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, May 10, 2024. I'm Brian Pietrangelo and welcome to the podcast. As I hope all of you remember as we go into this weekend, it is Mother's Day on Sunday. So we take time to celebrate and honor all of those mothers in our lives that have made a significant difference, including mothers, grandmothers, moms, stepmoms, everybody else that again deserves that day of special, including with their family. So we will celebrate that again on Sunday, this particular weekend.
With that, I would like to introduce our panel of investing experts here to share their insights on this week 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 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 and market news, the Economic Release Calendar was uncharacteristically light this week, with not a lot of information at all in terms of market-moving economic releases. That will change next week when we get a slew of information including PPI, CPI, retail sales, industrial production, and a whole host of other pieces of information. So with that, we'll just go directly to Steve to start our conversation today during the podcast with an update on what's happening in the overall stock market. Steve?
Stephen Hoedt:
Well, you're right, Brian. There's not been much data this week, so it's kind of been the continuing trickle of corporate earnings as we head toward into the home stretch for earnings reporting season. So just to give everybody an update where things have come in, where about 86% of the S&P 500 having reported. So this is kind of where the market stops worrying about earnings because we're almost to the end of the line. So it's good to recap where things are at.
Estimates have come in, in aggregate 7% or so better than what estimates were. 73% of companies are topping projections, so we're kind of in line with the historical averages there. EPS, if you kind of extrapolate how the data is going right now in terms of the historical beat rate, we're on pace for a 10.5% EPS growth rate this quarter. That's actually pretty good. It's surprising to the upside fairly significantly. Companies that beat on both revenue and EPS, however, are only going up four-tenths of a percent. Historically, they go up 1.7. So clearly, the upside has been muted if you've been reporting [inaudible 00:03:15].
Now, a couple weeks ago, the last time I talked about this, companies with double misses were down 3.1% on average. A couple weeks ago, they were down more than that for this particular quarter, and right now we're back to -3.1. So while you are getting penalized this quarter, you're not getting penalized any more than you usually do if you have a double miss on revenue and EPS. So upside muted, downside about the same, and it feels like that's kind of about where this market is. It's okay, but we'd like to see it a little bit more.
The thing that's really kind of caught my eye here over the last couple weeks has been to watch this change in leadership or attempted change in market leadership, I should say, as we've gone through the market digesting what it interpreted, I should say, as a little bit more of a dovish tone out of Powell by taking the rate hike off the table and emphasizing that the cutting cycle would likely obtain at some point later this year. The market took that to be quite a dovish, not pivot, but reemphasis, and we've seen a rotation underneath the hood.
Now, the commodities and cyclicals have been performing pretty well. Leadership here over the last couple of months taking the baton from tech. But over the last couple of weeks, which is what's caught my eye, is that you've seen staples, utilities, aerospace, defense, which are a number of traditional defensive sectors, start to bubble up to the top of the performance heap. That's really kind of counter to the narrative. Because if you were expecting the Feds to move forward with the cutting cycle, you'd expect aggressive stuff to start to be showing characteristics of market leadership. Maybe small caps, something like this, areas of the market where you would think people were putting on beta, but that's not been the case at all. There's been a kind of a rotation into some defensive stuff.
So I really think there are some cross-currents in the market. There's a lot of debate going on about what the impact of policy changes later this year are going to be. To be honest, like I said, this rotation toward defensive has gotten my attention because it's running counter to the narrative.
George Mateyo:
Don't you see a little bit of resurgence, Steve, in small caps? I mean, maybe I guess you're closer to it than I'm. But I've seen in the last couple days that small caps have outpaced large caps to some extent.
Stephen Hoedt:
They certainly have, George. There has been some performance there too. There are people on the Street that I respect have highlighted that as well too, that we've started to see a bit of a change there. Like I said, I think that there's an open debate over what's going to be leadership. Is it going to be small cap? Is it going to be commodities? Is it going to be defensives? I don't think the market's made up its mind yet.
As we head into the period of time, which people like to talk about sell in May and go away, I think when we think about how you head through this summer, we would emphasize for folks that sell in May and go away really isn't the thing. It's a sell in July move, the typical seasonal strength persists usually into July, not May. So the phraseology is not correct anymore. But from our perspective, sell in July or diversify or lighten your risk might actually apply in spades this year because of the political timing of the political calendar as we head into the back half of the year.
The conventions start in July, so really the market's attention will start to get distracted by the political calendar. Given all the uncertainty as we head in through the run into the election, it wouldn't surprise us at all to see the sell in May/really sell in July play a really important role as we move through the back half of the year.
George Mateyo:
Yeah, just to pick up on that theme a little bit, Steve, I think it is noteworthy that you mentioned the conventions do start in earnest. I think we had a chart in our investment briefing from this past week that talked a little bit about the calendar kicking off in July and August with the conventions. If you look back at the 2020 period of time or the 2016 election, that was kind of the case where I think markets did pause a little bit. To be clear, there was a bit of a turn.
I wouldn't say it's a big sell off, but we did see a correction in 2020, I think around August or September of about 8 or 9%, which at the time probably didn't feel good if I remember it very well. But then things did recover. So as we're waiting for this election cycle to resolve itself, it is kind of a short term phenomenon. It's not really something that would be symptomatic with a broader downturn or something more nefarious to use your word.
Stephen Hoedt:
Totally agree. I think that what we've always said, and we've been very consistent about it, is the market doesn't prefer the red team or the blue team. It just prefers the removal of uncertainty. When we go through that kind of indigestion period in between the election and the conventions, there's the potential for some uncertainty to rear its head. So I think that that's all we're highlighting for people is that the market may not be a straight line ride during the back half of the year.
George Mateyo:
So in terms of uncertainty, Rajeev, we certainly have a lot of uncertainty with respect to the Fed and their thinking. I mean, they've kind of confounded me in the last couple of weeks with what they say one minute and then they say the next. They change their mind almost like the weather it seems like. But are we kind of in the clear with the Fed right now or where do you think the Fed stands with respect to their thoughts on interest rates?
Rajeev Sharma:
Oh well, to Steve's point, I really agreed that the Fed by signaling that they are not in the mode of rate hiking, the market did view that as a dovish tilt, if you will. It's not a pivot like Steve said. I think it's more of a reinforcement of the fact that the Fed is still considering that they're closer to easing rates rather than doing anything like hiking rates right now. They just need to see inflation start to move towards that 2% target that they have.
With that, we did see some relief in the bond market. We did see yields fall across the Treasury curve during this week. There are a couple of reasons beyond the Fed really why we're seeing yields start to move lower. We did have the jobless claims that came in higher than expected. That adds signs to maybe there's some cracks in the labor market. Those cracks have market expectations back on track to think about rate cuts this year. It leaves the door open for the Fed to cut rates this year. Maybe we don't get those three rate cuts? I don't think anybody's anticipating that. But maybe we get one rate cut in 2024?
That immediate impact was seen on the two-year Treasury note, which is most sensitive to Fed policy. We saw the two-year Treasury note fall through the 4.82% mark. That being said, the path to Fed rate cuts would be much clearer if we saw some kind of reports that showed that we're again moving towards that Fed's 2% inflation target. So the bond market remains very data dependent and so does the Fed.
Now, if we focus a little bit on the 10-year Treasury note, we did see a bullish tone for the market this week on the 10-year. We're seeing 4.5% on the 10-year as somewhat of a resistance point for the 10-year. You do see buyers start to step in when we hit that mark. The 10-year Treasury yield has fallen 20 basis points this month, and that's really because buyers continue to step in when we get close to that 4.50% yield level for the 10-year.
Another reason we're seeing yields drifting lower is that we have seen less corporate supply in the last couple of days. We could see yields continue to move lower. If you look at what the next range would be, and looking at the 10-year Treasury note yield in particular, the next point would be 4.3 to 4.345%. We have not seen a 4.3% since April, but we did hit that a few times in April. I'm not trying to look beyond that, but I guess the next level would be 4.25% for the 10-year.
Now, there's another reason why yields are moving lower. It's been the surprise market reaction to the Treasury auctions this week. We had $125 billion in Treasury supply come into the market in the form of 3-year, 10-year, and 30-year treasuries. That's a lot of supply for the market to digest. However, these auctions did fairly well. If you look at the 30-year Treasury auction, which was $25 billion in 30-year Treasury supply, that auction was very well received by the market, which shows you that there are investors that are looking further out in the curve, especially pension funds. They're stepping in. They're participating.
Now, what else could bring Treasury yields lower? We have the Fed announcing a reduction in the amount of Treasury supply. They're doing a runoff of their balance sheet. That's going to start in June. They're going to bring less Treasury supply to the market. If there's less Treasury supply coming to the market, that's good for rates. That's good for yields to move lower.
Now, if borrowing costs move lower, you will see corporate bond issuers try to take advantage of that. We could see an uptick in corporate bond new issuance. We're expecting about 30 billion in new issuance to ramp up next week. There's been a lot of pent-up demand for corporate bonds. We could see these new deals come to market, be very well received. We've been seeing a lot of interest in these new deals at the yield levels that we're seeing. This could keep corporate bond credit spreads tight. Overall, the demand for fixed income remains robust right now. We've got bond funds seeing their biggest weekly inflows in more than three years.
So really all eyes are going to be on next week's CPI, PPI and retail sales reports. I think that's going to have a huge impact on where we see Treasury rates going from here. As the Fed continues to look for signs of inflation, you do have the Bank of an England chiming in and kind of leaving the door open for rate cuts at their next meeting. So there's right now a 50% probability of a rate cut for the Bank of England in June and almost a certainty of the first rate cut in August. The Bank of England is also monitoring inflation and wage pressures much like the Fed. The question really is does the Bank of England move and cut rates before the US Fed does? Again, data dependency is everything right now, George.
Stephen Hoedt:
Hey, Rajeev, I want to put you on the spot. So when you think about the CPI report next week, we've been running hot with CPI report over the last at least four months. I thought it was really interesting when Chair Powell was discussing the impact of the owner's equivalent rent in housing on the CPI number. It's almost like he's got an idea that the CPI numbers next week are going to surprise to the downside because of the imputed rent and all the machinations thereof in terms of the way that things are calculated. So what are your thoughts? I mean, are you looking for a surprise to the downside in CPI next week, which might really ignite this bond rally?
Rajeev Sharma:
I think you're absolutely right, Steve. I mean, when he mentioned that in his press conference, I think he may have some insights into that. We have seen an uptick in rents overall. We also see the fact that we've seen those reports where CPI is running hotter than expected. It's almost that he expects finally the reversal of that on the next CPI report. Obviously, the Fed's preferred measure is PCE, but the CPI report does dictate the market as well.
I do think that the Fed is anticipating a surprise. I think the market is actually also starting to come around to that viewpoint as well. That could be another reason why we see this probability of a one rate cut this year to at least still be on the table. If we don't see that in that CPI report, I think we're going to pretty much wipe out any chance of a rate cut this year.
Brian Pietrangelo:
George, as we oftentimes do, we go to you for your final thoughts on any generic observations that you see in the market.
George Mateyo:
Well, Steve and Rajeev talked about a lot of the great things. I don't want to dampen or confuse any other implications or takeaways from what they said because their insights were spot-on, I think, in many respects. But I think the key takeaway and listening to both of those great guys of ours is the sense that you want stay diversified. We've got some cross-currents coming up, maybe some things to kind of contend with respect to market volatility around the election, inflation. Maybe it is cooling, which would be great to see. At the same time, the bond market is actually providing us with income for the first time a while. I mean, I was looking back at just three years ago or so, rates were so much lower than they are today that you're getting compensated to wait even if inflation does tend to run a bit hotter.
So my view, again, is still really being diversified to kind of stay neutral towards your risk position. There are some opportunities out there for people to take advantage of. I still think that small caps are a bit underpriced relative to large caps. That might actually provide a bit of additional support and diversification in portfolio. We've talked about international markets, and Rajeev was right to talk about the Bank of England. You start to see other central banks maybe adjust their policy quicker than we're here doing the same at home, and so maybe international markets might be a place to think about as well.
So overall, Brian, I think it's important to really remain diversified. We've talked about the fact that stock markets and bond markets are now more correlated, meaning they're moving together more than they had in the past. Again, for that reason, we're trying to emphasize things that you can add into a portfolio. So I think given the fact that we're likely to see a bit more volatility in maybe the next couple months or so as we look out towards the end of this year, I think really being fully diversified would be the best thing I could say.
Brian Pietrangelo:
Well, thanks for the conversation today, George, Steve, and Rajeev. 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. 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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