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 open doors in the world of investing. Today is Friday, July 19th, 2024. I'm Brian Pietrangelo, and welcome to the podcast.
There certainly is a lot going on this week, including the Republican National Convention, as well as the CrowdStrike software update going on across the global environment, which is causing a lot of havoc. So, we'll try to talk about that possibly during the podcast. In addition, in the sports world, you've got the British Open kicking, off as well as the Major League Baseball All-Star game this past week, as well as Caitlin Clark continuing to make her imprint on the WNBA, leading the record of 19 assists during a basketball game.
However, all those going on, the one I want to talk about goes back a couple days, all the way to the week of July 8th through the 14th, which is the interesting concept of the nine-day Fiesta known as the Fiesta de San Fermín in Pamplona, Spain, otherwise commonly known as the running of the bulls, which is a two minute and 17 seconds of excitement and fear. Seven runners were in fact taken to the hospital. So interesting to always see that event unfold. We had a pretty good bull market so far this year, up 17%, but also will pull back this week due to some volatility. So we'll get Steve's take on the parallels of the stock market and the running of the bulls in the bull market, including excitement and volatility.
I'd 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 Tim McDonough, 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 the market and economic news for the week, we've got three economic releases to share with you and we'll start first with the overall retail sales environment from the Census Bureau that came out earlier in the week, which showed that as we look into the June numbers for month-over-month increases in advance retail sales, the number was flat or up 0.0%, and the revised number for May only went up a little bit to 0.3%. So if we look at those two months consecutively, we see that there is slowing in the overall consumer as measured by retail sales for roughly two months now, and we'll continue to look at this to see how much it is actually slowing within the overall environment.
And second, we look at industrial production, which came out also earlier in the week. There was a little bit more of a good news story on the opposite side of the economy with industrial production that showed the June increase was 0.6%, followed by the May increase from last month, which was 0.9%, which again, two good months following April, which was flat or zero. So we look at that as a positive sign, seeing some recovery, so to speak, and some continued growth in the overall industrial production.
And third, the Federal Reserve's Beige Book report came out this week and again, as a reminder, it typically comes out in advance of the next upcoming federal open market committee, which is about two weeks away, and it provides an update on what's happening across the 12 districts across the nation, in terms of overall economic activity, and the summary is pretty simple in that we look at those 12 districts, we see that the overall maintaining of a slight to a modest pace of growth in the majority of the districts did in fact occur. However, seven of the districts reported some level of business activity increases. The other side of the coin is that five noted flat or declining activity, which compared to the last time the Beige Book report was published, showed three more that were actually showing declining activity.
Overall household spending was little changed for the period according to most district banks, and overall, there was some soft demand for consumer and business loans. So we'll take that all into consideration with our panel today, in looking at three different reads of what's happening in the overall economy.
So George, let's start with you in terms of your reaction to the data and what other observations you have as you see it, in terms of what might be helpful for our audience members to know. George?
George Mateyo:
Well overall, Brian, the economy showed some more signs of slowing this week, but certainly not stalling. We've talked about that theme for a while, that we thought the second half would be marked by a slowdown, but not a real pronounced stalling out, meaning we still think that there's going to be growth, but maybe not an outright recession as the year comes to a close in the second half. Of course, there's a long way between now and then, but the numbers out this week suggest that, yeah, things are definitely softening further but not slowing out entirely.
Jobless claims, something that we talk about on these weekly calls, did actually pick up again, which is a kind of harbinger for what happens in the labor market. And what that number does pick up, it does suggest that maybe unemployment will also rise too, and I think that's something we want to keep our eyes on for sure.
Retail sales was another indicator that we watched pretty closely, that also did actually outperform a little bit, in a sense it was a little bit higher than expected. So maybe because of rise in stock prices, maybe because of rising home prices, and maybe even just some moderation at the gas station kind of suggests that maybe the overall consumer spending trends remain intact. So to me it seems again, that the overall economic narrative is one of a slow down, but not a stalling out.
You also mentioned, Brian, that the Republican National Convention was held this week, and it seems like the political dialogue and conversation is really dominating the overall narrative. I don't know if there's anything really marketable or anything that's market action oriented around that event. It does seem to me that the Republicans now look fairly unified and the Democrats maybe less so, even just if you look at betting polls this morning, it does suggest that Biden is no longer the front-runner for the Democratic nomination, which may be not be a surprise to many people but one thing that I think we have to keep our eyes on is, what does that mean? What does the overall notion of political instability mean for the market? It seems to be taken in stride right now. We've talked about normally, we start to see some volatility around the election and that's still likely to happen, potentially. At the same time, I think people are trying to figure out what this means for their portfolio and our view is really, I don't think you should really change too much.
There was an interesting Bloomberg article this week that talked about what former President Trump might do if he were reelected. He talked about maybe interest rates being too high and maybe kind of jawboning the fed a little bit. I think we have to see how that plays out. He made similar comments in 2016, but then left the Fed alone for the most part during his administration, despite the fact that he suggested he might do something different. And then also, he's talked a little bit about energy and kind of this pivot towards traditional energy, if you will. I think it's interesting to note, Brian, that clean energy under his administration actually outperformed, which might be kind of [inaudible 00:07:19]. So I think the market's going to kind of figure this out one way or the other and the market and the economies we say oftentimes will probably be the bigger driver, rather than one person trying to influence the economy or the market in any one direction.
So I think if I look at this, Steve, kind of getting your thoughts and what you're seeing through the stock market, maybe through the lens of the RNC itself or really just the overall shift in volatility and maybe the shift in leadership in the market, which seems to be pretty pronounced as well. So, what are your takeaway and what do you take away from the market this week, Steve? And how do you translate maybe the political realm to the investment realm?
Stephen Hoedt:
Well, I'm going to give you a series of numbers first, George, and then I'll dive into what I think is going on. So for the month, the NASDAQ 100 index right now is flat. The S&P 500 is up about 1.5%. Mid-cap stocks are up about 4% and small cap stocks are up more than 7.5%. If you go under the hood even more, commercial real estate's up eight, a basket of the most shorted stocks by hedge fund is up nine, non-profitable tech is up nine, and regional banks are up 14. So what has caused this large disparity in returns? Basically the NASDAQ 100 is driven by the magnificent seven, it had been leadership for the last nine months and you can see by all those numbers that I just gave you, not only is the NASDAQ trailing massively behind all the rest of this stuff month to date, but it's dragging down the returns of the S&P 500 as well because of the concentration issues that we've talked about on this call multiple times before.
I think that two things have happened in a very short period of time to cause this dispersion. One is the CPI number coming in light, which has caused a very large shift in expectations for what the Fed is going to be able to do between now and the end of the year, in terms of entering into a rate cut cycle. And then the second piece to what you alluded to before is a change in the market's outlook for the outcome of the election. And you put those two things together and it's lit a fire under some of the unloved parts of the market. Obviously, the most violent reaction was in small cap stocks, which have underperformed for quite a while now. But at the end of the day, really the question for us is, do you want to own these disadvantaged parts of the market as we get deeper into the economic cycle? Because clearly when you are talking about the Fed entering into a rate cut cycle, that's not early cycle by definition, right?
So the question that we have is, what do you do here? And we feel that where investors are best served right now is to take a look at their portfolio. Obviously we continue to advocate up in quality, but not only would we be up in quality but we would emphasize the ideas where you have the highest conviction. And that's what we've been doing in our internally managed strategies. We've been taking some profit in some of the names that were tech related that have really had really strong runs year to date, and we're rotating that into maybe some of our high conviction ideas that have lagged for one reason or another. And we think that investors would be really well served right now to continue to survey the landscape in their portfolio. And where you have high conviction, it's time to step up the high conviction, high quality kind of ideas. And we have no problem taking some profits in high flying tech at this point, given where we are in the economic cycle.
George Mateyo:
So you said, Steve, that when the fed's cutting rates, it's not really the early part of the cycle, and I agree with you, but you think it's late cycle? I mean, there's always this notion that the Fed could just cut a few times and maybe just kind of take a pause before they do anything more major. In other words, the reason behind the rate cuts might matter more than the cuts themselves. But do you think this is something that's just kind a mid-cycle slowdown or what would you think of where we are in the cycle or what kind of cycle are we in?
Stephen Hoedt:
George, I totally agree with you, and I think that the chart that really jumped out to me is one I shared a couple of weeks ago where it basically asked, what kind of rate cutting cycle is this? Is it a 1995 or 1998 rate cutting cycle, or is it a 2001 or 2007, '08 rate cutting cycle? And those are very different market reactions, right? I come down on the side of this feels much more like the 1990s to me, where we've got a strong underlying economy that is slowing but still showing above trend growth on a long-term basis. And to me, when you look at the rally that the tech names have had, it's very similar to what we saw in the 1990s. I mean, there are a lot of parallels here. And the bottom line is you had a soft-ish landing in the mid '90s, and then we had a re-acceleration that lasted for another five plus years. So I think-
George Mateyo:
And you sell corrections, right? I mean, even though those requirements-
Stephen Hoedt:
Absolutely.
George Mateyo:
I mean, it's not lost to me that we are going into the tough time of the year on a counter basis. I mean, you're the expert here when it comes to market technicals and what happens with the calendar but if I'm not mistaken, the summer, early part of the fall is kind of the seasonal part of the year where it wouldn't be out of the ordinary for the market to slide down five, six, 7%, right?
Stephen Hoedt:
100% correct. The weakest part of the year is from mid-July through the first two weeks of October. So for the next three months, this is the time when we typically see the market pull back. If you look on a monthly basis, the two weakest months of the year are August and September. So, and that it's irrespective of the election cycle or any of that kind of stuff. So I would tell you that our expectation is the market's going to be choppy from here through the election and then likely have a rally into year-end and that's the template that we would continue to apply. But we think in this environment, again, you invest in your highest conviction ideas and stick with quality.
George Mateyo:
So maybe to transition a little bit and other things we can be thinking about with respect to portfolios has to do with fixed income. There is actually income and fixed income again. Bonds are back and yields are up a little bit. Tim, I'd be curious to get your thoughts on how you're thinking about positioning bond portfolios as we think about the second half as well.
Tim McDonough:
Thanks, George. Well, yeah, the bond market hit the brakes after the rally we saw last week. Treasury yields were relatively flat on the week, rising about two to three basis points across the curve. But coming after that June CPI report, that rally that ensued last week, and the increasing probability of a September rate cut by the market, we kind of saw that bond markets at not a standstill, but we were definitely range bound. And while price action was muted for the week, we did see a big uptick in issuance. The treasury auctioned 13 billion 20-year bonds at a 447 yield this week, and another auction of 19 billion 10-year tips yielding 1.88%. Both auctions actually received lower demand from investors than were expected, but a new issuance also ramped up in the corporate and municipal debt markets as well. We saw close to 45 billion in investment grade corporate bonds hit the market, and 11 billion in munis. That's the highest we get issuance for both in over two months. On the issuance, investment grade spreads were up two to three basis points, and munis were actually lower three to six basis points.
So in a week where we saw treasuries go higher, corporates go higher, the munis actually outperform both and there's a two-pronged approach for this, for explaining this rally. We've seen favorable valuations of munis relative to treasuries. So right now, a muni is yielding anywhere between 65 to 70% of a treasury in the same tenor. And that's actually on the higher end for what we've seen over the last six months. So that in combination with an increasing amount of reinvestment coming from muni bonds and coupon payments made in July have given investors some money to put to work and even with the large week of new issuance that we saw, the deals were all well received and we saw a little rally from munis.
Turning our attention to the Federal Reserve. The market last week was pricing the probability of a September rate cut at 94%, following that June CPI report. We're now at 99%, and recent commentary from Fed officials we've noticed has shifted from focusing purely on getting inflation down, to a focus on the labor market. Comments over the past week from Chair Jay Powell, Governor Christopher Waller, and San Francisco Fed President Mary Daly, have all touched on, it's not just about getting inflation down, but we need to be mindful of where the labor market is. So this in combination with the market pricing, that 99% probability of a September cut, can clue us off to that Fed policy is going to be shifting more towards labor market and focusing on the unemployment rate than getting inflation down.
George Mateyo:
Well, thanks Tim. Appreciate the insights there and I think we'll have to keep our eye on the labor market too, as you talked about the Fed, who's trying to balance inflation, which seems to be [inaudible 00:17:40] but not completely, completely cooled, and there's some things that suggest that maybe inflation might be still and out and making further progress. We'll see. We'll have to also see how the labor market responds to what's happened lately. As we mentioned earlier, claims have started to pick up again, which does suggest that maybe the overall employment situation is softening too.
So as Steve and you have rightly mentioned, I think being up in quality makes a ton of sense in this environment, staying really diversified, which I know is something we've harped on, but many people frankly, aren't. I still talk to many investors who are very concentrated in certain parts of the market, and I think our view is to really remain fully diversified to really withstand volatility as it might come at us from many different directions in the second half of this year.
Brian Pietrangelo:
And thank you for the conversation today, George, Steven, Tim, 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 navigate your financial journey.
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