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, October 6th, 2023. I'm Brian Pietrangelo, and welcome to the podcast. Major League Baseball has started their playoffs, which is consistent with the month of October. We'll use a baseball analogy to consider whether the Federal Reserve is done raising rates. Are they in the seventh inning, the eighth inning, or the ninth inning of the game, or is the game over? We'll talk to our panelists today about the Fed reactions, specifically to some of the data that came out today on the employment front.
With me today, 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 Wednesday. In addition, if you have any questions, or need more information, please reach out to your financial advisor.
As we take a look at this week's economic news, we'll start with some of the purchasing manager's indices data, which showed on the manufacturing side of the economy, there was actually a tick up in the month of September over the month of August, which was good from the perspective that it's basically been in contraction territory for the last year. On the other side of the equation on the services side of the economy, month of September actually went down a bit from the month of August, but the good news is it's basically been an expansionary territory for the last three years.
Then we'll turn to the employment pictures, starting with the jobs openings report that came out earlier in the week, which showed an increase in August of 9.6 million job openings relative to July at 8.9 million, which showed, again, employer's willingness to hire in the strength of the economy. That's followed up by yesterday's initial unemployment claims report, which showed basically the same consistent from the prior week, at 207,000 initial unemployment claims. Again, showing not a problem right now in the employment picture. Finally, and probably most important, just this morning, the new non-Farm Payrolls report came out with 336,000 new non-farm payrolls created in the month of September, which was basically double the estimates, and also revisions for prior months showed increases of 119,000 jobs. A very strong report this morning.
In addition, within the same report this morning, the overall unemployment rate in the United States stayed at 3.8%, which was the same as last month. Both of these readings, and in fact all of these readings, indicate a strong labor market, which might have negative implications for the stock market, because it may mean that the Fed might need to continue raising rates to stave off inflation, given that the jobs market remains healthy for now. We'll have that discussion with our panel today. George, let's start with you. Do we think the Fed, based on this data, is in the eighth inning, or the ninth inning, in terms of the baseball analogy?
George Mateyo:
I'm not sure if this is actually going to be a nine inning game, Brian. I think this might go an extra inning, the way things are going. I think what we've seen in the last week or so is that the robust labor market continue to be very robust. I think there's a shockingly good number out this morning, with respect to payrolls, and jobs, and so forth, which I guess is good news in the sense that the labor market is really quite healthy. The recession call that people have been making for this year is going to get pushed out again, but all things being equal, it was a pretty strong number that suggests the Fed might not be done either.
There's a lot of strength, particularly in the services sector. We've talked about just how robust the services center has been. I think that's somewhat related to leisure, hospitality, and also healthcare, which has been a big focus of trying to get people back into the labor market. We've seen that in spades this month. Actually, one thing that was probably a slight positive is that wages didn't spike out of control. They're still elevated, and frankly they're probably still higher than where the Fed would want them to be, but we didn't see quite this big labor spike, or wage spike, that some people might've been fearing.
We'll have to pay attention closely to the employment report next week. That'll probably provide some further evidence as to whether inflation is coming under control. It seems like it's slowing, it seems like it's moderating, particularly in the housing sector, which would probably be a big positive. But in the near term, again, we can't argue, and can't dispute the fact, frankly, that the overall economic backdrop is really quite robust.
I think when we leave at this, when we think about this, and put this all together, to me suggests that the narrative that we've entered into the month of September was one that was predicated on the Fed staying high for longer, meaning that we would take rates up, keep them there for quite some time. Based on the report today, it seems like it might be higher for longer. In other words, that the Fed might not be done, might have to go again and raise rates yet again, and probably could provide some cushion, and probably provide some pushback to the overall strength of labor market.
I think that's their primary focus of concern right now, which is we can talk about a lot of the other things that are going on in the economy, but until the labor market really softens, I don't think the Fed is going to be able to back away from its policy tightening stance. Rajeev, I think one thing that I would ask you is that the Fed has been historically talking about data dependency, meaning that they're looking at data very closely before making decisions. What do you think the data says this morning to them?
Rajeev Sharma:
Well, George, that jobs report that we saw continues to see yields move higher. I think the Fed is looking at that report, and probably continuing with their narrative, "Okay, the economy is still strong, the labor market's strong, and we're not at our inflation target yet." It keeps the Fed in play. If we're looking at yields across the yield curve, specifically the intermediate and 30 year part of the yield curve, the resistance points for the 30 year is around 5%.
We are right on top of that right now. That 5% we hit in October 4th looks like we're going to close above that again. Keeping an eye on the tenure treasury note yield that has passed through the resistance points, to resistance points already. We're reached 4.8% there, and it looks to be going higher. With the surge in US hiring numbers, the selloff in treasuries continues, and it's turning to an issue with borrowing costs.
Borrowing costs continue to move higher. The payrolls report, it keeps the Fed back in play for one more rate hike for year-end. Even with this huge selloff that we've been seeing in rates, I don't think that's going to play in the minds of the Fed right now. Why? Because the Fed continues to point to that strong labor market. They're saying that inflation is still not where they want it to be, and the data, it looks like the recent pickup in job openings adds to the case for one more rate hike of 25 basis points by year-end.
The issue, really, in the rise in rates across the yield curve, that we have seen since the last FOMC meeting, is that it's doing the work for the Fed. If you see the way these rates have surged since the last FOMC meeting, it's pretty much adding another rate hike, even without the Fed doing that. I think that that could work to slow down the economy. The 10-year treasury note yield rose by 50 basis points in just one month.
Moves like this significantly raise barring costs, and you could see that as a threat to the economy, and it increased the likelihood of a hard landing rather than a soft landing, which is what the Fed is looking for. If we look at real rates, these are those rates that remove the impact of inflation. We see that long-term, real yields have soared to levels that we have not seen since 2007, and they're around 2.5% rate.
What is the Fed going to really do? We had a lot of Fed speak this week. A lot of Fed members were talking in round table discussions, or were giving interviews, and I think investors were looking for the Fed to say, "Okay, we need to reel this back in." Yields have moved too high, maybe cut down on their narrative a little bit, but they really did not do that. They're not really pushing up against the surge that we're seeing in yields. Fed members continue to stick to their narrative that they need rates to remain higher for longer, and they need more progress on the inflation front.
There are a number of reasons why rates could continue to rise. We've talked about that before. There's investor concern over the US budget deficit, lower demand for US treasuries from foreign investors, including China, and the expectation that Japan may be loosening, or it may exit their ultra loose monetary policy. That's another factor that we need to really take into consideration. The overall impact of this is that we're seeing rates that are continue to going one direction, and that's higher.
George Mateyo:
Rajeev, given that environment where rates are screaming higher, where do you think investors can hide right now? Where do you think people would probably be putting their incremental dollar to work, given the fact that the price on your bonds has actually been hammered, frankly? That's really a technical term, but I was surprised to see that if you look at long bonds, in particular, the price of some of those bonds has really fallen quite dramatically. Where do you think investors should be hiding these days in fixed income?
Rajeev Sharma:
We've been advocating for high quality assets, especially if you're thinking that we could be at the tipping point of a recession next year. We continue to like high quality assets, high quality corporate bonds in the short space, inside three years. I think that makes a lot of sense. These are very high quality names, very liquid names. I think that's also very important.
The pain trade has really been on adding duration, so we've not been doing that. I think the duration trade that many people were talking about a month ago, that was the painful trade. Especially, as you mentioned, longer duration securities have really gotten hammered over the past one month. They've lost a lot of value. We continue to want to be liquid in the short side, in the short space, in high quality assets right now. I think that that's the place to be.
Obviously, anything but interest rate sensitivity is going to be impacted by these kinds of moves that we've seen in the market. But if you're seeing yield on investment grade corporate credit right now, you're getting above 6%, and I think that's pretty attractive.
George Mateyo:
Shifting to equity, Steve, what's the transmission mechanism, excuse me, from fixing into equities? I would think that equities generally would probably respond to this in a good way, initially, because growth is pretty strong, and therefore earnings to be strong, but doesn't seem to be the case based on the fact that the market's down about a percent or so this morning.
Stephen Hoedt:
No, I think when you take a look at what's going on, the market has historically reacted very negatively to fast moves in the rate complex. When we get a scenario where the 10-year yield rips by 50 basis points in a month, that spooks equity market investors, and this has happened historically. There's a good reason for this. It's because levels of rates really don't matter to the markets, really, or to the economy. It's the speed that the rates get where they're going that bothers people.
The reason for that is very simple. Corporations, banks, others, when rates move really fast, they don't have the ability to hedge themselves in the marketplace, so it creates negative impacts for corporate earnings, negative impacts for bank ability to lend, all this kind of stuff. It creates ripples through the economy when things move fast. When they move slow, the economy, the companies have the ability to adjust, make hedges, do things that can take mitigative action toward what's happening in rates.
The speed of this move over the last month has really been a major drag on equity markets. As long as it continues, quite honestly, it's going to be that way. If we continue to have these moves, where we're going 10 and 15 basis points per day to the upside, the stock market's going to continue to trade very heavy. We're back down all the way to the 200-day moving average right now, where we're literally about 20 points ahead of it. It's right around 4,200. The market really knifed right through the 43.25 support line that we had been looking at for a while, and we continue to hang out, and make new 65 day lows. All of those things are indicative of a market that is questioning the uptrend, at the very least.
When you look at the earnings numbers, earnings numbers have continued to hold up largely because the investment community has been very reticent to mark down 2024 earnings. As you move through the course of the year, the forward 12-month earnings number always takes on more importance from the coming year than the current year. The 2024 numbers have not been marked down very much at all. It begs the question, is the market getting ahead of the idea that maybe those numbers are going to be coming down in the not too distant future, based on slower economics? We'll have to wait and see, but right now it definitely feels like this market wants to work its way lower for a little while longer, George.
George Mateyo:
Steve, where do you think there's places to hide? I'll ask you the same question I asked Rajeev, which is, given the selloff has been pretty broad-based, are the places you think investors should be hiding out right now?
Stephen Hoedt:
Well, when we think about the places within the equity market, there hasn't been a lot of places to hide lately. You've had a little bit of relative performance out of some of the more defensive areas, places like healthcare. Maybe it might surprise some people, but we've seen relative strength over the last couple of months or so in the energy complex, which still is holding up rail, even though we've seen crude oil pullback here lately.
Then I've got to tip my hat to the Magnificent Seven, because if you take a look at the equity market performance, small cap and mid-cap performance, we could use lots of colorful language to describe what their performance looks like over the last few months. It has not been good. Really, the S&P 500 is being elevated by the fact that the mega cap tech names continue to hold up pretty well on a relative basis defensively. That is because, again, they're viewed as having these competitive moats, and people feel safe holding money in the mega cap tech names relative to other market names during a market decline. I think that's likely to persist as well.
One area though, George, that has not held up very well, that is a traditional defensive, is utilities, and they have just gotten decimated in the last 10 days, dropping 15% within a five-day period. It's almost unprecedented, the type of move that they've had. You can't just hide in things that are traditional defensives right now. You got to pick and choose your spots.
Brian Pietrangelo:
That's great, Steve. You mentioned a little bit of a pullback in oil prices. Maybe we can talk a little bit more deeper about that, given that things are pretty interesting when people go to the pump. What are your thoughts a little bit more on the oil decline, recently?
Stephen Hoedt:
Yeah. I think that what we've seen is we've seen oil pullback a little bit here, as we've seen some of the economic numbers point a bit of a slowdown, both globally and here in the US. But I think that what people should take a look at, and really understand, is that there's really been no supply response over the last 12 to 18 months, as the global economy did start to pick up. That's why oil prices have remained at fairly high levels. When we look out over the forward view, it really doesn't take much from here to push oil prices toward triple digits again.
Given everything that was thrown at the oil market over the last 12 to 18 months, meaning the strategic petroleum reserve releases, the fact that the Chinese growth didn't come in at levels that people thought it was going to, the fact that growth X US disappointed, and yet we still had oil prices clinging to relatively high levels. It's something that I think people are starting to notice.
I think equity market investors, in particular, have started to rotate some money into these names. I think that people are getting the message that we've been saying for a while, which is that there's something structural going on here, and it argues for higher oil prices for a longer period of time. We're not going to see negative oil prices again, let me put it that way. Not in my lifetime.
Brian Pietrangelo:
Thanks for the details, Steve, and George, we'll turn over to you for some final thoughts for our listeners.
George Mateyo:
Well, Brian, I think it is fair to say that things are being repriced pretty aggressively. To Steve's point, that usually the faster they rise, the bigger they fall is probably of course the monitor in the near term. But I'm still positive that I think things are going to start slowing down sometime later this year. If nothing else, I think these interest rate hikes will start to feel a pinch for some people and some companies, and that'll cause them to maybe retrench a little bit, maybe pull back, and that'll eventually cause things to slow down. We're going through an adjustment period right now, that's going to take some time, and probably a bit more pain until we really settle out.
But that being said, I still think it's important to be invested, because over the long run, I think you want to have exposure to growth markets, and really growth segments of the economy that can provide some purchasing power to your portfolio, if you will. Just hiding out in cash might be attractive in the near term, but I think over time, as those rates reprice lower, once things slow down, I think it's important to be somewhat more diversified across stocks, bonds, and other assets too.
In the near term, I would say that we've talked a little bit about things that Steve and Rajeev mentioned, up in quality is a nice way to put it, but I think really focused on high quality companies, high quality securities, in this moment is probably more paramount importance than usual. I'd really focus on the quality trading going forward.
Brian Pietrangelo:
Well, thanks for the conversation today, George, Steve, and Rajeev. We appreciate your insights. 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. 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.
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