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 help you understand the mysteries of the markets and investing. Today is Friday, February 16th, 2024. I'm Brian Pietrangelo, and welcome to the podcast. As we head into a three-day holiday weekend, for some we are reminded of the celebration of President's Day, which has an origin that actually goes back to celebrating our first President, George Washington, but has also expanded to include President Lincoln and then has also expanded to include a celebration for the office for all presidents. In addition, it has origins in giving federal employees a three-day weekend in order to provide a celebration that has also led to some consumer spending. And as a side note, if you think about the origin of Mount Rushmore, four presidents were selected to basically represent the 150 years of American history, and two out of the four were on Mount Rushmore, being George Washington, Thomas Jefferson, Abraham Lincoln, and Teddy Roosevelt.
And with that, I'd like to introduce our panel of investing experts here to share their insights on this week's market activity and more. Some might say they're three faces of the Mount Rushmore of investing at Key Wealth. Steve Hoedt, head of equities, Rajeev Sharma, head of fixed income, and Patrick Grady, senior fixed income Portfolio Manager. 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 week. In addition, if you have any questions or need more information, please reach out to your financial advisor. Taking a look at this week's economic calendar and news for the week, the big item was the release of inflation as measured by the consumer price index for the month of January.
As we look at the numbers overall year over year, they weren't too bad, just worse than expectations given that over CPI came down from 3.1% year over year from 3.4% in the previous month. But overall, if you exclude food and energy and you look at core inflation, the numbers stayed constant at 3.9% for December and 3.9% year over year for January. Those in the market were expecting a little bit more of a decline, and overall, if we look at the services economy, the number actually went up from 5.3% last month to 5.4% this month in January. Now in general, that doesn't sound too bad, but if we look at the month-over-month numbers for January, all the numbers basically increase from the perspective of importance. All items went up, core items went up, food went up, and services, which is the lion's share of the economy at 60%, went up. Energy came down a little bit and goods came down a little bit, but overall, we think that was basically the surprising part of the market's report in the month over month, given that it actually escalated in terms of inflation.
Now the stock market took a hit that particular day, so we'll talk to Steve about that when we get into our podcast, but let's talk about a few more other economic reports. Overall, retail sales for the month of January actually showed a decline of 0.8% coming off of a December revised number of a positive 0.4%. So we're basically seeing the turn of the year after the holiday season is over, looking at different seasonal variations, but ultimately a negative number is not good. We don't want to see it that way, but it might be cyclical or it might be an opportunity to look at what's happening in the consumer market overall in terms of a slowing economy.
And finally, on the other side of the economy from a manufacturing perspective, overall industrial production came down for the month of January in the preliminary number for the month of January, 2024 at a -0.1% after being flat in December and positive in November. So again, we'll take a look at that as well in terms of the overall economy. So let's turn to Steve in terms of his reaction to what he saw this week in market volatility with the decline on the day of the CPI print, but a nice rebound the following day and we'll take a look at what that might mean for the rest of the month and year in terms of Steve's commentary. Steve, what do you think?
Stephen Hoedt:
Yeah, Brian, it's been definitely an interesting week, but it's also been a week that looks just like any other pullback that we've had since the start of the year, to be honest with you, where the market basically gets into the buy the freaking dip mode. And that's what we saw. So I think a lot of people were really surprised by the CPI number that came out this week because it ran hot and it ran quite a bit hot relative to expectations, and it made people, at least for one day think about what does this mean for the Fed? Is it going to make them change their language and maybe push out the idea of rate cuts even further away than the May meeting. But literally one day after we had that large gap down, we started to eat right back into the gap and here we are at the end of the week and the market's back above 5,000 again as we sit here on Friday morning.
And quite honestly, I think it's really been earnings that have driven the market this week as we've gone through and seen another batch of very, very solid reports. And I keep coming back to this idea that maybe inflation's going to run hot, but this is a boom, folks. You take a look at what nominal GDP is doing, nominal GDP is at 5% plus you've got the market continuously underestimating the growth potential for the economy. The economists and everybody else have been saying 1.5% growth, 1.5% growth, 1.5% growth for each of the last three or four quarters. Everybody had been calling for recessions, this kind of stuff last year. They were wrong last year. All the numbers this year, everybody's counting on 1.5% growth. And if you look at the GDP now numbers, they're coming in well north of three if not 4%.
And you look at the numbers that the companies are putting up when they're coming through and with beat and raise and guides higher, and it's telling you that the economy is doing very well right now. Whether that fits the narrative or not is a different question, but clearly the market is willing to take the results at face value and bid stocks higher. Now, I don't dispute that when you've got some of the concentration issues that we've got with the market when you've got valuations pushing north of 20 times forward earnings, the argument that stocks have a massive amount of upside from here is a very tenuous one, but that doesn't mean that stocks can't grind higher as long as the earnings numbers continue to go higher in this kind of boom environment where nominal GDP is going to run hot. And we see the numbers bearing that out for corporate earnings. So I think that we remain fairly constructive toward equities here as we head in to the middle of the year.
Brian Pietrangelo:
Steve, any thoughts on the retail sales numbers leading into consumer spending leading into the extended nature of that GDP being strong for the latter half of the year? And any thoughts on this?
Stephen Hoedt:
Consumers continue to spend. I think that the rule that we've always been told is to never underestimate the ability of the American consumer to spend money, and I think that we see that there are some pockets where we've got some consumers that are retrenching and you see some of it in some of the credit data, whether it's auto credit or whether it's some of the lower tier credit card folks. But at the same time, when I look at the performance of the lower tier credit card companies in the market, my analyst in the financial sector, Mike Schroder, tells me that this is a really early cycle configuration because those stocks are outperforming right now. So the market is looking through maybe some of the actual economic numbers, whether it's retail sales or some of this credit data and is seeing this boom for what it appears to be, something that will likely solve any of the problems that some of the data may have near term.
Brian Pietrangelo:
So Rajeev on the same token with the Fed as Steve mentioned, might push their rate outlook out to the future. What are your thoughts from what you've seen on the inflation read and what you hear from the Fed speak?
Rajeev Sharma:
So thank you Brian. With that CPI report more elevated than expected, there is now this question mark on the continued disinflation argument and that question mark not only took the March rate cut off the table, but it also worked to shift the entire treasury curve higher when it comes to yields with the Fed and the market. So data dependent and then you have this expectation of a headline number coming below 3% and you don't get that the resulting impact was immediate. Effectively the CPI report pushed rate cut expectations further out in the year as Steve mentioned. Not only was March rate cut taken off the table, the probabilities for a May rate and even a June cut were reduced. And now July is where Fed swap expectations point to the first Fed rate cut. And that's what happens when a market is completely dependent on queues from economic data traders took nearly a full rate cut off the table right when that CPI report came out.
Now what does this do to the fed's view of their Goldilocks narrative that they've been pointing to and that narrative is that an economy could keep growing and inflation could keep moving lower at the same time. Well, that CPI data report, it put that narrative in doubt. I view the CPI report as more of a warning. It's an opportunity for the Fed to keep rates higher for longer in the near term and be careful, methodical as they've been saying. They don't want to have to come in there and do a rate cut too quick and then start seeing CPI reports that are elevated more than expectations and have to go back and do a rate hike. That's something that nobody wants and I know the Fed doesn't want that either, but in the interim, yields will remain higher for longer. Typically, we have seen investors step in when yields move higher.
The resistance point on the tenure was about 4.20%. When that CPI report came out hotter than expected, we blew right through that resistance point. Now the street is suggesting that buyers are waiting for the tenure to hit 4.3 to 4.34%. That's the new resistance zone. We haven't seen that level since November of last year, but guess what? This morning we are at 4.3% and let's see if buyers start to really view this an opportunity to step in. Now, treasuries have benefited from continued demand for corporate bonds. We had a few jumbo deals this week in the corporate bond space and all of them were extremely well received by the market. The flight to quality is still in play with these markets. Investors are looking for these blue chip companies, corporate bonds of blue chip companies. They're getting good coupons there. This is also looking for providing some support to treasuries.
Treasury is also viewed as a safe haven, so we're seeing some support there, but it's going to be very important to see if we get through that 4.3% range and go to a new hike. But back to the credit markets, if you were invested in long duration corporate bonds or mortgage backed securities, you did feel exposed to those higher yields this week when that hot CPI print came out, those longer duration corporate bonds did not perform well at all. If you were in mortgages, you got extended on duration, you didn't perform well there either.
Where you performed well was shorter maturity debt sectors with less duration were the safe haven high grade credit default swaps went wider on the CPI print junk bonds moved in tandem with equities, also moved wider on that CPI print. But it's been a very interesting week and it's going to be interesting to see if we see some follow through next week. We did hear some Fed speak this week, but not enough to really shake the market. I think next week we should hear some more and I guess this market is really data dependent and we continue to be so and I think all expectations are going to move really quickly from one data print to the next. I'm wondering how the muni market fared in these days. Let's get Pat Grady in here. Pat, what do you think about the muni markets right here?
Patrick Grady:
Thanks for having me back on the pod and I thought it might be helpful talking about what's going on today in the muni market is to take a step back and explain generally how we got here. At the end of last October, 10 year muni yields were roughly 3.65%, which was up 100 basis points from the start of the year. So as yields moved higher, prices moved lower and not surprisingly, muni performance was negative for the first 10 months of '23 down roughly 2%. Then Fed announced policy change and signaled that began cutting interest rates in '24. And so this caused treasury rates to move dramatically lower, roughly 90 basis points in November and December. And munis will generally move directionally with the treasury market but not in lockstep. And so we also moved lower, but that move was a little bit more dramatic.
Munis moved lower by 130 basis points in November and December, which was exacerbated by a lack of new issue supply, which is fairly typical at year-end, just not a lot of issuance going on. All this added up to a pretty solid year performance, and we finished 2023 positive by over 6%, which was a dramatic turnaround from how we started the year. But the net result of all these rate moves and muni outperformance at year-end is that we began 2024 with munis looking expensive relative to other fixed income. Now this is a good thing, I guess if you own munis in the back half of 23. But I guess for those looking to invest today, you might be finding better alternatives elsewhere outside of municipals, especially on the short end of the yield curve where Muni valuations are looking extremely rich. There are some pockets of value in Munis, but generally we see remaining on the expensive side, at least in the short term.
That's because we just see a supply remaining on the lighter end and there's not really any selling pressures despite these rich valuations I guess. So if we see any catalysts in the muni market, that would move us back to fair value, we'll try to get back on the podcast to inform you.
Brian Pietrangelo:
That's great, Pat. Appreciate the update. For a lot of our listeners out there who do invest in municipal bonds, that's a great update and a timely one. So let's finish with the podcast with Steve. Last question to you, any quick thoughts on small cap versus large cap in your mind?
Stephen Hoedt:
It's been really interesting, Brian, because it's been kind of a tale of two years already during 2024. So if you look at the performance for mega caps versus equal weighted S&P or small caps, the market so far year to date is telling you that all the performance is concentrated in the mega caps, and we have yet to see any broadening out of market participation because the equal weighted S&P 500 year to date is up 1%. The Mag 7 index from Bloomberg is up up 10 in the S&P is up five driven by the Mag 7 performance. However, if you go back and you cut the year and from the date that small caps bottomed, which was January 17th, the performance picture looks a little bit different with small caps up almost 7% since January 17th. The market as a whole, the S&P is still up 5, 6%.
The Mag 7 is up 10. So really we've seen a performance gap close between small caps and the mega caps since the middle of January. That's a little bit of a nuance. It's kind of hidden underneath the hood of the market. We'd really like to see that continue to improve as we move forward here. If we continue to see that. I think it really bodes well for the health of the overall market. We're not, again calling for the Mag 7 to massively underperform here. We just think that they've maybe have gotten a little bit ahead of themselves as they've come through the first part of the year. A couple of them are up 40% for goodness sake. So we think that that's probably a bit overdone, but we have started to see some improvement in small versus large since the middle of January, and it's something we want to keep our eye on if that becomes a more persistent trend.
Brian Pietrangelo:
Well, thanks for the conversation today, Steve, Rajeev and Patrick. 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 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.
Speaker 5:
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