB is thinking will certainly be a key focus of market participants. And then on Friday we get first quarter earning seasons beginning in earnest, with big banks announcing results Citibank, jp Morgan and Wells Fargo all announcing results before the bell.

Keith Lanton: 16:24

Moving on to Barron's, talk a little bit about the financial markets and then talk about an article that Barron's had on its cover regarding big pharma, and then we'll turn things over to Brad to give us some more thoughts, especially on this bond market where we're seeing rates pick up dramatically in the last few weeks. So Barron's talking about April and how this year has lined up so far and how we may expect the market to react in April, saying there are many reasons for investors to worry about the stock market right now, but they say the month of April means that they should remain Nothing more than that, simply worries. There's no denying that last week was a tough week for the market. The S&P 500 index dropped 0.7%. Nasdaq was down about 0.5%. The Dow Jones Industrial Average was down 2%. At one point on Thursday, markets were on pace for their worst decline since March of 23.

Keith Lanton: 17:25

There's no ignoring the growing worries that drove this past week's decline. They include the possibility that the Fed won't cut rates anytime soon and potentially further confirmed when the consumer price report is released on Wednesday, whether or not those worries will be confirmed. Geopolitics is also adding to the wall of worry, with the price of oil rising 4% last week, on those concerns between Israel and Iran. Add all that up and you have the possibility that the S&P 500, which rose 10% in the first quarter trades a premium to its historical valuation is due for a correction. Yet despite all that, traders keep buying the dips. The market's momentum is forcing even the less optimistic market watchers to strike a relatively bullish tone. Citigroup strategist Scott Cronart said I don't know that there's anything that says you sell right now, even though he has a year-end target on the S&P 500 or 5100, which is below the current S&P level of 5250. Even at this time he's saying he's not sure what to sell, at least at this moment. So there is a lot to like once you stop to think about it. Barron says the strong payrolls report likely means the Federal Reserve will put rate cuts on hold for now, but it also suggests, as we talked about, that the economy remains strong and, as long as it's growing, us corporate profits likely will continue to grow as well. This is something that we, as market participants, would like to see. We certainly want to see growth, and if we see earnings growth continue and continue to show that it's moving forward nicely, we can live without those rate cuts.

Keith Lanton: 19:06

And now, if you go back and look historically, april historically has been the best month for the markets, going back to 1928. The average return in April has been 1.4%, which is more than double the average rise of markets in any given month, which is six-tenths of 1% for all the other months of the year. On average, odds favor that that type of gain will manifest itself, given that the market started the year up 10%, 10%. When the markets have started the year north of 10%, like they did this year, the average gain in April has been a bit better than that 1.4%, but 1.5%. So at least if you're looking at historical levels and typically what happens in April, you can think that April may be a positive for the markets. But One thing that April leads to is May and you may be familiar with the old adage sell in May and go away, and typically strength in April does lead to weakness in May and that's perhaps where that sell in May and go away thing comes from.

Keith Lanton: 20:21

So back to the thesis of the markets moving past rate cuts. Barron's, in the trader section of the magazine, said forget rate cuts. Here's what the market really needs now and what they're talking about is what we talked about, which is earnings, and this week we are going to get earnings from Delta Airlines, constellation Brands, jp Morgan we talked about Wells Fargo, and we'll also be getting earnings from Fastenal this week. In the past four quarters, aggregate earnings per share for the S&P 500 have beaten expectations by 7.1% on average, so it would take quite a sea change for companies to suddenly miss. Beats alone, though, won't be enough. This goes back to expectations. Markets will also need to see encouraging forward-looking guidance from management to justify higher valuations. S&p 500 is now trading at 20.1 times forward earnings Expectations versus a historical average coming into this year not a historical average, but versus about levels coming into 2024, which was 16.7 times earnings. So strong guidance would validate the market's belief that sales and profits can keep growing, keeping stocks moving higher, but anything that causes analysts to reduce profit forecasts could certainly lead to a hiccup in financial markets. Good news is early signs are positive. In the past three months, more companies have increased earnings guidance than reduced it. The gap in increases versus decreases has been near its widest level in two years. More S&P 500 companies in aggregate expect sales and earnings to rise from quarter to quarter throughout this year.

Keith Lanton: 21:59

We move on to the cover story of Barron's and turn things over to Brad. And the cover story of Barron's talks about big pharmaceutical companies, and those of us who have been in the markets for some time know that the general expectation is that big pharmaceutical companies are bastions of growth and safety, perhaps driven by our experiences in the 1980s. But Barron's is suggesting, even despite the success of Eli Lilly and Novo Nordisk, that investors may want to rethink at least their thesis on large pharmaceutical stocks. And they do this even in comparison to their own previous expectations regarding pharmaceutical stocks and suggest that perhaps we are in a new era and a new way of thinking is appropriate for big pharma. And if you think about big pharma, they say it's essentially a series of lucrative exclusives, which are those drugs, once they get patent protection, balanced by angst over when those exclusives or those monopolies will run out and kind of.

Keith Lanton: 23:05

The poster child for this phenomenon is Pfizer. And if you think about Pfizer, the angst has overwhelmed just about everything else over the past five years, including a world-saving COVID vaccine. Since CEO Albert Bourla settled into the captain's chair at Pfizer in early 2019, he has pulled every possible lever to help Pfizer brace for patent expirations. He has spent $80 billion in acquisitions, another $50 billion on research and development, while divesting the last of the company's ancillary businesses, including the consumer health division that once sold Advil. All this while Pfizer nabbed approval for 22 new medicines and two years in which the company's COVID vaccine grossed more than any other medicine in history. Yet investors haven't given Borla credit for any of it. Pfizer shares traded around 41 when he became CEO in January of 19. They closed at around 27 last week, a decline of 33%, a period where the S&P 500 has more than doubled in the same timeframe.

Keith Lanton: 24:11

And it's not just Pfizer's problem. Most big pharma stocks have struggled in recent years. Decades of efforts by these companies haven't changed a fundamental truth Drug makers eventually lose exclusive rights to their best inventions. And if you think about it, if you were thinking about rivals being allowed to sell, for example, perfect clones of Apple's iPhone, or if McDonald's had to give up the exclusive recipe on the delicious French fries that they make over at McDonald's, would we view those stocks in the same way? So these pharmaceutical companies have to constantly come up with a new iPhone or a new French fry every decade or so in order to replace the drugs and the blockbusters that they have in their arsenals at the moment.

Keith Lanton: 25:03

At the same time, the pharmaceutical companies are also staring down some new laws which allow Medicare to negotiate the prices it pays for some of those very successful medicines that are still on patent. So that's only exacerbating the issue. Not only do you have to fight to come up with new products when you lose patent exclusivity. Now, when your product still has patent exclusivity, something's changed. The narrative has changed. Now the government's saying, hey, we're going to negotiate the prices here. That we haven't done before, and perhaps you'll even make less when you do have patent exclusivity. This wasn't the rules of the road before. So allowing companies to make cheaper copies of branded medicines is certainly a win for humanity, but it is an ongoing loss, barron says, for investors, a fact that seems to get overshadowed amid the hype for the next big drug.

Keith Lanton: 25:53

Over time, big pharma stocks haven't worked as long-term investments.

Keith Lanton: 25:56

Pfizer, merck, johnson, johnson and Bristol-Myers have all trailed the S&P 500's performance over the past 5, 10, 15, and 20-year periods, even if you take their generous dividends into account. European drug companies like Glaxo, smithkline and Sanofi have similar records. Now you may be saying to yourself. Well, eli, lilly and Novo Nordisk have been standout exceptions. Their performance has been boosted by the rapid success of weight loss drugs. But, barron's points out, in just over a decade for Lilly and just under a decade for Novo, those treatments will face patent expirations as well, and the pattern could restart for those companies. The rallies by Lilly and Novo Nordisk in fact show that big pharma stocks are trading more like trading vehicles than blue-chip holdings, an idea that runs contrary to the conventional wisdom of buying pharma stocks and holding them for generations. So, on that thought and that perhaps narrative change there with respect to big pharma, turn things over to Brad to give us his thoughts on the markets and his thoughts on the narratives that have taken place in markets, especially the bond market. Good morning, Brad.

Brad Harris: 27:03

Good morning Keith. Good morning everyone. I hope everyone had a great weekend and I'm going to be brief today because there's a lot more interest, obviously, in this eclipse today and the earthquake that hit the Northeast last week than the market. So let's get going.

Brad Harris: 27:18

In less than six months, the bond market has done a complete about-face. The 10-year treasury, which had hovered just above 5%, rallied all the way down to yield around 3.75%, which was a way of market basically accounting for, say, a 4 to 6, 25 basis 4 to 6, 25 base point cuts. At the time I thought maybe 3 to 4 were in the cards, assuming that the tighter monetary policy would put some pressure on other markets. The equity market absolutely defied this logic, as did many of the economic indicators that were being released over the last couple of months. And here we are now discussing the possibility of no rate cuts, as Keith had mentioned earlier. And here we are now discussing the possibility of no rate cuts, as Keith had mentioned earlier, there have been a couple of commentaries, not by the Fed, but some of the talking heads who I like to drown out at times, but some of them are saying that maybe rate hikes are in the cards. I don't think that the country can handle rate hikes. Let's not forget that our country is paying around a billion dollars a year annually just in interest on our debt. To me that's a sickening number.

Brad Harris: 28:29

In municipals, 4% bonds still rule the day. If you're in the 37% bracket, that 4% is a taxable equivalent yield of around 6.35% For those in high tax states like New York, california and New Jersey. We're looking at an equivalent for 4% municipals at better than 7.5%, which gives a lot of reason, after such a big rally in the stock market, why money is still flowing there. Municipals have definitely got richer in price versus treasuries, but the tax pickup is still intriguing enough that there's been a lot of demand. This demand has come at a time when there's also been a record amount of supply in this municipal bond market. So I am truly impressed with the resiliency of the municipals here. The municipals here. It will probably continue to have that. There will probably continue to be that demand as people are rebalancing their portfolios. I'm going to leave it at that and I'll hand it back to Keith. Thanks.

Alan Eppers: 29:35

Keith Lanton) Thank you, brad. That's everything I've got. (Alan Eppers) Thank you for listening to Mr Keith Lanton. This podcast is available on most platforms, including Apple Podcasts, Spotify and Pandora. For more information, please visit our website at www. heraldlantern. com.