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, December 8th, 2023. I'm Brian Pietrangelo, and welcome to the podcast.
And just yesterday, we remember the 82nd anniversary of the attack on Pearl Harbor back in 1941, which is not only a reminder that as we see war going on across the entire globe, we remember what happened to the United States in 1941 and hope it never happens again, from the perspective of honoring those who served and died in World War II. In addition, this week marks the beginning of the December holidays as those that celebrate Hanukkah had an opportunity to start that festivity this week.
Well, joining 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. And as always, we remind you that there's a lot of great content 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 and market news, we have a couple of reports to share with you. We'll begin with the purchasing manager indices, which give a pulse on the overall economy where it showed this week that the services economy continues to expand and has basically expanded in the month of November for the 11th consecutive month. Now, this differs a little bit from last week's report, which showed the manufacturing side of the economy has basically been in contraction for the past 11 months. So, as we look for 2024 to see the pulse of the economy, we're getting slightly different reads.
The next few reports are basically giving us a pulse on the overall jobs or employment market where we'll start with the overall JOLTS report, the Jobs Opening and Labor Turnover Survey report, and specifically focus on job openings that declined as we looked at the month of September where it was 9.4 million job openings across the nation, but in October, that dropped to 8.7 million job openings, again, giving us a small indicator of a slowing in the overall employment market.
Next, in terms of the weekly unemployment claims, we actually had the number came out for the week ending December 2nd for the initial claims report at roughly the same amount from the prior week at 220,000, so that's good that it stayed constant. We also were reporting in the last few weeks that the ongoing or continuing unemployment claims were beginning to rise over the past six weeks.
And for the first time we've seen an actual decline in November 18th at 1.9 million to November 25th at 1.86 million. So again, good news there. Some people are returning to work, but again is also a mixed signal.
And finally, just this morning, the Bureau of Labor Statistics released their employment situation report, which covers two key items in the employment market. The first is new, non-farm payrolls that were created in the month of November came in at 199,000, which was a little bit higher than expectations and may have encountered some return to work from those that were currently on a labor strike in the past few months.
In addition, we see that the overall unemployment rate for the United States came down from 3.9% last month to 3.7% for the month of November. So, from that perspective, some mildly favorable news. However, we always have to caveat that with the fact that the jobs numbers do get revised for the prior two months on an ongoing basis, and we'll continue to look forward to those numbers as we get into the new year in 2024.
So, with that, let's turn to George. George, what's your take on the overall economy in terms of the data that came out, in terms of the jobs data as well as the overall items that we are seeing for the week and heading into the December Federal Reserve meeting, George?

George Mateyo:
Well, Brian, I think people have said that the reports of the death of the labor market have been greatly exaggerated, kind of came home to roost this morning. People have been talking about leaning into this week thinking that we would see a pretty sloppy number on the payroll side, and I think it has this nice upside surprise. I mean, there's probably, again, ongoing strength in the labor market and of course we have to expect some distortions and some weird numbers with respect to what's happened with labor strikes and other things that caused these numbers to be a little bit fluky. But the unemployment number came down again, people were thought, I think people were actually expecting it to be about 4% for the first time in years, I think, but it didn't and it went the other way. And so, the labor market is still quite strong overall and it's healthy. So that's really good news as we head into the last few weeks and few days of the year.
I think it's also fair to say that things are slowing so, to be true, it's not really, things aren't really accelerating higher. So, to some extent, we're getting this pretty nice environment where this soft landing may be upon us. It's hard for me to say though, to be sure. We don't really know if we're in a soft landing until we've already gone through it. So, we probably won't know exactly how things play out over time because we just ... things are still uncertain. But I do think that overall the environment is still pretty healthy in general in terms of getting closer to balance.
We've talked about things being out of balance for quite some time in the labor market particularly, and that seems to be normalizing pretty nicely overall, but there's been a lot of volatility in the rates market regime, a lot of uncertainty what the Fed might be doing and might be thinking just prior this morning, it seemed like there was probably a little bit too much optimism around what the Fed would be doing in terms of the cutting rates next year. But maybe things have changed a little little bit. So, what's your thought about, what do you think the Fed's thinking about the latest reports this morning?

Rajeev Sharma:
Well, it's a really good point you made, George. There has been a lot of volatility in the rates market and we saw moves along the yield curve. You talked about the JOLTS report, the ISM services report. They both pointed to maybe jobs market is not falling off a cliff, but maybe just cooling. And that kept this bullish mood in the bond market. I know the Fed has been looking at that bullish move and the sentiment with the rates moving lower.
The Fed really didn't want to see that because when the Fed saw rates climbing higher back in the third quarter in October, you did see the market doing the job for the Fed. Now, in the reverse, you're seeing these yields really start to drift lower and we saw the 10-year US Treasury note yield move all the way down to 4.1%. That was a new low since September 1st.
And for further context there, the 10-year move, that's about 80 basis points since the beginning of November lower in yield. It also fueled that market expectation that the Fed would start cutting rates sooner rather than later. Rate expectations have consistently been pulled forward for March now, where the market's expecting a 25 base point cut in March and the Fed is again, never talked about those rate cuts coming so early. So, this latest report that we saw today, the non-farm payrolls number, that takes away some of that fuel about bringing yields lower in these rate cut expectations.
Treasury yields climbed right after the report. It suggests that the market had gone a little too far with these rate cut expectations for early next year. We saw the two-year note yield move 10 basis points higher to 4.7%. I do feel that the decline in yields that we saw last month was a bit overdone, especially since we have an FOMC meeting coming up next week. And that's going to give us a real glimpse into the Fed's thinking. They're going to talk about their summary of economic projections, they're going to show us the dot plots. It'll be very interesting to see how that moves the market. But this job report indicates that the labor markets remain strong and that's another opportunity to the Fed to say that we can be in a wait and see mode. We can keep rates higher for longer.

George Mateyo:
Yeah. Do you think the Fed, do you think Powell's going to really be ... I mean he's got to be pretty hawkish, right? He's got to feel like coming into this report in the last month, as you mentioned, things have gotten really, for lack of a better term, easy. I mean people thought there'd be a lot of easing going through the economy next year, and as you mentioned, it wouldn't be late next year like we think it's going to be, the market was thinking it might be January as you mentioned, or March at the latest, where I think that he has to probably send the message, don't you think? So, you think we should prepare for some stern words from the Fed chair next week?

Rajeev Sharma:
Yes, I do. I think Fed Chair Powell has had a couple of opportunities in the last week or so to make some really strong statements. I don't think the market paid attention to it. They really were looking at other Fed members who were talking about, we've made great progress in inflation. But I do think that this is his opportunity next week, especially in the press conference, where I think he's really going to harp on we have to keep higher for longer, rates higher for longer, job's not done yet. We're not doing a victory lap. He could make a lot of those kinds of statements and we will see the impact in the yields market.

George Mateyo:
So Steve, we've got the equity market up this morning looking at my screen and so far, I guess we should note the recording is around 10:00 AM and markets are up about a half a percent or so. It seems like the stock market's got ... it gets what it wants either way, right? I mean, the overall labor market is strong and therefore the Fed has to come in maybe think about raising rates again, and the market seems to embrace the strength. Just a few weeks ago, the market was actually strong because the Fed might be backing off. So, how do you square this circle of what the equity markets are thinking about this?

Stephen Hoedt:
Yeah, it's hard to do, George. I mean, very clearly the markets have embraced over the last few weeks both economic data and market developments, which have been positive for the growth narrative as we head into next year. So, I think the market is believing that the growth is likely going to continue to surprise to the upside, which should push earnings higher as we move through the course of the year next year.
The Fed stuff is a real wild card because if growth continues to persist, it's really hard to see how the market's going to get quote unquote what it wants, in terms of Fed policy loosening in March when you've got gold at $2,000 an ounce and continue to remain strong even in the face of a weaker dollar and other things, there are countervailing things in the market that are telling you that the Fed needs to be careful what it wishes for in terms of keeping the inflation bogey under control. If they cut too early, they risk making a policy error in terms of being too loose again, and that could maybe actually trip the market up, quite frankly. So, that's something that we should think about.
I think the market would love to see the rate cuts, but should be careful what it wishes for because if inflation gets out of control, they're going to be ruing the day that those rates were cut. So we'll see how things go. I mean, this week, you're right, market has been modestly higher, but really if you look at it's almost been like watching paint dry for the market this week. It's been up a couple basis points most days. It really seems like we just have been drifting higher.
If you look at the SIBO volatility index, it's been going sideways below 13 all week. So, there's been no expansion of volatility. If you look at high yield CDX, it's gone sideways all week. So, really this has been a week that if you had gone to sleep last Friday and woke up today, there wouldn't have been much difference between what happened last week and this week. So, maybe that's hopefully a precursor of what the rest of the month has to offer as we head to the holiday period-

George Mateyo:
Well, at the least you'd be very rested, I guess, right? You'd be well rested if you did that.

Stephen Hoedt:
Exactly.

Brian Pietrangelo:
Well thanks, Steve. Great update on that. Always appreciate your perspective. And now we've got a real special opportunity within today's podcast where the teams have been working on their outlook for 2024, and that will actually be released next week on December 11th in written format as part of our article series in terms of our 2024 economic and investment outlook. And it will be made available on key.com.
But for our audience today, what a great opportunity to get a little bit of a preview of that article from each of our folks on the call today. So George, why don't we start with you in terms of your outlook and the components of it, and then we'll go to Rajeev and Steve for theirs as well, in terms of the 2024 investment and economic outlook.

George Mateyo:
Sure Brian, thanks for the setup. I think it's fair to say that we are going to be hitting election year next year, and it's something we've mentioned on these podcasts too, and that's definitely going to be the narrative next year. But I think it's important for investors and clients to remember that frankly, we don't want to have people's political views taint and influence their investment views. Really try to keep those separate as best we can.
So, we'll be talking a lot about this I'm sure in the coming months ahead, but that's going to be one theme. But the bigger driver I think really is going to be, again, this ongoing discussion around inflation, what the Fed's thinking as we just talked about. But even more than that, I think we're going to probably see more conversation take place around the outlook for growth.
The Fed is tasked with doing two things. It's trying to keep inflation somewhat in control, somewhat in check as best they can. And there other responsibility is to make sure that there's what they call full employment, which is a vague term, but I think that that notion around employment and growth is going to be the bigger part of the conversation next year. And our outlook, I think overall, is premised on the fact that we're going to probably see growth slow but not stall. We don't really see a recession as the base case. I think it's still in the scenarios of what could happen next year, but in this environment, as we just talked about, the labor market's doing pretty well and I think that's going to probably build well for the ongoing discussion around growth in year ahead.
As it relates to the Fed and Rajeev, I'd love to get your thoughts on this. I don't think they can really back off too much as for the reason we just talked about, but as Steve alluded to, I don't think they want to repeat of the '70s Show. I mean, I don't think they want to go back to the time of the mid '70s where they had to effectively reverse course two or three times.
As Steve mentioned, they cut rates too early and then they regretted that and they had to raise rates more aggressively thereafter. And I don't think they want to repeat that, but as I think about the year ahead, I think those are things that I'm watching, but what do you think about that with respect to the Fed regime?

Rajeev Sharma:
Yeah, George, you're absolutely right. The Fed really would not like to find themselves in a situation where they have to cut and then start hiking again. That causes tremendous volatility in the market. I think the Fed has been very resolute in their narrative, that they want to keep rates higher for longer. I think the market disconnect between what the Fed is saying and their market expectations need to be somewhat bridged.
Our expectation is that the Fed will keep the target range at 5.25% to 5.5% in the near term. They're going to continue to monitor the impact of tighter lending standards, financial conditions, inflation, the labor market. They've got all these issues and data dependency to look at. But I do think the big question that is facing bond investors as we go to the new year is this notion of higher for longer, how long is that going to be and is there going to be an economic slowdown or some kind of growth slowdown, that would force the Fed to start cutting rates sooner rather than later?
Our expectation is that the Fed is going to keep those rates higher for longer, and we don't expect to see rate cuts early next year. We're more on the camp of second half of next year. I also think that there's an opportunity for bond investors in this environment. I think bond investors will be rewarded in the asset allocation decisions that they make. We have consistently called for corporate bonds to outperform US treasuries, and our focus is really those high quality corporate bonds that provide liquidity as well.
We do think that some of the risks that we face going into the new year is this reinvestment risk, as we've seen yields be extremely high in the front end. We do think that those yields could start to collapse with any notion that the Fed would decide on cutting rates. If those yields on the front end start to collapse, we could see the reinvestment risk, which would compel investors to go further out in duration, and that's what we're advocating for as well.

Brian Pietrangelo:
Steve, how about you?

Stephen Hoedt:
When we take a look at 2024, we always go through the process of trying to formulate what some scenarios are for potential market performance for the year. We know these scenarios are going to be wrong, but we always go through the process in order to help ourselves understand what the relative upside versus potential downside is to the market. And our base case is that, as George and Rajeev have alluded to, that the Fed's not going to cut rates until the back end of the year next year, and that we're likely going to have a soft landing, however you choose to define that.
I mean, I think one of the interesting things is there's no definition for what a soft landing is. So, it's the ideal thing for market participants because you can find it however you want and it always seems to work out.
But when we think about a soft landing scenario, you've got $250 this year for 2025 EPS at the end of the year. We are likely going to exit this year at 240. So, that's modest growth in the earnings line, about 4%, 4% to 5%. We think multiples in a soft landing scenario stay roughly the same where they're at today, high 18s. And what that equates to is roughly a 4,700 target for the S&P. And I know that doesn't seem all that far away from where we're at, but you got to keep in mind the year's had ... We've had a heck of a lot of performance this year that's been concentrated in a narrow list of names.
So, we think the headline index has a very modest return next year of roughly a 5% total return. But we see moderating growth in the magnificent seven, which is going to lead to, in our view, investors to look for the area of the market which has higher relative improvement, which is everything else.
So, we think that there's the potential for this broadening of performance, even if the headline index doesn't go as high as people may want to see it in the base case scenario. So, I think that we think there's still going to be plenty of opportunity. In a bull case, we think that earnings can get to 80 if growth surprises materially to the upside and scenario multiples might drop a hair, and then you'd see maybe a 5,000 target on the S&P 500, which would give you roughly an 11% return on a total return basis, which is in line with historical average. So basically, you need to have growth surprise to the upside in order to get returns in line with historical equity averages in 2024.
A bear case scenario is the obvious one, which is a recession. If we end up with a recession, earnings typically decline 15% to 20%. That would mean an earnings number for the 500 exiting next year at 195. Multiples typically rise in that type of a scenario. So you could see multiples around 19 or a little higher, and that would equate to a 3,700 to S&P 500 target.
So, your range of potential outcomes next year, we seize from 5,000 to 3,700 skewing toward the top end of that, given that we think 4,700 is the base case scenario for next year. So, I guarantee you those numbers are going to be wrong, Brian, but we still think it's fun to go through the exercise.

Brian Pietrangelo:
And Steve, I know you guarantee that because you're being humble because it is very difficult to make such a prediction, but you've been pretty good on your calls in the last couple of years, so we always appreciate that you've at least given us the direction of where you think things are headed. So, thanks so much for that. George, any other final closing comments for today?

George Mateyo:
I would just reiterate what my colleague already said. I mean, I think Steve pointed out something that's really important, which I think is the relevant growth we have to look at. The market as we've talked about sometimes is focused not really on growth itself, but the growth of the growth rate. So, that second derivative we talked about, and I think it's important to say that in the context of what's happening with the economy, where again, things are slowing, but maybe at a slower rate, if that makes sense?
And then I also pick up on what Rajeev talked about, which is quality. I think in this kind of marketing environment, our thesis are anchoring around quality, I think is going to make eminent sense. And then thirdly, there's going to be things to do. So, I think it's going to be very important to be active but not overly active next year, and really focus on your long-term strategy and maintain as much discipline as you can, knowing that there's going to be a lot of noise in the year ahead.

Brian Pietrangelo:
Well, thanks for the conversation today, George, Steven 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 achieve your financial success.

Speaker 5:
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