Speaker 1 (00:02):
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, March 1st, 2024. I'm Brian Peter Peterangelo, and welcome to the podcast. As I'm sure you're well aware, yesterday we celebrated a leap day or a leap year, and it's not an official holiday or anything like that, but it is rooted in a mathematical calculation in case you weren't aware, that actually looks at the circumference. When the earth rotates around the sun, it actually takes 365 and approximately one quarter of a day. So approximately 365.25 days to rotate instead of an actual year in that regard. In order to keep the calendar right, we've got to have an extra day every four years, which is where it comes in in terms of a leap day or a leap year.
(01:01):
And coincidentally, the leap year happens every time there's an actual year, like 2024 that is divisible by four. So 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, and actually a little bit more on our agenda for today's podcast, George Mateo, chief Investment Officer, Steve Haight, head of equities, Rajeev Sharma, head of Fixed Income, and Sean Poe, senior Multi-Strategy Research Analyst. As a reminder, a lot of great content is available on key.com/wealth Insights, 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 market and economic news, we've got a few updates for you starting with gross domestic product or GDP for the fourth quarter of 2023.
(02:06):
This is the second estimate that comes out from the BEA, the Bureau of Economic Analysis, and it's basically the same as the advance estimate that came out last month. So the annual rate came in at 3.2% for the fourth quarter, again versus 3.3%, which was the advanced estimate. So not a big change there. However, it is indicating that the economy continues to be fairly stronger than expected, and of course about 70% or so of the GDP number from a formulaic economic perspective comes from consumer spending. And we got consumer spending for the month of January, 2024. This year, it was up relatively modestly up 0.2% in terms of January over December last year. So it shows us again that the economy continues to move forward in terms of overall consumer spending. Weekly initial unemployment claims ticked up a bit but remained consistent with prior. And finally, probably the most important read for the week was the consumer spending or PCE inflation read personal consumption's expenditures, measure of inflation, which again is the Fed's preferred measure of inflation for the month of January, 2024 came in at 2.8% when it excludes food and energy, which was less than the number from December at 2.9%.
(03:22):
So inflation at PCE Core continues to moderate and was in line with expectations around inflation receding. So with that, George, what are your thoughts on the overall economic data, what it might mean for investors and what it might mean for the Fed George?
Speaker 2 (03:38):
Well, Brian, I think the key reading for the week, as you've mentioned, was this thing called PCE Inflation, which is kind of a fancy way of the Fed talking about what consumers experience as it relates to inflation, and I think the numbers were kind of what they were a little bit better than expected perhaps, or maybe in line with expectations. If you look at some of the numbers though, I would suggest that January's numbers were the fastest increase since last January. So we've seen inflation start to pick up a little bit again, and I think that really deserves mention. It's going to probably factor into the Fed's thinking when they get together later this month now that we're in March, it's kind of curious to see some things underneath the hood. There's one part of it that relates to our business actually within financial services experience, a pretty big jump in actually the contribution that financial services make towards the inflation numbers.
(04:27):
And those are somewhat cyclical as markets move up and down as they do. But nonetheless, I think if you kind of think about what the Fed might be thinking about, they have to be paying attention to the fact that maybe inflation isn't coming down as quickly as they like it is moving down. It is kind of trending in the right direction, but it's not moving as fast as they might like. So I think there's probably a growing course that the Fed maybe not necessarily achieve a soft landing, but maybe there's a no landing scenario, meaning that they might actually have the situation where inflation say somewhat elevated rates maybe don't come down as much as people think. We've talked about this from time to time, and Rajiv, you've been all over this with respect to what the Fed might be doing later this year with respect to rate cuts.
(05:07):
And at the beginning of this year, there was some consideration that the Fed might be cutting interest rates as much as seven times. Now. It seems like the more likely scenario is that it's three or four times if that's kind of aligned what the Fed is thinking, that's probably closer to what we were thinking, but I think we can't dismiss the fact that maybe the Fed might be wrong. The Feds forecast for the last six or seven months has been rate cuts of around three or 4 24, and maybe there's a consideration or maybe a possibility I should say, that they might consider walking one or two of those cuts back. Rajiv, as you think about what the Fed's thinking now and we think about what they might be doing next month, how do you think they're processing this?
Speaker 3 (05:47):
Well, George, what has happened to the bond market is that we've seen market expectations kind of fall in line with the Fed narrative, and you're absolutely right. We started the year off with the market expecting seven rate cuts, which was egregious. I don't think that we ever bought into that. Now with that PCA data, it kind of aligns the Fed and the market expectations. And what's happened is we've seen yields fall across the yield curve. We saw the two year treasury yield, which is the most sensitive to monetary policy we saw that fall to a session low.
(06:23):
It all started with the hotter than expect the CPI print last month. But PC is very important because that is what the Fed really focuses on. So we touched yields at high levels back in November, but with that PCA print, which was in line with expectations, I feel the bond market is now pretty much in line with what the fed's summary economic projections were in their last meeting. So the Fed was calling for 75 basis points of rate cuts to 2024. The market is now finally calling for the same thing. And I think that we've talked about the volatility based on the dislocation between the market expectations and the Fed. Now I feel like the Fed and the market are in line with each other. We have a two week break from treasury auctions, so we could see yields start to trend lower based on the lack of supply that we're going to see from these treasury auctions that we were seeing.
(07:23):
However, after seeing yields move higher for the most of February, we did see buyers step in. In fact, we did see foreign buyers actually step in and saw opportunities on the 10 year part of the curve to get involved. This is even after a very robust corporate bond issuance that we've seen. We've had record issuance for the first two months of the year in corporate bonds, especially investment grade, and we are now leading towards the biggest ever investment grade issuance for the first quarter of this year. But it has not put a dent on investor demand. Investors are still very interested in investment grade corporate bonds, and the reason is that we're seeing coupons for blue chip companies that we have not seen in a very long time. Any pullback in yields that we see will cause investors to continue to tap a new issue market. And I think that the inflows will continue, and now we have a fed in the market that's aligned with three basis, three rate cuts for this year. I think if we get any type of change in the March meeting, if for whatever reason the Fed decides that we're going to say two rate cuts, I think that's going to cause a lot of volatil in this market because everybody expects now three rate cuts.
Speaker 2 (08:44):
I kind of wonder if the Fed is thinking at all or looking at all at the equity market, and maybe Steve, you've got a view on this, but it seems to me that the equity market is also confounded expectations. Some of this year it's off to a pretty strong start. We're two months in and the s and p 500 is up seven or so percent, which is all accounts a pretty good year. And of course there's a lot of euphoria it seems to me, in certain parts of the market around AI that are even up more. So I'm not sure, Steve, if you've got a view on that, but I'm curious to get your take on the read through from the equity market to the Fed and vice versa.
Speaker 4 (09:18):
Yeah, George, to us, it really has come down to the equity markets reflecting the change in the growth outlook, right? I mean, when you take a look at the softer data in terms of things like ISM, which just came in a tiny bit below expectations this morning, but the s and p version of that came in above expectations. So you got a little bit of mix there, but at the end of the day, those numbers tend to be good leading indicators for future earnings growth. And those numbers have been coming in better than expectations for a few months now. And when you take a look at how markets tend to behave, markets tend to behave by rerating ahead of earnings. So what that means is the price to earnings multiple expands prior to seeing their earnings growth follow through. And when you see that performance year to date, we've had the scenario where we've had, it's really the best scenario you can get from a market, which is earnings numbers going up into the right.
(10:23):
At the same time, you've got multiples expanding because the market is betting on this rerating of growth. So we've had a really virtuous situation. Now, I feel like the market looks a bit tired to me here. Sentiment and positioning as to your point is a bit extended, so it could easily be time for the market to take a breather and let things digest, but when you look at the price action in terms of the response to some of these strong earnings reports, it really does feel like the market wants to go higher in spite of all of that.
Speaker 2 (11:01):
Anything seasonality wise, Steve, that you're thinking about? I mean, again, we've had this kind of Christmas time in Santa Claus, rally year end positioning, repositioning. Is there anything that suggests that as we go through the spring, early spring months that we should be aware of?
Speaker 4 (11:17):
I don't think so, George. Typically, if you look at the seasonal pattern for the market, the market runs from the, let's say the end, mid to end of October through the middle of July is the best seasonal run of the year. So we've got a few months ahead of us there. I really think it comes down to right now just the fact that we've come so far so fast in a short period of time, and we've gotten a little bit ahead of ourselves. So I keep looking for indications that this market might want to have say, a three to 5% correction in order or pullback in order to reset things before we continue to rally. But I don't see anything nefarious unfolding here.
Speaker 1 (12:02):
So Steve, you always do an outstanding job giving us the perspective on the public equity markets, but for a little extra session on today's podcast, we're going to bring in Sean Poe, senior multi-strategy research analyst. And Sean, we're going to hear from you in terms of the private equity markets that how much they differ, why investors should be interested, and what's your thought on the overall private equity market. And Sean, by the way, wrote a key questions article this past week that if you're tuning in and listening to us, you might want to see it on key.com. Sean, what are your thoughts?
Speaker 5 (12:33):
Yeah, thanks Brian. Happy to be on the podcast here. So private equity, I think we probably want to start with the definition, and it really can be boiled down pretty simply to its ownership of any company that isn't publicly listed. So it's ownership just like a public equity, it's just not traded on an exchange. When you think about private equity, it's really a blanket term. It covers many different types of investing. So you've got venture capital growth, equity, leverage, buyouts, distress secondaries, all of those are kind of just terms for different parts of the enterprise life cycle. So you definitely hear the most headlines about venture capital and leverage buyouts, and those tend to be the deepest areas of the market. I think when you're talking about private equity, you also have to talk about the structure for a second. Typically, we are thinking about a fund structure that will purchase equity in several companies, the work on improving the businesses, and then they'll look to sell their ownership in total funds typically last seven to 10 years.
(13:35):
There can be the opportunity for extensions, but generally speaking, this is the long-term investment that allows for the private equity general partner to improve their companies and focus just on that without having to worry about public equity fluctuation. So the most important takeaway just definitionally is that private equity is still equity, it's just not the publicly traded kind. So why does it matter? There's two main reasons. One, it's a huge market. So if you think about all the companies in the United States that have greater than a hundred million dollars in revenue, private equity makes up 85% of those companies. I mean, it's just 15% of these large companies are publicly traded. So we tend to think of the market as the Russell 3000 or the SP 500 that's missing a huge chunk of the market that private equity is relevant to. The other main reason, and to put it very bluntly, is that private equity has driven higher returns historically, roughly 500 basis points per year over the long term.
(14:35):
Just to put it very simply, think of private equity as generating about 13% per year, and public equity is generating 8% per year over the long term. There's a huge effect on your returns if you're generating that kind of alpha. So what actually drives the higher returns goes back to that control factor. Think about buying a stock like IBM, for instance. You buy into it, you hope that management does the right thing, you hope that the market appreciates it, and there's a valuation growth. And on the flip side here, private equity firm actually takes control that allows them to take actual steps to improve the company. There's mainly three ways that they do this. They'll upgrade management, they'll build new revenue streams, and they'll reduce costs. So at the end of this, they hold these companies, they make all these upgrades, and then they sell back to the market.
(15:25):
That can be to another private equity firm that can be through an initial public offering. But the key factor on value creation there is that they can be flexible in buying and selling, so they can kind of buy when they want to in the early life of the fund, and they can sell when the conditions are right and wait for the ideal partner to come along. So there's a couple different structural elements that allow private equity to generate these higher returns. So how is it different than public equity aside from the control factor, we talked about the higher returns. That sounds pretty great, but what's the catch? Of course? The first one is that it's a blind pool. So when you're going into a private equity fund, you typically don't know exactly what the manager's going to buy. They'll tell you, Hey, this is our strategy.
(16:07):
We think it's going to be this many investments. We think it will take this long, but you don't know ahead of time. So that means the work we do on the multi-strategy research team is vital because we are doing all this work to diligence that we find investors and managers that have a strong pedigree, a really strong track record of coherent strategy so we can reasonably understand what the private equity investment will look like. And then finally, there's the illiquidity piece. The same factor that gives the private equity managers control to improve these companies also means that you can't just get out of your private equity investment like you can when you sell a public stock. Typically these funds last seven to 10 years. So you need to be a true long-term investor. That may sound like a bad thing. It can actually be a good thing because it can prevent you from selling at the wrong time.
(16:56):
So if you sold maybe as a public investor, you would've sold in March, 2020, private equity would not have afforded you that opportunity, and ultimately you made much more money because of that. So the current state of private equity, it's an interesting time to look at it. So if you look just at the last year, private equity has been solid, but it hasn't really held up to it. Its benchmark benchmarked, and venture actually did even a little bit worse over that same time period. Private equity returned 7% in the four quarters ended September 30th, venture was down 10%. Actually in that time, that doesn't compare so well. Admittedly to public equities, the Russell 3000 returned 20% over that same, however, it's important to that private equity and venture capital inherently need merger and acquisition activity with the, that we've touched on m and a activity was very slow in the last couple of years. So that has inherently compressed the returns of private equity. But if you're a believer in buy low, sell high, this could be the right timing. But we know, again, going back to we were long-term investors, one year is not necessarily indicative of a sustainable strategy. And so again, over almost any longer term period, you look at three years, five years, 10 years, 15, 25 private equity is consistently outperformed by about 500 basis points per year, which is exactly why we think it can be a valuable return answer for portfolio.
Speaker 1 (18:26):
Well, thanks for the conversation today, George, Steve, Rajeev and Sean. 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.
Speaker 6 (19:01):
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(20:46):
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