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, December 6th, 2024. I'm Brian Pietrangelo. Welcome to the podcast.
As you may recall, we were off last week to celebrate Thanksgiving, so we hope that you and your family had a great Thanksgiving and had a great Turkey and everything else, spending time with family and friends. This morning 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 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 market and economic activity, we've got five quick updates for you because we want to spend the lion's share of today's podcast on our 2025 investment and economic outlook from our team. So starting first with the Institute for Supply Management PMI indices in terms of overall ratings, the manufacturing PMI came in higher in November, which was a good sign, but remember that for the last 24 out of 25 months, it's been in contractionary territory, which again is not that good for the manufacturing side of the economy. On the other side of the economy, the services PMI came in lower in November than October, but again, remember that scenario has been in expansionary territory for the last 51 out of 54 months. So again, two sides of that coin, services continues to be strong.
Second, the Fed released its Beige Book report, which comes out roughly two weeks in advance of the next upcoming Federal Open Market Committee meeting, which is on December 18th. The report showed that economic activity rose only slightly in most of the 12 districts across the nation, with three regions exhibiting modest or moderate growth that offset two regions which had slightly declining activity. The others were essentially flat. In addition, employment levels were basically flat or only up slightly across districts with hiring activity being subdued as worker turnover remained low and few firms reported increasing their headcount.
Third, the initial unemployment claims for the week ending November 30th that came out on Thursday of this week were only 224,000, which were slightly up from the prior week, but considered stable and remained stable and have been for roughly the last four to six months. So good news there on the unemployment front in terms of initial claims.
Fourth, probably the most important number of the week came out this morning with the Bureau of Labor Statistics employment situation report, which gives us two numbers. The first is, the non-farm payrolls for November came in at 227,000, which were up significantly from October's report, which only had 12,000. Now it's important to remind everybody that the 12,000 number in October was extraordinarily low and did take into consideration some hurricane and weather-related numbers, as well as some port strikes and some labor strikes. So ultimately, that seems to have been an anomaly as we returned to the 227,000 number that came out in November, which was very near towards the three-month average. So good to see that there. In addition, the overall revisions for the two prior months of October and September were actually revised up by 56,000.
Finally, fifth is also part of that employment situation report, which the unemployment rate for November came in at 4.2%, up 0.1% from October's 4.1%. Again, pretty smooth there. Not a lot of changes to report in the overall unemployment rate.
So now let's turn to our panel with an overall update as we release our overall 2025 economic and investment outlook with really five key questions that we're going to answer and ask our panel in terms of what we think is going to happen in the upcoming year. We're going to start with George. So George, let's start with the first question, and that is, how do you think the election results are going to impact the economy and the markets?
George Mateyo:
Well, Brian, I think we want to reiterate that the markets are going to do what they're going to do and the economy's going to do what it's going to do irrespective of what really happened in Washington. I think Washington could kind of move the needle a little bit, but I think there are going to be broader forces at play. As we've been seeing along for much of the past 12 months, it's not just really up to one person or a group of people that can move an economy our size. But that being said, I think it is fair to say that there's four big things that are probably getting some attention, rightly so, one of which of course has to do with regulations. There's some thought that maybe the new administration will be more regulatory friendly. I think Steve's been a bit on this call out that notion with a bit nuance in the sense that there'll be some industries that do well under that new regime and some probably less well. So that's more of a sector specific statement.
I think the other thing that, of course, gets a lot of attention has to do with taxes. That in my view is probably a modest positive. I think to some extent though, taxes are already... We're not going to see a big decrease in the tax rate overall. We might see some tweaking, tweaking the corporate rate, but I don't think we're going to see a really big tax cut given our deficit situation. We'll probably talk more about that in a little bit. So I think taxes are probably a small positive.
The other thing, of course, is tariffs, which might be upsetting some of that. Tariffs might actually be used to fund some of those tax cuts if they are sustained or lowered. And I think that's going to be probably a lot of contentiousness over the next couple months or so because some people view those as inflationary, some view them as really a cost, and indeed they are. But there's also a lot of game theory that goes along with tariffs too, meaning that some countries might opt to play ball, they might actually try to negotiate things. It's going to be kind of a hard thing for us to really get our heads around, and I think it's going to become one of the things that's going to be subject to a lot of noise over the next couple months rather than anything really newsworthy just yet. And that's probably what the Fed is going to have to be thinking about too as they think about policy. So we'll kind of leave off the side for now.
And then fourth I think is immigration, and that's another thing that we'll probably see some news on that pretty quickly. But there too, in terms of the impact long term, I think it's fair to say that it's also going to be one of those things that it's hard to really measure. Most economists haven't really got their heads around, for example, how much immigration has benefited the job market thus far. So I think it'll take some time to sort this stuff out. Again, in our view, it's really more important to focus on some of the bigger issues like interest rates, monetary policy, earnings and some other fundamentals rather than just worry too much about the politics.
Brian Pietrangelo:
George, we've talked in the office and you talked on a national call that 2016 Trump is not necessarily the same as 2024 Trump. So maybe give your thoughts on that real quick.
George Mateyo:
Yeah, you're right. I mean, Robert has called the meet the old boss, I'm sorry, meet the new boss, same as the old boss, which again is kind of I guess a tip to the band, The Who, that actually released that song back in the '70s. So probably more our generation than not. But nonetheless, I think what we try to reference is the fact that many people are extrapolating what happened in 2016 to today, and they're essentially kind of taking that same dynamic. And if you look back at the market, the market actually had a really strong rally from the election till about the end of 2017. So the market was up about 40% in that, call it 15-month period of time.
In my view, I think we've kind of already pulled forward some of those gains. I think Steve would probably agree with that too, looking at the equity market. But I think in terms of what's happened today versus eight years ago, today our deficit situation is a lot larger. We've got twice the size of debt overall. We also have valuations that are much fuller, and at the same time, inflation and industries are already higher. So the idea of trying to borrow more money for tax cuts and some other things that actually were put forth in 2017 probably are unlikely in my view going forward and facing the near term.
Brian Pietrangelo:
Wait, George, as our second question, let's dive a little deeper into that comment that you just made. How do you think the national debt and the deficit will impact the economy and the markets?
George Mateyo:
Well, it's going to be an overhang for sure. I don't think it's quite the clarity that some people think it would be. And again, it could be. I guess it's one of those things we just don't know it's a problem until it's a problem. In other words, we know it's an overhang for sure. The markets have kind of taken in stride. I mean, I think if there were a lot of consternation around the deficit situation, we probably see bond yields a lot higher. Today they're at 4.15 or so in the long-term tenured treasury. If we really were concerned about the deficit situation, we'd probably be, gosh, maybe 5% plus. So I think the market would essentially kind of signal that they were concerned about it before it became a really big issue. Right now the market doesn't seem to be too concerned about it.
To some extent though, I think there is some longer term repercussions of that though in the sense that, as we talked about on our call earlier this week, I think to some extent, and Rajeev singled this out in his [inaudible 00:09:17] Thomas, this kind of leads to a crowding out. Meaning, essentially when you've got higher deficits and frankly spending more money on interest expense and other things, you're not spending as much money on things that are properly more productive, things that generate a higher ROI in the overall economy. So I think to some extent it's going to probably suppress growth, but not probably into the out years, meaning that it's probably not really a near-term drag, but longer term, it probably could become an issue. Rajeev, what do you think about that? I mean, you've been thinking about interest rates and the Fed. Is that actually kind of keeping your thoughts about what the Fed might be thinking?
Rajeev Sharma:
Yeah, I think it's very important. I mean, any kind of fiscal policy we're thinking about in the future, it has to take into account the deficit, the debt situation, the new political regime. They're going to have to confront these issues. I mean, we talked about these kind of figures on the call this week. Net interest spending increased by 223 billion for 2023. It's nearly tripled since 2020. So you're going to have to have a combination of sustained economic growth, but you're going to have to get this through tax revenues. But you're going to really need targeted government spending reform. And I think that's something that the new administration has been talking about. Let's see how successful they are in that. But your point about the crowding out effect I think is very important. There's a very delicate balance between managing the national debt and maintaining economic growth.
Brian Pietrangelo:
Great. Thanks, George and Rajeev. We'll move to the third question, which has gotten a lot of attention recently for a lot of different reasons. We'll just ask the question outright, George, will king dollar be dethroned and lose its reserve currency status? Or what else do you think is happening with the dollar?
George Mateyo:
The short answer is no, and I know that's a big question, particularly in the age of crypto and some other things that people are paying attention to. President-elect Trump, for example, was actually, I think he's on Twitter, Trump's social, I'm sorry. So he was on his own social media post this past weekend, talking about the fact that he was going to levy tariffs on I think much of the Asian block essentially, and saying that he might actually raise tariffs to 100%, which would be Draconian if he did that. But I think he was kind of threatening them to say that, "Look, you've got to kind of fall in line and use dollars as your currency of choice." And I think he can kind of... I think that's a lot of bluster, a lot of rhetoric. Maybe I guess it's probably more signal than noise. But I do think, overall, I think the question around the dollar being dethroned and losing its reserve currency status is something that's a bit overplayed and overstated in the media.
I think there are probably other currencies that are becoming more attractive on a relative basis. Again, digital currencies are something to really we can spend some time thinking about perhaps on conversation. But I really just pushed back the idea, I push back on the idea hard, frankly, that the dollar is going to give up its reserve currency status. Frankly, there's really no viable alternative on a global basis to really make up that difference. So if you look at the overall world reserve currencies, you take all the currencies in the world and look at the reserves that exist out there, the dollar has gone down in terms of percentage of those currencies. That said, it's still probably 65 or so percent of the overall reserves are in dollars. More importantly, the transactions that conducted on a global basis, probably 85, 90% of those are conducted in dollars as well. So I don't think that's going to be a near-term risk. Again, I think there are probably some things at the margin we'd be mindful of, but I don't see the dollar going away and losing its reserve currency status anytime soon.
Brian Pietrangelo:
Great. So let's turn to our fourth question, which we'll pitch to Rajeev to start the conversation, and that is basically, where do we anticipate the Fed going in terms of policy, where interest rates going? And possibly, comment, Rajeev, on today's jobs report, which again may have implications for the December 18th Fed meeting, and then we'll talk about 2025 in addition to that.
Rajeev Sharma:
Well, Brian, inflation moderating and the Fed ready to maintain their rate cutting cycle, I think bonds should perform pretty well in 2025. Most fixed income assets, they provide a high level of yield, as George mentioned as well, right now. This is good news for bond investors. They're in a rate cutting cycle. The Fed is cutting rates. This is good news for bond investors. It gives them income, gives them total return opportunities in 2025. The two main risks I see in the market right now with the Fed or one around fiscal policy, what are these large scale tariffs going to look like, and would they reaccelerate inflation? If we start seeing inflation start to pop up higher again, that could kind of slow the pace of rate cuts. It could actually make the Fed pause too. So it's going to be very important going into the new year, anticipating what the Fed is going to do next.
They're in this non-recessionary rate cutting cycle, which is very unusual. Generally, rate cuts are happening when there's an economic downturn, but we don't see that economic downturn. It's not recession right now. But the Fed continues to look to cut rates, get ourselves closer to levels below 4%. But the pace of future interest rate cuts is going to really be dependent on not just economic data, but also fiscal policy data. And I think that's going to be really important for the market to get their hands around, and also the Fed. There is a fear in the market that the stimulated fiscal policies could add some near-term inflationary pressures. That could result in fewer rate cuts, that could result in a yield curve that remains at these elevated levels.
We have our next FOMC meeting on December 18th, and currently the odds of a 25 basis point rate cut stand around 85%. If you heard some Fed speak over the past week, it also suggests that the Fed is ready to cut rates in December. We got the jobs report, as you mentioned, Brian, with the rise in unemployment rate. That's only further supporting this rate cut for December as well, for December 18th. And now the attention is going to move from the jobs report to the CPI report that we get next week. That's the final data print that we get to see before the December 18th FOMC meeting. And we're going to start then, starting to really start thinking about what's going to happen next year.
So if inflation shows signs of moving higher, the Fed will have to limit the number of rate cuts. They're going to have to change course of future rate cuts. That's really kind of the market recalibrating itself as well as to how many rate cuts to expect in 2025. The market is coming to that realization that just about six weeks ago, the market was pricing in over seven rate cuts for next year. Now you have a market that's more in touch with the Fed narrative, more in touch with what the Fed is saying, and that's coming out from Fed members. And now the market is expecting about three rate cuts, and these will likely be one rate cut per quarter.
What that really means is you're going to have an FOMC cycle next year with a bunch of meetings, but not every meeting is going to be a rate cut. It's more likely that you'll see a rate cut that will be associated with the summary of economic projections that are released. So you're talking about March, June, and September being likely candidates for another 25 base point rate cuts. But the main questions going to remain, how is the dual mandate doing for the Fed? For inflation, the main question is, will inflation hit the Fed's 2% annual goal? And if it doesn't hit that 2%, how much would the Fed tolerate being above the stated 2% inflation goal? So we have been talking about data dependency by the Fed for a very, very long time. I think that continues into 2025. The question really now is going to be not just data but fiscal policy as well.
Brian Pietrangelo:
That's great, Rajeev. Kudos to this team for the outlook. If we go back 12 months, when we did this last year, looking into 2024 as our outlook, we anticipated that we thought the Fed would cut two or three times in 2024 where market participants thought six or seven times. So now that we're right on the last meeting, we're spot on at two or three cuts, depending on how you want to measure it for 2024. So kudos to this team for doing that. What a great call. Now, as we move into 2025, Rajeev, with everything that you said, what could change? What could change the outlook for rate cuts?
Rajeev Sharma:
What could change is, the one thing the Fed doesn't want to see is a policy error. If we start seeing inflation start to spike up because of tariffs or some other kind of fiscal policy that may intervene into the market, you could see the Fed say, "We have to stop cutting rates." There is a fear out there that the Fed might get it wrong and have to actually hike rates. I'm not subscribing to that notion right now, and I do think that that could be one of the outliers out there, that what if the Fed makes a mistake and inflation starts to rear its ugly head again and we have to start hiking rates?
You also have the X factor of geopolitics, which I think is very important to just understand that there is geopolitical tensions out there which often cause a run to safety haven assets like treasuries. So I think that's also something that will be on the mind of the Fed. Very hard to predict how geopolitical tensions will play out, but I think the Fed's going to have to keep an eye on that as well. So there are some factors out there. I think what's going to be very important is, the Fed has got it right up to this point. They obviously were slow to the game to hike rates back in 2022, but they have done what they needed to do. I think right now the Fed is being very careful. They're in no rush to cut rates. Fed chair Powell has already come out and said that there's no rush to do that because the economy is strong. Any downturn in the economy I think would cause an acceleration of rate cuts, but we're not seeing that right now.
Brian Pietrangelo:
Great. Thanks, Rajeev. Appreciate that summary. We'll finish up with our fifth question towards Steve, and that is basically, do you think US equities will continue to outperform? And will the Magnificent 7 remain magnificent? And what's your general outlook for the stock market, Steve?
Stephen Hoedt:
Well, Brian, those are a lot more than one question for our last question, but we'll try to take them piece by piece. When you think about the Magnificent 7, look, the performance that those stocks have generated over the last decade plus have been for a very good reason. They've delivered massive earnings growth relative to the rest of the market. So in fact, if you take a look in terms over the last five years, 45% or so of the entire market's total return has come from those seven stocks, which is mind-boggling. Or from technology in general, but technology has been driven by those seven stocks.
When you look at though how's it going to play out in 2025, the issue that we've got is, these companies are going from having a earnings growth rate of four times what the market is, so 40% plus, to only having 5% earnings growth greater than the market's rate. So you've got this large deceleration in earnings growth relative to the market for these names, and that actually puts them in a very difficult position in terms of generating outperformance relative to the broad market. So I think when you look at that, that tells you that from our perspective, it's going to be tough for the S&P 500 to have a massive up year in 2025 because 35% of the index is tied up in those names.
Now, that doesn't mean that we think that it's going to be a bad year for stocks because if you look under the hood of everything else, for example, if you look at the earnings projection for small cap names for next year, you see small cap earnings set to grow by more than 50% on a year-over-year basis. So we think that this is a market that is going to reward people that are willing to broaden their view well beyond the Magnificent 7 to small mid-cap names, smaller names within the S&P 500. We really do see the rally broadening out as we move into next year, and we think that the market will have a positive year. It's just going to be other stocks driving the performance of the market than the Magnificent 7 names as we head into next year.
Brian Pietrangelo:
Great. Thanks, Steve. Just a reminder for everybody, we will be publishing our official written version of the 2025 Economic Investment Outlook on key.com here in the next few weeks. So take a look for that. But I'll end it with you, Steve. Anything else you just want to share with us as we go into the new year?
Stephen Hoedt:
I think that when we take a look at history, history tells us that the market has historically gone up in multiple years in a row when we have these 20 to 25% years. You have the market string together two, three, four of these years, and then you have a bear market. You don't typically have the market go up by eight or 10% a year, which is the long-term historical average. You deviate well above that and well below that.
We've had two years in a row where we've had returns in the ballpark of 25% plus. So it feels to us that some of those returns, to what George's point earlier, have been pulled forward a little bit from next year. So even though we see a positive year, we don't think next year is going to be another one of those 25% years. We think a high single-digit number actually makes sense next year based on that. But we don't see anything right now that tells us that we're set up for a bear market driven by some kind of a recession. It seems to us that we're set up in a pretty decent place as we head into 2025.
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, 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 5:
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