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, October 13th, 2023. I'm Brian Pietrangelo, and welcome to the podcast. With me today, I would like to introduce 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.
Taking a look at this week's economic news, the calendar was very light for the week, with two important reports that came out just yesterday, on Thursday. First, we have the initial unemployment claims that came in at 209,000 for the week ending October 7th, which was exactly the same as the week prior, ending September 30th. So according to these indicators, the job market continues to remain resilient.
In addition, also yesterday, inflation, as measured by the Consumer Price Index, or CPI, for September came in exactly the same as August at 3.7% year over year, while core CPI, excluding food and energy, came in at 4.1% for September, slightly lower than August report at 4.3% year over year. However, the shelter number of inflation, which is a significant portion of overall CPI, stayed high and came in at 7.2% year over year for September, slightly below the August number of 7.3%. Again, staying higher than expected and also came in hotter than estimates, so when the inflation read comes in hotter than expected and hotter than estimates, it actually reminds me a little bit of an Nashville hot chicken sandwich, which surprises you a little bit because you didn't think it would be a little bit hot. That being said, the inflation numbers certainly have an implication for overall Federal Reserve policy and the interest rates for the November and December meeting.
We also had the Federal Open Market Committee meeting minutes released this week from their September 20th meeting, so we'll talk about that in our podcast to see what it tells us going forward for additional policy for the remainder of the year and potentially into 2024.
So George, let's start with you in terms of your reaction to some of the CPI data and the Fed minutes and your overall thoughts on where the economy is headed. George.
George Mateyo:
Well Brian, I think the first thing that I want to mention really quickly is just the entire situation in Israel is something we should mention very quickly, and frankly, the devastating loss of life that resulted from the Hamas attacks is really at the forefront of our concerns. And really because of that, our thoughts go out to all those who've been impacted by this really terrible, terrible tragedy. I'd note that we're not geopolitical strategists, so I'm not going to [inaudible 00:03:17] too much into that discussion around the geopolitical considerations, but I wouldn't be surprised if the impacts from this terrible tragedy are really wide and long-lasting. I also don't want to appear cavalier or callous when we talk about these events or the market response to this, but since this is a market-oriented podcast and this is our mandate and people frankly are listening to get our thoughts on market reactions, we'll focus on that for this morning.
I think it's interesting thus far the global equity markets are slightly higher since the attacks first took place. Buy yields are down a little bit and oil prices are up slightly. And then if you look back historically, Brian, I think historically speaking, some of these major geopolitical events have seen sharp corrections in equity markets, but they've been pretty short-lived, and they usually follow with pretty rapid recoveries. So on average, looking back, global equity markets have declined around 10% shortly after one of these events takes place, and then the recoveries usually follow pretty shortly thereafter. Usually this is a period of weeks and months before markets are fully recovered. So markets have a way of looking through these events, as terrible as they seem, and really try to process the fact that these are somewhat isolated at the time once we get these moments behind us.
I do think, again, this is going to be one of these things that's pretty long-lasting, and certainly, I want to acknowledge the fact that certain events like this can really aggravate the overall economic environment, but ultimately, I think a lot depends on really the scale and duration of some of these conflicts overall.
So it's kind of curious to me, Steve, if I think about what's happened recently, and I mentioned energy prices are up a little bit, I think it's a double-edged sword in the sense that you could probably see some inflationary impact from this, but at the same time, it could dampen demand if energy prices stay higher for longer. I'd also note that it seems like we, the United States as a country, are less dependent upon outside energy sources than we were 50 years ago ago, and maybe there's even a friendlier relationship between Israel and other countries in the Middle East. So what's your take really quickly on the energy market reaction to what's happened in the last week or so?
Stephen Hoedt:
Sure, George. Well I think that we've seen oil move up this week, and right now we're trading roughly where we opened at the beginning of the week. So we've been back and forth around this $85 area. And keep in mind when we came into this, we were in the low '80s, having pulled back from about 95, so we haven't even gone back to the levels that we saw at the end of September. Just to put it out there, the market has a cold heart is what the saying is in the markets, and that means the market's job is to take a look at all the situation, as nasty and horrible as it is, and try to boil it down to what does it mean for the economy? Does it mean the Fed is going to be more likely to be not raising rates or are they going to be cutting sooner? What does it mean for the supply of oil? Israel's not a major oil supplier. Does it mean if it spreads wider, is there an impact if, for example, Iran was involved and then the U.S. and others decide to get involved, and maybe it takes that production off the market?
But the market also is looking at that and thinking a year ago somebody who produces way more oil than Iran, namely Russia, got involved in Ukraine, and we didn't see oil go to $150 a barrel then. So I think the market has gotten, again, calloused to this from the standpoint of it sees the potential impacts. Unless this spills over and somehow ends up creating a very large regional conflict that pulls in power blocks from around the world, I think that the market's reaction to this has been pretty rational, which is the impacts are going to be fairly well contained. And again, whether we're going to see anything spread wider, that's a question that is still open to being answered, quite frankly. It's too soon to know.
George Mateyo:
So I would think the overall message is that we wouldn't want to de-risk portfolios. We wouldn't want to be taking down risk in general given the fact that this conflict and this situation is really very uncertain, and it's going to probably stay that way for a while. How it evolves is also uncertain, and also, again, typically, as you mentioned, these geopolitical events are somewhat short-lived. And so instead, I would probably really urge people to rely on diversification and really focus on fundamentals, such as economic conditions and earnings. So on that front, Steve, on the earnings side, we've started to see a few companies report earnings for the recent end quarter. Anything you can glean from that thus far?
Stephen Hoedt:
Earnings have been coming in pretty good shape, George. It's probably surprising for a lot of folks, but we are not seeing numbers come down, and as we look forward into 2024, I'm sitting here right now staring at the forward 12-month earnings line for the S&P 500, and it made another high for the year yesterday, right? It's closing in on $238. I think I've mentioned on this call before, I think that 240, maybe 240 plus is where we're going to exit the year. That would be another all-time high for earnings, and when you think about where stock prices typically go over time, they tend to follow earnings. So again, the numbers for next year have been really strong in terms of not being marked down by analysts, and unless we get some kind of a real negative shock, it seems like the earnings numbers for next year, we're going to exit this year with expectations that they're going to be pretty good.
I've been positing lately, George, maybe we're headed into a period of time where people really are not familiar with, and that's this inflationary boom scenario, where growth is really strong on a nominal basis, but inflation runs hotter than what people expect. And when you're in an inflationary boom period, it doesn't mean stocks have to perform poorly because inflation is running hot or because interest rates are high. You're in an inflationary boom. There's a word at the end of that. It's called boom, right? It means growth is really, really strong, and if that's the case, it bodes well for stocks.
George Mateyo:
Well we've seen that in the Atlanta Fed survey they're [inaudible 00:10:00] from time to time that GDP now forecasts, which I think just wrapped up their period of time where they look at the recent end quarter, and yeah, it looks like a boom if you look at that chart, which suggests that GDP is running closer to what, 4 or 5%, which would be pretty amazing considering three months ago people thought the number would be close to zero. But I guess... And you're right, it probably would be completely for stocks. I think it might be more challenging for bonds, however. And again, we've seen more volatility in the bond market it seems like this year, Rajeev, and now we've got the Fed trying to suggest that maybe their work is done. But if that boom takes place, how do you think that sets up for the fixed income markets?
Rajeev Sharma:
Well you're right, George. The fixed income markets have seen some volatility in the last several weeks, but really pronounced this week. The horrible events over the weekend did play a part in a run for safety haven assets, so we did see treasuries rally when we started the week off, but then we gave up a lot of that, too. If you look at credit spreads, investment grade spreads on the week are fairly unchanged. I don't think they've even moved. And if you look at high yield spreads, they're only wider by three basis points. So the market has somewhat moved past some of the volatility that we've seen in the market, some of the expected volatility that we've seen.
But there's been this geopolitical tensions. Immediately, I think the consensus on the market was that the Fed it would be done because of the geopolitical situation, and the Fed would not raise rates even though they penciled in one more rate hike for the year. So that was pretty much the theme throughout the week and the tone of the market throughout the week. However, we had a CPI report that was higher than expected, and in turn, it was viewed bearish by the fixed income investors. We saw the immediate impact on the yield curve where rates moved higher. The sentiment is that, okay, the CPI report was higher than expected, and it puts the Fed back into play for another rate hike this year, something that the market has all been discounted over the past week. So specifically, if you look at the two-year treasury note yield, which is the most sensitive to monetary policy, that CPI report put the two year firmly above 5%, and I think we're going to stay there for a little bit.
Another piece of data that we had this week was the FOMC minutes, and again, that also played a factor into how the market responded to the FOMC minutes from the September FOMC meeting. If you parse through those minutes, the Fed has penciled in one more rate hike. They feel that inflation remains problematic. Even as the Fed is viewing the current state of the economy as neutral, the Fed still thinks that inflation is the issue here, and so that puts the odds of another rate hike by the end of the year, those odds have increased just in the last two days, so those odds are now around 50%. So it's basically a coin flip of whether we have another rate hike this year or not. As I mentioned before on these calls, 525 basis points, what's another 25 basis points? The market's already probably put that into their odds of where rates are right now. All said and done, however, my expectation is that the yield curve is going to continue to steepen.
And then as you mentioned on volatility, George, adding to all the markets unease right now, there was a spike in the MOVE index. The MOVE index is a measure of bond market volatility. The MOVE index surged more than 140 points this month. That's the highest level that we've seen since May. And again, that shows the underlying uncertainty that bond investors have right now with the market. We've talked about the pace at which rates have moved higher, and I think it's really caught a lot of investors off guard. They don't like to play in a market where things are moving so fast. They look at the volatility index, they look at volatility in the market, and investors are staying on the sidelines here and trying to find an entry point to maybe add duration. But as we've mentioned before, the duration trade has been the pain trade over the last one month and continue to feel that with the volatility right now, there will be more headwinds that the bond market faces.
George Mateyo:
So I think if we put all that together, it suggests us again that the situation that's really happening right in front of our eyes suggests that you really want to stay diversified across geographies, frankly, and across different strategies and really be open to different considerations, what it means for things economically. And again, I think the fundamentals will win on at the end of the day, and for that reason, diversification, I think, will also be the winning strategy over the long run, too.
Brian Pietrangelo:
Well thank you for the conversation today, George, Steve, and Rajeev. We appreciate your insights as always. 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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