Brian Pietrange...: Welcome to the Key Wealth Matters weekly podcast where we casually ramble on about important topics including the markets, the economy, human ingenuity, and almost anything under the sun, giving you the keys to unlock the mysteries of the markets and investing. Today is Friday, August 4th, 2023. I'm Brian Pietrangelo, and welcome to the podcast. And with me today I'd like to introduce our panel of investing experts here to provide their insights on this week's market activity and more. George Mateyo, Chief Investment Officer, Steve Hoedt, Head of Equities and Rajeev Sharma, Head of fixed income. As a reminder, a lot of great content is available on key.com/wealthinsights, including updates from our wealth institute on many different subjects and especially our Key Questions article series addressing a relevant topic for investors each Wednesday.
In addition, if you have any questions or you need more information, please reach out to your financial advisor. Taking a look at this week's economic news, we have economic data on manufacturing and services, but we also have information on jobs. So we'll cover both of those today with our update and with our panel. On the PMI side with purchasing managers index data, we see the manufacturing side of the economy is actually slowing and continues to contract month over month. On the other side, we see the services economy has also been expanding on a consecutive basis month over month. So we're getting a little bit of two stories on the overall services versus manufacturing economy and will continue to watch both.
On the jobs front, we've got a couple reports earlier in the week, the JOLTS Report from the Bureau of Labor Statistics, otherwise known as the Jobs Opening and Labor Turnover Survey Report showed that the jobs opening remain consistent with the prior month at roughly 9.6 million. So there's still demand for employees out there. Just yesterday, initial weekly unemployment claims remain consistent, so we won't necessarily cover that one today, but more importantly, just this morning, the overall employment situation from the Bureau of Labor Statistics had a number of data points that we'll cover and also get reaction from our panel.
First, new non-farm payrolls increased at 187,000 for the month, which was slightly below expectations and also a decline from the prior month at roughly 209,000, which is showing consecutive month over month declines even though they are still positive in terms of new non-farm payrolls. The overall unemployment rate remained low at 3.5%, which was one 10th down from last month to 3.6%. And average hourly earnings increased a little bit higher than expectations at 0.4% month over month and 4.4% year over year. Well, we'll talk about that continuing demand for labor.
So before we get our panel's reaction to that economic data, we'll talk about the big event this week, which was Fitch Ratings, downgrade of the United States Treasury or the debt for our overall company from AAA to AA plus. So we'll start with Rajeev to get his reaction, then get everyone else from George and Steve as well in terms of what does this mean, what did Fitch do and what are the implications for all of the markets and the economy?
Rajeev Sharma: Yeah, so this week Fitch did downgrade the United States from their AAA ratings to AA and there were a couple factors behind this. I mean, Fitch had alluded to this a couple months ago. We actually put a Key Questions article out a few months ago that was talking about what the rating downgrade would mean and how it would affect bonds in your portfolio. What's interesting about the downgrade is we're going from AAA to AA, but the real rationale behind why Fitch downgraded the US, they've been looking at all the political battles that are happening in the nation, and it's been this repeated standoff during the concern about the debt limit, both parties always reaching a political impasse, and even though the latest impasse, legislative impasse was resolved, it's still a potential issue of concern going forward and we all know that the debt limit discussions continue to be a point of contention.
And it seems like this legislative impasse shows up every few months, and I think Fitch finally said that it just continuing to be a battle to get things done and so they downgraded the US. The US has now rated AA plus by Fitch. It's one step below AAA. It's still a stable outlook on the country. If you want to compare it to the other rating agencies, Moody's has them, currently US is sovereign debt is AAA rated. It's the top rating. S&P rating right now for the United States is a AA plus. Again, one notch below the top tier. They had actually downgraded, S&P actually downgraded the United States back in 2011 and again, it was due because of debt ceiling crisis.
So we've seen a lot of political pundits come out and talk about how this downgrade doesn't make sense, the timing is off. Treasury Secretary, Janet Yellen came out and said that rating agents and rating agencies are wrong and basically the ratings are arbitrary and outdated now. So you're seeing a lot of that kind of noise in the market right now, and I suspect that the market's going to have to digest this over the next several days, but again, it's one of those downgrades that I think the timing was off on this one. So I think that the market itself has digested the news. Ironically, I think the sell off that we saw in bonds wasn't completely because of the downgrade, but we did see a sell off in bonds in the last two days and I think the downgrade is likely to raise some more questions about some of the blue chip companies that are there.
Right now we have two companies right now that are rated AAA, and I think it's going to be very important to see if they maintain their AAA rating. Are you able to have a rating that's stronger than the United States government? And we've seen emerging market countries get downgraded by rating agencies and most of their highly rated corporate issuers, they were also downgraded subsequently after that. So it's going to be very interesting to see, and I'm going to keep an eye on this one.
George Mateyo: So couldn't the US government, Rajeev just decide to tax these two companies and kind of use the revenues to pay their bills for lack of better term?
Rajeev Sharma: They could and if they did that, I think that again, the rating agents would probably want to downgrade them because they're going to be implementing this cash strategy. So yeah, we have to keep an eye on that, but AAA is not what AAA used to be. Companies used to really strive to get that AAA rating, and I think now companies are operating much more efficiently at the lower ratings.
George Mateyo: Well, unfortunately, the fiscal authorities, AKA Congress is not asking with the same responsibility that you just mentioned. So that seems to be the issue of the day. Steve, what do you think this kind of leads to?
Stephen Hoedt: Well, I mean, the thing that struck me about this was that if you look at the CDS markets, this has been forecast for at least since the turn of the year because if you take a look, there's a handful of other major countries that are AA plus credits. They are Canada, Singapore, New Zealand, Finland, Germany, Austria, the Netherlands, and Denmark and our CDSs, US CDSs, five year has been pricing above all of those countries since January and even now post downgrade, we're still 10 basis points wider than the worst of any of those countries.
George Mateyo: So really quickly explain what a CDS is maybe for [inaudible 00:07:34]-
Stephen Hoedt: It's credit default swaps. So that is insurance that bond investors take out that pays out only if there's a default by the issue and there's a whole host of things that have to happen for a default to be declared, but given the scare that happened earlier this year with the US regarding the potential for default, I think it has shown a pretty bright light on the fact that the situation in D.C. relative to these other countries that are also AA plus credits is more negative and less stable.
So if that's the case, then we should be no worse than them in terms of where the credit rating is and frankly, the only reason we had a AAA credit rating is because we can print whatever dollars we need to pay off the bills. So I get what's going on. The market implications are different or it can be a different question. I mean, equity and market investors seem to handle it initially, but then we did sell off a little bit more sharply later in the week, but still, I think it was more investors were looking for a reason to sell stocks after a rally that had been persistent for almost four months without a break, and this is just a convenient stopping point, which also happens to coincide with the seasonally weak period in the market. So to me, I think that's kind of what was the story for this week.
George Mateyo: Yeah, I think some people are kind of fixated on what this might mean for the US dollar. We've talked about this quite a lot on these conversations. I've read a few things that suggest that the dollars best days are behind it. That might be true at the margin, but I don't think the dollar's going to go away. I mean, I still think it probably remains pretty much the world reserve currency of choice and you talked about Steve, how that the US government frankly can print its way out of a situation, whatever, however you want to define that, but if you look at ways that we can measure the dollar's relevancy, I mean, I still think it represents close to 80% of the world's foreign currency transactions.
All kinds of payment systems are kind of paid to the dollar and it's still, even though if you look at the global basket of currencies, the dollar probably used to be, I don't know, 70% of the overall basket. It's now down to I think probably about 60, 55, 60%. So it's come down a little bit from where it was 20, 25 years or so ago, but it really remains, I think the world currency of choice. I guess if we kind of think about things going forward in the second half of this year, Rajeev, the Fed seems like they're kind of probably on hold for now based on some of the economic releases in the past few days or so. Do you think that's still the case?
Rajeev Sharma: I do think it's still the case, but we're going to have more data to look at. Every single strong labor report that we see keeps the Fed back in play, and I think the Fed is not happy with where inflation is right now. They want to get to that 2% point. Are they going to overshoot? Are they going to really try to keep this narrative going that they need to raise rates? Market's discounting that completely. Market feels that maybe one more rate hike and that's it. I think that the rate cuts that the market is expecting, I think that's going to be the volatility factor that we're going to have to deal with because the Fed is not talking about rate cuts at all, but I think that, again, we were talking about the downgrade, does that really change the Fed's narrative? I don't think it does, but it does add to the growing list of concerns for credit.
Stephen mentioned CDS, I think there's a couple of other factors that are really also going to be important for credit going forward. We have tighter money now, rising leverage. We have an economic slowdown to think about, and then we have this increased debt issuance as well. So these might all be catalyst for credit to start widening. We haven't seen credit wider spreads this year at all. Credit's done extremely well. It's been extremely resilient, but could all of these factors taken together at to some distress? Do we start seeing more default risk in the market?
Credit's going to be very important to monitor from where we're here along with the Fed as you mentioned, but these are all really, really big concerns, especially when we're looking at the credit markets and we're not seeing any sign of distress, any sign of recession. Things are so tight right now in credit that these type of catalysts could be a cause for concern. It could start to lead to wider spreads.
Brian Pietrange...: Sticking to monetary policy, Rajeev, let's talk about the other side of the world where we had some interesting conversations with the Bank of Japan and the Bank of England in terms of their policy. What are your quick thoughts on that and then we can move on to Steve with the conversation on earnings?
Rajeev Sharma: Well, Bank of Japan has been the anchor for the world pretty much with their yield curve control program that they started, and they kept yields very low and I think that's kind of been an anchor for the world, really, that the yields are so low there. You saw a lot of Japanese pension funds, insurance companies leave investing in Japan, and they started investing in the US and Europe. It's very early right now, but yes, Bank of Japan, the Governor Bank of Japan said that they would allow yields to rise. We've seen that. We've seen yields move up from their artificially low levels that they had set. You see yields start to move up there. The question becomes do foreign investors say we're going to take our money out of the US out of Europe and start investing back in Japan?
That could be a big, big thing to monitor because obviously flows are very important in our markets. We have foreign investors that are big part of our credit markets right now. It's very early for something like that to happen, but it's something to monitor for sure.
Brian Pietrange...: Thanks Rajeev, and Steve, just a couple of closing comments as we get through earning seasons for the second quarter, any other observations you're making this week? I know we had a couple big tech reports, but it's also a constant theme throughout the quarter.
Stephen Hoedt: Yeah, just a couple highlights. So we're at 84% of the market cap of the S&P 500 now having reported, so pretty much through earnings season, once we get to the end of this week. Earning surprises have been very strong. 75% of companies have topped expectations. The average earnings beat is over 7%. So you would think that, that would generate strong price action following the results. That's not it, not what's happened at all this quarter, and everybody who's heard me talk on these calls knows I focus more on the price action reaction to the earnings numbers than the actual numbers themselves, because it tells you a lot about how the market is perceiving what's going on in corporate fundamentals and if you take a look at companies that beat on both revenue and EPS this quarter, they're outperforming the market over the couple day window surrounding the earnings reporting by 1%.
The average move is 1.7%. So companies that double beat are performing just a little bit better than half as good as they usually do. Companies that miss on both revenue and EPS are down 2.8%. The average is minus 3.1. So even the companies that are missing, aren't getting penalized as much as they usually do. So the reactions this quarter are very, very muted to earning season in aggregate. The biggest positive for me though, coming out of the earnings season is that guidance has been good enough to get the market analysts and market participants to mark up their forward earnings forecast for the S&P 500 by a good dollar to dollar and a half and that's broken us out of this consolidated range that we've been in for the last five or six weeks or so, or the index aggregate earnings for the 500 directionally that's positive for the market.
So even though we've got the market pulling back a little bit this week, earnings are moving higher strongly coming out of earning season. It's very similar to what happened in March, and we believe that that'll likely lead to equities following as we move deeper into the third quarter and head in toward the end of the year.
Brian Pietrange...: Well, thanks Steve, and we'll leave it with George for your final comments and any thoughts that you have to close the podcast today, George?
George Mateyo: Yeah, Brian, thanks. I mean, I think we've all discussed a lot of these big cross currents that are kind of floating around right now in the world that's going to kind of buffet us in many different directions. So I think our overall stance of just being neutral towards risk makes a lot of sense. I mean, there's frankly things that we could probably be excited about on the positive and also maybe some things to be concerned about on the meeting the longer term. So it's hard to really, I guess, the old set adages that you can't predict but you can't prepare and so I think that would probably be one thing I'd probably close with today. And we talked about the fact that maybe just revisiting your risk posture, we've seen a very strong market this year, not to say we're turning bearish.
I mean, as we've talked about here, we don't see the recession happening this year, but things will slow down at some point. You've got also these issues at the macro level that are going to probably be with us for a while longer. So it seems to me that being neutral towards risks being an opportunist in certain parts of the portfolio makes sense also and Steve, Rajeev had their ways they can express that in portfolios more specifically, but I think that's how I'd probably sum up the environment we're in right now.
Brian Pietrange...: Well, thanks for the conversation today, George, Stephen and Rajeev. We appreciate your insights and thanks to our listeners for joining us today. Be sure to subscribe to the Key Wealth Matters podcast through your favorite podcast app. As always, past performance is no guarantee of future results, and we know your financial situation is of course personal to you. So reach out to your relationship manager, portfolio strategist, or financial advisor for more information, and we'll catch up with you next week to see how the world and the markets have changed and provide those keys to help you achieve your financial success.
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