Brian Pietrangelo:
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, November 17th, 2023. I'm Brian Pietrangelo, and welcome to the podcast. As we head into the weekend and into next week, we'd like to pause and say thanks to everybody who's listening on a regular basis on our podcast, and thanks to our clients that continue to do business with KeyBank, but most importantly, thanks to our friends and family, who we will celebrate the holiday with next week. So take time to embrace those relationships. Thanks everybody.
And with me today, I'd like to thank my colleagues, who are here as our panel of investing experts here to share 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 need more information, please reach out to your financial advisor.
As we take a look at this week's economic news, there were three key reports we want to share with you today, starting on the first with the overall measure of inflation as the consumer price index data was released for the month of October and showed moderation or slowing in inflation year over year from 12 months prior. So back in September, we had an inflation read of plus 3.7% year over year. That dropped to 3.2% year over year for the month of October. So good news there. The markets certainly liked it.
On the other side of the equation, we've only had a little bit of slowing if you remove food and energy components, where inflation went from 4.1% year over year in September down to 4.0% year over year in October, so not as much favorable news, but still headed in the right direction.
And last but not least, as we continue to watch a major sub-component of inflation known as shelter, we actually saw shelter inflation decrease from 7.2% in September year over year down to 6.7%, so a pretty meaningful change in terms of overall inflation, which is why we're seeing the numbers generally start to cool in terms of the overall inflation read.
Second, also this week we saw the nominal retail sales numbers came in, which were showing an indicating of slowing economy with the specific reference to consumer spending for the month of October. US retail sales declined 0.1%, which was the first time in six months we actually saw a decline month over month. Again, September, the month prior, was up 0.9%, so a meaningful decrease in terms of overall indicators of the economy cooling.
Significantly, in the same regard, we also got the report on industrial production in the manufacturing side of the economy, which also showed a decline month over month from September to October of minus 0.6%, again breaking the streak of positive numbers for the past four months.
So we've got two signals out of three that are showing the economy is cooling, which is slightly unfavorable, to match up with the favorable side of inflation that's cooling. So again, we'll take a look at all this economic data when we have our conversation today with our experts.
A few other pieces of news in terms of the government shutdown continuing to be averted, with progress made there in DC to again extend that conversation with the overall spending bills into 2024 before a full resolution is achieved, and we also had major progress on the UAW strike with the automakers.
So with that, George, let's turn to you for your thoughts on this week's overall economic data and anything else that you're seeing that you'd like to share with us. George?

George Mateyo:
Well, Brian, as always, there's a lot of ways you can read through some of the inflation prints and the various economic releases that you talked about. I think the numbers of inflation are interesting, and again, just go through the numbers again, the overall month-to-month change to inflation was 0.05%, so just barely above flat, basically, on a month-to-month basis. And then I guess if you want to look bit more on a year-over-year basis, as you noted, it's about 3.2% increases, which actually is the slowest pace, I think, if I went back and looked since March of 2021. So we've seen a significant drop in inflation. Of course, roughly 16 or so months or so ago in the middle of the summer of last year, we were dealing with 9% inflation, so progress made there for sure.
Of course, people like to recognize the fact that some of that's been driven by the energy prices, which have been falling quite notably in the past few months, that maybe account for some of that. And so if you take account maybe what people consider this core inflation reading, which takes out energy and food, which I guess is one way to look at it, although I also think that food and energy are pretty important, but that being said, the core CPI numbers they call it was up two tenths at 1% month over month, which again is a pretty significant slowdown, but it's still 4% year over year, which, again, doesn't suggest we've made progress. But I think that's still quite a bit above, obviously, the Fed's official target of 2%.
And then interesting, behind the scenes or maybe further down in the numbers, there still seems to be good kinds of economic strength. Frankly, one thing I look at once in a while is just the overall measure of prices of food or eating out versus eating at home, and it continues to be the situation where people are spending more eating out than they're eating at home. Not to say that they prefer one or the other, but that to me suggests that there's an overall underlying demand of consumer spending and consumer activity that's really coursed into the economy. Of course, that also feeds into things like retail sales. We saw that also come up this week, a little softer than I think people would have thought, but maybe not as soft as feared. It's still growing, though, again around [inaudible 00:06:04] percent year over year, which is still a pretty healthy number.
And the other thing we saw this week was the jobless claim numbers, and of course we've watched those pretty carefully the last few months to see if there's any weakness in the labor market, and thus far, the overall number of initial people filing for unemployment insurance remains pretty flat. The number of people that are actually going through continuing levels of unemployment, those continuing claim numbers as they call them, suggests that those [inaudible 00:06:30] are picking up, and those maybe suggest that maybe the employment situation is maybe cooling a little bit in the sense that people that are out of work are having a harder time finding jobs. So that to me suggests that maybe, again, inflation's cooling. We might see some continuing [inaudible 00:06:45] in wages. You've got energy prices falling off a little bit.
And I guess, Steve, if I put that all in a blender, it says to me that maybe profits, frankly, are poised for a bit of a rise. So we saw the pop in the equity market. Do you think there's a transmission mechanism between the inflation report and earnings, or what am I missing?

Steve Hoedt:
George, inflation has run hot for a while, and inflation filters through to earnings via the transmission mechanism of corporate revenues. So revenues are in nominal numbers, so any time you have inflation running hot, you have nominal revenues higher, so you see EPS come in typically strong.
Now, the question is: are margins able to hold up in that type of environment? Because you've got the other flip-side of the inflation game, which is labor, because when prices are high for people at the grocery store or the gas pump or wherever, they typically try to demand more money from their employer to cover for it.
So margins have actually held up pretty strongly here as we've gone through this inflationary period, and that has resulted in corporate profits coming in strong, and in fact, now even we've come out of what I would call an earnings recession over the last 12 months. We've now made a new all-time high in the forward 12-month earnings number after coming down last year, and the trajectory of that tends to be the trajectory that you see the equity markets take. So it's going to be interesting to watch here over the next two or three months.
Guidance this quarter was a little bit weak as people came through and talked about potentially seeing slowdowns. We've seen a lot of headline luxury companies talking about luxury goods sales coming in below expectations. So I think that there are some puts and takes under the surface here. So the real question is going to be: are earnings numbers for 2024 going to hold up or are we going to see those numbers start to get revised down? If they get revised down, I think that we can see the markets churn here for a while at levels where we currently are at.

George Mateyo:
Well, at the same time, Rajeev, we've got inflation coming down. Unemployment is ticked up a little bit, not to be too alarmist about it, but we've seen that move up in the past few months, and as I mentioned, some of the labor pressures that we've seen earlier this year have started to abate a little bit. If you think about this and you put this into your blender, what do you think the Fed's thinking right now? I mean, are they done? Have they hit the peak in rates, or what do you think the Fed is thinking about all this news of late?

Rajeev Sharma:
Well, George, I think the CPI print this week, it worked to keep the market expectations that the Fed is done raising rates. The market really feels that the Fed is not going to raise rates any more, but not only that; it actually fueled expectations that rate cuts are coming. If you look at Fed rate expectations, Fed Fund futures traders have pretty much priced out any chance of a rate hike this year, and traders are now pricing in 50 basis points of rate cuts by July 2024 and 92 basis point rate cuts by December 2024.
This is all without the Fed claiming any victory on inflation. The Fed continues to talk about... We haven't reached their target of 2%. The Fed has not said anything about rate cuts, but the market really is anticipating these rate cuts to happen in July, and there's about maybe a 5% probability of rate hikes by January of this year. So essentially, Fed rate hikes are off the table.
The movement that we saw on the yield curve, however, it really showed that... Based on the CPI print and the labor data that you talked about, George, I think that we've seen some tremendous moves across the yield curve. It's something the Fed, in my opinion, does not want to see. We saw rates come down across the yield curve. The Fed really wants the market to think like the Fed, that we will be higher for longer, but the market is not doing that.
And if you recall, we talked about a really ugly 30-year Treasury auction last week. It was the worst 30-year Treasury auction since 2011. It priced at 4.77%. Now, the long bond itself is 15 basis points below that. So those bonds have already returned 2% since November 9th. So the shape of the yield curve continues to be a big factor in the market, and it's moving on big clips. When we saw that 30-year Treasury auction last week, everybody thought that was the worst, and if you bought at that 30-year auction, you actually did pretty well.
Now we see the Fed speak this week. We saw a lot of Fed speakers come out. They said that we're not at the 2% target yet. They want to keep that Fed put in place. They want to say that we're data-dependent, but the market is not buying it. The anticipation of rate cuts by the early second quarter of 2024 is being priced in.

George Mateyo:
So I'm glad you mentioned the bond auction, Rajeev, because I still think that's something that is in the middle part of people's minds at the very least, and particularly, people are paying attention to the fact that there's less foreign demand for US treasuries. That seems to be a topic of some concern to many people. Do you have the same concern about that? Other countries have been able to navigate that. Of course, their debt level is a lot less than ours and we've got just so much paper out there, basically, to float. But what are your thoughts on, I guess, the buyer strike or maybe some of the foreign buyers pulling back away from US treasuries?

Rajeev Sharma:
Yeah, we have seen data that says that foreign buyers are not really coming in droves as far as buying treasuries, and I think that the 10-year and the 30-year auctions that we saw in the past have just not done well, and what happens is broker dealers are getting stuck with these treasury auctions. They're getting stuck with holding the treasuries. We're not seeing the pension funds in Japan; we're not seeing the Asian life-insurance companies coming in big droves. And I think that's going to add some more pressure on these 30-year bonds, specifically 30-year bonds. 10-year bonds should do okay, and 20-year bonds are probably going to feel some pressure as well.

George Mateyo:
Steve, you've got a good finger on the pulse when it comes to some of the plumbing issues of the market. Are you concerned about that at all?

Steve Hoedt:
Not right now, George. Everything seems to be functioning the way that it's supposed to. I know that people were caught off guard by that Treasury auction, but it seems like there were some strange anomalies around that, whether it was the Chinese situation with ICBC getting hit at the same time or not being able to settle trades. There were low liquidity conditions that afternoon in particular if you listened to some market pundits and people who were talking about what was going on at that particular moment. So I think any time you get into low liquidity conditions, weird things can happen, and that seemed to be a particular maelstrom in that one afternoon. We'll see if there's any real impact longer-term.

Brian Pietrangelo:
So George, we finish today's podcast with a preview that we're heading up a national call coming up here in a couple of weeks on December 6th. You want to talk about that for our listeners?

George Mateyo:
Yeah, Brian. First of all, I want to wish everybody a very happy Thanksgiving and a great time to try to take some time away and just be together with friends and family, but soon thereafter, we will get together and talk about our outlook for the year ahead. It's still in the formation stages, but we're looking forward to discuss that with everybody and talk about maybe this road to the old normal that we're on, where we're getting back to the level of rates being somewhat elevated relative to the past, but also recognizing the fact that maybe, just maybe, we're coming out of the post-COVID era in the sense that we've gotten fears behind us, thankfully, and hopefully, that doesn't resurface, but the economy's gone through a lot in the past couple of years and maybe some of those lingering effects are diminishing a little bit. To be sure, there'll probably be some things that'll probably be with us a bit longer, but I think it's fair to say that we are normalizing from some of the COVID impacts from 2020, and that will be something we'll talk about going forward as well.

Brian Pietrangelo:
Well, thanks for the conversation today, George, Steve and Rajeev. We appreciate your insights as usual, 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 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 two weeks from now as we take a break for Thanksgiving, and back on December 1st when we rejoin you, we'll see how the world and the markets have changed and provide those keys to help you achieve your financial success.

Speaker 5:
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